However, securities lending has been associated with counterparty risk. If a borrower, for whatever reason, does not return the shares, the ETF would be left in a short squeeze.
On the provider side, ETF sponsors usually receive collateral in the form of cash or other securities. Consequently, fund companies can reinvest the cash or lend out the securities, but they usually steer toward conservative bets like short-duration, low-risk assets. However, other fund providers may invest collateral in overly risky instruments, leaving investors at risk. Some providers, though, compensate their ETFs in case of losses due to share lending.
Some ETF sponsors, like Vanguard, return all profits back to its funds, minus fees. However, some others only return a portion of profits – iShares takes 20% to 30% of revenue and State Street takes 15%. Last year, two pension funds filed suit against iShares for taking excessive profits on securities lending, but the case was later dismissed. [Court Dismisses Securities Lending Suit Against BlackRock]
For more information on ETFs, visit our ETF 101 category.