Basics on SLB (Stock Lending & Borrowing)

 

Traders,

• Do you have stocks that has been sitting idle in your Zerodha demat account, and would it interest if I told you can earn extra  just by lending those shares?
• Do you want to take those arbitrage trading opportunities like when futures are at a discount, but you don’t hold the stock to do so?

This post should help understand SLB which is gaining popularity of late and a facility that is available to you from Zerodha, both for borrowing and lending securities. Do note that you can use this facility through us only if you have a demat account at Zerodha.

SLB introduction

SLB is a legally approved medium for lending and borrowing of securities. The regulations were originally formed by SEBI in May 1997 and last modified in Nov 2012. All market participants including retail (except Qualified Foreign Investors) in the Indian securities market have been permitted to lend/borrow securities but only through an Authorized Intermediary(AI).

NCL (NSE clearing limited) and BOISL ( BSE clearing corporation) are the only 2 authorized intermediaries presently, NCL is preferred and is getting bulk of the transactions today.

Lender

What is in it for a lender?

It provides an incremental return on an idle portfolio. So if I am holding 1000 shares of Infosys which I intend to hold it for long term, in the shorter term I could lend this whenever there is a demand and get additional return in terms of lending fees knowing that  NCL are the guarantors.

 

Imagine if tomorrow we could lend all that gold jewelry that is sitting idle in the bank locker for a fee and there is someone like NCL guaranteeing the return of the jewelry.

Who are the lenders?

Insurance companies, Banks, HNI, Mutual funds and Retail

 

Borrower

What is in it for a borrower?

A borrower is probably looking at one of these opportunities, arbitrage in stock price between 2 exchanges, reverse arbitrage when futures are at a discount to stock, to cover short position: to avoid settlement failure, mis-pricing in options, and other F&O arbitrage or hedging strategies which requires you to have stocks and this could be borrowed from a lender for a fee using SLB.

A simple example would be the many reverse arbitrage opportunities Tata motors has been giving over the past. Stock price is at Rs 400 but futures price is at 394 a discount of Rs 6 when ideally it should be at premium. (lot size of Tata motors is 1000)

An arbitrageur would using SLB  borrow 1000 shares of Tata motors for a fee and sell it in the market at Rs 400. At the same time he would buy 1 lot of Tata motors futures at 394 and on the expiry day when the price of Tata motors futures and stock would be the same, he will sell the futures and buy back the stock and give it to the lender, potentially making a risk less Rs 6000 per lot (1000 x Rs 6).

Who are the borrowers?

Cash and derivatives arbitrageur, short sellers – especially the long term shorts, market makers and retail traders.

Getting Started

Zerodha has a partnership with ISSL (ILFS securities services ltd) who is the largest contributor of total volumes being generated in SLB segment.

There are 2 forms that have to be signed for both the borrower and lender, Form A and Form B respectively. Form A is an agreement between ISSL and NSCCL and Form B is an agreement between you the client and ISSL. As is the normal case, both these forms together are 90 pages long.

Once the forms are signed and relevant proofs are submitted you are good to go within 2 weeks.

Update: As of January 2019, Zerodha Broking Limited has become a member of NSE & BSE in the SLB segment and is facilitating borrowing and lending of shares subject to the acceptance of the various terms and conditions

The Process

• Lender places an order with the participant mentioning the stock, quantity to lend , time period, and lending fees he is expecting. Lending fees is quoted on a per share basis, so in the Tata motors example it could be 1000 shares to lend at Rs 3/share.
• Borrower places an order with the participant mentioning the stock, time period, quantity and the lending fees he is ready to pay.
• Order matching on the lending fees takes place similar to trading on an exchange.
• The lender is asked for 25% of the total amount of stock he is lending immediately to ensure that he doesn’t default after saying yes to lend. This margin is released as soon the stock moves out of his demat account to the participant. At Zerodha we ask for the security the same day from the lender and hence don’t ask for the 25% margin.
• Borrower is asked to bring in 125% of the stock value he is borrowing as margin, and also lending fees over and above the margin. Out of the 125% asked, once he borrows he can sell the stock effectively blocking only 25%. But he would have to bring in 125% while entering the transaction.
• Daily MTM on the margin to ensure no borrower default risk.
• At the end of contract, lender gets back the stock and borrower margin is released.

Which stocks can be lent/borrowed and for how long?

Usually, all stocks trading in the F&O segment are available in the SLB segment along with a few other stocks prescribed by the Exchanges. You can find the list of stocks available here (Go to Securities Lending & Borrowing –> List of eligible securities).The contract period for lending can vary between immediate expiry(1 month) upto 12 months. Usually the maximum liquidity for borrowing and lending will be for 1 month.

Also an interesting  thing  is that in case the borrower wants an early repayment or lender wants an early recall there is a mechanism to do so. The borrower would place an early repay request with the fees they are willing to receive and the lender would place an early recall request with the fees they are willing to pay.

See the live market for SLBM on NSE by clicking here .

What happens in case of a corporate action like Dividend payout, stock split or others?

The borrower would pay the dividend received on the record date +1 (1 day after stock goes ex dividend) to the Exchange and the Exchange would pass it on to the lender of the securities.

In case of stock split, the borrowers obligation is adjusted proportionately and lender receives the revised quantity.

What is important to note is that it would be as good as the lender holding the stock, so he will get all benefits of any corporate action even though he would not be holding stocks in his demat account. Also, as a lender you wouldn’t know who you’re lending the stocks to and the same goes with the borrower as well – he wouldn’t know who he’s borrowing the stocks from.

Borrower Risk?

In the example above what if  the arbitrageur borrows 1000 shares and defaults to pay back? How does the AI (authorized intermediary) ensure that the risk is covered?

The borrower is asked to put up a margin of 125% of the value of the stock borrowed which is also marked to market daily similar to futures. So to borrow stocks worth Rs 4 lakhs ( Rs 400 x 1000), the borrower has to keep a margin of Rs 5 lakhs (125% of 4 lakhs) with the AI.  The lender knowing that 125% margin is put by the borrower also feels secure lending stocks using the SLB mechanism.

The only risk a lender has would be the close out risk (When the borrower defaults but gets the credit of shares from AI(NSCCL) using the 125% of borrower margin blocked by having an auction to purchase those shares). This close out credit of shares is deemed as a sale transaction and if the stock has made any gain from the time the lender had purchased Short term capital gain tax would apply on the gain.

Though 125% of the margin is blocked, once the borrower gets the share and sells it in the market he gets back the value of the stock on T+2 day, effectively blocking only 25% margin.

Costs

Lender

Zerodha would levy a percentage commission on the lending fee. GST on the lending fee is applicable.

Presently there are no regulatory charges applicable, No – Stamp duty, Exchange transaction charges, SEBI fees or STT

Depository charges applicable for debiting shares from your demat

Note that lending doesn’t mean selling and hence no short term capital gain tax (STCG)  would be applicable. But as mentioned above if the transaction goes to close out mode STCG would apply.

Borrower

Processing fees levied by Zerodha (also called as participant) + GST, this would be a % of the lending fees

Presently there are no regulatory charges applicable, No – Stamp duty, Exchange transaction charges, SEBI fees or STT

Depository charges applicable for debiting shares from your demat, both when you sell the borrowed shares in the market and when you have to give it back to lender

Hopefully this answers any basic queries that you might have on SLB, you can also see the various reports available on the same on NSE website.

Important  thing is that if you are sitting on decent quantity of stocks ( Rs 10lakhs + per stock in your Zerodha Demat account), or if you are looking to borrow stocks for executing trade ideas, get registered through us for SLB and when the opportunity beckons you will be ready.

 

 

 

Happy Trading,