Getting securities lending right

Getting securities lending right

The Securities and Exchange Board of India (Sebi) seems to have finally gotten it right with its new norms for securities lending. Market participants have been granted their demand for flexibility with the tenure for lending and borrowing stocks. Besides, a facility for early recall/repayment of shares has been approved.

These are welcome moves. After all, the primary reason India’s securities lending system hasn’t taken off even 20 months since its launch is Sebi’s insistence on standardized contracts with a fixed tenure. The system was launched in April 2008 with a seven-day contract. It soon became evident that there were no takers and the tenure was extended to 30 days, but this too didn’t work.

Sebi has now allowed flexibility in deciding the tenure within a limit of 12 months. This removes unnecessary constraints on short-sellers and arbitrageurs who are primary users of the securities lending and borrowing market. A short sale may take months to turn profitable, and having a fixed tenure meant that the short- seller would have to go through a costly exercise of borrowing securities for 30 days at a time. Similarly, an arbitrage opportunity between the cash and derivatives markets exists for a specific period, until the expiry of the derivatives contract. The rigidity of a fixed tenure contract prevented such opportunities from getting exploited.

But while the primary demand of market participants has been met, one should not expect a flurry of trades. In India, it’s far more convenient and cheaper to engage in a short sale using the stock futures market. The utility of securities lending, therefore, will be the most for stocks on which futures trading is not available. Ironically, it is permitted only for stocks on which futures trading is already available.

For now, the system would be most useful for arbitrageurs between cash and derivatives markets. In order to enjoy the full benefit of securities lending and borrowing, the facility needs to be extended to all listed stocks.

It’s heartening, however, to note that Sebi has made major changes to the design of the contract. Securities lending is the one missing piece in India’s equity market infrastructure and any move to revive it is welcome.

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