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Unlocking the Securities Lending Potential of SPY

Relying on the expense ratio to assess an ETF’s total cost is limiting — it’s crucial to consider other factors like securities lending potential.
Securities lending, an essential component of capital markets activity, facilitates settlement, injects liquidity, and fosters confidence for risk taking.
SPY accounted for an estimated average of 93% of S&P 500 ETF notional short interest and 28% of total ETF notional short interest in 2022.

8. November 2022

Colin J Ireland, CFA

Sales Execution and Institutional Strategy

Bradley E Kotler

Fixed Income ETF Sales and Analytics

Antonio Avila

Relying solely on the expense ratio of an exchange traded fund (ETF) to assess its total cost can be limiting. That’s why it is crucial for institutional investors to consider additional factors — like securities lending potential — when selecting the right ETF to trade.

Compared to other investment vehicles tracking the S&P 500 Index, the SPDR® S&P 500® ETF Trust (Ticker: SPY) delivers a specific cost offset advantage through its unique lending market.

Securities Lending with ETFs

Securities lending, or the exercise of loaning securities to other investors, is a key aspect of capital markets activity that facilitates settlement, injects liquidity, and fosters confidence for risk taking. These benefits are accessible to all types of investors, spanning from long-term stable asset base investors to more active participants, like hedge funds or market makers.

ETF securities lending has grown alongside broader adoption of the structure. Many investors may be familiar with “inside” lending, or the practice in which ETF issuers lend out the constituents of the ETF. “Outside” lending, however, refers to when ETF beneficial owners make their ETF shares available for borrowing.

In some cases, “outside” lending can serve as a more relevant driver of returns, with the potential to earn lending returns that offset the fees of the fund.

The Unique Nature of SPY Securities Lending

At the forefront of most ETF capital markets activity stands SPY, the world’s largest and most actively traded ETF.¹ For SPY, securities lending is an important contributor to the overall efficiency of secondary market trading.

Through the first three quarters of 2022, SPY represented an estimated average of 93% of S&P 500 ETF notional short interest and 28% of total ETF notional short interest from among 2,900 US-listed funds.²

Most importantly, SPY’s year-to-date $40B in average daily secondary value traded accounts for more than 20% of all ETF trading.³ As different users meet on the exchange, centralized pools of liquidity form, benefitting all users of SPY. And as different investors access SPY’s liquidity, demand to borrow SPY shares ebbs and flows with market dynamics across use cases.

Why Investors Borrow SPY

Borrowers of SPY are typically hedge fund managers, investment managers, options traders, or market makers that are seeking to: short, hedge, cover pending settlements, and create arbitrage opportunities. Two notable persistent drivers of supply and demand are the following:

Listed Options

SPY represented 99.2% of S&P 500 ETF options contract open interest and 17.9% of total ETF options contract open interest at the end of Q3 — that’s greater than 46% of all ETF options open interest on an estimated notional basis.⁴
On a transactional basis, SPY’s average of 6.9 million contracts traded per day through the first three quarters represented greater than 45% of all ETF options trading.⁵

Fungibility with Futures

SPY is a significant bridge between futures and cash markets.
Given the availability of liquid futures contracts tracking the S&P 500 Index, an investor can hold SPY and sell an S&P 500 futures contract as a market neutral arbitrage strategy.
From a securities lending perspective, this natural hedge provides an incentive for banks to carry SPY shares — ultimately making them easily accessible to borrow within the institutional trading community.

Potential Yield from Lending SPY?

When evaluating the potential yield generated from securities lending, we can look at the volume-weighted average fee (VWAF) and the utilization rate percentage:

The VWAF represents the average fee charged by a lender to a counterpart expressed in annualized terms.
The utilization rate is the shares on-loan as a percentage of shares made available for loan.

To demonstrate the potential return on shares made available, we can multiply the VWAF by the utilization rate to determine the historical return on lendable assets, as shown below.

Ticker	Fund Name	Trailing 1-Year Average
Ticker	Fund Name	VWAF bps	Utilization Rate %	Gross Return on Lendable Assets (bps)
SPY	SPDR S&P 500 ETF	15	50%	7.5
IVV	iShares Core S&P 500 ETF	9	4%	0.4
VOO	Vanguard S&P 500 ETF	11	11%	1.2

Source: Markit IHS as of September 30, 2022; Estimates are for illustrative purposes only and do not include additional return factors such as agency lending fees, reinvestment rates, or other considerations. Past performance is not a reliable indicator of future performance.

Relative to its peers,⁶ SPY’s historical return on lendable assets reflects how the fund’s broader user base supports consistent demand. And, it underscores how vital it is for institutional investors to look beyond a fund’s expense ratio to consider factors like securities lending potential and transaction costs when selecting the right S&P 500 ETF.

Connect with the SPDR Sales Execution and Institutional Strategy (SEI) Team

Through strong relationships with Authorized Participants, market makers, liquidity providers, execution trading desks/platforms and stock exchanges, the SPDR SEI team plays an active role in supporting competitive markets and maintaining the SPDR ETF liquidity ecosystem.

The team’s insight into primary and secondary market activity — as well as access to numerous proprietary pre-trade liquidity analytics tools — can help you to evaluate execution strategies and meet your objectives, even in volatile markets.

You can connect with them to learn more about the lending potential of SPY or to request the team’s help.

Footnotes

Glossary

Disclosure

Securities lending programs and the subsequent reinvestment of the posted collateral are subject to a number of risks, including the risk that the value of the investments held in the collateral may decline in value and may at any point be worth less than the original cost of that investment.

Securities lending is not without risks, and investors should fully understand the risks involved before participating. Risks include the potential for the lender to suffer a financial loss if: 1) the borrower becomes insolvent, or 2) the value of the collateral becomes less than the cost of buying back the securities that have been lent.

This communication is not intended to promote or recommend the use of options or options trading strategies and should not be relied upon as such.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.

Hedging involves taking offsetting positions intended to reduce the volatility of an asset. If the hedging position behaves differently than expected, the volatility of the strategy as a whole may increase and even exceed the volatility of the asset being hedged.

Investing in futures is highly risky. Futures positions are considered highly leveraged because the initial margins are significantly smaller than the cash value of the contracts. The smaller the value of the margin in comparison to the cash values of the futures contract, the higher the leverage. There are a number of risks associated with futures investing including but not limited to counterparty credit risk, basis risk, currency risk, derivatives risk, foreign issuer exposure risk, sector concentration risk, leveraging and liquidity risks.

There can be no assurance that a liquid market will be maintained for ETF shares.

Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations.

Past performance is not a reliable indicator of future performance.

In general, ETFs can be expected to move up or down in value with the value of the applicable index. Although ETF shares may be bought and sold on the exchange through any brokerage account, ETF shares are not individually redeemable from the Fund. Investors may acquire ETFs and tender them for redemption through the Fund in Creation Unit Aggregations only. Please see the prospectus for more details.

Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.

Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole.

Passively managed funds invest by sampling the index, holding a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index.

While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

Investing involves risk including the risk of loss of principal.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

The views expressed in this material are the views of the SPDR SEI team through the period ended September 30, 2022 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.

The funds presented herein have different investment objectives, costs and expenses. Each fund is managed by a different investment firm, and the performance of each fund will necessarily depend on the ability of their respective managers to select portfolio investments. These differences, among others, may result in significant disparity in the funds' portfolio assets and performance. For further information on the funds, please review their respective prospectuses.

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