This article is written by Aura Das, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.
What is Securities Lending and Borrowing?
Securities Lending and Borrowing (SLB) is a medium of lending and borrowing securities that are legally approved by SEBI. Securities Lending and Borrowing is a scheme that enables the settlement of securities sold short. It also enables lending of idle securities through the investors by way of clearing corporations or clearing house of stock exchanges in order to earn a return through the same. Short sale of securities generally occurs when investors sell securities that they do not own. They sell the securities with the belief that the prices of the securities. This would enable the investors to buy back the securities at a lower price and make a profit.
SEBI in May 1997 formed the regulations for SLB which were further modified in November 2012. All market participants including retail (except Qualified Foreign Investors) in the Indian securities market have been legally permitted to lend or borrow securities but only through an Authorized Intermediary (AI). The only two authorized intermediaries are NSCCL (NSE Clearing Corporation) and BOISL (BSE Clearing Corporation).
The SLB operations are managed by the clearing corporation of the National Stock Exchange of India (NSE) which operates through a screen-based exchange-traded system called SLB-NEAT. All the borrowing and lending are cleared, settled and guaranteed in a centralized anonymous order book. The lending fees and the price are quoted and the tenure is generally up to 12 months. Moreover, the facility to make an early repayment of securities and to further related them is made available to the borrower.
Securities in the Future and Options (F&O) are the majorly traded stock derivative in the share market. These are basically contracts signed between two parties for trading a stock asset at a later date at a predetermined price. It allows investors to prevent future risks of their investment through pre-determined prices. Certain companies list their shares as F&O for future transactions. Securities in the F&O segment are eligible for short selling. Presently, derivatives of securities that are available in the F&O segment are available for SLB transactions.
NSCCL gets the bulk of the transactions and acts as a central counterparty providing a financial settlement guarantee for SLB transactions. It collects margins from participants which is adequate to cover counterparty risks.
The position limits which are specified by SEBI are not applicable to early recall or repayment transactions. They are applicable to original transactions till the successful completion of early recall or repayment transactions. Participants may deposit collaterals in the form of cash equivalents i.e. cash, fixed deposit receipts and bank guarantee. The collateral deposited by the participant is utilized towards the margin requirement of the participant. A minimum of Rs. 10 lakhs in the form of cash needs to be continuously maintained by every participant, as prescribed by the NSCCL. The deposit needs to be provided by the participant at the time of registration in the Securities Lending and Borrowing Scheme (SLBS). All transactions are subjected to margins as prescribed by the scheme.
SEBI framework for Securities Lending and Borrowing
In order to regulate the borrowing and lending of securities to enable settlement of securities sold short, SEBI notified a full-fledged securities lending and borrowing (SLB) scheme “Securities Lending Scheme, 1997” (SLS 1997) for all market participants in the Indian securities market. The main features of the scheme are as follows:
- The securities lending and borrowing scheme would be operated through Clearing Corporation/ Clearing House of stock exchanges which would have their terminals all over the nation and would be registered as Approved Intermediaries (AIs) under the SLS 1997. The AIs would provide screen-based automated platforms which would be independent of all other trading platforms.
- As discussed above, securities traded in the F&O segment would be eligible under the scheme for lending and borrowing.
- All categories of investors such as retail, institutional, financial, etc. would be eligible for borrowing and lending of securities. The borrowers and lenders can do so by accessing the lending and borrowing platform set up by the AIs through the Clearing Members (CMs). The CMs can include banks or other bodies and need to be authorized by the AIs for such activities.
- An agreement is undertaken by the AIs, CMs and the clients specifying the rights, obligations and responsibilities of the parties. It would also include specific conditions for borrowing and lending as per the scheme and may include suitable conditions to ensure proper execution, settlement of lending and borrowing transactions with the clearing member and client as well as risk management. The main responsibility of the CMs is to ensure compliance with the KYC norms. The exact roles of each party with respect to the clients would be elucidated in the agreement. There would also be one master agreement, the first part of which would be between the AIs and the CMs and the second part would be between the CMs and the clients.
- The tenure of the lending and borrowing is generally fixed as standard contracts. The settlement of the transactions would be independent of normal market settlements and would be on a T+1 basis. Suitable risk management systems would be formulated by the AIs to guarantee the delivery of securities to the borrower and return the same to the lender.
- Any case of failure to deliver the securities to the AIs or any failure by the borrower to return the securities to the AI would amount to an auction to be conducted by the AI for obtaining the securities. In the event of exceptional circumstances resulting in the non-availability of securities in the auction, such transactions would be financially closed-out at appropriate rates, which may be more than the rates applicable for the normal close-out of transactions, so as to act as a sufficient deterrent against failure to deliver securities.
- The position limits would be determined by the AIs in consultation with SEBI. The market-wide position limits for SLB transactions shall be 10% of the number of shares in the refloat capital of the company. A clearing member is not allowed to have an open position of more than 10% of the market-wide position limit or Rs. 50 crores, whichever is lower. The position limits for an FII shall be the same as any clearing member. The position of the client shall not be more than 1% of the market-wide position limits.
- For the purpose of compliance with the FDI/FII limits and the norms regarding the acquisition of securities or any disclosure requirements specified under various regulations of SEBI, any borrowing, lending or return of securities would not amount to purchase, disposal or transfer of the same.
Lending and borrowing regulations for other entities
Foreign Portfolio Investors (FPI) and the Foreign Institutional Investors (FII)
For the Foreign Portfolio Investors (FPI) and the Foreign Institutional Investors (FII), the lending is allowed subject to the FDI policy. Lending is not permitted for shares that are listed in the caution list of RBI. Borrowing is permitted only for delivery into short sales. Margins need to be paid in the form of cash. Short selling, lending and borrowing of securities will have to be reported by the custodians on a daily basis.
In the case of mutual funds, offer documents will have to disclose the intention of the parties to lend securities, the exposure limit for the scheme as well as the market risks. The Asset Management Companies (AMCs) need to report to the trustees about the lending with respect to their values, volume and intermediaries, earnings and losses and other details as may be required on a daily basis.
For insurance companies, lending is allowed to the extent of 10% of the quantity in the respective funds. The lending limit needs to be adhered to at all times. Any security lent in SLB shall not be treated as creating any charge, hypothecation, encumbrance or lien on such security. Lending shall be allowed only after approval from the investment committee. The lending fees shall be accounted for on an accrual basis.
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