During a recent chat with a friend, we somehow drifted into a discussion about some of the complex terms and capital market products. Something interesting that caught my attention, was how money market funds and Ziidi Trader dominated the conversation. Securities lending and borrowing (SLB) also came up.
SLB is the lending and/or borrowing of capital market securities (shares, bonds, among others) for a definite period, with a simultaneous agreement to return them (or their cash equivalent) at an agreed future date, together with an agreed lending/borrowing fee.
Under SLB, one can lend ‘idle’ securities they own but do not intend to sell. This therefore implies that for it to be successful, an SLB transaction needs to have a lender, a borrower, an agreement (usually referred to as SLB agreement), an SLB consideration (or fee) and a platform where the transaction is effected.
A common question is: why would someone participate in an SLB transaction? An SLB transaction is driven by one of three reasons: First, a borrower may need to settle an existing securities debt arising from a previous transaction, where they owe securities to a counterparty.
Secondly, there may be a need to sell borrowed securities with the expectation that prices will fall, allowing the borrower to repurchase them at a lower price, make a profit, and settle their obligation. This is known as short selling.
Thirdly, a borrower with an underlying derivative contract (such as a future, forward, or option) may use SLB to hedge against potential losses by protecting themselves from adverse price movements in the underlying asset.
SLB can generate forward and backward linkages with stakeholders such as custodians, clearing and settlement institutions, derivatives traders, fund managers, pension schemes and investment banks among others, contributing to the establishment and sustenance of a vibrant SLB market.
For securities lenders specifically, it is an ideal opportunity to make extra income by availing their ‘idle’ securities portfolios to those willing to borrow them at a fee, with a commitment to return them at the agreed time.
One of the most important documents in any SLB transaction is the agreement; a contract between counterparties in the transaction. This allows temporary transfer of securities from the lender to the borrower for a fee. It details the name of the borrower/lender identification, the loaned securities, fees payable, collateral provided (by the borrower) to stand-in for the value of the borrowed securities.
The agreement also includes details on how corporate actions (dividends, interest, or voting rights to the lender) will be handled, default provisions, the applicable law and agreement termination clauses. At the international stage, we have the Global Master Securities Lending Agreement, which is a standardised legal framework that governs cross-border securities lending transactions.
So, how are SLB transactions executed? There are three main ways; trading through SLB through bilateral trading, screen-based trading, and hybrid trading. In bilateral trades agreements are direct over the counter customised deals with lenders (like custodians, pension schemes, stockbrokers etc.) using an SLB to directly lend securities to interested borrowers.
Bilateral SLB transactions allow flexible terms on dates, fees and margins among others.
In screen-traded SLB, multilateral transactions involving many borrowers and lenders are executed through an on-exchange formal platform that uses automated processes to execute transactions with borrow/lend orders being matched, based on price-time priority of the SLB orders.
On its part, hybrid SLB trading implies that stakeholders use a combination of both screen-based and bilateral approaches. This leverages quick, anonymous, exchange-traded transactions with the need for customized transactions to optimise efficiency and improve liquidity.
However, SLB activity in Kenya’s capital markets has remained relatively low since the framework was introduced, with only a handful of transactions recorded.
This is largely due to low market awareness, limited availability of lendable securities, operational complexities, and cautious risk appetite among market participants.
To address these challenges, SLB needs positioning as a key tool for improving market liquidity, price discovery, and overall efficiency in Kenya’s capital markets.
In terms of the regulatory environment for SLB in Kenya, all SLB activity is regulated by the Capital Markets Authority (CMA) under the Capital Markets (Securities Lending, Borrowing and Short Selling) Regulations 2017, and the Central Depository (Securities Lending and Borrowing) Rules 2019.
The two legal instruments guide CMA in ensuring market discipline through regulatory oversight, approval and supervision and policy advisory. The Central Depository and Settlement Corporation (CDSC) ensures protection of the parties to any SLB transaction through mandatory collateralisation, daily transaction monitoring and provision of settlement guarantee services for all executed transactions.
However, SLB activity in Kenya’s capital markets has remained relatively low since the framework was introduced, with only a handful of transactions recorded. This subdued uptake is attributed to factors such as low market awareness, limited availability of lendable securities, operational complexities, and cautious risk appetite among market participants.
To address these challenges, SLB needs positioning as a key tool for improving market liquidity, price discovery, and overall efficiency in Kenya’s capital markets.