The securities lending and borrowing scheme has the potential of taking the Indian stock market to great heights. But every time the market waits for takeoff, the engine stops after making some noise. Will the story be different this time? Well, we may not know the answer for sure but we surely hope that it does. But before you fasten your seat belts, let’s try to understand how the whole scheme works.
Johnny: One of my friends wants to know how the securities lending and borrowing scheme works. Can you tell us about that, Jinny?
Jinny: Sure, why not? Under the securities lending and borrowing scheme, an owner of securities can lend the same to a borrower through an approved intermediary that acts as a central counterparty. An approved intermediary has to be registered with the Indian stock market regulator—the Securities and Exchange Board of India, or Sebi.
Presently, Sebi has authorized the clearing houses of both the National Stock Exchange and Bombay Stock Exchange to act as an approved intermediary. There is no direct contact between the borrower and lender, and both the borrower and lender of securities independently enter into a contract with the approved intermediary.
At present, the securities can be borrowed for seven days, after which the borrower has to return securities of the same type and class. So, if you have borrowed the shares of company A, you have to return the shares of company A only. You can’t return the shares of company B in their place. The approved intermediaries provide an automated screen-based platform where the transactions of borrowing and lending take place by order-matching on price and time priority with the first leg settlement on T+1 day and reverse leg settlement on T+8 day.
Borrowers and lenders can place their orders through clearing members of the stock exchanges, including banks and custodians that are registered as “participants” as per the terms of the scheme. “Participants” have to enter into separate agreement with each client as per the format specified by the stock exchanges. In case the borrower fails to return the securities, the approved intermediary shall be liable to make good the loss of the lender.
At present, securities traded in the futures and options, or F&O, segment of the stock exchanges are eligible for lending and borrowing under the scheme.
Johnny: What are the advantages of the new scheme for borrowers and lenders?
Jinny: The main advantage of this scheme is that it nicely complements short-selling in the stock market. As you may be aware, short-sellers enter into sale transactions even without owning securities. Short-sellers believe that the prices of securities will fall in future so they can meet their settlement obligations by purchasing securities subsequently at a lower price.
They temporarily use the facility of borrowing securities for meeting their settlement obligations and subsequently return the securities to lenders after purchasing these from the market. In this whole transaction, the lenders of securities get paid for lending securities which otherwise would have remained idle.
Johnny: What happens to corporate benefits that accrue to the securities during the period of borrowing and lending?
Jinny: As per the Sebi securities lending scheme, 1997, all corporate benefits such as dividends, rights, bonus, redemption benefits, interest or any other right or benefit accruing on the securities lent would remain with the lenders of the securities. So, for all practical purposes, the lender of the securities will continue to be the beneficial owner.
But, you may ask, what happens to voting rights? Who exercises voting rights during the period of borrowing and lending? Well, the practice in many countries seems to be in favour of transfer of voting rights from the lender to the borrower.
For instance, the UK’s Securities Borrowing and Lending Code of Guidance provides that the borrowers should make it clear to lenders that any voting rights will be transferred along with the securities and hence the lenders would not be able to exercise their voting rights until the securities are delivered again.
By putting such a clause into contracts, borrowers can actually use security borrowing for temporarily acquiring voting rights which they can exercise at any crucial meeting of the company.
The Sebi scheme, on the other hand, does not talk about voting rights. So, it can be presumed that voting rights remain with the lenders. But presumptions always leave room for dispute.
The use of the borrowing facility purely to exercise voting rights has large implications on corporate governance. At present, stock exchange guidelines provide that borrowing and lending of securities undergoing corporate actions shall remain suspended. But that may not be enough. It would be better if we could make things clear by suitably incorporating changes in the whole scheme.
Johnny: That’s true, Jinny. I think we have a long way to go before the securities lending and borrowing scheme starts roaring in the Indian stock market.
What: The securities lending and borrowing scheme enables the owner of securities to lend these to a borrower through an approved intermediary.
How: Borrowers and lenders can place their orders through clearing members of the stock exchanges, including banks and custodians registered as “participants”.
When: Borrowing and lending remains suspended during corporate actions.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at firstname.lastname@example.org