Securities lending is growing across Asia, but India has so far been immune to the rising appetite. Nicholas Pratt examines whether this may change.
The appetite for securities lending and borrowing across Asia has grown in recent years. Regional regulators are engaged in a number of initiatives to encourage more activity, especially from global institutions. Indonesia and South Korea are partnering on bilateral securities lending model, due to be implemented next year.
Philippines has issued guidelines for short selling in March and Taiwan has sought market views on current daily short selling ceilings.
Meanwhile, participants anticipate that the much-vaunted Hong Kong Shanghai Connect will include a provision for securities lending. For India, the rush for securities lending may not happen quite yet.
Despite regulators’ efforts to ease restrictions in lending and borrowing rules, the level of activity remains limited.
“The majority of participants are small, regional players,” says Chris Benedict, director of market data firm DataLend. “Shares in the local market are not often borrowed for securities lending transactions. Most institutions looking to short Indian securities do so through exchange-traded funds (ETFs) or depositary receipts.”
In terms of the asset classes, Indian securities and ETFs were in greater use last year than they have been this year, although they have enjoyed a small rally in the second quarter of the year, while equities have been cooling thus far this year, says Benedict.
Meanwhile, securities lending in Indian fixed income is limited to a few agency names, mostly utilities, along with corporates including the State Bank of India (London) and Reliance Industries.
It was in 1997 that the Securities and Exchange Board of India (Sebi) allowed lending and borrowing via authorised intermediaries and with a limited range of instruments, including cash, bank guarantees and registered securities.
Despite early enthusiasm, stringent rules and a limited set of eligible stocks have stunted the market’s growth.
Since then the regulators have tried numerous times to ease restrictions, most recently in May last year, as well as issuing new guidelines in June, thereby putting many of the necessary building blocks in place for an expanded market.
Despite these efforts, it is unclear whether the Indian market will develop beyond one that is primarily used by small and regional players looking to reduce their settlement risk.
“The Indian regulator and exchanges have shown keen resolve to seek market feedback to implement changes to deepen the securities lending market,” comments Aashish Mishra, head of securities and fund services, Citi India.
Tenor expansion, extending eligible securities, rationalising collateral requirements, early recall (on a best efforts basis) and easing documentation are some key positive changes that have been well received and helped the market grow over the past few years.
However, Mishra says that in order for the securities lending market to benefit both foreign and domestic investors, there are some further steps that need to be taken.
The first of these is to allow non-cash collateral for foreign borrowers. They are currently required to place more than 115% in cash, which Mishra says makes it commercially unviable.
Additionally, there should be an allowance for early recall, the permission for borrowing of securities for fails coverage, an increase in eligible securities which still remain limited.
“Given that the programme has been in place for over five years and given the confidence in infrastructure and risk management, the eligible securities should be broad-based, Mishra says. “There should also be a redefinition of the lending portfolio for insurance companies which cannot currently lend more than 10% of their portfolio.”
Inadequate awareness among the market participants, especially the domestic investors has been one of the biggest obstacles to the growth of the securities lending market, says Mishra, although concentrated efforts by exchanges and other international participants has helped raise awareness and participation among domestic and overseas investors.
“Since the introduction of enhanced features in July 2010, the securities lending and borrowing volumes have grown over 50 times to an approximate average monthly market turnover of $100 million,” says Mishra.
“In our discussions with large international players they have shown keen interest in this market but remain restrained due to lack of flexibility especially around collateral form and specific features of how the contract operates. However, they are eager to increase participation as opportunities present themselves.”
India is among a few countries that has a liquid single stock futures market, thereby allowing investors to take a short position in this segment. Coupled with the fact that securities lending is largely restricted to these securities, the key motivation for borrowing trades have been cash-futures arbitrage.
“An increase in eligible securities, permitting fails coverage and active participation by foreign investors (non-cash collateral, early recall and repayment) would help to expand the market as sophisticated institutional players can bring in more strategies, which will deepen market liquidity,” says Mishra.
According to Martin Corrall, chairman of the Pan Asia Securities Lending Association (Pasla), it is the various infrastructural nuances that make India such a challenging market for securities lending.
“From a borrower’s perspective it is costly as they have to post Indian rupee as collateral and do not receive any rebate on the cash. From a lender’s perspective probably the biggest issue is the fixed-term contracts with market rate recalls you effectively borrow to cover and could end up paying more than you earned in the first place.
“I am in regular dialogue with the National Stock Exchange,” says Corrall. “I would hope to see this market develop over time but I am not sure when that is likely to happen. Recent reforms just make the documentation process more streamlined. I do not believe this will have any significant impact.”
In the domestic market, there is the potential for more indigenous insurers to get involved in India’s securities lending and borrowing market. Lobbying the regulators to allow domestic insurance companies to participate in borrowing and lending has resulted in regulatory change, and Corrall says the sector has potential for further growth.
Perhaps the biggest stumbling block to an expanded the market – and one that will be harder to overcome – is the use of an exchange-based central counterparty (CCP) model,
as opposed to a bilateral over-the-counter (OTC) model employing third party lending agents, is more commonly used in other markets.
The current framework is run by the clearing corporation of the National Securities Clearing Corporation and the Bombay Stock Exchange (Indian Clearing Corporation) that act as the authorised intermediaries.
“The opening of India to securities borrowing and lending was eagerly awaited by market participants who together with industry associations, such as Pasla lobbied Sebi to introduce a structure to accommodate global standards,” says Corrall.
“India has a lot of direct retail investment into stock markets and understandably they were nervous to open up the market to foreign participation in one go and hence developed a CCP model that has many nuances not suited to offshore participation.”
Strategically, India could be a significant market. Corrall says a bi-lateral model or optional structures for example as seen in Korea, Taiwan and Malaysia would be preferable.
“Unfortunately, as a result of the present CCP infrastructure, there is still little activity,” he adds.
Participation at this current time is mostly from domestic entities including high-net-worth individuals, family offices and local licensed brokers.
“What we are seeing is selective trading rather than structured securities lending programmes due in main to the limited ability to affect an early recall and hence potentially restricting trading activity,” Corrall says.
“We have yet to see any participation from offshore lenders but remain optimistic – the domestic India CCP structure as it stands creates many hurdles to overcome.”
Corrall’s views are shared by Citi’s Mishra. “The Indian regulators have confidence in the CCP model since it brings in more transparency and improved risk management framework. It also provides equal opportunity to every investor to participate,” Mishra says.
“Though the market itself is small there is potential to grow significantly with some of the proposed changes in the model.”
An alternate OTC model with an enhanced list of securities and more flexibility around tenors and collateral that is restricted to institutional investors may help attract a more global user base may be worth considering suggests Mishra.
He adds: “An OTC model with an enhanced list of securities and flexibility around tenors and collateral. while restricting it to institutional investors, who leverage this product globally.”
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