India
21 September 2010
It’s early days for India’s securities lending industry, but the building blocks are in place
Image: Shutterstock
With an enormous population, a well-educated and committed workforce, and a legal and financial infrastructure that is at least recognisable to major financial institutions, India is set to become a major financial player, and the structure for a booming securities lending market is in place. But it’s not quite there yet.
The problem is essentially the same as for anyone who wants to do any kind of business in the country: bureaucracy and inertia. The Indian Government is keen to attract international investment and build up a domestic industry, but when it comes to financial markets it is treading carefully - the economy is by no means as fragile as that of some of its neighbours, but it doesn’t want to risk the kinds of problems seen around the world over the past couple of years.
Securities lending and borrowing has actually been available in India for many years. The Securities and Exchange Board of India (SEBI) first permitted transactions as early as 1997, via authorised intermediaries. A range of financial instruments was allowed, including cash, bank guarantees, Government securities, CDs and other registered securities.
The rules around this introduction were very much geared to the domestic market, however, and weren’t really brought in to take securities lending as a financial product in its own right - it was simply to reduce the risk of settlement failures, something that was already in place through other measures, such as daily auctions on the exchanges. But it has moved on.
Over the past few years, SEBI has relaxed the regulations surrounding securities lending and borrowing. Short selling is now allowed, and securities lending tenures were permitted for up to seven days, then 30 days and, since the start of the year, 12 months. Transactions can still only be made in securities that trade in the futures and options segment. The auction process still used to reduce settlement risk, but providers feel that this is an archaic system, and the removal of the process will stimulate the securities lending market.
“Settlement risk is key to securities lending, and we want to have a system that is recognised internationally,” says one participant. “But the auction process is holding us back - people who have been in the market for a long time are sticking to what they know and steering clear of the more advanced options. If we can get rid of auctions [as has been proposed] then securities lending can only grow.”
Vikramaditya, head, HSBC Securities Services (India), in Mumbai says, “Securities lending and borrowing will enable the market to reach the next level in terms of infrastructure, and increase the options available to market players.”
Participants
Becoming authorised to participate in securities lending activities is relatively straightforward, even if it can take a long time. Domestic providers and mutual funds are permitted to operate, and international firms are allowed to apply for authorisation. Custodians with a minimum specified net worth may also be considered as an intermediary.
The main lending and borrowing comes from the large domestic mutual fund arena, and local and international banks. There is some interest from international funds, but this is yet to materialise. There are also calls for insurance companies to be allowed to come into the arena.
“India has a large and growing middle class, and they are increasingly keen on putting their money to work,” says one fund manager. “Domestic funds management firms such as Reliance have seen a huge inflow of monies and the fund sector is growing faster than almost anywhere else in the world. As the funds become more comfortable with securities lending, there should be a significant amount of activity.”
Growth
In part, the growth is being driven by India’s greatest export: talent. Thousands of educated Indians are working for the biggest financial institutions all over the world, and when they return to their home country they have built up new knowledge and enthusiasm about the potential of securities lending. This is then feeding through to the domestic banks and the domestic arms of the international providers, the stock exchanges and the regulators.
“Things always happen slowly in India,” says trader Naveen Khalia. “We have the world’s worst bureaucracy and - when it comes to Government bodies - a fear of using initiative. “But people who have worked abroad are coming back and saying India is ripe for a booming securities lending industry. It has it all - a growing and untapped fund market, growing electronic trading platforms, a motivated and educated group of professionals who can cope with the business, and a reasonable regulatory environment.”
In percentage terms, growth this year has been fantastic. In real terms, levels are still very low. Between January and June this year, there was just one transaction on average every two trading sessions; in July and August it rose to an average of about seven a day, and so far this month it has reached around 15 trades a day.
This has coincided with the implementation of the new rules agreed at the start of the year, and also the increased flexibility in the type of contracts which allows borrowers and lenders to make an early recall or repayment of the securities.
Kapil Seth, head, HSBC Securities Services (India), says, “We haven’t seen much activity on the securities lending front. The volumes in the past two months may be from domestic participants taking advantage of arbitrage opportunities between the cash and futures markets. There’s nothing to indicate to us a reversal of trend as far as interest from foreign institutional investors goes.”
It’s generally accepted that it will be foreign investors that drive the market. As securities lending volumes shrank worldwide as a result of the downturn, entering new markets became less important. But as Indian businesses become increasingly global - and many Indian companies are comparable in size to the largest multinationals - more investors are taking an interest.
Some of the world’s biggest international banks already have a major footprint in the country, with HSBC seemingly leading the way. And where these behemoths go, others will follow.
The problem is essentially the same as for anyone who wants to do any kind of business in the country: bureaucracy and inertia. The Indian Government is keen to attract international investment and build up a domestic industry, but when it comes to financial markets it is treading carefully - the economy is by no means as fragile as that of some of its neighbours, but it doesn’t want to risk the kinds of problems seen around the world over the past couple of years.
Securities lending and borrowing has actually been available in India for many years. The Securities and Exchange Board of India (SEBI) first permitted transactions as early as 1997, via authorised intermediaries. A range of financial instruments was allowed, including cash, bank guarantees, Government securities, CDs and other registered securities.
The rules around this introduction were very much geared to the domestic market, however, and weren’t really brought in to take securities lending as a financial product in its own right - it was simply to reduce the risk of settlement failures, something that was already in place through other measures, such as daily auctions on the exchanges. But it has moved on.
Over the past few years, SEBI has relaxed the regulations surrounding securities lending and borrowing. Short selling is now allowed, and securities lending tenures were permitted for up to seven days, then 30 days and, since the start of the year, 12 months. Transactions can still only be made in securities that trade in the futures and options segment. The auction process still used to reduce settlement risk, but providers feel that this is an archaic system, and the removal of the process will stimulate the securities lending market.
“Settlement risk is key to securities lending, and we want to have a system that is recognised internationally,” says one participant. “But the auction process is holding us back - people who have been in the market for a long time are sticking to what they know and steering clear of the more advanced options. If we can get rid of auctions [as has been proposed] then securities lending can only grow.”
Vikramaditya, head, HSBC Securities Services (India), in Mumbai says, “Securities lending and borrowing will enable the market to reach the next level in terms of infrastructure, and increase the options available to market players.”
Participants
Becoming authorised to participate in securities lending activities is relatively straightforward, even if it can take a long time. Domestic providers and mutual funds are permitted to operate, and international firms are allowed to apply for authorisation. Custodians with a minimum specified net worth may also be considered as an intermediary.
The main lending and borrowing comes from the large domestic mutual fund arena, and local and international banks. There is some interest from international funds, but this is yet to materialise. There are also calls for insurance companies to be allowed to come into the arena.
“India has a large and growing middle class, and they are increasingly keen on putting their money to work,” says one fund manager. “Domestic funds management firms such as Reliance have seen a huge inflow of monies and the fund sector is growing faster than almost anywhere else in the world. As the funds become more comfortable with securities lending, there should be a significant amount of activity.”
Growth
In part, the growth is being driven by India’s greatest export: talent. Thousands of educated Indians are working for the biggest financial institutions all over the world, and when they return to their home country they have built up new knowledge and enthusiasm about the potential of securities lending. This is then feeding through to the domestic banks and the domestic arms of the international providers, the stock exchanges and the regulators.
“Things always happen slowly in India,” says trader Naveen Khalia. “We have the world’s worst bureaucracy and - when it comes to Government bodies - a fear of using initiative. “But people who have worked abroad are coming back and saying India is ripe for a booming securities lending industry. It has it all - a growing and untapped fund market, growing electronic trading platforms, a motivated and educated group of professionals who can cope with the business, and a reasonable regulatory environment.”
In percentage terms, growth this year has been fantastic. In real terms, levels are still very low. Between January and June this year, there was just one transaction on average every two trading sessions; in July and August it rose to an average of about seven a day, and so far this month it has reached around 15 trades a day.
This has coincided with the implementation of the new rules agreed at the start of the year, and also the increased flexibility in the type of contracts which allows borrowers and lenders to make an early recall or repayment of the securities.
Kapil Seth, head, HSBC Securities Services (India), says, “We haven’t seen much activity on the securities lending front. The volumes in the past two months may be from domestic participants taking advantage of arbitrage opportunities between the cash and futures markets. There’s nothing to indicate to us a reversal of trend as far as interest from foreign institutional investors goes.”
It’s generally accepted that it will be foreign investors that drive the market. As securities lending volumes shrank worldwide as a result of the downturn, entering new markets became less important. But as Indian businesses become increasingly global - and many Indian companies are comparable in size to the largest multinationals - more investors are taking an interest.
Some of the world’s biggest international banks already have a major footprint in the country, with HSBC seemingly leading the way. And where these behemoths go, others will follow.
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