What Is Fully Paid Securities Lending (FPSL) in Stocks?

Fully Paid Securities Lending (FPSL) offers a way for investors to earn additional income from their existing stock holdings. This practice involves allowing a brokerage firm to lend out shares that an investor has fully paid for and owns outright.

Understanding Fully Paid Securities Lending

Fully Paid Securities Lending refers to the practice where an investor lends out shares they own outright, meaning these shares were purchased without margin debt. The term “fully paid” emphasizes that the investor has paid the total purchase price for the shares. This distinguishes it from margin lending, where shares purchased on margin are typically already available for the broker to lend.

An investor temporarily transfers their shares to a borrower, usually an institutional investor like a hedge fund, through a brokerage firm. Borrowers seek shares for various reasons, including facilitating short sales, hedging, or arbitrage strategies. For instance, a common reason for borrowing is short selling, where the borrower sells borrowed shares hoping to buy them back later at a lower price and return them, profiting from the price difference. The brokerage firm serves as the intermediary, connecting lenders and borrowers and managing the lending process.

How Securities Lending Programs Operate

When an investor participates in a Fully Paid Securities Lending program, their eligible shares are moved into a separate securities lending account or program for the duration of the loan. The borrower provides collateral, often cash or other securities, usually valued at 102% to 105% of the loaned shares’ market value.

The value of this collateral is subject to daily mark-to-market adjustments, meaning it is re-evaluated and adjusted to reflect changes in the market value of the loaned securities. The borrower pays a lending fee, which is then shared between the investor and the brokerage firm. Investors can typically request their shares back at any time through a recall process, with the broker facilitating the return, often within a few business days.

Investor Perspectives on Securities Lending

Participating in a Fully Paid Securities Lending program can offer investors a way to generate income from their existing portfolio holdings. The income earned, typically in the form of lending fees, is influenced by the demand for the specific stock in the market and prevailing market conditions. This additional income can supplement an investor’s overall returns, particularly on securities that might otherwise remain idle. For example, if a stock is in high demand for short selling, the lending fee can be more substantial.

While shares are on loan, the investor generally relinquishes their shareholder voting rights, as these rights temporarily transfer to the borrower. Collateral is held by the brokerage firm or a third-party trustee, providing a layer of protection for the investor. Although collateral mitigates much of the risk, a theoretical counterparty risk exists, which is the risk that the borrower or broker could default; reputable brokerage firms employ measures to manage this risk.

Investors maintain the ability to recall their shares at any time, typically with a short turnaround period, allowing them to sell their shares if desired. If a dividend is declared on shares that are on loan, the investor receives a “substitute payment” from the borrower in lieu of the actual dividend. This substitute payment may be treated differently for tax purposes compared to qualified dividends. While collateral provides protection, shares on loan may not be covered by Securities Investor Protection Corporation (SIPC) in the same manner as shares held directly in an account, as the collateral replaces the shares.

Tax Treatment of Lending Income

Income generated from Fully Paid Securities Lending programs is subject to specific tax rules. Generally, the lending fees an investor receives are treated as ordinary income for tax purposes. This means these fees are typically taxed at the investor’s regular income tax rate, rather than at potentially lower capital gains rates.

A significant tax consideration arises with “substitute payments” for dividends. When shares are on loan, the investor does not receive the actual dividend directly from the issuing company. Instead, the borrower remits a cash payment equivalent to the dividend amount. These substitute payments are typically reported on Form 1099-MISC and are generally taxed as ordinary income, even if the underlying dividend would have qualified for a lower tax rate had the shares not been on loan. Investors are encouraged to consult with a qualified tax professional to understand the specific implications.

Enrolling in a Program

For investors interested in participating in a Fully Paid Securities Lending program, the first step involves identifying brokerage firms that offer such programs. After selecting a brokerage, investors typically need to express interest in the program.

The enrollment process generally requires reviewing and understanding the specific terms and conditions of the securities lending agreement provided by the brokerage firm. This agreement outlines the operational details, risks, and responsibilities for both the investor and the broker. Investors will then typically sign this specific lending agreement to formally opt into the program. Some programs may also have eligibility requirements, such as minimum account values or specific account types, which investors should confirm with their brokerage.