Supply Constraints and Limits to Arbitrage in the ETF Loan Market

Abstract

We find that exchange-traded fund (ETF) lending fees are significantly higher than stock lending fees. Two institutional features unique to ETFs play significant roles in explaining the high fees. First, regulations restrict investment companies, such as mutual funds and ETFs, from owning ETFs. As these institutions are key lenders, their absence reduces the lendable supply in the ETF loan market. Second, while the create-to-lend (CTL) mechanism alleviates supply constraints when borrowing demand increases, its efficacy is limited by the associated costs and frictions. Our results speak to the limits to arbitrage in the ETF markets.

Keywords: ETF; Lending fee; Create-to-lend; Ownership structure; Lendable shares

JEL Classification: G10; G11; G23