Securities Lending & Borrowing Market (SLBM) serves 4 broad purposes;
1.Access to securities for covering settlement obligations (Short / Bad delivery)
2.Facilitates directional short selling by borrowing the stock;
3.Facilitates arbitrage by borrowing the stock (Reverse arbitrage);
4.Lending of idle securities by the investors
Global market size (as of April 2012) is $ 1.8 trillion, i.e. total securities on loan globally. It is widely regarded as a crucial link in any securities market infrastructure.
Now, globally the architechture of the securities lending market is OTC in nature. In India, it is an exchange based model.
So how does it work in India. Now being an exchange based platform it has to have a CCP i.e. a central counterparty that stands in between two counter parties. Since the contract is not bilateral, it has to be standardised so that it means the same to all (monthly expiry on the first thursday of a month). Also, there have to be brokers as also custodians. Ofcourse, there are lenders (typically institutional investors) and borrowers (propritory traders / brokers again).
Securities Lending & Borrowing Scheme (SLBS) in its current form got operationalized in April 2008 under the overall framework of Securities Lending Scheme, 1997.
Market hours track the equity market timing – 9.15 am – 3.30 pm. Borrow / Lend transactions done through a separate SLB window on the broker NEAT terminal. Price time priority is used to match trades (here borrowers and lenders quote the lending fee per share). T+1 settlement cycle followed. Lenders deliver the securities on T+1 day. Borrowers pay the lending fee on T+1. Margining involves collection of margins from both, the Lender (except early pay – in of securities) & Borrower. Lender subjected to 25% of the value of the underlying security as margin. Borrower pays margins of about 30% over and above collateral @ 100% of security value. Thus, in effect, borrowers pay ~ 130% of the value of the underlying as margin (which could be a big deterrent for borrowers who have a competing avenue for shorting. i.e the futures market).
Now, since the cost is prohibitive for the shorter, he would indulge in borrowing of security only if the yield (i.e. the security is trading at a massive discount in the futures market, i.e. a massive reverse arb oppurtunity). Presently, BHEL is trading at discount of 1.25 – 1.5 rs in the futures market. So ideally, the short – seller would buy BHEL Futures and go short in the underlying spot market by borrowing in SLBM. He would quote a lending fee such that on a net basis he makes a decent profit on arb.
Also, incases of corporate actions, the transactions are squared off except in cases of a dividend and stock split. The lend / borrow transaction can also be square off by Early RECALL / REPAY if the counter – parties wish to square off the transaction before the designated expiry date.
Volumes as of now are not all that great with the notional volumes of ~ 300 – 400 Cr transacted which is not that great. The avenue is a great one for exploiting primarily reverse arb oppurtunities. There are brokers / custodians who offer ‘ spot the oppurtunity’ services which is kind of a discretionary account. The regulator too has taken steps to popularise it.