25% cap on MFs for stock lending

Mutual funds may be among the first set of intermediaries to participate in the stock lending and borrowing programme, which will be launched simultaneously with the proposed introduction of short-selling by institutions in the domestic markets.

Sources said fund houses will be allowed to lend or borrow securities only from their new schemes.

Stock lending allows stock market intermediaries to lend securities they hold to another person or entity for a fixed period at a negotiated compensation to enhance returns on the portfolio.

The securities lent will be returned by the borrower once the stipulated period expires.

However, the approval for the fund houses will come with stiff riders. They will not be allowed to lend more than 25 per cent of net assets in a scheme through the stock-lending mechanism and will not be able to lend more than 5 per cent of its net assets to a single entity.

Under the proposed rules, mutual funds may not be allowed to borrow more than 20 per cent of the net assets of a scheme and the duration of such borrowing would not exceed six months.

SEBI has not decided who will qualify to participate in stock lending and borrowing. But it is learnt that apart from the Clearing Corporation and clearing houses of stock exchanges, custodians, banks and financial institutions would be considered as "approved intermediaries".

The mutual fund industry is confident that Sebi would allow them to take part in the stock lending and borrowing plan, at the beginning stage itself. Stock lending and borrowing would be allowed only in those stocks in which shortselling is allowed, sources said.

Sensing an opportunity to enhance the returns on their portfolio of investments, most fund houses including Tata Mutual Fund, JM Asset Management, Kotak Mutual Fund and Lotus AMC, in their filings with Sebi for new launches, have mentioned their intention to participate in the stock lending mechanism, if allowed by the regulator.

Stock Lending & Borrowing

IMPLICATIONS: Fund houses that do not churn their portfolio on a regular basis get to earn more return for investors by lending stocks in their portfolio to people/entities for a fixed period at a negotiated price.

RISKS: There will be temporary illiquidity of the securities lent out and the fund may not be able to sell such securities, resulting in an opportunity loss. Counter-parties could also default.

RISK MITIGATION STEPS: Mutual funds will not be permitted to lend more than 25% of their net assets. Mutual funds will also be barred from lending 5 per cent of their net assets in a scheme to a single entity.