Understanding Stock Lending And Borrowing

Amit Bhanot files a report on making investors how a stock market investor can lend his share through a dedicated platform for an anticipated price of the scrip

It is usually said that in the stock market money can be earned by entering into the stocks at the right time and exiting at the right spot. In this cue, usually an investor crumbles due to greed as well as wrong assessment of the growth prospects in future, and in both cases he loses his hard-earned money to the stocks. It usually happens that when your stock’s price reaches the target that you have set, the market’s assessment about the price of that particular stock changes dramatically and by sheer greed we stick to that share in anticipation of more growth in the stock.

On the other hand, if the stock price goes down, we usually do “averaging” so that we can recoup our losses. But in both the cases we lose good amount of money. In such a scenario it is of immense importance that we should do profit booking at right moment and also limit our losses by putting “stop loss.” Quite different from this is another practice that can also help you to make efficient use of our investment in equities without actually selling the stocks. We are referring to the practice of Stock Lending and Borrowing (SLB) where any investor, be it retail or institutional and even FII/MF via an agreement with participants, can lend his share through a dedicated platform for an anticipated price of the scrip, called lending fee.

This practice, though present there for quite some time, is not quite common among investors but any investor can make use of this opportunity. Actually, when in 2007, SEBI allowed short selling of certain securities then automatically a need arose wherein there should be a mechanism from where anybody can arrange or borrow shares that have been sold short by the participants. For this a mechanism of SLB has been established by SEBI for enabling settlement of securities sold short. SEBI has also put in place a full-fledged Securities Lending and Borrowing Scheme (SLB) for all market participants in the Indian securities market.

With this mechanism in place retail investors can also take benefit of this system to become the lender of stocks. This phenomenon is constantly on the rise and turnover-wise the SLB turnover is constantly increasing and it crossed more than Rs 600 crore in August 2015. According to Phillip Capital, during the first six months of the current year around 70 stocks have participated in SLB mechanism and gave annualized return of even more than 20 per cent. Stocks like SAIL, NMDC, BHEL and TVS Motors have given annualized return of even more than 24 per cent for the same period.

What is Stock Lending & Borrowing?

Stock Lending & Borrowing (SLB) is a practice where shares will be lent and borrowed on an online platform of NSE and BSE just like purchase and selling of shares. Interestingly, it is a product launched by exchanges within the overall framework prescribed by SEBI. SLB is a temporary loan of stock for a fee called lending fee. Market participants can lend or borrow at NSE / BSE, wherein NSCCL / BOISL are approved clearing house for such transactions.

National Securities Clearing Corporation (NSCCL) is powered by NSE platform, which is a screen-based exchange traded terminal called SLBNEAT. On the other hand, on BSE it is facilitated by BOISL through FOW. NSCCL / BOISL acts as the central counter party providing financial settlement guarantee for SLB transactions. As far as stock lending is concerned, all the stocks, in which derivative trading is allowed, qualify for SLB transaction. In addition to this, exchanges can also allow other stocks for SLB on the basis of average monthly turnover.

Stocks can be loaned at a fee called “lending fee” that is quoted on per share basis. In principal the lending fee may be quoted based on the annualized yield expected by the lender or the cost which the borrower expects to pay. Going by this if any share owner wants to lend his share, say for 90 days, then he can quote the fee on the basis of per share at a price according to the return he expects from that share. As far as margin is concerned, no margin is levied on the lender in case of early pay in, while the borrower has to pay margin of 100 per cent of the lending price as well as volatility margins and mark to market at the end of the day.
[PAGE BREAK]

This margin can provided in form of cash, fixed deposit or bank guarantee. Interestingly, a participant who has an existing lend position can recall a position by entering a recall order on the trading terminal. In this, the lender of the stock will quote the lending fee it wishes to forgo for the balance period and this transaction can happen on T+1  basis. At the same time a participant having an existing borrow position can repay the securities to NSCCL before the tenure. On receipt of securities the margins levied on borrower are immediately released. If borrower does this then he can further lend the securities for the balance period of the tenure. For this the borrower needs to enter a repay order on the trading terminal by selecting order type as “Repay”. The borrower shall quote the fee he expects to receive for the balance period. This transaction again can happen on T+1 basis and repay orders can be entered up to three days prior to the respective reverse leg settlement day.

How Safe is SLB?

As per the legal framework of exchanges and SEBI SLB, it seems quite safe as it is governed by SEBI’s guidelines and SEBI has permitted all categories of investors - retail, institutional as well as FIIS - to take part in the stock lending and borrowing scheme. Also, the order booking mechanism of SLB is quite transparent where anybody can transact same as like buying and selling of shares. For example, NSE’s NEAT platform has a centralised anonymous order book and all the borrowing and lending are cleared, settled and guaranteed suo motto in a transparent way.

Importantly for investors, lending fee is quoted on per share basis. As lending can be done for a period of one year; so 12 fixed monthly tenures with fixed reverse leg settlement dates are available for transactions in SLB and any investors can see these dates and order accordingly. As per the system, the first Thursday of the respective month has been fixed as the settlement dates for SLB transaction. Any lender of the shares can recall his lend position through the trading terminal just like selling of shares and recall his existing lend position.

In terms of security, exchanges’ full support exists for the SLB mechanism both from NSE and BSE. On the NSE part, NSCCL acts as a central counterparty providing financial settlement guarantee for SLB transactions. NSCCL claims that it has a robust risk management system and collects adequate margins from participants to cover counterparty risks.  NSSCL currently calls for minimum deposit of Rs 10 lakh from the participants

Complete Coverage Against Corporate Actions and Complete Tax Benefit

If any investor goes for stock lending then he also need not worry about the benefits of corporate action like bonus announcements as it is taken care of well in the current system. Importantly, except dividends and stock splits, SLB transactions are to be foreclosed two days prior to the ex‐date or as prescribed by clearing corporation from time to time. The dividend would be collected from the borrower and passed on the lender at the time of book closure or record date, whereas borrower’s obligations are revised as per stock split. In this way all the corporate actions will be well taken care off.

On the tax benefit part also, SLB is quite beneficial as it has already been clarified that stock lending doesn’t amount to transfer or sale of shares and also STT is not levied on such transactions. Also, participants have the option to recall existing lend position and also repay existing borrowed position. As per the CBDT circular issued in 2008, lending and borrowing of securities under the SLB would be covered by Section 47(xv) of the IT Act and hence, not be liable to capital gains tax