Securities Lending and Borrowing (SLB)
What is SLB in stock market and how does it work?
The Securities Lending and Borrowing refers to the process through which a trader can temporarily lend or borrow stocks to/from the market. The fees, duration and other terms of borrowing are defined beforehand in the contract.
An individual usually borrows the securities to fulfill short-term delivery obligations. On the other hand, the lending of securities is usually done when an individual is holding the stock for a long-time horizon and he/she wishes to earn additional returns.
Only the securities that have sufficient liquidity can be traded in the SLB segment. For example, SLB trading is common in stocks that also trade in the Futures and Options (F&O) segment. It is open for all stock market participants (except some foreign investors), but the traders would need to check if their Stock Broker offers participation in this market.
Stock Lending and Borrowing Mechanism
Trading in the SLB market works in a very similar way to the normal trading of stocks. Both the lenders and the borrowers submit their respective orders to the Stock Exchange in the SLB segment.
These orders are slightly different from the normal orders because SLB orders contain details like stock name, quantity, lending period, lending fees etc. For example, a lender might be willing to lend 500 shares for 1 month, at a lending price of INR 7 per share. The lending price can be divided by the stock price to get the yield that the lender will achieve.
The Stock Exchange matches the orders and notifies the parties about their obligations. The Settlement Process then begins and the buyer is supposed to pay the Collateral amount + a margin + lending fees to the lender. The exact margin requirements will depend on the security being traded and it can be checked with the Stock Broker.
Delivering the securities
The lender has an obligation to deliver the securities to the borrower. Till the time the borrower does not get possession of the securities, the lender might have to provide a margin of 25% of the value of the securities. This margin is to ensure that the lender will deliver the securities on time.
The securities are debited from the Demat Account of the lender for settlement. So, the lender might have to pay DP charges for the transaction. In addition, there would be other fees and Brokerage that will be charged to both the lender and the borrower. So, it is best to check the fee structure for Securities Lending and Borrowing with your Broker.
Recall and Return
After the securities have been lent out, a ‘Stock Return Day’ will be defined in advance. This is the date on which the contract will end and the securities have to be returned to the lender. However, if the borrower wants, he/she could return the securities before the Stock Return Day. This is known as ‘Early Return’ of securities.
Similarly, the lender could ask the borrower to return the securities before the Stock Return Day. Since this is initiated by the lender, it is known as a ‘Recall’ of securities. In case of early recall, the excess lending fee which was paid to the lender is recovered and paid back to the borrower. There might also be some other charges in case of an early return or recall.
Ownership of securities
An important point to note is that the stocks are only being lent temporarily in the Security Lending and Borrowing scheme. The ownership of the stocks does not change and the lender is still the actual owner.
As we have explained below in this page, if there is any Corporate Action for securities like Dividends, Bonus issue etc., then the benefits will be passed to the lender.
Benefits of Stock Lending and Borrowing
The Share Lending and Borrowing is an efficient way to temporarily transfer the stocks to the individuals who require it for the short-term. Since there are 2 parties involved in this type of transaction, the benefits are different for the borrower and the lender. The main advantages of the stock lending scheme can be seen below.
Benefits for borrowers
The most common use for borrowed securities is to take a short position in any particular stock. The trader borrows the securities and sells them in the market if he/she expects the price to go down in the near future. After a few days, the trader could buy back the securities and return them to the lender.
Securities Lending and Borrowing is also used in Futures and Options (F&O) trading, where the borrower wants to hedge the position. Or the stocks could also be used to give delivery on the expiry of the F&O contract. In addition, SLB is used in Arbitrage strategies and other trading strategies that focus on price divergence.
Benefits for lenders
The main benefit for lenders is that they can earn interest income on securities which would otherwise lie idle in their Demat Account. This income will be in addition to the other benefits of owning the securities like price appreciation, Dividends etc.
Even though the securities have been lent out, the lender would still be eligible for any Corporate Actions from the company like Dividends, Bonus Shares, Stock Split etc. But the lender loses Voting Rights for the securities which have been lent out.
Risk in Securities Lending and Borrowing
Perhaps the biggest risk in the lending and borrowing of securities is that the borrower might not be able to return the securities to the lender. The Stock Exchanges try to minimize this impact for the lender by having an Auction Process for the securities on which there has been a default.
In addition, the buyer is also required to provide securities or cash as collateral to secure the transaction. For example, the borrower might be asked for a margin which is 125% of the value of securities that have been borrowed. As the price of the security moves every day, Mark to Market calculation is done and new margin requirements are calculated.
Similarly, the borrower is exposed to a counter-party risk that the lender might fail to deliver the securities, after the lending agreement was finalized. To minimize this risk, the lender is asked to deposit a cash margin (25% of trade value) till the securities have been delivered. The lender can avoid this margin by doing an Early Payin of securities.
Impact of Corporate Actions
In a Security Lending and Borrowing Contract, the lender is still the actual owner of the securities. So, if any Corporate Action happens for a security when a lending contract is in force, then the benefits have to be passed to the lender.
As explained below, the handling of the benefits and the contract will depend on the type of Corporate Action itself.
Dividend: The total Dividend amount is recovered from the borrower on Record Date and paid to the lender
Stock Split: The position of the borrower is proportionately adjusted. The lender is repaid the revised quantity of shares on the Stock Return Day.
Bonus, Merger, Amalgamations, Open Offers etc.: In case of all other Corporate Actions, the contract is foreclosed on the day prior to the Ex-Date. The securities are returned to the lender and the lending fee (calculated on pro-rata basis) is recovered from the lender and paid back to the borrower.
AGM and EGM: All the market participants might not be interested in attending the Annual General Meeting (AGM) or the Extraordinary General Meeting (EGM). So, the lending contracts could be executed with or without the provision of foreclosure in case of an AGM / EGM. So, this can be controlled in the beginning of the contract.
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