There are many reasons to borrow equities. But for this example, let’s assume that a borrower is about to set up a transaction that calls for a long position of a convertible bond and a short position of the underlying equity. However, he must first find out if the equity can be borrowed, because he must deliver the equity without converting the bond for this particular transaction to be economically viable.

1. He contacts his equity finance desk and tells a trader which equity he is looking for, how much he needs, and when and where he needs it to be delivered. This is where the loan begins its life.

2. A lender (who has already been vetted and contracted by in-house documentation specialists) receives a call from the borrower’s trader or representative to discuss the possibility of borrowing the equity. The discussion typically covers the following points: quantity and name of the security, its identifier number (SEDOL, ISIN, etc), the full value of the deal, the type of collateral that will be given by the borrower to the lender via their respective agents; the lender’s dividend requirement, the fee or cost to borrow (or the rebate to be received by the borrower if cash collateral is given and accepted), and the delivery date and custodian instructions. Once all this has been discussed and agreed, confirmations are exchanged detailing each point.

3. On settlement date, the securities are sent to the borrower and the collateral is given to the lender. Both transactions are carried out via the respective custodian banks or agents. Thereafter, on a daily basis, the lender will mark to market the borrower’s collateral versus the value of the securities loaned. The collateral should be 105% of the value of the borrowed securities. If the value of the collateral falls below 105%, the lender will ask the borrower to deliver additional collateral within 24 hours. However, if the value of the collateral increases in value above 105%, the lender will await instructions from the borrower requesting the return of an appropriate portion of the collateral.

4. Since the loan of securities is usually open-ended, i.e. without a termination date, the lender will await instructions from the borrower as to when the securities are going to be returned. When the lender receives this notification, he will make arrangements to return the securities to the lender. Again, both movements are done via the respective custodian banks or agents.

5. At month-end, both the borrower and the lender will prepare a statement that indicates the loan details and the fee (or rebate) to be paid. Once these statements are agreed, money is exchanged and the loan ends.