SLBS allows an investor or a trader to short a stock, something that current regulations don’t permit unless one owns the stock. The product allows investors sitting on idle shares to lend them for a fee to those wanting to short the stock either in anticipation of a fall in its price or to meet a delivery obligation or to simply exploit a price differential in the same stock traded on different segments—cash and futures.
The minimum borrowing period is one month, while the maximum is up to a year. At the end of the tenure, the borrower returns the stock to the lender with the settlement being guaranteed by the clearing corporation of the stock exchanges—NSE Clearing Ltd (NCL) and BSE’s Indian Clearing Corporation Ltd (ICCL).
All categories of investor—retail and institutional—are eligible to trade on the SLBS segment since the scheme was launched in April 2008. The number of stocks currently available for trading stands at around 1,000, according to Sandeep Chordia, chief operating officer of Kotak Securities. These include the 209 stocks eligible for derivatives trading and other stocks on which derivatives are unavailable.
However, as of Monday the number of stocks active on SLBS stood at just 220 securities, including the likes of Ashok Leyland, Bharat Forge, Voltas, DMart and Dr Reddy’s Laboratories.
Amid this tepid investor activity, the Securities and Exchange Board of India (Sebi) plans to revamp the product to get more investors to participate on SLBS and deepen the cash market. This, it hopes, will narrow the skew in volumes between the equity cash and the derivatives segments, where options’ notional volumes exceed cash volumes by a wide margin.
For instance, notional volumes of index options stood at 279 times cash volume of ₹21 trillion last month , per NSE data.
Sebi plans to undertake a comprehensive overhaul of the short-selling and securities lending and borrowing scheme (SLBS) frameworks—marking their first major update in almost two decades, Sebi chairman Tuhin Kanta Pandey said during the CNBC Global Leadership Summit last week.
However, market experts cited the exorbitant costs to trade, apart from a lack of awareness among retail investors for the lacklustre activity.
Exorbitant costs
To borrow a stock, the borrower has to maintain a margin of 125% of the current market value of the stock, half in cash and the rest in cash equivalent, and pay an interest of 1.5-2% a month to the lender. The minimum tenure of the lending is one month while the maximum tenure is up to a year. Besides incurring these charges, the borrower has to cough up goods and services tax (GST) of 18% on the interest, which in certain cases cannot be claimed as input tax credit or ITC, like a proprietary trader who trades on his own account using his own capital, and doesn’t service any clients.
“When I can buy or sell a stock in the futures market at a margin of 20% , why will I come to the SLBS, which entails a margin of 125%,” asks Chirag Shah, a senior securities lawyer.
Queries emailed to Sebi remained unanswered till press time.
Shah said that to expand activity, Sebi would have to consider expanding the universe of scrips under the SLBS to include other stocks on which futures and options aren’t available. But for that, he said, rationalizing costs and changing squaring-off rules are necessary.
“The sticking points are the high margin of 125% to execute a trade on SLB, the GST on the interest paid by borrowers not inputable as credit, and the inability to square off intraday in the event of the market inversion disappearing,” he said.
Market inversion refers to stock futures trading at a discount to their underlying stocks in the cash segment. Normally, futures trade at a premium to underlying stocks because of opportunity cost—that is, the money forgone by a client had he invested in a fixed deposit instead of putting cash up as margin to buy or sell a stock in the futures market.
However, at times the futures trade at a discount to cash due to heavy punting by short sellers in anticipation of an adverse event or during bearish markets.
On such an occasion, a risk-free return can be earned by selling the cash stock at a higher rate and buying stock futures at a lower rate, as at expiry the spot and futures prices converge. These opportunities are exploited by proprietary traders and arbitrage schemes of mutual funds.
Kotak Securities’ Chordia agreed that reducing costs to trade SLBS could deepen the market.
“To further deepen participation in the Stock Lending and Borrowing Scheme (SLBS), the government could consider lowering GST on lending fees from 18% to 5% for proprietary trading firms, as they are unable to claim input tax credit given that their output is non-taxable. Additionally, rationalizing the lender margin requirement by the clearing corporation from the current 125% to around 110–115% would make the mechanism more efficient and attractive for market participants,” Chordia added.
Low product awareness
Apart from the high trading costs, retail investors lack awareness about SLBS. To spread awareness, online trading platform Dhan became the country’s first broker earlier this month to launch an SLBS product, offering retail investors an integrated digital platform to rent their stocks.
Jayprakash Gupta , director of Dhan, said a vibrant SLBS product could deepen the cash market and enable retail investors to generate greater returns on idle stocks. He said his company’s new product had raised interest among his clients, but added that he would wait to see the final response from them.
Early last month, a Sebi official said that one way to improve participation on SLBS was for brokers to make borrowing and lending a stock as “seamless” as buying and selling on their front-ends or apps.
Chordia of Kotak Securities added that retail investors must be made to realize that lending the stock would not divest them of benefits accruing from corporate actions such as bonus or dividend, etc. These stocks are marked as lent stocks by the clearing corporation, ensuring that the title vests with the lender and not the borrower.
Rajesh Baheti , managing director of Crosseas Capital, suggested creation of only options, not futures, on certain stocks which are not available in the derivatives segment, similar to the US markets, which don’t run single stock futures and have a vibrant SLB mechanism with only stock options.
In such a case, one need not have a naked open position—a short on a cash stock without a hedge. Having only options on a certain category of cash stocks would enable the seller to hedge himself by selling a put option on the stock or buying a call. In the event of the share rising after he sells the same, the sold put or the purchased call would offset the loss.
“This strategy of allowing only options is something I will suggest to Sebi when it floats a consultation paper on SLBS,” Baheti told Mint.
