Does The Party Borrowing Shares In A Short Sale Transaction Borrow In A Different Way Than The Interest On The Loan?

To answer this question, we must first clarify who will provide the loan in a short sale transaction. Many individual investors think that because their shares are lent to the borrower, they will receive an advantage, but this is not the case.

When a trader wants to take a short position, he or she borrows the shares of a broker without knowing where the shares come from or where they belong. The borrowed shares may come from the margin account of another trader, from the shares held in the broker’s inventory or even from another brokerage firm. It is important to note that once the transaction has been placed, the broker is the party that makes the loan. So any received benefit (along with any risk) belongs to the broker.

As your question suggests, the broker does receive an amount in interest for lending the shares, and a commission is paid for providing this service. In the event that the short seller is unable (due to bankruptcy) to return the shares he or she borrowed, the intermediary is responsible for returning the borrowed shares. Although this is not a huge risk for the broker because of the margin requirements, the risk of loss is still present and therefore the broker receives the interest on the loan.

 

The main reason why mediation, rather than the person holding the shares, receives the benefits of lending shares in a short sale transaction can be found in the terms of the margin account agreement. When a client opens a margin account, there is a clause in the contract stating that the broker is authorized to lend – to himself or to others – securities held by the client. By signing this agreement, the customer waives any future benefit of lending his or her shares to other parties. (For more information, see the Short Sales Guide and the Margin Trading Guide .)

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