India
12 November 2019
India鈥檚 securities lending market continues to grow, with borrowing volumes hitting record levels in October, but what should the country do to maintain this momentum?
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India has been hailed as one of the major success stories in Asia by industry experts as the country鈥檚 securities lending industry has continued to grow in recent years. So far this year India鈥檚 government and market regulator have been proactive in seeking to encourage market activity and have made several moves to encourage further growth. Their efforts were rewarded in October when the country experienced an all-time high in borrowing volumes, reaching around 30 million shares on loan.
However, challenges still remain. First and foremost, the market is hampered by the fact that it operates via a mandatory central counterparty (CCP) structure that many foreign institutional investors are not currently comfortable with. Further, to this, issues exist with the term requirements, recall process and collateral.
The Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) have come up with a number of initiatives over the past years in order to overcome these challenges.
In September, RBI deputy governor Shri Kanungo announced that the bank is working with market regulators on a securities lending product to improve India capital market liquidity and avoid a short-squeeze incident.
As well as this, back in January, SEBI notified the market that all derivatives will be settled physically as part of an initiative to help promote securities lending. One of the main objectives of this is to have a better alignment of cash and derivatives segments. At the time, SEBI stated that a 鈥減rerequisite for the successful introduction of physical settlement of derivatives is efficient and transparent lending and borrowing mechanism in cash segment鈥�.
Discussing how effective SEBI鈥檚 initiative has been almost a year on, Prem Purohit, senior vice president of securities lending at HSBC Global Banking and Markets, India, says that although it is difficult to quantify the effect and causal relationship on the securities lending market, the lending activities did see positive growth post implementation of physical settlement of derivatives.
Another major factor contributing to the growth, Purohit observes, is policy changes related to treatment of corporate action, such as allowing markets to have securities lending contracts without mandatory foreclosure in event of annual general meetings or extraordinary general meetings. This, he says, has contributed to the expansion in breadth of the market in terms of the variety of stocks being borrowed.
However, despite proposed changes and initiatives, Ed Oliver, managing director, product development at eSecLending, comments: 鈥淎 SEBI-led workstream made a series of recommendations for updating the securities lending rules a few years ago. Whilst there have been some small changes, there are still fundamental issues that require resolution before widespread foreign participation is likely.鈥�
Oliver also noted that the Pan Asia Securities Lending Association is engaging with market members in India to offer its support as required.
鈥淗owever, at this stage, other markets in Asia, such as Indonesia, the Philippines and China appear to be more engaged on developing both securities lending and short selling markets,鈥� he adds.
A rocky ride
Growth could be spurred further if an easier route to market was established as there are still some challenges for foreign institutional investors who want to engage with India. eSecLending鈥檚 Oliver says: 鈥淚ssues exist with the term requirements, recall process and collateral. Loans are on a fixed term basis, typically one month to one year, and recall (ahead of the end date of the loan) is on a best efforts basis.鈥�
As well as this, Oliver notes, that collateral must be onshore cash only. 鈥淭he ability to execute loans on an open basis with offshore cash and non-cash collateral would be more attractive to foreign institutional investors, preferably through a bilateral arrangement,鈥� he explains.
Currently, to be able to participate in the Indian securities lending market, one needs to go through a registered 鈥榩articipant鈥�, which includes brokers or custodians designated as such in the securities lending segment.
For a registered foreign portfolio investment (FPI), investors have to execute an agreement (the same way they do for other segments) with the registered participant to engage in India鈥檚 securities lending market. HSBC鈥檚 Purohit argues that the challenges for FPIs to participate in India鈥檚 securities lending are inconsequential and highlights that many foriegn investors are active today in India, but external sources indicate that the barrier to entry is still too high for some.
Yogesh Radke, head of alternative and quantitative research, institutional equities at Edelweiss Securities, outlines that 鈥渨ith respect to the foreign borrows, it is expensive to borrow as the margin requirements are still in the form of Indian rupee (no other cash equivalents are allowed)鈥�.
Secondly, Radke notes that the remittance of the funds generated by selling of the borrowed equity needs to be cleared. 鈥淐urrently, it can鈥檛 be taken out of the country as tax can鈥檛 be calculated of the equity sold via borrowing,鈥� he explains.
However, Purohit observes that although the expense is an issue, it has been addressed by the RBI. He says: 鈥淔PIs now are permitted to offer non-cash collateral (same as applicable in cash and finance and operations segments) for their securities lending trades. So from that sense, I think it is a level playing field for foreign borrowers.鈥�
Further to this, in terms of challenges, during a panel at the International Securities Lending Association post trade conference earlier this year, one panellist said that India鈥檚 securities lending is quite a convoluted marketplace. Of this, Radke notes: 鈥淲e do believe it is different from the global borrowing and lending mechanism as it is exchange traded and exchange guaranteed platform. SEBI, exchanges and the RBI have to make some changes to make the system more smooth.鈥�
Purohit disagrees on India being a convoluted marketplace, however, and argues that securities lending in India, which is exchange traded, may be different from the more common international experience of the over the counter (OTC) model but it is gaining momentum.
鈥淭he exchange-traded model has its pros and cons as has the OTC model,鈥� He says. 鈥淭he market is picking up momentum and with increased participation by domestic and cross-border investors, it should further deepen.鈥�
When all is said and done, while there is clearly some ongoing challenges in India, the data doesn鈥檛 lie. Purohit points to the fact that overall, the country鈥檚 securities lending market is expected to grow by 20 to 25 percent in 2019 over the previous year, which shows that the industry is heading in the right direction.
Dissecting the data
Breaking down the data to see the roots of this growth, Purohit highlights that for 2019, market-wide lending fees stood at approximately US$20 million and the value of lent stocks stood at $3.8 billion till September.
This data compares with lending fees of $18 million and $9 million in 2018 and 2017, respectively.
On a macro level, Sam Pierson of IHS Markit says: 鈥淟ooking at the INDA exchange-traded funds (ETF) (see figure one) we can see an increase in borrowing in recent years to an all-time high in October of 30 million shares (20 percent of shares outstanding).鈥�
The chart shows that the value of the borrowed shares, a proxy for the total short position, reached $1 billion for the first time in October. The ETF currently has $5.2 billion in assets after $360 million in inflows year to date (YTD), while the value of loan has increased by $270 million YTD.
According to Pierson, the spike in shares on loan in late May 2019 coincided with the largest weekly inflow for the ETF, suggesting some of the inflow was creation of ETF units for borrow. Currently, shares of the ETF remain inexpensive to borrow with utilisation at only 50 percent.
Figure 1
So, while the data shows growth in India鈥檚 securities lending, further work can be done in order to achieve even more opportunities in the country鈥檚 marketplace, with a focus on making life easier for foreign investors coming near the top of the market鈥檚 wish list for the coming months and years. Radke notes that once the foreign margin and remittance issue gets ironed out the offshore supply/demand will pick up in India.
In the broader Asian picture India鈥檚 development is in tandem with many countries in the region that are growing their securities lending market. Earlier this year one industry expert observed that markets across the Asia Pacific region are continuously developing, providing a plethora of growth and revenue optimisation opportunities. As long as India continues to focus on developing their market infrastructure and encouraging participation, the regional tailwinds pushing Asia鈥檚 growth as a whole will continue to ensure momentum is sustained into 2020 and beyond.
However, challenges still remain. First and foremost, the market is hampered by the fact that it operates via a mandatory central counterparty (CCP) structure that many foreign institutional investors are not currently comfortable with. Further, to this, issues exist with the term requirements, recall process and collateral.
The Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) have come up with a number of initiatives over the past years in order to overcome these challenges.
In September, RBI deputy governor Shri Kanungo announced that the bank is working with market regulators on a securities lending product to improve India capital market liquidity and avoid a short-squeeze incident.
As well as this, back in January, SEBI notified the market that all derivatives will be settled physically as part of an initiative to help promote securities lending. One of the main objectives of this is to have a better alignment of cash and derivatives segments. At the time, SEBI stated that a 鈥減rerequisite for the successful introduction of physical settlement of derivatives is efficient and transparent lending and borrowing mechanism in cash segment鈥�.
Discussing how effective SEBI鈥檚 initiative has been almost a year on, Prem Purohit, senior vice president of securities lending at HSBC Global Banking and Markets, India, says that although it is difficult to quantify the effect and causal relationship on the securities lending market, the lending activities did see positive growth post implementation of physical settlement of derivatives.
Another major factor contributing to the growth, Purohit observes, is policy changes related to treatment of corporate action, such as allowing markets to have securities lending contracts without mandatory foreclosure in event of annual general meetings or extraordinary general meetings. This, he says, has contributed to the expansion in breadth of the market in terms of the variety of stocks being borrowed.
However, despite proposed changes and initiatives, Ed Oliver, managing director, product development at eSecLending, comments: 鈥淎 SEBI-led workstream made a series of recommendations for updating the securities lending rules a few years ago. Whilst there have been some small changes, there are still fundamental issues that require resolution before widespread foreign participation is likely.鈥�
Oliver also noted that the Pan Asia Securities Lending Association is engaging with market members in India to offer its support as required.
鈥淗owever, at this stage, other markets in Asia, such as Indonesia, the Philippines and China appear to be more engaged on developing both securities lending and short selling markets,鈥� he adds.
A rocky ride
Growth could be spurred further if an easier route to market was established as there are still some challenges for foreign institutional investors who want to engage with India. eSecLending鈥檚 Oliver says: 鈥淚ssues exist with the term requirements, recall process and collateral. Loans are on a fixed term basis, typically one month to one year, and recall (ahead of the end date of the loan) is on a best efforts basis.鈥�
As well as this, Oliver notes, that collateral must be onshore cash only. 鈥淭he ability to execute loans on an open basis with offshore cash and non-cash collateral would be more attractive to foreign institutional investors, preferably through a bilateral arrangement,鈥� he explains.
Currently, to be able to participate in the Indian securities lending market, one needs to go through a registered 鈥榩articipant鈥�, which includes brokers or custodians designated as such in the securities lending segment.
For a registered foreign portfolio investment (FPI), investors have to execute an agreement (the same way they do for other segments) with the registered participant to engage in India鈥檚 securities lending market. HSBC鈥檚 Purohit argues that the challenges for FPIs to participate in India鈥檚 securities lending are inconsequential and highlights that many foriegn investors are active today in India, but external sources indicate that the barrier to entry is still too high for some.
Yogesh Radke, head of alternative and quantitative research, institutional equities at Edelweiss Securities, outlines that 鈥渨ith respect to the foreign borrows, it is expensive to borrow as the margin requirements are still in the form of Indian rupee (no other cash equivalents are allowed)鈥�.
Secondly, Radke notes that the remittance of the funds generated by selling of the borrowed equity needs to be cleared. 鈥淐urrently, it can鈥檛 be taken out of the country as tax can鈥檛 be calculated of the equity sold via borrowing,鈥� he explains.
However, Purohit observes that although the expense is an issue, it has been addressed by the RBI. He says: 鈥淔PIs now are permitted to offer non-cash collateral (same as applicable in cash and finance and operations segments) for their securities lending trades. So from that sense, I think it is a level playing field for foreign borrowers.鈥�
Further to this, in terms of challenges, during a panel at the International Securities Lending Association post trade conference earlier this year, one panellist said that India鈥檚 securities lending is quite a convoluted marketplace. Of this, Radke notes: 鈥淲e do believe it is different from the global borrowing and lending mechanism as it is exchange traded and exchange guaranteed platform. SEBI, exchanges and the RBI have to make some changes to make the system more smooth.鈥�
Purohit disagrees on India being a convoluted marketplace, however, and argues that securities lending in India, which is exchange traded, may be different from the more common international experience of the over the counter (OTC) model but it is gaining momentum.
鈥淭he exchange-traded model has its pros and cons as has the OTC model,鈥� He says. 鈥淭he market is picking up momentum and with increased participation by domestic and cross-border investors, it should further deepen.鈥�
When all is said and done, while there is clearly some ongoing challenges in India, the data doesn鈥檛 lie. Purohit points to the fact that overall, the country鈥檚 securities lending market is expected to grow by 20 to 25 percent in 2019 over the previous year, which shows that the industry is heading in the right direction.
Dissecting the data
Breaking down the data to see the roots of this growth, Purohit highlights that for 2019, market-wide lending fees stood at approximately US$20 million and the value of lent stocks stood at $3.8 billion till September.
This data compares with lending fees of $18 million and $9 million in 2018 and 2017, respectively.
On a macro level, Sam Pierson of IHS Markit says: 鈥淟ooking at the INDA exchange-traded funds (ETF) (see figure one) we can see an increase in borrowing in recent years to an all-time high in October of 30 million shares (20 percent of shares outstanding).鈥�
The chart shows that the value of the borrowed shares, a proxy for the total short position, reached $1 billion for the first time in October. The ETF currently has $5.2 billion in assets after $360 million in inflows year to date (YTD), while the value of loan has increased by $270 million YTD.
According to Pierson, the spike in shares on loan in late May 2019 coincided with the largest weekly inflow for the ETF, suggesting some of the inflow was creation of ETF units for borrow. Currently, shares of the ETF remain inexpensive to borrow with utilisation at only 50 percent.
Figure 1
So, while the data shows growth in India鈥檚 securities lending, further work can be done in order to achieve even more opportunities in the country鈥檚 marketplace, with a focus on making life easier for foreign investors coming near the top of the market鈥檚 wish list for the coming months and years. Radke notes that once the foreign margin and remittance issue gets ironed out the offshore supply/demand will pick up in India.
In the broader Asian picture India鈥檚 development is in tandem with many countries in the region that are growing their securities lending market. Earlier this year one industry expert observed that markets across the Asia Pacific region are continuously developing, providing a plethora of growth and revenue optimisation opportunities. As long as India continues to focus on developing their market infrastructure and encouraging participation, the regional tailwinds pushing Asia鈥檚 growth as a whole will continue to ensure momentum is sustained into 2020 and beyond.
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