India
05 February 2013
Citi may have confidence in India’s burgeoning securities borrowing and lending market, but the country has some changes to make, as SLT finds out
Image: Shutterstock
More than 15 years have passed since securities lending and borrowing became doable in India. The Securities and Exchange Board of India (SEBI) first permitted transactions as early as 1997, via authorised intermediaries, with a range of financial instruments including cash, bank guarantees, government securities and other registered securities.
But permission to lend and borrow does not necessarily mean that actual business is carried out, with India’s rules very much geared towards reducing the risk of settlement failures for domestics.
The current framework was first introduced in 2007, with a view to provide a mechanism for investors to participate in covered short selling, by borrowing securities to enable settlement of the short sold securities.
“Securities borrowing and lending in India is an exchange-traded model with orders executed on an anonymous basis; screen-based order matching platforms are provided by approved clearing corporations/clearinghouses of stock exchanges which are registered with SEBI for this purpose.
“Currently, NSCCL and BOISL are approved to offer this product,” says Pierre Mengal, Asia Pacific head of securities finance at Citi Transaction Services.
SEBI has continuously tried to relax rules around the market, evolving its model over three phases: an initial launch in April 2008 where lending/borrowing contracts were restricted to seven days tenor; December 2008, when tenor extended to 30 days and margin requirement for borrowers reduced with flexibility in collateral form; and July 2010, when tenor extended to one year, with the feature of early recall (for lenders) and early repay (for borrowers) introduced.
Two thousand and ten proved eventful when it came to igniting the market, with Mengal pointing out that since then, average monthly traded volumes have grown multi-fold. “From turnover levels which were insignificant in July 2010, they grew significantly in the first year. Since August 2011, the market has continued to grow at a rapid pace. This clearly demonstrates investor interest and uptake of this product.”
As the first and only international custodian bank to offer securities lending services on the National Stock Exchange in India, Citi has needed to be proactive with exchanges and regulators on securities borrowing and lending right from inception. “Citi has been closely involved in the overall contract structure, providing feedback to address investors’ needs, etc. Some of our key recent initiatives include discussions with the Reserve Bank of India around short selling period and foreign ownership limits and changes to the treatment for corporate action,” says Mengal.
Citi’s service, which gives its domestic and offshore clients access to the exchange-traded central counterparty model in the country, has the advantage of being the first global custodian to cross the finishing line, with the caveat of having no template for adapting an international securities lending solution to the exchange traded framework in India. Now that the bank has made the first steps into the country, Mengal expects other custodians to follow in its wake.
Though November 2012 saw another relaxation of lending and borrowing guidelines, critics argue that the new and improved rules will not stir up the market, with the biggest problem being tough margins.
SEBI allowed lenders and borrowers to carry forward their positions for up to three months rather than one, but brokers at the time were reported as saying that a market for stock lending and borrowing would be more effective outside of the stock exchange settlement system in an OTC format.
But Mengal argues that the exchange-traded model uses clearing corporations with robust risk management systems and employs a time-tested margining mechanism.
“While there is a demand from some market participants for a parallel OTC model, the current central counterparty model in India has emerged as a viable alternative which is working well.”
As well as the system may work for local participants, foreign interest is low. “Considering the total asset pool of foreign institutional investors (FIIs) estimated at approximately $180 billion, the current participation of FIIs as lenders is very small as compared to the traditional international ratios of lendable assets/actual loans and is bound to grow and deepen further,” states Mengal.
He adds that lenders of Indian securities are seeing average annualised returns of 600 to 1000 basis points, surpassing Taiwan (400) and Hong Kong (200).
“Given the high returns, we are seeing an increased interest from offshore players to participate as lenders in this market.”
Mengal admits that there has traditionally been a shortage of lenders—and therefore supply—in the market. But he is confident that changes in insurance regulation will change this. “Insurance companies, which hold significant proportions of equity assets, are currently not permitted to lend securities and to participate in securities lending. However the insurance regulator has recently issued draft guidelines to permit insurance companies to participate as lenders in this market. This will be a key change.”
On the borrowing side, Mengal says that he continues to see active interest from FII borrowers (broker-dealers and hedge funds), which are keen to participate. One of the key constraints for them is the high cost of collateral, as they can only place collateral in Indian rupee cash. “If such players were permitted to place non-cash collateral like government securities (as is allowed for them in cash equity and derivatives segments), it would go a long way towards increasing their participation. The other factor is that currently securities borrowing and lending is permitted only in stocks which have underlying equity derivatives. If the permissible list was expanded to include other stocks, it would increase the demand in the segment.”
“Finally, across institutional lenders and borrowers, investor awareness has been a factor impacting participation,” remarks Mengal. “This is especially true given the fact that the India securities borrowing and lending model is different from most other markets. Lenders/borrowers need to be familiarised with the nuances of this market and as the awareness increases, we expect more participation on this segment.”
Though SEBI has made changes to address shorter tenors and the inability of lenders to recall stock that is lent, it looks as though the country has a long way to go before it can make a real dent in the market. But with Citi placing confidence in the region, as well as upcoming insurance regulation, it would be remiss to discount India just yet.
But permission to lend and borrow does not necessarily mean that actual business is carried out, with India’s rules very much geared towards reducing the risk of settlement failures for domestics.
The current framework was first introduced in 2007, with a view to provide a mechanism for investors to participate in covered short selling, by borrowing securities to enable settlement of the short sold securities.
“Securities borrowing and lending in India is an exchange-traded model with orders executed on an anonymous basis; screen-based order matching platforms are provided by approved clearing corporations/clearinghouses of stock exchanges which are registered with SEBI for this purpose.
“Currently, NSCCL and BOISL are approved to offer this product,” says Pierre Mengal, Asia Pacific head of securities finance at Citi Transaction Services.
SEBI has continuously tried to relax rules around the market, evolving its model over three phases: an initial launch in April 2008 where lending/borrowing contracts were restricted to seven days tenor; December 2008, when tenor extended to 30 days and margin requirement for borrowers reduced with flexibility in collateral form; and July 2010, when tenor extended to one year, with the feature of early recall (for lenders) and early repay (for borrowers) introduced.
Two thousand and ten proved eventful when it came to igniting the market, with Mengal pointing out that since then, average monthly traded volumes have grown multi-fold. “From turnover levels which were insignificant in July 2010, they grew significantly in the first year. Since August 2011, the market has continued to grow at a rapid pace. This clearly demonstrates investor interest and uptake of this product.”
As the first and only international custodian bank to offer securities lending services on the National Stock Exchange in India, Citi has needed to be proactive with exchanges and regulators on securities borrowing and lending right from inception. “Citi has been closely involved in the overall contract structure, providing feedback to address investors’ needs, etc. Some of our key recent initiatives include discussions with the Reserve Bank of India around short selling period and foreign ownership limits and changes to the treatment for corporate action,” says Mengal.
Citi’s service, which gives its domestic and offshore clients access to the exchange-traded central counterparty model in the country, has the advantage of being the first global custodian to cross the finishing line, with the caveat of having no template for adapting an international securities lending solution to the exchange traded framework in India. Now that the bank has made the first steps into the country, Mengal expects other custodians to follow in its wake.
Though November 2012 saw another relaxation of lending and borrowing guidelines, critics argue that the new and improved rules will not stir up the market, with the biggest problem being tough margins.
SEBI allowed lenders and borrowers to carry forward their positions for up to three months rather than one, but brokers at the time were reported as saying that a market for stock lending and borrowing would be more effective outside of the stock exchange settlement system in an OTC format.
But Mengal argues that the exchange-traded model uses clearing corporations with robust risk management systems and employs a time-tested margining mechanism.
“While there is a demand from some market participants for a parallel OTC model, the current central counterparty model in India has emerged as a viable alternative which is working well.”
As well as the system may work for local participants, foreign interest is low. “Considering the total asset pool of foreign institutional investors (FIIs) estimated at approximately $180 billion, the current participation of FIIs as lenders is very small as compared to the traditional international ratios of lendable assets/actual loans and is bound to grow and deepen further,” states Mengal.
He adds that lenders of Indian securities are seeing average annualised returns of 600 to 1000 basis points, surpassing Taiwan (400) and Hong Kong (200).
“Given the high returns, we are seeing an increased interest from offshore players to participate as lenders in this market.”
Mengal admits that there has traditionally been a shortage of lenders—and therefore supply—in the market. But he is confident that changes in insurance regulation will change this. “Insurance companies, which hold significant proportions of equity assets, are currently not permitted to lend securities and to participate in securities lending. However the insurance regulator has recently issued draft guidelines to permit insurance companies to participate as lenders in this market. This will be a key change.”
On the borrowing side, Mengal says that he continues to see active interest from FII borrowers (broker-dealers and hedge funds), which are keen to participate. One of the key constraints for them is the high cost of collateral, as they can only place collateral in Indian rupee cash. “If such players were permitted to place non-cash collateral like government securities (as is allowed for them in cash equity and derivatives segments), it would go a long way towards increasing their participation. The other factor is that currently securities borrowing and lending is permitted only in stocks which have underlying equity derivatives. If the permissible list was expanded to include other stocks, it would increase the demand in the segment.”
“Finally, across institutional lenders and borrowers, investor awareness has been a factor impacting participation,” remarks Mengal. “This is especially true given the fact that the India securities borrowing and lending model is different from most other markets. Lenders/borrowers need to be familiarised with the nuances of this market and as the awareness increases, we expect more participation on this segment.”
Though SEBI has made changes to address shorter tenors and the inability of lenders to recall stock that is lent, it looks as though the country has a long way to go before it can make a real dent in the market. But with Citi placing confidence in the region, as well as upcoming insurance regulation, it would be remiss to discount India just yet.
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