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Exchange body backs well-thought-out sec lending in emerging markets

25 January 2017

South Africa, India, and Turkey all enable securities borrowing and lending

Read more: Securities lending emerging markets

The gradual and well-thought-out introduction of securities lending models plays a key role in boosting liquidity across emerging markets, says one of the world’s largest financial service trade bodies.

Providing a diverse and active investor base exists, along with and a large pool of securities and solid pre-and post-trade infrastructure, the World Federation of Exchanges (WFE) says securities lending can benefit emerging markets which have already moved beyond early stages of development.

"Securities lending and borrowing (SLB) is an important enabler for the successful introduction off short-selling, as well as market-making programs, the introduction of products such as equity derivatives, and exchange traded funds," experts at the main trade association for global bourses wrote in a recent whitepaper.

"While short-selling enjoyed some notoriety during the 2008 financial crisis, the ability to engage in short-selling is generally regarded as contributing positively to price discovery, increasing market liquidity, and facilitating risk management."

Several emerging markets have already or are in the process of implementing frameworks for SLB and short-selling. WFE’s analysts, along with experts at Oliver Wyman who co-authored the study, claim details vary depending on specific policy and regulatory concerns and stage of market development.

Kuwait introduced rules in 2005 to allow short-selling in conjunction with allowing the trading of derivatives. In 2012, the UAE’s Securities and Commodities Authority (SCA) issued rules to authorize both stock lending and short-selling, but restricted their adoption by limiting the ability to short-sell to licensed market makers. South Africa, India, and Turkey all enable SLB and short selling, while Morocco is in the process of implementing an SLB framework.

Tim Smollen, global head of agency lending at Deutsche Bank, recently wrote that more beneficial owners, such as pension funds and investment managers, are turning to markets like India, China, Brazil and Indonesia in their quest for yield. "When a client buys assets in a new market, it prompts a number of questions: does that country allow for securities lending? And is the infrastructure in place to allow it?" he noted in a recent Deutsche Bank study.

That said, for markets looking to implement SBL, WFE and Oliver Wyman say the emphasis must be on creating a well-managed and safe environment. "There are several risks associated with SLB that may have systemic implications. These include counterparty credit risk, operational risk, collateral risk, settlement risk, and market risk. There is no one-size-fits-all approach." 

However, broad principles apply, such as introducing SLB gradually, beginning with only a few of the most liquid counters and restricting participants to regulated entities.  "Understand what, if any, legislative or regulatory changes may need to be made, e.g. allowing pension funds to engage in SLB and necessary insolvency protections. Require the use of internationally-aligned Master Agreements (GMSLA) adapted for the local market and approved by the securities market regulator."

In addition, WFE says careful consideration must be given to what would constitute suitable collateral for SLB transactions. Initially, it may be best to limit this to cash. "Either impose regulatory restrictions on the ability to rehypothecate collateral, or ensure that what is acceptable with regard to rehypothecation is clearly articulated in the master agreement," the report adds.

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