CFM74120 - Other tax rules on corporate finance: stock loans: what are stock loans: collateral

The treatment of collateral arrangements

The lender of the securities will normally require collateral from the borrower so that it is protected from the consequences of default. The collateral may be given in the form of cash or may itself involve the loan of securities.

The amount of the collateral required may vary during the course of the loan to accommodate changes in the value of the securities lent. Generally the value of the collateral will be somewhat higher (2% - 5%) than the value of the securities loaned. This excess is sometimes known as the ‘haircut’.

Collateral is ‘marked to market’, usually daily, meaning that the current value of the collateral is compared with the current value of the loaned stock. Some of the collateral may be returned, or more may be required, depending on the outcome of the valuations. Such transfers are called ‘margin calls’. Interest and other income arising on the collateral will generally be returned to the borrower. Where the collateral is securities, this means that manufactured payments (CFM74300) may flow both ways.

Quasi-cash collateral may be involved in quasi-stock lending arrangements. Quasi-stock lending arrangements are not commercial arrangements and may be used for tax avoidance. See CFM74180 for further details and for the anti-avoidance provisions.