Manufactured payments in respect of Loaned Securities - GMSLA Provision

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2010 Global Master Securities Lending Agreement
A Jolly Contrarian owner’s manual

Clause 6.2 in a Nutshell
Use at your own risk, campers!

6.2 Where a Loan extends over an Income Record Date, on the distribution date the Borrower must manufacture the Income the Lender would have received had it held the Loaned Securities on the Income Record Date.
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Clause 6.2 in full

6.2 Manufactured payments in respect of Loaned Securities
Where the term of a Loan extends over an Income Record Date in respect of any Loaned Securities, Borrower shall, on the date such Income is paid by the issuer, or on such other date as the Parties may from time to time agree, pay or deliver to Lender such sum of money or property as is agreed between the Parties or, failing such agreement, a sum of money or property equivalent to (and in the same currency as) the type and amount of such Income that would be received by Lender in respect of such Loaned Securities assuming such Securities were not loaned to Borrower and were retained by Lender on the Income Record Date.
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Related agreements and comparisons

Related agreements: Click here for the same clause in the 2018 Pledge GMSLA
Comparison: Template:Gmsladiff 6.1

Resources and navigation

2010 GMSLA: Full wikitext · Nutshell wikitext | GMLSA legal code
Pledge GMSLA: Hard copy (ISLA) · Full wikitext · Nutshell wikitext |
1995 OSLA: Full wikitext · Nutshell wikitext | GMSLA Netting
Let me Google that for you: Guide to equity finance | ISLA’s guide to securities lending for regulators and policy makers
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Content and comparisons

For the equivalent provision under the 2000 GMSLA see Paragraph 6 - 2000 GMSLA Provision. There is also some discussion under Income.


In other words the Borrower pays what the Lender would have received net, by reference to the Lender's own situation. This means that the Lender doesn't need to worry about different rates of tax or withholding applying to the Borrower. The Borrower, being the person who wanted to borrow the securities, takes the risk of untoward taxes related to its own position (as opposed to the Lender’s position) — if the tax is one the Lender would have suffered anyway, the Borrower doesn't have to account for this.

Makes sense, really.

Witholding rates

Notwithstanding the starting point — the Borrower takes the risk of whatever withholding may be imposed on the taxes, in practice dealers may commit to general levels with WHT country-by-country — say 85% or something — and generally stick with these even though the specific rates applied for individual dividends may be marginally more or less. This is largely an operational convenience: no-one wants to be forensically tracing precise withholdings actually applied on every dividend, as that may vary on all kinds of factors (e.g. whether the dividend was paid out of capital reserves, whether it was a special dividend or a regular one and so on), and to commit to that is not only expensive and resource intensive, but opens the broker up to all kinds of remediation claims should the amount turn out to be even fractionally wrong — and here the dealer is short an option, as, commercially, it will never be able to recover from its customers after the fact where it has overpaid[1], but regulators will insist on dealers accounting to customers for any downside — treating customers fairly — even though the customers may have as little interest in receiving the extra money as the dealers do doing the work to calculate and pay it[2]

So setting a fixed rate which is a good approximation of the expected dividend, and which you can adjust flexibly from time to time should withholding rates change or particular circumstances differ, is basically sound business management. The dealer takes some overs-and-unders risk, but it will be minimal in the context of their overall business, and would be drowned out by the cost of employing battalions of contractors in an offshore centre to do the work of reconciling to the penny in any case.

Now the odd thing here is that these accommodations will typically not be set out in the legal agreement.

...Income paid in relation to any Loaned Securities

Another example of that loose prepositional phrasein relation to” being used carelessly in the 2010 GMSLA. The preposition in question here really ought to be “under” or, if you really must, “pursuant to”.

This is Income paid by the issuer under the terms of the contract comprising the Loaned Securities or Collateral; “in relation to” might be misread to imply something a little looser. For example, moneys paid by someone else in relation to the securities —— a derivative counterparty or credit default insurance provider, or even a payment made by the issuer that relates to the shares, but is not a distribution under them: for example, a liability under a private suit to a shareholder as a result of misstatement to the market.


General discussion

Retrospective compensation for corporate mismanagement

An interesting question arises as to whether settlements or judgments reflecting corporate malfeasance by issuers of Loaned Securities or Collateral — and which manifest themselves in compensation payments to shareholders of record as of a certain date (and which falls during the term of a Loan) — qualify as “Income” under the 2010 GMSLA that must be manufactured back to the Lender.

Such disputes can take years — decades even — to iron out, can take any number of different forms and, if viewed as Income, represent a significant tail risk in a Borrower’s trading book.

On one hand, the definition of Income is very wide:

Income means any interest, dividends or other distributions of any kind whatsoever with respect to any Securities or Collateral;

On the other hand — and it pains me somewhat to lay some Latin on you, but I will — the ejusdem generis rule of interpretation says where general words (here, “distribution of any kind whatsoever”) follow specific words (“dividends, interest”), the general words are cover only objects similar in nature to those specific words. So the distribution should be of the same nature as interest or dividends.

So, is a court-mandated compensation for historic corporate malfeasance “of the same nature” as voluntarily declared dividend, intended by its issuer to reflect its own satisfactory stewardship of the corporation’s commercial affairs? The JC would argue that it is not. Quite the opposite, in fact: if we take it as read that one borrows securities to short-sell them in the market we see that the short-seller’s exact view is that the securities are overvalued: this is consistent with the theory that their issuer is mismanaging the company.

The Short-seller bets that the truth will eventually come out and, when it does, the securities will fall in price. It can then buy them back, take a profit, and deliver them back to the Lender.

It can't be right that a short-seller who is so right that such an issuer is actually breaching its fiduciary duties to its shareholders, that it is not entitled to benefit from its bet. Why must it compensate the Lender in an extreme case, but not in an ordinary one?

True, true, this puts the poor Lender in a sorry spot. Because it has lent the securities by title transfer, it is not on the share register as of the Income Record Date, so however you characterise that compensation payment, it can’t claim it from anyone.

“The deal”, it will argue, “is that the Borrower should put me in the position I would have been in had I continued to hold the shares myself. I wasn’t expressing a view here. I stayed long the economic exposure of the securities. All I wanted was a lending fee.”

It is hard not to be sympathetic about this. Were the borrower to have held the securities, it might even be prepared to make an ex gratia payment on the basis that it was a windfall: it knew the company was rubbish and made its money on the short sale. But there’s the rub: The borrower didn’t hold the shares. It sold them. That is why it Borrowed them in the first place. So the Borrower is in no better place to claim that compensation from the Issuer than the Lender.

However you look at it, there’s a loser here. But remember this is essentially a windfall payment — some public-spirited activist hedge fund[3] has jemmied some extra cash out of a reluctant issuer. Had it not done so no one would have been any the wiser.

Limitation periods

What about limitation periods? Unlikely to help: if the amount only becomes due ten years after the original incident that gave rise to it — modern commercial litigation does tend to rumble on a bit — but, in the elegant words of Section 5 of the Limitation Act 1980[4], “an action founded on simple contract shall not be brought after the expiration of six years from the date on which the cause of action accrued”. No cause of action existed until the court award was made, so the clock only just started running.

See also



  1. It should be said, usually for good reasons: “I’ve cut my NAV! I’ve closed my book! I’ve suffered subscriptions and redemptions and I have no way to pass on the loss”.
  2. For exactly the same reasons: “I’ve cut my NAV! I’ve closed my book! I’ve suffered subscriptions and redemptions and I have no way to pass on the gain”.
  3. What? What?
  4. The Limitation Act 1980 was the subject of a 320 page law commission monograph in 2015 — knock yourself out — so clearly someone sees the opportunity to change the law.