Activating Idle Stock

Keeping in view the need to ensure the safe return of borrowed stock, the Securities Lending Scheme 1997, provides for multiple in-built safety features including the creation of a new class of intermediaries, authorised and regulated by SEBI. The scheme permits lending of securities (deposited by the approved intermediary by the lenders), for a specified period, to borrowers under the condition that the borrower will return equivalent securities of the same type and class at the end of the contractual lending period. The liability of the borrower is to return equivalent securities. The approved intermediary shall enter into separate agreements with lenders and borrowers. The lender in consultation with the approved intermediary may, if he so desires, stipulate in the agreement, specific eligibility criteria for the borrower of his securities. Any risk of default in returning securities shall be borne by the approved intermediary who shall maintain a minimum networth of Rs 50 crores and limit his business of

 

lending to 10 times his networth.

The approved intermediary shall also be entitled to the collateral in its possession, for the purchase of equivalent securities, to be returned to the lender. The beneficial interest in the securities deposited with the approved intermediary shall remain with the lender who shall be entitled to all corporate benefits declared by the company during the period of lending.

The borrower on the other hand is obliged to return equivalent securities of the same type and class as borrowed by him in addition to any corporate benefit that may have been declared. The borrower shall however have legal title of the securities borrowed and he shall be entitled to deal with and dispose off such securities as he deems fit.

Considering the large business potential, the Securities Lending Scheme, 1997, is fairly simple and its regulations limited, allowing for maximum flexibility among lenders, borrowers and the approved intermediary. The period of lending and borrowing of securities, charges and fees payable by the borrower, amount and type of collateral, has been left to the market to determine through an internal part of every agreement.

The scheme hopes to address the problem of settlement failure, to reduce the number of speculative transactions at the exchanges and to increase the delivery ratio, approved intermediaries are also expected to become members of the clearing house and clearing corporations of stock exchanges for direct receipt and delivery of securities in the settlement process. Brokers now have a viable alternate mechanism to borrow stock for delivery rather than square off the transaction or facing an auction close - out.

There also exists a direct relation between the vibrant functioning of a derivatives market and the operation of securities lending. Hedgers and arbitrageurs may undertake trading strategies involving going long in the derivatives market but may wish to hedge the exposure with short position in the cash market.

Securities lending is a business whose time has truly come. In 1989, the G 30 presented a list of recommendations for improving the efficiency of settlements and clearing systems in the securities markets around the world. One of the recommendations was to encourage the business of securities lending. It called for the removal of regulatory and taxation barriers.

The government has issued the necessary clarifications stating that the lending of securities shall not amount to transfer of capital assets under Section 47 (2) of the Income Tax Act and is thus exempt from the levy of capital gains tax. Domestic financial institutions, mutual funds, FIIs,

and high networth individuals have a large stock of unutilised securities.It is for them to capitalise on this opportunity and increase yields on their portfolios.

Nitish Idnani is an officer with the Securities and Exchange Board of India (Sebi). The views expressed here are the authors own.

Limits to freedom

Although the RBI has freed NBFCs borrowing limits, it has restricted the end use of these funds. According to the central bank, banks should provide finance to NBFCs only for financing of assets. Bank finance will not be given to finance companies for:

Bill discounting or re-discounting,

Investments in and advances to subsidiaries,

Group companies and investments in and intercorporate loans/deposits to or in other companies, or As bridge loans.