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Self Managed Super Fund (SMSF) Article
Stock lending and super funds

By Tony Negline.

This article may be out of date.

8th October 2008

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When a super fund owns stock which it doesn't intend to sell for awhile should it loan that stock to someone else?

Before we answer this question we firstly need to understand what stock lending is and then examine some of the super law issues that may be relevant to the transaction to see if it is allowed.

Unfortunately stock-lending is probably a bad description of a certain type of transaction.  The transaction involves the actual sale of an asset.

The Australian Securities Lending Association (ASLA) says that stock lending involves the lender actually transferring absolute ownership of the original securities to the borrower and the lender is only entitled to receive identical or equivalent securities in return.  This transfer of absolute ownership enables the borrower to sell or otherwise deal with the securities.

Typically ASX 200 equities as well as Government, Semi-Government and corporate bonds and inscribed stock are lent in Australia.

A stock lender can operate its own lending system and some of the very large super funds are rumoured to do this.

Most institutions in Australia use an intermediary such as a custodian bank.  This helps them avoid the expense, administration and operational difficulties as well as the credit and other risks of running their own stock lending arrangements.

A prudent lender of anything will always assess the bona fides of the borrower.  Stock lenders should be no different.  If the borrower is a custodian then it is a matter of working out how financially viable that organisation is.  If the stock lending is organised directly then the lender needs to directly assess that borrower.

 What security is offered?  Typcially stock lenders accept security in the form of cash, securities and irrevocable standby letters of credit.  The ASLA say that it is legally unclear if a super fund can accept cash as collateral.

What does a lender receive for offering their stock in these types of arrangements?  This will depend on the loan agreement but typically the lender will earn income (somewhere between 25 and 400 basis points per annum on listed securities depending on supply and demand of the stocks being lent).

Most lenders will also negotiate to fully receive the full benefit of all dividends paid from a stock during the loan period as well as the impact of any franking credits.  This is especially important for super funds because the value of franking credits can be quite valuable to funds.

Any super fund entering into these types of transactions also needs to consider the transactional costs including GST and CGT.  There appears to be a lot of conjecture as to when and how all these taxes apply specifically to super funds involved in stock lending.

Can a super fund lend stock and other securities?  Some people argue yes.  The Association of Superannuation Funds of Australia (ASFA) recommends trustees should inform members whether or not their fund is involved in securities lending.

Before a super fund trustee proceeds with this type of transaction it must carefully consider all the relevant legal issues.  This means that a super fund trustee must first decide if the transaction is permitted.  In this particular case there are two places to look.

Firstly the trustee should check the powers that have been given to them in their fund's trust deed.  If the trust deed is silent then a trustee should check the Trustee Act in their State or Territory jurisdiction.

Next trustees must consider what their common law obligations might be.  For example trustees have a duty to properly invest their fund's assets.

Lastly a trustee must also take into the account relevant super laws.  For example one super rule says that a trustee must not "enter into any contract, or do anything else, that would prevent the trustee from, or hinder the trustee in, properly performing or exercising its functions and powers".

Another super law which trustees need to consider is the requirement to create, implement and monitor an investment strategy.  When implementing this strategy a trustee must consider the risk of holding a particular investment.

One of the main purposes behind stock lending is to make additional income returns for a fund.  However if the stock is then lent to someone who is able to manufacture events so that the value of the stock is drastically reduced then the purpose of the stock lending arrangement might be called into question.

If losses do arise based on the market-value of particular stocks what is the real economic cost of any loss caused?  By its nature, superannuation is a very long-term investment – potentially more than eighty years.  If a super fund trustee is a long term holder of a particular asset and the fund loaned stock to an organization whose action temporarily reduced the share price what is the ultimate problem?

It might be a problem if the trustee wants to sell the assets whilst the share price is lower than its long-term trend because of the action of some stock lenders.

The ASLA's website contains an excellent document titled "An Introduction to Securities Lending (Australia)" which can be accessed in pdf format at the following link: http://www.atcbiz.com.au/r.php?r=k162w52

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