Is the only missing piece in India equity’s market infrastructure finally falling in place? The DNA Money newspaper had an interesting report this Monday that volumes in the securities lending and borrowing (SLB) market have picked up sharply in the past two months. Between January and June this year, there was just one securities lending transaction happening in two trading sessions, on an average. In July and August, average daily trades rose to around 7, while in September, it has risen further to around 15 trades.
This coincides with the implementation of the revised securities lending scheme, which increased flexibility in the tenor of the contract and added a facility for borrowers and lenders to make an early recall/repayment of securities. The Securities and Exchange Board of India (Sebi) had revised the norms for securities lending in early January, but this was operationalized only in end-June, after the National Stock Exchange sent a circular in this regard. Since then, volumes have picked up.
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In July and August, average daily volumes stood at 57,000 shares. In September, they’ve risen to 166,000 shares. For perspective, in the National Stock Exchange’s cash market, average daily volumes are at 750 million shares, on the back of around 6.3 million transactions each day. So despite the sharp rise, the size of the SLB market is still roughly only 0.02% of the cash market.
Kapil Seth, head, HSBC Securities Services (India), says, “We haven’t seen much activity on the securities lending front. The volumes in the past two months may be from domestic participants taking advantage of arbitrage opportunities between the cash and futures markets. There’s nothing to indicate to us a reversal of trend as far as interest from foreign institutional investors goes.”
SLB transactions in Monday’s trading session substantiate this. For each of three securities that traded in this segment, namely Mahindra and Mahindra Ltd, UltraTech Cement Ltd and Larsen and Toubro Ltd, the futures price traded at a discount to the cash market price during the day (based on volume weighted average price). Evidently, market participants are using the SLB market to engage in reverse cash and carry arbitrage, by selling short in the cash market and buying an equivalent number of shares in the futures market at a lower price. The short sale transaction in the cash market is settled using the borrowed shares in the SLB segment.
In its current form, the Indian SLB market isn’t likely to be used to facilitate short selling. This is because the SLB facility is available only on stocks on which futures and options trading is already available. Since it’s much easier and cost-effective to take a short position using the derivatives markets, market participants wouldn’t take the trouble of entering into two transactions on the cash market and the SLB market to take a short position. This is why it makes immense sense to extend the SLB facility to stocks that aren’t part of the derivatives list.
Besides, volumes can be expected to pick up when offshore institutional investors start participating in the market. Lawrence Komo, Asia-Pacific head of securities finance for Citigroup Inc., says, “As far as lending interest goes, most of the current supply is from onshore lenders. Offshore lenders are still getting used to the exchange-traded, centrally cleared model, which is a departure from the global model for SLB. In most other markets, offshore institutional investors are accustomed to having access to the collateral posted by the securities borrower, as well as having the comfort of knowing who the counterparty to the deal is. Whenever there is a non-standard model, investors take some time before participating.”
While the exchange-traded model is non-standard, offshore investors have some experience of similar exchange-traded models in markets such as Brazil, where SLB volumes are quite healthy. So, while it may take time for investors to get accustomed to the Sebi-prescribed model, it’s not that they would not participate at all because bilateral trades aren’t possible. And while Sebi has insisted on the exchange-traded and centrally cleared format, it has been flexible with the product features.
As Seth says, “Sebi has been continually taking feedback from market participants and has addressed issues such as flexibility in the securities lending contract, both in terms of tenor of the contract and the ability of borrowers and lenders to end it prematurely.”
As far as investor preference for bilateral trades goes, nothing stops them from deciding the terms of the transaction such as tenor and fee bilaterally and striking the transaction on the exchange. Of course, this would go against Sebi’s intent that price discovery happens transparently on the exchange screen, but then such transactions happen regularly in the cash market and there’s no reason why similar SLB transactions can’t happen.
Even though volumes are small currently, it’s important that there is some activity in the SLB segment. This is simply because liquidity breeds liquidity. But as pointed out earlier, in its current form, the scope for the SLB market is limited in that it serves only reverse cash and carry arbitrageurs. Sebi should soon extend the facility for more stocks, for the markets to fully benefit from SLB.
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