What is stock lending and borrowing & how it works

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What is SLB?

Securities Lending and Borrowing is a mechanism through which investors can borrow or lend shares to other market participants. The platform provides a viable alternative to derivatives market for purposes of hedging. Borrowers in SLB are usually short-sellers i.e. traders who want to sell shares that they don’t own. Lenders on the other hand are those investors who have bought shares for long-term purposes and such shares are lying idle in their demat accounts.

Why SLB?

Just like a loan you avail from a bank, if you have borrowed the shares from another investor, an interest has to be paid for the lender. The interest rate varies from stock to stock and also depends on tenure of such borrowings. As per Sebi rules, stocks can be borrowed for a maximum period of 12 months. The interest rate for such lending is not fixed but is determined by the market conditions. Globally, long-term investors such as mutual funds or insurance companies are key lenders in SLB. On the other hand, SLB is a less risky option for short-sellers compared to the more complex options and futures contracts. In India, over 200 stocks are available on SLB platform for borrowing and some of the stocks that are not part of derivatives or that see thin volumes in futures market are available for borrowing on SLB.

What is the current relevance of SLB?

Market regulator Sebi has announced transition of Indian derivatives market from cash settlement to physical settlement by September this year. Until now, investors largely used SLB for reverse arbitrage opportunities i.e. those situations where future contracts of a company are trading at a discount to the cash market prices. In such scenario, traders sell stocks and buy futures contracts.

However, Sebi’s decision to move to physical settlement will bring more short-sellers to SLB platform.

Typically an F&O trader has three courses of action available for him. Either he can square-off his position before expiry and pay the cash differential, or he can roll-over the contract for next month. If the investor doesn’t choose any one of these two options, the contract gets expired and under physical settlement, shorts will have to offer shares to cover the open position. In such scenario, rather than buying shares from open market to cover position, a trader can go to the SLB platform and borrow the required shares for covering. At a later stage when the share prices are favorable, he could purchase the shares from cash markets and return them to the lender. This process is known to be more cost efficient than buying shares from open market.

What is the risk involved?

Market regulator Sebi has placed several safeguards for the platform including reliable settlement system. “Unlike many other countries, SLB is an exchange-traded product in India, settled by the clearing corporations, which means there is no counterparty risk,” said Sriram Krishnan, head of securities services, Deutsche Bank. “Investors should ideally lend out stocks and make an additional return as every penny counts. While yields are a function of the demand, we have seen attractive lending fee levels in the past 18-24 months, in many stocks.”

[“source=economictimes.indiatimes”]