By Mr. Oyetola Muyiwa Atoyebi, SAN
There is a plethora of benefits accruable to security lending transactions. One of them is the facilitation of various trades that allow investors or institutions to take a bespoke position in arbitrage situations.
Security lending transactions can be best described as the most essential aspect of the Nigerian capital market, as it plays a pivotal role in the capital market by providing liquidity, which in turn reduces the cost of trading and promotes price discovery.
Despite the importance of security lending transactions in Nigeria, several impediments have constantly stared at the face of security lending transactions in Nigeria, which has eventually resulted to some shortcomings and pitfalls in Security lending transactions in Nigeria.
This article seeks to provide a cursory overview of the securities lending transactions in Nigeria, the risks, as well as prospects.
Securities Lending Transactions in Nigeria:
It is apt and pertinent to underscore the meaning and scope of security lending transactions in Nigeria, before transcending into the realms of the overview of security lending transactions in Nigeria.
Security lending is the temporary transfer of securities, from one party to another, with a simultaneous formal agreement to return the securities either on demand or at an agreed date in future.
According to the Section 315 of the Investments and Securities Act, security lending is defined as; ‘the temporary exchange of securities, generally for cash or other securities of at least an equivalent value, with an obligation to redeliver a like quantity of the same securities on a future date and includes securities loans, repurchase agreement(repos) and self-buy back agreements.’’
It has also been defined as the practice of loaning shares and stock, commodities, derivative contracts, or other securities to other investors or firms. Security lending requires the borrower to put collateral, whether cash, other securities, or a letter of credit.
Securities lending and borrowing transactions are governed by the terms of securities lending agreements, aligned to terms and conditions as agreed by the parties and in line with international best practices. The lending agreement must be completed, and it sets forth the terms of the loan including duration, fees and the nature of collateral (cash, government securities, equities among others).
It is also important to mention that during the tenor of any securities lending transaction, the title and ownership of the security are also transferred to the borrower. The borrower is obliged to return the security either on demand or at the end of an agreed term.
In securities lending model, borrowers are typically market participants such as market makers, portfolio investors, broker-dealer firms, investment banks, intermediaries, stockbrokers and other similar organizations. While Lenders are usually institutional investors, pension funds, mutual funds, sovereign wealth funds, investment companies, some High Net-worth Individuals (HNI) as well as insurance companies that are long or medium-term investors in the securities market. In addition to these, we also have high net worth individual investors whose interest is to grow the value of their portfolios over the medium to long term. They, therefore, lend securities to earn a lending fee, cover costs, create performance enhancements and increase the return on their portfolio.
In light of the above, it is important to note that there are litany and plethora of benefits of security lending transactions. One of them is that it facilitates various trades that allow investors or institutions to hedge, take a bespoke position, or in arbitrage situations. Also, it allows for the ability to earn additional income through the face charged to the borrower to borrow the security, as well as providing liquidity to markets which can generate additional interest income for long-term holders of securities, and allows for short selling. 
Security lending transactions in Nigeria are beautifully adorned with a garment of benefits, however, it has been engulfed with myriads of impediments, shortcomings, pitfalls and risks. Nevertheless, the risks facing security lending transactions in Nigeria shall be discussed hereunder;
Risk of Security Lending Transactions in Nigeria
There are three major risks in security lending transactions in Nigeria and they are:
- Borrower default risk.
- Operational risk.
- Cash collateral reinvestment risk.
- Borrower default risk occurs where the counterparty fails to return the borrowed security to the lender.
- Operational risk arises from failed and inadequate procedures, systems or policies. In this case of securities lending this may include, but is not limited to, errors in transactions between the lending agents and the borrower, errors and faults in transaction flows, faults in the IT platforms, etc.
- Cash collateral reinvestment risk is a larger source of risk. It is one that if reinvested too aggressively and the risk-taking results in losses, then the fund may suffer losses.
In addition to the above highlighted, one of the major risks that poses a threat to security lending transactions in Nigeria is that the borrower becomes insolvent, and the value of the collateral provided falls below the cost of replacing the securities that have been lent.
The Way Forward:
The Nigerian Stock Exchange’s securities lending market is valued at N1.07 billion ($2.96million) according to official data by the Exchange. The NSE, in its Securities Lending Report of October 2019, said 20.78 million shares were available for lending to investors, which is a 3,307 per cent increase from the 61,435 shares available for lending in the whole of 2019. The Nigerian Securities and Exchange Commission and the Nigerian Stock Exchange have existing rules and regulations which unequivocally erect a legal framework poised at regulating securities lending transactions in Nigeria, but operators in the Nigerian Capital Market are unwilling to rely on these rules to engage in securities lending transactions because of the tax issues.
Therefore, lawyers have a key role to play by creating awareness on the changes in the Act, and possible impact on securities lending.
Also, the Security and Exchange Commission have another huge role to play. Lawyers need to be sensitized to understand the documentation for securities lending agreements in the Nigerian market, and the need to have a standard master Securities Lending Agreement for the Nigerian market. Finally, it may also be necessary for the Federal Inland Revenue Service (FIRS) to issue guidelines on the implementation of the provisions of the Act in relation to securities lending.
To this end, we believe that the introduction of the above policies would be a step in the right direction.
Additionally, the recent legislative changes to the Companies and Allied Matters Act 2020 (CAMA 2020) significantly impact lending in Nigeria. As part of its changes, CAMA 2020 now limits the cost of registration of security with the Corporate Affairs Commission (CAC) (Nigerian’s company registry) to 0.35% of the value of the Charge, which is a significant reduction from the previous 1% and 2% for Private Companies and Public Companies respectively.
Some of the other key inventions introduced by CAMA 2020 which we believe to have a positive impact on lending transactions in Nigeria include:
- Introduction of netting provisions, which should now provide legal certainty to financial institutions entering into financial contracts such as derivatives and repurchase agreements.
- Introduction of the definition of book debts and exclusion of marketable securities and negotiable instruments from the definition of book debts, which may settle the question of whether a fixed charge of instruments such as treasury bills is registrable.
- Re-introduced the priority of fixed charges over contributions due and unpaid under the Employees Compensation Act 2010.
- Introduction of company voluntary arrangements and administration, which are procedures that companies experiencing financial difficulties could embark on with creditors to address financial challenges outside of insolvency.
Key terms: Security Lending transactions
Mr. Oyetola Muyiwa Atoyebi, SAN is the Managing Partner of O. M. Atoyebi, S.A.N & Partners (OMAPLEX Law Firm).
Mr. Atoyebi has expertise in and vast knowledge of Corporate Law Practice and this has seen him advise and represent his vast clientele in a myriad of high-level transactions. He holds the honour of being the youngest lawyer in Nigeria’s history to be conferred with the rank of Senior Advocate of Nigeria.
He can be reached at firstname.lastname@example.org
CONTRIBUTOR: Jamilu Samaila
Jamilu is a member of the Corporate Team at OMAPLEX Law Firm. He also holds commendable legal expertise in Investment Law Practice
He can be reached at email@example.com
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