Is Indian sec-lending appeal on the rise?
India has become one of Asia’s most attractive markets for securities lending on the back of regulatory liberalisation and demand-supply dynamics, say regional business managers at Citi.
The US bank became the first foreign custodian to offer sec-lending services in the country this month, and last week signed its first offshore broker as a borrower of Indian securities (it declines to reveal a name).
Sec-lending in India has picked up since 2010, notes Citi, and hit $100 million in monthly turnover for the first time this January, as registered by the nation’s two primary exchanges – the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).
Total notional value of sec-lending transactions in India surged to $160 million in June this year, a smart recovery from around $40 million this March (which was a six-month low).
Market participants generally point to two key regulatory relaxations from the Securities and Exchange Board of India (Sebi) that have fuelled market interest: it extended the maximum transaction tenor to 12 months, from seven days when the service was launched in 2009; and lenders are now allowed to recall loaned securities prior to maturity.
Citi points out India is one of the few markets in Asia where sec-lending transactions are done on exchange mandatorily: the NSE’s and BSE’s clearing houses act as central counterparties to guarantee settlement and manage counterparty risk exposure of borrowers.
This contrasts with Taiwan, Hong Kong and Australia, where sec-lending is done over-the-counter and borrowers post securities/cash to lenders directly to secure bilateral transactions.
Lenders of Indian securities are seeing average annualised returns of 600-1,000 basis points, surpassing Taiwan (270bp) and Hong Kong (175bp), says Pierre Mengal, Citi’s head of investment and financing solutions for Asia-Pacific.
“For the lender side, we see interest from offshore participants such as sovereign wealth funds and long-only funds. Recently we also saw interest from exchange-traded fund managers who have issued ETFs with underlying Indian securities,” Mengal notes.
A peculiarity of the Indian market is that offshore borrowers are only allowed to post cash as collateral, or margin, to the clearing houses, while local borrowers can post fixed deposit receipts and bank guarantees as well as cash.
Since these cash or cash-equivalents are collected by the clearing houses for upfront margins, lenders are not earning reinvestment returns; instead they are compensated by an upfront lending fee paid by the borrower.
Meanwhile, the clearing houses monitor collateral and mark-to-market margin value, meaning borrowers may need to top-up if margin value falls short of the market value of securities on loan.
Debopama Sen, Citi’s managing director of securities and fund services in India, notes that demand for Indian securities outweighs supply, laying the grounds for high returns for lenders.
Further, she points out that the upfront lending fee a borrower is prepared to pay also depends on the arbitrage and hedging opportunities at the time of the trade.
“On the borrower side, we see a concentration of demand coming from local retail investors and proprietary trading from Indian brokerage houses, who seek out to borrow securities from lenders to take advantage of arbitrage opportunities that may exist in the market,” notes Sen.
For now, Sebi only allows borrowing and lending of securities that are also trading as listed futures and options on the two domestic bourses. So lender returns are driven by the arbitrage opportunities between the cash and the futures/options market, adds Mengal.
As custodian, Citi receives trade instructions from a lender, performs matching with the borrowers, collects margin collateral from borrowers and places that with the central counterparty. It then delivers the loaned securities to the borrower.
The order matching platform is provided by the clearing houses and trades are executed anonymously.
It is estimated that there is $180 billion in securities available for lending across Asia, of which $40 billion (22%) is represented by securities currently on loan.