The relentless pressure to reduce fees on exchange-traded funds ( ETFs ) is pushing even Asian ETF providers to turn to securities lending to generate additional revenue, enhance performance, and hopefully reduce fee pressure.

This is evident by the experience of Tokyo-headquartered ETF provider Nikko Asset Management ( Nikko AM ) in Singapore where it is launching a couple of securities lending products based on two local ETFs, namely the Nikko AM Singapore STI ETF and the Nikko AM Straits Trading Asia ex-Japan Reits ETF.

The new lending products will make available to borrowers – typically prime brokers acting on behalf of their hedge fund clients – Singapore Exchange ( SGX )-listed securities of locally domiciled companies and securities of real estate investment trusts ( Reits ) listed in Hong Kong, Malaysia and Thailand, which are the underlying shares of the two ETFs.

The launch of Nikko AM’s ETF securities lending products is part of a global trend that has seen securities lending by ETFs grow rapidly during the past two years. It has almost doubled since 2017, data from EquiLend show, reflecting the huge growth in assets under management ( AUM ) in the ETF industry as a whole.

The value of ETF on-loan balances or securities on loan at any point in time increased by 77% from an average of  US$37.5 billion in 2017 to US$66 billion between January 1 and mid-May 2021, Equilend data indicate. However, this is still much smaller than the overall increase of 21% in the wider securities lending market.

One reason for the faster growth of securities lending by ETFs, explains Jermyn Wong, head of Asia ETF business development at Nikko Asset Management, in an interview with The Asset, is to generate more revenue for the ETFs in the face of increasing pressure to reduce fees and costs.

“ETF AUM have been growing quickly, just as the demand for securities lending and participation from ETFs has grown,” Wong says. “And really because there is more incentive for ETF issuers to participate in securities lending, especially given the recent fee pressures on ETFs, more and more ETF issuers want to have lower fees, and securities lending is a way to offset the expenses of the ETF.”

There are over 350 ETFs globally whose revenue from securities lending has already exceeded the management fees of the ETF, Wong notes. “What we do is we make these underlying securities available for lending,” he adds. “Whoever wants to borrow can approach our securities lending agent, of course, subject to certain regulatory limits and restrictions. For example, we can’t lend out more than 50% of our overall portfolio.”

ETF investors benefit from the securities lending as the revenue goes into the fund; and, as a result, the fund performance is improved and the tracking difference reduced. “It’s a very positive trend for ETF investors to participate in this with this huge potential upside at very, very limited risk,” Wong points out. “More and more ETF issuers are waking up to that.”

Although securities lending by ETFs has long been allowed and practiced in Hong Kong and other markets, it was only in the past two years that regulatory changes in Singapore paved the way for ETF providers like Nikko AM to launch securities lending products in this market.

“ETF AUM have grown substantially in Singapore over the past three years,” Wong shares. “Before then, all the ETFs were relatively small, and in terms of the diversity of products, there weren’t that many. But today, given the growth of the ETF market in Singapore, and the growth in the number of different types of products that are available on SGX, demand for the borrowing of the underlying securities will start to increase.”