Most of us must have faced the following situations while trading:

• Stocks have been lying idle in your demat account since you are a long term investor
• You find some good arbitrage opportunities but you do not own those stocks and hence lose out on them

In these situations the mechanism of SLB, which is slowly gaining popularity, comes handy.

What is SLBM?

Stock Lending & Borrowing Mechanism is a scheme for lending & borrowing of securities. It is a legally approved medium formed by SEBI in May 1997 and modified in November 2012. All market participants, except Qualified Foreign Investors, can lend/borrow securities through an Authorised Intermediary.

NSCCL (NSE Clearing Corporation) and BOISL (BSE Clearing Corporation) are presently the only 2 authorized intermediaries. NSCCL is the preferred one and is getting bulk of the transactions today.

Why should one lend?

You can lend your securities which are sitting idle in your demat account for additional returns. Suppose, you have 500 shares of XYZ Company which you wish to hold for a long time. In the short term you can lend these shares, if others in the market are demanding shares of XYZ, and earn additional returns in terms of lending fees. There is no risk of default as NSCCI/BOISL is the guarantor for this transaction.

The lenders are Insurance companies, Banks, Mutual Funds and Retail investors.

Why should one borrow?

Now and then there are various opportunities in the stock market that are available for traders.

• Arbitrage in stock price between two exchanges
• Reverse arbitrage- When futures are trading at a lower price than spot
• Short positions that needs to be covered to avoid settlement failure
• Mispricing in Options
• Other F&O  arbitrage or hedging strategies

All these opportunities require you to hold those stocks. However, with the help of SLB mechanism you can now benefit from these opportunities even if you do not hold those stocks. You can easily borrow the shares from others in return for a lending fee.

Suppose the stock price of ABC Ltd is Rs 350 but the future is priced at Rs 342, giving a discount of Rs 8, when ideally the futures are priced at a premium (The lot size for futures being 1000 shares). This is a classic case of reverse arbitrage opportunity. An arbitrager would use the SLB mechanism to borrow 1000 shares of ABC Ltd for a lending fee, say Rs 2 per share, and sell it in the market at the spot price (Rs 350). Simultaneously, he will buy 1 lot of ABC Ltd futures at Rs 342 and on the day of expiry when the Stock and futures price is the same he will sell the futures, buy back the shares and return it to the lender. He will be making a risk less profit of Rs 6000 [1000 x (8-2)] per lot in this scenario.

The borrowers are cash and derivatives arbitrageur, short sellers, market makers and retail traders.

How is it executed?

There are participants who connect the borrowers/lenders with NSCCI/BOISL. Usually brokers tie up with these participants to offer SLB mechanism to its clients. The process is as follows:

• Lenders place an order with the participants through their brokers or directly mentioning the stock, the quantity of shares to lend, time period of lending, and the lending fees he is expecting. Lending fees is usually quoted on a per share basis as seen in the above example.
• Similarly borrowers place an order with the participants through their brokers or directly mentioning the stock he wants to borrow, the time period for borrowing, the quantity of shares he wish to borrow and the lending fees he is ready to pay.
• Order matching on the basis of lending fees takes place similar to trading on an exchange.
• The lender has to lend 25% of the total amount of stock value immediately to ensure that he doesn’t default after agreeing to lend. This margin is released as soon the stock moves out of his demat account to the participant’s account.
• The borrower has to bring in 125% of the stock value he wishes to borrow as margin, and the lending fees over and above the margin. Once he borrows he can sell the stock, blocking only 25% of the stock value effectively. But he has to bring in 125% margin while entering the transaction.
• The margin is marked to market daily to ensure that there is no risk of default.
• At the end of the contract, the lender gets his shares back and the margin of the borrower is released.

Which shares can be lent and for how long?

Only those stocks that are trading on the F&O segment can be lend/borrowed under SLB Mechanism. The contract period for lending can vary between immediate expiry (1 month) upto 12 months. Usually the maximum liquidity for borrowing and lending is 1 month.

There is a mechanism for early settlement as well i.e. settlement before the agreed time period. In case the borrower wants an early repayment, he would place an early repay request with the fees he is willing to receive and in case the lender wants an early recall, he would place an early recall request with the fees he is willing to pay.

Corporate Actions during the lending period

In case of any corporate actions like Dividend payout, stock split, etc during the time period of lending, the borrower would pay the dividend received one day after the dividends were received (i.e. record date + 1) to the lender. In case of stock split, the borrower’s obligation is adjusted proportionately and the lender receives the revised quantity.

For a lender, the situation is same as holding the stocks. He will get all benefits of any corporate action even though he would not be holding the stocks in his demat account at present.

Risks & Costs involved

There is a risk of default on the part of the borrower. What if the arbitrageur defaults to pay back the shares that he borrowed? How does the guarantor ensure that the risk is covered?

The authorised intermediary (AI) demands a margin of 125% of the stock value from the borrower, which is marked to market on a daily basis similar to futures. In the above example, the arbitrager needs to put in Rs 4,37,500 to borrow 1000 shares of ABC Ltd (CMP Rs 350). This margin makes the lender feel secured to lend his shares.

Even though 125% of the margin is blocked, once the borrower gets the share and sells it in the market, he gets back the value of the stock on T+2 day, effectively blocking only 25% of the stock value as margin.

The only risk the lender faces is of the close out risk. Close out risk is when the borrower defaults on the pay back and the AI purchases the shares through the auction process using the 125% of borrower margin blocked and gives these shares back to the lender. However, this close out credit of shares (credit in borrower’s demat account) is considered as a sale transaction. So, in case the stock had made any gain from the time the lender had purchased the stock to the time the close out happens, the lender will have to pay the short term capital gain tax on the gain.

The cost levied on the lender & borrower is as follows:

Lender	Borrower
Processing fees levied by the participant + service tax. This is a percentage of the lending fees.	Processing fees levied by the participant + service tax. This is a percentage of the lending fees.
Depository charges for debiting the shares from the demat account	Depository charges for debiting the shares from the demat account, both when selling the borrowed shares in the market and when returning it back to the lender
	Lending Fees

Currently there are no regulatory charges applicable i.e. no Stamp duty or Exchange transaction charges or SEBI fees or STT