Energising the SLB platform

Written by Bijith R | Updated: Jan 30 2010, 04:27am hrs
In order to give a much needed boost for the securities lending and borrowing (SLB) scheme, which was lying dormant since its operationalisation in 2008, the stock market regulator Securities and Exchange Board of India (Sebi) recently extended the tenure of SLB contracts up to a maximum period of 12 months, from the existing one month tenure.

The SLB scheme was initially introduced to bring in better price discovery and stability in the market. The reasoning was that the system would provide traders and investors an alternative mechanism whereby they could sell a security in the cash market which they think is over-priced without actually owning it.

At the moment, the system requires that the short seller, somebody who sells securities, without owning them, to square off their positions at the end of the day. The options for the short seller would, therefore, be to buy from the open market or borrow these securities. The earlier tenure was for a month and now these securities can be borrowed for a year long tenure from an approved intermediary that acts as the central counter party to meet the settlement obligation.

At present, the regulator has authorised clearing houses of both the stock exchanges - National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) - to act as the approved intermediary with which the borrower and lender enter into an independent contract. And the trader, who has borrowed the security, has the flexibility to return it within the specified tenure of the contract. In case the borrower fails to meet his commitment on the expiry of the contract tenure, the approved intermediary will be liable to return the sufficient quantity of securities to the original lender.

Earlier when the tenure for the SLB scheme was fixed at one week and then was later extended to one month and this still was seen as a risky proposition for traders and therefore there were few takers for this platform. Since the market was highly volatile and swung wildly on either side, it was risky for an investor or trader to short a particular stock and borrow through the SLB mechanism to meet their commitment for a shorter period of one month. Since the stocks that were permitted to trade under the futures and options segment were only allowed under the SLB mechanism, it made sense for investors to use the NSE derivative segment rather than the SLB platform.

Globally, short selling on the cash market is permitted to facilitate fair price discovery based on the actual demand and supply. In the absence of short selling in the cash market, a trader who has a bearish view tends to keep away and takes short positions in the futures market, which is highly leveraged and by that virtue is seen to be risky. And the cash market is then dominated by bulls driving the stock prices to exorbitant levels distorting a fair price discovery in the market. This, according to experts, posed systemic risk to the equity market as a whole and often resulted in steeper correction impacting the confidence of ordinary investors.

Now, with the regulator deciding to extend the tenure of the SLB contract to one year and allowing the flexibility for a trader to repay the securities borrowed any time before the completion of the tenure could spur some of them to actually consider this platform according to expert.

Siddarth Bhamre, head of derivative at Angel Broking reckons, "Earlier when the tenure of the both SLB contracts and F&O contracts were for one month, traders and investors were attracted towards the later one. Since now the SLB tenure has been extended up to a year, a trader having a bearish outlook on a particular stock or index over a longer period of time may look at this option as the rollover cost in the derivative segment tends to be higher over a longer duration".

This will also provide opportunity for those long-term investors to earn additional income on their idle portfolio by lending their securities through the SLB platform.

But Bhamre further says that for the SLB platform to take-off in a big way requires liquidity and just like in any other product market making exercise should be thought of to make this product popular among the investing community.

Others feel that the tenure of one year looks a lot better than the previous one, still the regulator has to reduce the cost of SLB system and widen its scope to make it more attractive.

"The present system requires an investor to pay a 100% margin to be maintained with the approved intermediary. This makes the system looks less attractive and viable for only cash-rich investors," said Manish Shah, associate director, Motilal Oswal Financial Services (MOFSL). Further, the regulator should also think of widening the scope of SLB platform to non-F&O stocks, he said.

For instance, a trader who wants to sell 100 shares of security 'A' valuing Rs 1,000 per share will have to pay 100% margin (Rs 1 lakh) in the SLB platform. For the same security of similar quantity, the trader is required to pay 7% to 10% as margin in the derivative segment depending upon the value at risk (VaR) margin specified by the stock exchanges from time to time.

This makes the derivative markets more attractive than SLB scheme for investors. However, this also emboldens speculators to excessively leverage on the futures and options segment increasing the volatility in the market.

Overall, the SLB mechanism is yet another piece that will add to the depth of the Indian equity markets. While there will be different views on its efficacy, this is clearly a mechanism that offers choice and promises to improve liquidity and stability in the market place.