Patrick Dunne is a managing director at Barclays Global Investors, San Francisco, one of the biggest issuers of ETFs. Mr. Dunne, who also manages the firm's U.S. securities lending program, said ETFs in both U.S. equity and fixed-income markets are in high demand.
The value that borrowers — most typically hedge funds, but also other money managers and broker-dealers — place on ETFs fluctuates with market volatility and the strategy in place, securities lending professionals said.
Fees for borrowing ETFs can range from as low as 15 to 25 basis points up to 200 basis points for more hard-to-borrow ETFs, a fee structure not dramatically different from that of other securities, said Mark Payson, senior vice president and co-head of global securities lending at Brown Brothers Harriman, Boston.
He said borrowers will pay up "if they're (the ETFs) trading special for a couple reasons, like there's a shortage in the market or certain industry, or sector ETFs are in high demand.
"When more (underlying securities) are widely held, that filters down to securities lending," he said. "Demand does fluctuate day to day, week to week, month to month."
Still, demand for ETFs by borrowers has picked up noticeably in the last six months or so, and that demand has remained steady, especially with more ETFs being created to offer more slices of the markets to play.
"The attractiveness of the lending of various different ETFs depends on what other substitutes there are out there," Mr. Dunne said, explaining that in some market sectors, futures contracts can provide the same strategy as borrowing an ETF, namely going short or hedging a market position.
"For example, the Russell 2000 iShares tends to be a security that has a lot of long and short interest," he added, noting there is no futures contract on the Russell 2000 index. "There's a lot of borrowing to get long or short the exposure."
Other popular ETFs include the Lehman Aggregate iShares ETF and emerging markets ETFs, he added.
"They've become a pretty good vehicle for hedge funds or broker-dealers or any other entity out there as a hedging vehicle to get long or short exposure," Mr. Dunne said. "By trading one security, you become long or short a basket of securities. It's a very efficient, liquid vehicle."
Peter Economou, senior vice president and head of global trading and risk management at State Street Corp., Boston — another big ETF creator — agreed that hedge funds have been the biggest borrowers of ETFs.
In addition, broker-dealers — either in their capacity as prime brokers for hedge funds or for their own proprietary trading — have become significant borrowers of ETFs, industry participants said.
ETFs are not subject to the uptick rule, a characteristic that that makes them more attractive than other equity securities for short positions. The uptick rule, established by the SEC, restricts short sales of stock to when the price of a stock is higher or equal to the last trade.
In fact, short interest in U.S.-listed ETFs has been increasing since the beginning of the year, according to a recent report from Morgan Stanley, New York.
Mr. Payson at Brown Brothers said most borrowing is likely used for directional plays and hedging, rather than for arbitraging mergers and acquisitions, interest rates or dividends, which is common in other areas of securities lending.
For lenders, ETFs pose no greater risk than other securities, with collateral requirements the same as well, securities lending executives said.
"I don't know of any lending-specific structural issues from an owner's perspective that they'd have to be concerned with" relating to lending ETFs, said Mr. Pridmore, the pension fund consultant.
Mr. Payson added: "We don't think the ETF world, outside of the fact that it's new, has anything super-exciting from a risk or fee perspective."
But that doesn't mean demand to borrow ETFs is likely to ebb.
"I don't think demand is going to disappear as the market matures," Mr. Payson said.