Securities Lending Scheme

The Securities Lending Scheme (SLS) is a financial mechanism that allows lenders (investors or institutions) to temporarily lend their securities, such as shares or bonds, to borrowers (usually traders or market participants) in exchange for a fee. The borrower, in turn, is required to return the equivalent securities after a specified period. The scheme plays an essential role in improving market liquidity, facilitating short selling, and promoting efficient price discovery in the securities market.
In India, the Securities Lending and Borrowing Mechanism (SLBM) is regulated by the Securities and Exchange Board of India (SEBI) and operated through recognised stock exchanges such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).

Concept and purpose

The Securities Lending Scheme was introduced to enable investors who hold securities in their portfolios to earn additional income by lending them for a short duration without losing ownership. Borrowers use these securities primarily for short selling, arbitrage, or settlement obligations.
The system ensures that both lender and borrower benefit:

• The lender earns a lending fee while retaining ownership rights such as dividends and bonuses.
• The borrower gains temporary access to securities needed for trading strategies or to meet delivery requirements.

Key participants in the scheme

1. Lender: The investor or institution (e.g., mutual funds, insurance companies, retail investors) that owns the securities and lends them to earn a return.
2. Borrower: A market participant who borrows securities to fulfil short-term trading or settlement needs.
3. Approved Intermediary: An entity registered with SEBI to facilitate lending and borrowing transactions, ensuring compliance, security, and settlement. Examples include clearing corporations or designated clearing members of stock exchanges.
4. Clearing Corporation: Acts as a central counterparty guaranteeing the completion of transactions, managing collateral, and mitigating counterparty risk.

Operational process of securities lending and borrowing

1. Registration and eligibility:
   • Both lenders and borrowers must be registered with an approved intermediary and maintain a dematerialised (demat) account.
   • Only securities listed and eligible under the scheme can be lent or borrowed.
2. Order placement:
   • Lenders and borrowers place their offers and bids on the exchange’s electronic platform, specifying quantity, duration, and acceptable fees.
3. Matching and contract creation:
   • When a lender’s offer matches a borrower’s bid, a contract is automatically created.
   • The clearing corporation acts as guarantor to the transaction.
4. Settlement:
   • The lender’s securities are transferred to the borrower’s account, while the borrower provides collateral or margin (usually cash or eligible securities) to safeguard against default.
5. Tenure and recall:
   • The loan period typically ranges from one day to twelve months, depending on market and regulatory guidelines.
   • Lenders may have the right to recall securities before maturity, subject to conditions.
6. Return of securities:
   • On or before the contract’s expiry, the borrower must return identical securities to the lender.
   • The clearing corporation ensures settlement, returning the collateral to the borrower once obligations are fulfilled.

Example

An investor owns 1,000 shares of a listed company but does not plan to sell them soon. Through the securities lending platform, they lend the shares for one month at a lending fee of ₹2 per share.

• The lender earns ₹2,000 (1,000 × ₹2) as lending income.
• The borrower can use these shares for short selling or arbitrage.
• At the end of the period, the borrower returns 1,000 equivalent shares to the lender, completing the transaction.

During the lending period, if the company declares dividends or bonus shares, those entitlements remain with the lender, as ownership does not transfer.

Benefits of the Securities Lending Scheme

For lenders:

• Additional income: Earn lending fees without selling the securities.
• Portfolio utilisation: Idle holdings can generate returns.
• No loss of ownership: Lenders continue to receive dividends and bonuses.

For borrowers:

• Short selling: Enables traders to sell securities they do not own, profiting from anticipated price declines.
• Market arbitrage: Facilitates arbitrage between cash and futures markets.
• Settlement flexibility: Allows participants to meet delivery obligations in case of settlement shortages.

For the market:

• Enhanced liquidity: More active trading and efficient price discovery.
• Reduced volatility: Greater market depth and balance between long and short positions.
• Efficient functioning: Supports the overall smooth operation of financial markets.

Risks and safeguards

1. Counterparty risk:
   • The borrower might fail to return the securities.
   • This is mitigated by collateral, margins, and the guarantee of clearing corporations.
2. Market risk:
   • Price fluctuations of the borrowed securities during the lending period may affect both parties’ strategies.
3. Operational risk:
   • Errors or system failures in trade matching and settlement could disrupt the process.
4. Regulatory and compliance safeguards:
   • SEBI regulations and clearing corporations ensure standardisation, transparency, and protection for both lenders and borrowers.

SEBI’s Securities Lending Scheme – Key features (India)

• Introduced under SEBI’s Securities Lending Scheme, 1997, later integrated into the Securities Lending and Borrowing Mechanism (SLBM).
• Transactions are conducted only in dematerialised form through approved intermediaries.
• Securities eligible under the scheme are notified by the stock exchanges in coordination with SEBI.
• Lending and borrowing are permitted for tenures up to 12 months, extendable in certain cases.
• Collateral and margin requirements are maintained by the clearing corporation to cover potential losses.
• Dividends, bonus shares, and rights issues during the lending period accrue to the lender.

Global perspective

Securities lending is a common practice in major international financial markets such as the United States, United Kingdom, and Japan. Global institutions — including mutual funds, pension funds, and sovereign wealth funds — routinely lend securities to enhance portfolio returns.
Regulatory frameworks worldwide ensure transparency, capital protection, and risk management through mechanisms similar to those employed in India.

Economic significance

• Supports short-selling and hedging activities, vital for efficient market functioning.
• Enhances liquidity in secondary markets, narrowing bid–ask spreads.
• Provides revenue streams for long-term investors and institutional portfolios.
• Aids in settlement efficiency, reducing instances of delivery failure and enhancing market credibility.