Throwing light on Lending and Borrowing of Securities

Throwing light on Lending and Borrowing of Securities

FPJ BureauUpdated: Saturday, June 01, 2019, 07:18 AM IST
article-image

There are two types of persons dealing with the stock market. One is basically an investor who is aware of the fact that the market, by and large, beats inflation and the returns in the long run therefrom are superior to any other avenue.

Moreover, there are a myriad of tax incentives offered to a long-term investor which reward him adequately. Such an investor, whenever he has investible funds buys shares which are best expected to rise handsomely and once he has completed the transaction, he rarely sells. He holds for the long-term. The income earned by such a person is by way of dividends and capital gains.

The other person is a speculator (alternatively called market maker) who buys and sells shares frequently trying to benefit from their regular rise and fall (=volatility). There is no problem if he buys the shares and pays the full amount for their purchase. But more often than not, he sells a scrip without having it in his ‘warehouse’ with a hope that the market will fall and he will square up for a profit.

But if his estimate goes wrong and the market rises, he is in trouble and may default in squaring up the deal eventually.

Such a deal was termed as ‘Badla’ during the old days and is known as ‘naked short sale’ now. SEBI, the regulator of the stock market very wisely banned such transactions after encountering the famous ‘Harshad Metha’ and ‘Ketan Parekh’ scams. Unfortunately, this resulted in curtailing, even truncating market depth which is very necessary to locate the real value of any scrip.

To tackle this issue, the Secondary Market Advisory Committee of SEBI recommended facilitating all classes of investors (individuals, institutions, etc) to borrow securities from any willing lenders who own them. In order to provide a mechanism for borrowing of Indian securities to enable settlement of securities sold short, Circular SMD/POLICY/SL/CIR-09/97 dt 7.5.1997 promulgated ‘Securities Lending and Borrowing Scheme, 1997” (SLB). Having received a lukewarm response, it modified the Scheme on October 08, June 10 and further in November 12. Unfortunately, the response continues to be lukewarm even though this Scheme is actually a win-win for both the borrowers and lenders.

The lenders earn some income on their otherwise idle investment and the borrowers can indulge in short selling at a very small cost.

This piece is targeted towards those investors who have not looked at this SLB so far.

Modalities

The risk for the lenders is almost NIL.

The Stock Exchanges / Depositories ensure that all appropriate trading and settlement practices as well as surveillance and risk containment measures, etc., are made applicable and implemented in this regard. They put necessary systems in place so as to distinguish the SLB transactions from the normal market transactions in the demat system. Consequently, SLB takes place on an automated screen-based order-matching platform set up by the clearing corporations, who also become the central counterparty guaranteeing settlements and collect margins for the same. This is independent of the other trading platforms.

At present, there are two Approved Intermediaries (AIs) — NSCCL and ICCL, the respective Clearing Corporations of NSE and BSE.

All the securities traded in F&O segment are eligible for short selling.

Any institutional investor shall disclose upfront at the time of placement of order whether the transaction is a short sale. However, a retail investor would be permitted to make a similar disclosure by the end of the trading hours on the transaction day.

The tenure of lending/borrowing shall be fixed as standardized contracts. The settlement cycle for SLB transactions shall be on T+1 basis. The settlement of lending and borrowing transactions shall be independent of normal market settlement. The settlement of the lending and borrowing transactions shall be done on a gross basis at the level of the clients. In other words, no netting of transactions at any level will be permitted.

In case lender fails to deliver securities to the AI or borrower failing to return securities to the AI, lending transaction would be financially closed out and for borrowing transaction the AI shall conduct an auction for obtaining securities. In the event of exceptional circumstances resulting in non-availability of securities in auction, such transactions would be financially closed-out at appropriate rates, which may be more than the rates applicable for the normal close-out of transactions, so as to act as a sufficient deterrent against failure to deliver securities.

Limits

The market–wide position limits for SLB transactions shall be 10% of the free-float capital of the company in terms of number of shares

No Participant and/or SLB member shall have open position of more than 10% of the market-wide position limits or Rs. 50 crore (base value), whichever is lower.  For a FII/MF, the position limits shall be the same as of a Participant and/or SLB Member

The client level position limits shall be not more than 1% of the market-wide position limits.

Any borrowing/lending and return of securities would not amount to purchase/disposal/transfer of the same for the purpose of compliance with the extant FDI/FII limits and the norms regarding acquisition of shares/disclosure requirements specified under the various Regulations of SEBI.

AIs shall provide suitable arbitration mechanism for settling the disputes arising out of the SLB transactions executed on the platform provided by them.

Taxation

CBDT has, vide Circular 2/2008 dt 22.2.2008 clarified that STT is levied on purchase and sale of an equity share, unit and derivatives. SLB being a transaction not involving any of these is not liable to STT. Moreover, no stamp duty is applicable on the confirmation memo issued by the participants.

The lending fee would be an income in the hands of the lender and would be taxable either as Business Income or Income from Other Sources.

To Conclude

As observed earlier, if you have some shares in your demat account and you do not wish to sell them in near future, you can earn some extra income by undertaking SLB. The risk is almost nil.

Unfortunately, the ‘Investor’ at large, particularly the retail investor, so far, has not looked at this Scheme and prefers to sleep over his investments even when there is a possibility of the earning some income, on his otherwise idle assets.

Wake up.

(The authors may be contacted at

wonderlandconsultants@yahoo.com)

A N Shanbhag

RECENT STORIES

Game-Changing Alliance: Ambani's Reliance Ventures Into Adani's Power For The First Time; Acquires...

Game-Changing Alliance: Ambani's Reliance Ventures Into Adani's Power For The First Time; Acquires...

SRM Contractors IPO Subscribed 86.57 Times On Last Day Of Bidding

SRM Contractors IPO Subscribed 86.57 Times On Last Day Of Bidding

Tax-Saving Tip From Zerodha CEO Nithin Kamath: 'If You're Married And Hindu..."; Here's How To Save...

Tax-Saving Tip From Zerodha CEO Nithin Kamath: 'If You're Married And Hindu...

Holy Cities Like Ayodhya, Varanasi Attracting Big Retail Brands: Report

Holy Cities Like Ayodhya, Varanasi Attracting Big Retail Brands: Report

A Big Relief For Byju's: NCLT Rejects Investor Plea To Stay Byju's Rights Issue EGM On March 29 Amid...

A Big Relief For Byju's: NCLT Rejects Investor Plea To Stay Byju's Rights Issue EGM On March 29 Amid...