India’s insurance sector regulator has decided to allow insurance companies to lend shares to foreign and domestic institutions, a move that will create a new stream of revenues for these firms, and increase overall trading activity in the stock market.
Indian laws currently allow institutions to short sell in the futures segment of the market. From 21 April, they will also be allowed to sell short in the so-called cash segment of the market. A company that sells short, sells the stock without actually owning it in the hope that the price will fall in the coming days. It hopes to be able to buy the stock at a lower price when this happens—well in time to deliver it or settle the transaction.
In the cash segment, traders buy and sell shares and this transaction is necessarily completed by a delivery. In the futures segment there is no delivery. Investors just buy a futures contract by paying up to one-fifth of the value of the underlying shares. They then make (or lose) money depending on which way the underlying shares move. The differential is added or subtracted from the investors’ accounts. This process continues till the contract is sold or expires.
To sell short in the cash segment, sellers will need to have possession of the stock. However, they do not need to buy stock for this—they can just borrow it. This is where the insurance companies enter.
Most insurance companies have large, varied and valuable stock portfolios and are usually long-term investors. “We do see scope for life insurers to unlock value of their holdings through lending their shares because they have long term liabilities. We will, however, not be permitting short selling by the insurance companies (themselves),” said C.R. Muralidharan, finance member of Insurance Regulatory and Development Authority, or Irda, the regulator. “Compared to private insurers, Life Insurance Corp. of India can benefit more from lending their shares given the size of their investments,” he added.
According to Bloomberg, Life Insurance Corp. (LIC), which has almost two-thirds share of the life insurance market in India, has investments in 23 of the 30 Sensex stocks with a total market value of 2,232 crore. Collectively, the company has invested in around 410 listed firms. According to a Mint analysis on 11 December, the market value of the state-owned insurer was at least Rs1.97 trillion in late 2007.
Executives at LIC did not respond to queries.
Muralidharan said because the proposal “has got the approval from the Government of India, it doesn’t need Parliament’s approval.” Irda usually requires the government to move amendments through Parliament, effecting changes in insurance laws. In this case, a notification would suffice, Muralidharan clarified.
Under the so-called securities lending and borrowing scheme, or SL&B, stock markets regulator Securities and Exchange Board of India has allowed short sales by institutional investors as long as they have borrowed shares to cover the transaction.
All so-called clearing members of National Securities Clearing Corp. Ltd, including banks and custodians, can participate in the scheme. These members provide banking services to traders and facilitate electronic settlement of deliveries. Any entity whose shares are held by them can participate in the SL&B scheme. Sebi will initially allow borrowing and lending only on stocks that are already available for trading in the derivatives segment.
Irda’s move allows insurance firms to participate in the process.
The firms will earn money the same way other lenders do—when institutions that have borrowed stock return them, they will do so with a fee that is yet to be decided but will likely depend on the price of the underlying shares.
Existing laws allow individuals or retail investors to sell short in the cash market.
Irda is yet to make an announcement on this and insurers are waiting for some clarity from the regulator. “There is no clarification yet about the interest rates. But a go-ahead will be given only after going through all the accounting, investment and other prudential norms,” said Muralidharan.
“If IRDA were to agree and allow us to move in this direction insurers can play a significant role on the lending side of the business, said Sunil Kakar, director finance and CFO of Max New York Life Insurance Co. Ltd.
“It will give a platform to earn interest income on the stocks lying idle with the insurance companies,” added Sashi Krishnan, chief investment officer of Bajaj Allianz Life Insurance Co Ltd.