A Half hearted Correction of Lending & Borrowing rules
November 1, 2008
By Deepak Sanchety
Yesterday, the Securities & Exchange Board of India (SEBI) modified the framework for Securities Lending and Borrowing and has addressed some of the factors responsible for the scheme being a non-starter. Immediately after the operationalising of the scheme, MoneyLIFE had brought out detailed analysis through an article in the issue dated 21 May 2008 explaining what ailed the SLB scheme. It was pointed out by MoneyLIFE that the obvious problems with SLB appeared to be limiting it to F&O stocks, having a fixed tenure of seven days, allowing lending and borrowing in a window of only an hour in a day, and stringent margining for both lender as well as borrower.
Although SEBI has addressed some of these points, some fundamental questions still remain.
The tenure for borrowing has been increased from 7 days to 30 days. This will avoid repeated borrow transactions and allow the borrower to take a view upto 30 days before having to return the stocks or re-borrow. The timings of the SLB session have also been increased from one hour to the full trading day, so that a borrower can borrow stocks when he decides to short sell, instead of having to pre-borrow in the one-hour window provided in the earlier scheme. The margins for SLB have also been reduced from the earlier levels.
However, the following fundamental issues still remain.
Short selling of securities continues to be restricted only to the F&O stocks. Anyone who wants to short in these stocks can do so in the F&O segment, where the tenure is from one day to three months, existing liquidity is high and impact cost is low. The F&O segment gives flexibility of covering the short position within a day or keeping it open for three months, without going through the trouble of borrowing stock and paying a fee on the borrowing. There is no incentive or compulsion for a trader to use SLB for F&O stocks for the purpose of short selling. F&O segment itself does not create any need for stock borrowing, as this segment is purely cash settled. So the question of why anyone would use SLB, when they can short sell in the F&O segment remains.
Yes, the modified scheme can meet the need for SLB in F&O stocks for reverse arbitrage. In this case, a trader may have adequate incentive to borrow stock and short sell in the cash market. However, the borrower may still be discouraged by the margins he will have to pay on the borrowed stock. The potential arbitrage gains are likely to be eaten up by the cost of transaction in SLB, the margin payment and borrowing fee. There is further scope for reducing margins, so that the transactions costs do not wipe out potential returns for the borrowers and lenders of stocks.
Without addressing these issues, the SLB scheme may still not see the desired level of activity and liquidity to make it workable.
(The author was formerly a General Manager with the Securities & Exchange Board of India; he has now taken voluntary retirement from the Indian Revenue Service and is a practicing advocate).
Please read his earlier article on SEBI’s Lending & Borrowing rules at