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5.7 Securities lending transactions
Publication date: 30 Sep 2020
us Transfers of financial assets guide
Owners of securities sometimes lend them to third parties for a fee. The borrower of securities frequently uses them to make delivery on a short position or to settle a customer sale transaction that has failed. If a dealer sells a security that it does not own, it may borrow the security temporarily to settle the transaction. Securities under these agreements may be lent for a prescribed term or for an indefinite period. Securities lending programs are often managed by custodians to earn additional income for clients.
The securities lender generally requires the borrower to provide collateral, which can be cash, standby letters of credit, or other securities. The collateral typically has a value higher than that of the borrowed securities (i.e., there is overcollateralization). If the collateral is cash, the transferor typically earns a return by investing it at a rate higher than the rate paid or rebated to the transferee. To the extent the collateral is other than cash (e.g., standby letters of credit or other securities), the transferor typically receives a fee for lending the securities. Distributions (e.g., dividends) received on the securities lent and on the collateral, if applicable, during the term of the agreement inure to the transferor and securities borrower, respectively.
Much like repurchase agreements, securities lending transactions are structured to minimize counterparty credit risk. Accordingly, the market value of the securities borrowed and corresponding collateral is determined daily. Changes in the relative market value of these positions may give rise to a "margin deficit" or a "margin excess" that, in turn, requires the securities borrower to post additional collateral or obligates the securities lender to return a portion of the collateral if requested by the securities borrower. Margin calls may be on a loan-by-loan basis, or may be determined considering all loans and related collateral in the aggregate.
5.7.1 Accounting for securities lending
Since securities lending transactions involve the transfer of a financial asset (most often, an equity security), the proper accounting for the exchange is predicated on whether the transaction meets the criteria in ASC 860-10-40-5 for sale accounting. If these conditions are satisfied, ASC 860-10-55-55A provides further guidance regarding the derecognition accounting for securities lending transactions.
If the conditions in paragraph 860-10-40-5 are met, a securities lending transaction should be accounted for as follows:
- By the transferor as a sale of the loaned securities for proceeds consisting of the cash collateral and a forward repurchase commitment. If the collateral in a transaction that meets the conditions in paragraph 860-10-40-5 is a financial asset that the holder is permitted by contract or custom to sell or repledge, that financial asset is proceeds of the sale of the loaned securities.
- By the transferee as a purchase of the borrowed securities in exchange for the collateral and a forward resale commitment.
During the term of that agreement, the transferor has surrendered control over the securities transferred and the transferee has obtained control over those securities with the ability to sell or transfer them at will.
In that circumstance, creditors of the transferor have a claim only to the collateral and the forward repurchase commitment.
If the transfer meets the criteria for a sale in ASC 860-10-40-5, the lender should derecognize the transferred securities, recognize the collateral received (cash and/or other securities, provided that the lender can sell or repledge the latter) as an asset, and record a forward repurchase commitment. Depending on the economics of the transaction and the carrying value of securities sold, a gain or loss may be recorded.
The vast majority of securities lending transactions do not meet the conditions for sale accounting because the transferor maintains effective control over the transferred securities. ASC 860-30-25-7 provides guidance on the accounting treatment of securities lending transactions required to be reported as secured borrowings.
Many securities lending transactions are accompanied by an agreement that both entitles and obligates the transferor to repurchase or redeem the transferred financial assets before their maturity. Paragraph 860-10-40-24 states that an agreement that both entitles and obligates the transferor to repurchase or redeem transferred financial assets from the transferee maintains the transferor’s effective control over those assets as described in paragraph 860-10-40-5(c)(1), if all of the conditions in paragraph 860-10-40-24 are met. Those transactions shall be accounted for as secured borrowings, in which either cash or securities that the holder is permitted by contract or custom to sell or repledge received as collateral are considered the amount borrowed, the securities loaned are considered pledged as collateral against the cash borrowed and reclassified as set forth in paragraph 860-30-25-5(a), and any rebate paid to the transferee of securities is interest on the cash the transferor is considered to have borrowed.
To summarize, the transferor’s reporting for securities lending transactions under the secured borrowing accounting model is as follows:
- Any cash, standby letters of credit, or other securities received as collateral should be considered the amount borrowed by the transferor and recognized as an asset on its financial statements (provided that any such non-cash collateral can be sold or repledged by the transferor).
- The securities loaned are considered pledged as collateral against the amount borrowed and may require reclassification under the collateral provision of ASC 860-30-25.
- Any rebate paid to the transferee should be considered interest expense on the cash borrowed by the transferor, recognized over the life of the contract.
ASC 860-30-25-8 further clarifies that cash or securities received as collateral for securities loaned (and any investments made with that cash) should be recognized as an asset by the lender (provided that the securities received can be sold or repledged), regardless of whether the transaction is accounted for as a sale or secured borrowing. In the latter case, the securities lender should also recognize a liability for the obligation to return the collateral.
Example TS 5-7, Example TS 5-8, and Example TS 5-9 illustrate the accounting for various securities lending transactions reported as secured borrowings.
EXAMPLE TS 5-7
Securities lending transaction — cash received in exchange for transferred (borrowed) security
Securities lending transaction — cash received in exchange for transferred (borrowed) security
Transferor Corp and Transferee Corp enter into a securities lending agreement accounted for as a secured borrowing. The terms of the agreement and other relevant facts are as follows:
- Transferor Corp lends an equity security carried at its fair value of $1,000 to Transferee Corp for 35 days. The security’s fair value remains unchanged over the agreement’s term.
- Transferee Corp pledges $1,020 as cash collateral to Transferor Corp.
- Transferor Corp’s return from investing the collateral is $5. Transferor Corp has agreed to rebate $4 to Transferee Corp.
Transferee Corp sells the security upon receipt and later buys an identical security to return to Transferor Corp.
How should Transferor Corp and Transferee Corp account for this securities lending transaction?
Analysis
The following journal entries illustrate the accounting for this example. For simplicity, the example does not include journal entries to recognize and update the allowance for credit losses. Also, interest income and expense relating to the cash invested by Transferor Corp is assumed to be recognized only at the conclusion of the transaction. In addition, Transferee Corp’s investment of the proceeds from the sale of the borrowed security is omitted from this example.
Transferor Corp |
Transferee Corp |
|||||
At inception: |
At inception: |
|||||
Dr. Cash |
$1,020 |
Dr. Receivable under securities borrowing agreements |
$1,020 |
|||
Cr. Payable under securities lending agreements |
$1,020 |
Cr. Cash |
$1,020 |
|||
To record the receipt of cash in exchange for loaned security, and related obligation |
To record transfer of cash to Transferor Corp in exchange for borrowed security |
|||||
Dr. Securities pledged to Transferee Corp |
$1,000 |
Dr. Cash |
$1,000 |
|||
Cr. Securities |
$1,000 |
Cr. Obligation to return borrowed securities |
$1,000 |
|||
To reclassify loaned security that Transferee Corp has the right to sell or pledge |
To record sale of borrowed security to third party and obligation to return |
|||||
Dr. Money market instrument |
$1,020 |
|||||
Cr. Cash |
$1,020 |
|||||
To record investment of cash collateral |
||||||
At conclusion: |
At conclusion: |
|||||
Dr. Cash |
$1,025 |
Dr. Cash |
$1,024 |
|||
Cr. Interest income |
$5 |
Cr. Receivable under securities borrowing agreements |
$1,020 |
|||
Cr. Money market instrument |
$1,020 |
Cr. Interest income (rebate) |
$4 |
|||
To record results of short-term cash investment |
To record the receipt of cash collateral and rebate interest upon return of borrowed security |
|||||
Dr. Securities |
$1,000 |
Dr. Obligation to return borrowed securities |
$1,000 |
|||
Cr. Securities pledged to Transferee Corp |
$1,000 |
Cr. Cash |
$1,000 |
|||
To reclassify security no longer pledged (received from Transferee Corp) |
To record the purchase of security borrowed and delivery of security to Transferor Corp |
|||||
Dr. Payable under securities lending agreements |
$1,020 |
|||||
Dr. Interest expense (rebate) |
$4 |
|||||
Cr. Cash |
$1,024 |
|||||
To record repayment of cash collateral and interest to Transferee Corp |
||||||
EXAMPLE TS 5-8
Securities lending transaction— Treasury securities received in exchange for transferred (borrowed) equity securities; borrower does not sell the securities
Securities lending transaction— Treasury securities received in exchange for transferred (borrowed) equity securities; borrower does not sell the securities
Transferor Corp and Transferee Corp enter into a securities lending agreement accounted for as a secured borrowing. The terms of the agreement and other relevant facts are as follows:
- Transferor Corp lends shares of ABC Corp common stock carried at their fair value of $1,010 to Transferee Corp for 35 days. The fair value of the stock remains unchanged over the agreement’s term.
- Transferee Corp pledges Treasury securities with a fair value of $1,020 as collateral to Transferor Corp. The fair value of the securities remains unchanged over the agreement’s term.
- Transferee Corp pays a securities lending fee of $1 to Transferor Corp.
Transferee Corp does not sell the borrowed stock.
How should Transferor Corp and Transferee Corp account for this securities lending transaction?
Analysis
The following journal entries show the accounting treatment for this arrangement. For simplicity, interest accruals relating to the Treasury securities held by Transferor Corp and the corresponding payable to Transferee Corp are omitted.
Transferor Corp |
Transferee Corp |
|||||
At inception: |
At inception: |
|||||
Dr. Treasury securities |
$1,020 |
|||||
Cr. Payable under securities lending agreements |
$1,020 |
No entry is required by Transferee Corp. See Question TS 5-2. |
||||
To record the receipt of Treasury securities (in lieu of cash collateral) that Transferor Corp can sell or pledge, in exchange for loaned ABC Corp common shares |
||||||
Cash or securities collateral that the transferor can sell or repledge is considered the amount borrowed under a secured borrowing. |
Transferee Corp does not recognize the borrowed ABC Corp common stock on its balance sheet. It records an obligation to return the stock only upon the stock’s subsequent sale or if Transferor Corp defaults. |
|||||
Dr. Securities pledged to Transferee Corp |
$1,010 |
|||||
Cr. ABC Corp common stock |
$1,010 |
|||||
To reclassify loaned ABC Corp common stock that Transferee Corp has the right to sell or repledge |
||||||
At conclusion: |
At conclusion: |
|||||
Dr. ABC Corp common stock |
$1,010 |
Dr. Securities borrowing fee |
$1 |
|||
Cr. Securities pledged to Transferee Corp |
$1,010 |
Cr. Cash |
$1 |
|||
To reclassify ABC Corp common stock no longer pledged (returned by Transferee Corp) |
To record fee paid to Transferor Corp |
|||||
Dr. Payable under securities loan agreements |
$1,020 |
|||||
Cr. Treasury securities |
$1,020 |
|||||
To record return of Treasury securities |
||||||
Dr. Cash |
$1 |
|||||
Cr. Securities lending fee |
$1 |
|||||
To record fee received from Transferee Corp |
||||||
EXAMPLE TS 5-9
Securities lending transaction — Treasury securities received in exchange for transferred (borrowed) equity securities; borrower sells the securities
Securities lending transaction — Treasury securities received in exchange for transferred (borrowed) equity securities; borrower sells the securities
Transferor Corp and Transferee Corp enter into a securities lending agreement accounted for as a secured borrowing. The terms of the agreement and other relevant facts are as follows:
- Transferor Corp lends shares of ABC Corp common stock carried at their fair value of $1,010 to Transferee Corp for 35 days. The fair value of the stock remains unchanged over the agreement’s term.
- Transferee Corp pledges Treasury securities with a fair value of $1,020 as collateral to Transferor Corp. The fair value of the securities remains unchanged over the agreement’s term.
- Transferee Corp pays a securities lending fee of $1 to Transferor Corp.
To settle a previously-existing short position, Transferee Corp delivers the borrowed ABC Corp common stock immediately upon receipt. It subsequently buys shares of the same stock to satisfy its obligation to return them to Transferor Corp.
How should Transferor Corp and Transferee Corp account for this securities lending transaction?
Analysis
The following journal entries show the accounting treatment for this arrangement. For simplicity, interest accruals relating to the Treasury securities held by Transferor Corp and the corresponding payable to Transferee Corp are omitted.
Transferor Corp |
Transferee Corp |
|||||
At inception: |
At inception: |
|||||
Dr. Treasury securities |
$1,020 |
|||||
Cr. Payable under securities loan agreements |
$1,020 |
|||||
To record the receipt of Treasury securities (in lieu of cash collateral) that Transferor Corp can sell or repledge, in exchange for loaned ABC Corp common stock |
No entry is required by Transferee Corp. See Question TS 5-2. |
|||||
Dr. Securities pledged to Transferee Corp |
$1,010 |
Dr. Short position in ABC Corp common stock |
$1,010 |
|||
Cr. ABC Corp common stock |
$1,010 |
Cr. Obligation to return borrowed securities |
$1,010 |
|||
To reclassify loaned ABC Corp common stock that the secured party has the right to sell or repledge |
To record settlement of short position with borrowed ABC Corp common stock, and corresponding obligation to return |
|||||
At conclusion: |
At conclusion: |
|||||
Dr. ABC Corp common stock |
$1,010 |
Dr. Obligation to return borrowed securities borrowed borrowed |
$1,010 |
|||
Cr. Securities pledged to Transferee Corp |
$1,010 |
Cr. Cash |
$1,010 |
|||
To reclassify ABC Corp common stock no longer pledged (returned by Transferee Corp) |
To record purchase of ABC Corp common stock and delivery to Transferor Corp |
|||||
Dr. Payable under securities lending agreements |
$1,020 |
|||||
Cr. Treasury securities |
$1,020 |
|||||
To record return of Treasury securities |
||||||
Dr. Cash |
$1 |
Dr. Securities borrowing fee |
$1 |
|||
Cr. Securities lending fee |
$1 |
Cr. Cash |
$1 |
|||
To record fee received from Transferee Corp |
To record fee paid to Transferor Corp |
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