Lending Equities

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Lending of equities for additional return is a good product. It is gaining traction with volumes picking up

As a property investor, you have two options—keep the house locked or give it out on rent. The first option fetches you the capital gains as returns, while the second option earns you regular returns in the form of rent and capital gains. For stock investments too, you can either hold on to your shares and wait for them to appreciate in value or lend your securities through the security lending and borrowing (SLB) scheme to earn money in the interim.

Though a very good product, the SLB scheme is yet to attract large scale interest. SLB holds huge potential for interested investors. It is yet to pick up because of lack of awareness. We try to educate our clients about it on a regular basis

The efforts are showing. Volume in the SLB segment has started picking up and in the last five years, transactions have moved from around ₹100 crore to ₹2,000 crore

WHO BORROWS YOUR STOCKS?

Stock borrowing is mostly done by institutions and traders who want to hedge their positions in the futures and options (F&O) segment. At present, more than 90% of the people are borrowing securities to meet their delivery obligation under reverse arbitrage

Reverse arbitrage opportunity arises when prices in the futures market quote at a discount to spot price and arbitragers buy in the futures market and sell in the cash market. Since they need to give delivery in the cash market in a few days, they borrow the same from the SLB segment.

Traders, hedge fund managers, etc can also use stock borrowing to short a stock. There is a reason why they use this segment instead of F&O. They get in here only when the forward premium or the difference between the future price and spot price is higher than the rent charged by lenders on that stock. Traders try to make additional money by borrowing a stock at a cheaper rate and selling the same at a higher rate.

WHAT ARE THE RISKS?

Unlike the high-risk borrowing activity, securities lending is relatively risk-free and hence suitable for long term investors. Regulator Sebi and the bourses have imposed heavy margins on borrowers and the entire process is managed by Indian Clearing Corporation Limited (ICCL).

There are also several other provisions to take care of the interest of investors. Lenders in the SLB segment will continue to benefit from corporate actions. Corporate actions can be in the form of dividends, bonus or rights issue, etc. For one, if a company declares dividend when your share has been lent, the borrower will collect the dividends and pass it on to you.

Stock lending entails transfer of securities from the lender's demat account to the borrower and back. However, this does not complicate tax calculations. That is because the tax authorities have already exempted the SLB transactions from the definition of 'transfer' through a clarification dated February 22, 2008.

HOW SHOULD YOU LEND?

Despite the benefits, lenders should be aware that they cannot expect fixed returns from a product like this (see chart). They also need to moderate return expectations. Normal market yield is in the range of 5-6% per annum. Depending on the stock and market situation, these yields may vary in the range of 2% to 15% per annum. It can even shoot up 30-40% for short periods. Lending fees usually shoot up due to technical reasons. Special situations can arise if a big bear operator is stuck and has to give a large delivery. Then yields can go up to 30-40% levels. However, note that these are annualised figures and the absolute return you get will be less because the lendings happen over short periods of 10-20 days.

Since stock brokers need to take separate membership in the SLB segment, make sure your broker has a membership in the segment before proceeding. If not, you need to shift to another broker. The second step involves informing your broker about the stocks you want to lend and also the quantity. Once you reveal the stock list, the brokers will alert you about lending opportunities.

Every day, we get details of the stocks that are in demand and inform clients when such opportunity exist. Another option is to place an order for lending on a daily basis and the deal happens depending on the market situation

Heavy penalties await lenders if they don't deliver on time. So be ready to do that. We alert clients about lending opportunities and ask them to transfer to our account. This is to avoid the chance of default on lending obligations

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