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Securities Lending and ETFs: How Simple Became Complex

Over the weekend, I watched the US House Committee on Financial Services testimony on “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part II”. I can think of about 15 different blogs, podcasts and more content that I think are needed based on what I saw and heard. Today though, I thought it might be helpful to show how complex these issues have become, and I think ETFs are a fantastic product to examine. ETFs nicely encapsulate the interconnectedness of investing trends, a strong value proposition, and how their success has changed the investment paradigm and the knock-on impact on securities lending.

I have been actively engaged with ETFs and securities finance since 2006, when one of my clients suggested I add ETFs to the securities lending trading platform I was running at the time. As I investigated them, I unashamedly fell in love with them as they solved so many problems for investors and to boot, I saw numerous applications in the securities finance space. We added them to the platform and because of adding ETFs, within three months we more than doubled the number of firms trading on our platform. Ironically, it was Lehman Brothers that made the suggestion, but three months after going live with ETFs, Lehman went into default, and that was for all intents and purposes, the end of my anonymous trading platform. It wasn't really anonymous, but in October 2008, no credit department anywhere wanted to debate subtleties.

Note: Much of the remainder of this post can be applied to other fund types and investor portfolios. I am merely demonstrating the issues using ETFs as the use case.

Stacked with benefits!

As a retail investor, ETFs are perfect for me – I can identify industries, sectors, asset classes, indices country-specific, regionally focused or global. I can get leveraged ETFs and inverse or bear ETFs if I want tactical short exposure. All shapes, sizes, colours and flavours. It is impossible for me to replicate, and clearly, ETFs are also used by numerous institutional investors to augment their own trading.

They are actively used by trading firms, arbing out price discrepancies between cash securities and derivatives priced based on those securities. They are also frequently used by many hedge funds, more so US ETFs than outside the US, but they are still significant assets to short. ETFs as a whole are important participants in the lending market, making the underlying assets available for loan. For various reasons, they haven't been as successfully used as collateral as I expected, but their merits are stronger today than when I co-authored a white paper on ETFs and Securities Finance in 2012. More than eight years old, but I believe it is still relevant today.

… But not without challenges

All good so far, but here is where the complexity comes in and how it ties into GameStop.

According to, 63 ETFs hold GameStop with approximately 10 million shares at’s publication date. According to MarketWatch, GameStop's public float is 54.49 million shares (just over 18%).

Pricing. The thing about ETFs is they buy and sell the underlying portfolio assets primarily as investors put money into the ETF or withdraw money. Price point of the underlying assets is a secondary consideration (not true of all ETFs, for example, actively managed ETFs). The impact here is that irrespective of the GameStop price, they largely aren’t enticed to sell. That limits the supply of stock available to buyers and contributes to price rises. Understandably, we seldom hear people complain about stock prices rising, but if those price rises aren’t sustainable because they are driven by short term liquidity price squeezes, levels will normalise, and an ETF’s NAV will drop. Many members of Congress expressed concerns over the price volatility of GameStop and the impact on retail investors.

Liquidity of underlying. In many ways, ETFs' success as asset gatherers can impact the liquidity of the underlying assets – similar to how recent negative repo rates for US Treasury 10Y bonds was partly due to the Fed having bought much of the available supply.

Exceeding the Free Float. One question that keeps coming up generally and was mentioned many times during the Congressional testimony was how it was legally possible for more than 100% of the free float of GameStop. As mentioned earlier, ETFs are active lenders, and no doubt many of them lend GameStop. In fact, according to IHS Markit, lenders of 'GME' earned $41 million USD just in the month of January! If investors bought into ETFs holding GME, then it is entirely possible that an individual ETF will have loaned out GME to a short seller into the market, and that very same ETF could be a buyer of stock that originated with them lending it. This is equally true of any lender that was simultaneously buying GME and lending it. I put together the following video to explain it...

Voting. In a speech entitled “Every Vote Counts: The Importance of Fund Voting and Disclosure” on 17 March 2021, SEC Acting Chair Allison Herren Lee highlighted voting by index funds. She includes the phrase “…index funds face their own economic pressure to lend out their shares, or not recall shares, instead of voting.” While she accepts the value that securities lending brings to investors, she goes on to say: “Ultimately, corporate accountability is only possible when the funds that manage American investors’ savings diligently exercise their authority to vote…”. I have never worked for an index fund, so I don’t know whether they face ‘pressure’ to lend/not recall, but as a borrower for most of my career, I can say that we exerted the same amount of pressure on all of our lending counterparties regarding recalls. And if she believes that voting is the only way for funds to exercise corporate accountability, then that is an anti-lending stance. Given the focus on securities lending by so many members of Congress, it is more than a little concerning to me if the SEC Chair openly presents such a bias.

There is an excellent article/thought experiment exploring splitting voting and economic ownership written by Matt Levine of Bloomberg, which I recommend you read here. (It starts with a review of the recent Goldman analyst survey. Read that as well if you have time.)

This is where it gets a bit twisted

So, what does this all mean (from a selfish securities lending perspective)?

  • I want ETFs to continue to innovate in their fund offerings as continuous innovation is one of the most essential characteristics ETFs have brought to investment products.

  • I want ETFs to grow in Assets Under Management, but outside of the main indices because we have enough of those.

  • I expect ETFs to expand in the ESG space, which is good, but I don’t want them to exclude their assets from lending programmes: a) because I believe that if properly governed and conducted, ESG can co-exist comfortably with securities lending; b) companies will need to be scrutinised for greenwashing and if activist short sellers can’t access supply, they won’t investigate companies (allowing frauds with the implicit approval of funds that don’t lend); and c) I would rather see oversupply than undersupply. Oversupply just impacts lending revenues while facilitating function (e.g., automation of GC as opposed to manual intervention for specials). Undersupply impacts the overall value lending brings to the market.

  • But I don’t want ETFs to grow so large that they impact the liquidity of the underlying assets as squeezes like GameStop are not good for this business.

  • I don’t want them to exercise votes too enthusiastically (again, remember “selfish” is in the description). Yes, I recognise the inherent hypocrisy of saying I don’t want them to vote but earlier moaning about fraudulent companies. I think that activist short-sellers have proven to be better at spotting frauds than long investors who vote at AGMs.

  • Mostly, I don’t want index trackers of any kind becoming such large shareholders of so many companies that regulators start forcing them to take actions that, in my opinion, harm the daily functioning of the markets of which short selling and securities lending are essential components.

See, I told you it was complex.

PS – Special kudos to anyone that guesses how I have used part of the blog title in the past

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