Stock Loan Desks: The Hidden Market Makers of the ETF Ecosystem

Create-to-Lend: Quiet Primary Market Activity

Hedge funds frequently go straight to stock loan desks when looking to borrow specific securities — either to short, hedge, or execute more complex trades. When the desk doesn’t have inventory on hand, it may initiate a "create-to-lend" process:

• Arranges for a primary market creation of ETF shares
• Holds the ETF shares temporarily
• Uses the underlying securities to fulfill the borrow request
• Later redeems the ETF shares once the loan winds down

This process adds shares to the ETF’s float and enhances market liquidity, often without any traditional investor buying activity. The demand is driven not by inflows, but by short-side mechanics.

Create-to-lend: When shares are created not due to investor demand, but to satisfy borrow needs for short interest — often initiated by a stock loan or AP desk.

A Hidden Cog in ETF Liquidity

Because stock loan desks respond to real-time borrow demand, their actions can have immediate impacts on ETF spreads and trading volume. They are a hidden cog in the ETF liquidity machine — influencing both the primary and secondary markets, even if they're not quoting on screen like traditional market makers.

ETF Capital Markets Professionals: The Crucial Link

ETF issuers often don’t see this activity directly — but their ETF Capital Markets experts do. These professionals act as the bridge between issuers and desks. They:

• Field calls about ETF construction, liquidity, and holdings
• Provide insight into rebalance timing, concentration limits, and portfolio mechanics
• Help desks understand the risk profile of creating shares to lend — especially in complex, thematic, or concentrated ETFs

When managed effectively, this collaboration results in:

• Better risk alignment for the desk
• Smoother liquidity for investors
• Additional revenue via securities lending

Offsetting Slippage and Execution Drag

Beyond facilitating short interest, stock loan revenue plays another critical role in ETF management. As ETFs rebalance — particularly index funds — they incur slippage, market impact, and trading costs. Lending revenue helps offset these execution costs, preserving net returns and keeping tracking error in check.

Leaning In: Short Interest as a Path to Creation

In newer or riskier asset classes, it’s common for market makers and traders to lean short into positions at first, especially when uncertainty is high. They may incrementally build exposure through short activity until reaching a threshold where it becomes economically and operationally feasible to create a full ETF unit — particularly relevant for funds with large minimum creation sizes.

During this process, stock loan desks play an active role, often sourcing and loaning inventory to facilitate that shorting. This pre-creation short interest, supported by loaned inventory, becomes a leading indicator of eventual primary market activity — another way these desks operate as de facto liquidity providers.

When the Desks Trade for Themselves

There are also moments when stock loan desks and AP desks act on their own behalf. A notable example is VNM (VanEck Vietnam ETF), which once traded at large premiums due to strong demand and creation limits imposed by the issuer to manage underlying market liquidity risks in Vietnam.

As premiums widened, there was a natural rotation to APs still able to create, often due to relationships or risk tolerance. In some cases, stock loan or AP desks created ETF shares for themselves, not on behalf of a client, but to sell immediately into the market and capture the arbitrage premium — made possible by their dual access to primary creation and market insight.

These moments reveal how stock loan desks are far more than facilitators — they are informed actors, capable of identifying inefficiencies and capitalizing on them in ways that benefit both the ETF ecosystem and their firm.

Final Thought: It's Not Just About the Fee

Investors often focus on expense ratios and bid/ask spreads, but stock loan desks — and the ETF Capital Markets teams working with them — are integral to the efficiency of the entire ecosystem.

Understanding how create-to-lend supports liquidity, offsets operational drag, and connects major institutional flows with ETF mechanics offers a deeper appreciation for what makes modern ETFs function so smoothly.

Stock loan isn’t a back-office function. It’s a strategic force — and it’s time more people understood its role.

About the Author

Nicholas Phillips | President of ETF Capital Markets Advisors LLC
With over 25 years of experience in ETF market making and capital markets, Nicholas Phillips is recognized as a subject matter expert in the ETF industry. He started his career spending the first ten years as a lead market maker for SIG and Goldman Sachs.

At the helm of MCAP LLC's ETF Desk, Nicholas built and scaled the division, enhancing its operations through innovative pricing and risk models, and robust relationships with market makers and issuers. His tenure at VanEck Associates as Director of ETF Capital Markets further solidified his expertise, managing critical facets of operations and deepening connections within the trading community.

Beyond market making, Nicholas is an avid content creator, sharing insights that demystify complex market dynamics. He is keen on exploring board member roles that benefit from his extensive background and forward-thinking approach to ETF strategies. His dual US/Ireland citizenship complements his global perspective, enriching his professional endeavors in diverse markets.

Disclaimer

Please note that this article reflects the author's personal views and does not represent the opinions of the publication or its affiliates. It is for informational purposes only and does not constitute investment advice. It is essential to seek guidance from a registered financial professional before making any investment decisions.