Sebi should allow stock lending borrowing in OTC format

Santosh Nair
moneycontrol.com

The latest relaxation in the Securities Lending and Borrowing (SLB) guidelines by Sebi is unlikely to excite short sellers, feel market participants.
Ever since its introduction in April 2008, SLB never took off the way it was intended to. SLB was set up so that investors with a bearish view on stocks could borrow the shares for a charge, sell them in the market, and later on buy them back at a lower rate.
But the mechanism has been a flop, and market watchers blame it largely on faulty design and partly on cultural factors/policy uncertainty.
The single biggest reason has been the stringent margins which made it near unprofitable for a bear trader to borrow shares and sell them in the market. Over the years, Sebi has relaxed some of the rules hoping to boost volumes, but the segment has remained comatose.
On Friday, the regulator said that lenders and borrowers of shares could carry forward their positions up to three months, instead of one month as is the current norm. But that will not be of much help, say market participants.
“The stocks eligible for SLB are those which are eligible for F&O (futures and options) trading. Those bearish on a stock can short sell the futures as the margin requirements (refundable money to be deposited with exchanges) are much lower in futures trading compared to SLB,” a market observer told moneycontrol.com.
Brokers say a market for stock lending and borrowing will be more effective outside the stock exchange settlement system in an over the counter (OTC) format. Since such trades are done by sophisticated investors, the borrower and lender can work out customized agreements without involving the stock exchange. This practice is quite prevalent in developed markets.
A similar trend was observed in the Indian markets as well in 2008, when many foreign broking firms were lending shares held in participatory note accounts, to other overseas investors looking to short sell them.
Participatory notes or P-notes are derivative instruments, with Indian equity shares as the underlying. Foreign investors who want to invest in India, but do not want to register with market regulator Sebi, buy and sell Indian shares through the P-note route. They buy the P-notes through foreign broking houses that are authorized to issue them. The underlying shares remain in the custody of the broking house, but the beneficiary owners of those shares are entitled to the dividends.
When Sebi learnt of this practice of short selling share through the P-note route, it first asked institutional investors to make public disclosure of such trades. Later, Sebi banned the practice altogether.
Then there are some of the unwritten rules as well. Traditionally, short sellers have been perceived as ‘value destroyers’, while operators and companies manipulating stock prices on the upside are feted as ‘value creators’ till the tide goes out.
Typically, a behemoth like Life Insurance Corporation (LIC), and even many big domestic mutual funds would be able to generate good returns on some of their long term holdings which lie idle for much of the time. But in a falling market, can the government be trusted not to move the goal post? Even otherwise, will the government watch silently when LIC lends large chunks of PSU shares to short sellers? Regulators in developed markets too have imposed curbs on short selling during periods of crises. But more often than not, such moves have not been of much help, and eventually the stocks settle at market determined prices.
Also, there is a good chance that Indian corporates will use their pull with policy makers to ensure that their shares are not lent out.