BLESS: A step to two markets

S. Vaidya Nathan

THE introduction of a new Borrowing and Lending Securities Scheme (BLESS) by the Bombay Stock Exchange (BSE) along with the already existing Automated Lending and Borrowing Mechanism (ALBM) of the National Stock Exchange (NSE) may lead to the development of two separate markets.

One for lending and borrowing of securities/funds, and the other, a market for futures/forward prices, with the latter explicitly servicing the interests of hedgers and speculators who want to make a call on future price.

The underlying premise in a lending and borrowing milieu is also to settle transactions at a later date. But with badla as the only forward trading vehicle in stocks, the end result was a mix of the forward/lending/borrowing markets. Badla was all rolled in one, which had implications for pricing in the cash market too and the possibility of a separate big market linked to future prices.

Contours of BLESS: The BSE will launch BLESS on January 22. The BLESS is positioned as an alternate competitive product and the carryforward system (badla) would cease to exist from that date. BLESS would be offered in the 141 stocks in the A group of the BSE. A borrower would be able to withdraw shares, which is not now available in the carryforward system.

At present, under the carryforward system, neither the borrower of securities nor the lender of funds can withdraw the position till the stipulated period. It is modeled on the ALBM on the NSE. BLESS would serve the purpose of deferral of settlement obligations by netting off BLESS obligations and those in the normal settlement.

Behind BLESS introduction: The BLESS move by BSE comes in the wake of a steady spurt in the volumes in the ALBM market of the NSE. As the accompanying graphic shows, ALBM volumes have doubled.

In the last two weeks, the ALBM and badla volumes have almost been level pegging. The enhanced use of the ALBM market also saw NSE's share in daily turnover jump and open a big gap with the BSE.

The ALBM spurt had come at a time when the markets were largely flat, indicating many takers for the product offered by the NSE. Now with both having similar products, the battle may be joined once again as far as market share goes. There are other factors too behind the move from badla to BLESS.

*One could be the BSE's effort to consign the negative perception of badla, which has become the subject of controversy and been tinkered around with so much over the years.

*It may also be a recognition of the scope for two markets -- lending/borrowing and futures. If BSE had continued with badla and single stock futures were ushered in, it could have eroded BSE's competitive position.

*Three, it could also be due to the less stringent regulatory requirements, especially margins, that have been prevalent in the ALBM segment. Now both the major stock exchanges would have products that are more or less similar and would attract regulatory requirements of a similar profile.

Trading volume spurt: The introduction of ALBM with badla-like features and the rise in carryforward levels on the BSE has lifted the turnover levels on the stock exchanges. Of course, the fact that mutual funds and foreign institutional investors (FIIs) have been big traders on a scale not seen before 2000 has also been a factor in the rising levels of turnover.

This could get a further push once the market players and investors become familiar with BLESS and once the effect of the winding-down of badla is absorbed. All this means that the NSE, BSE and above all, the Securities Exchange Board of India (SEBI) will have to be more vigilant than ever before.

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What would be of importance is the better surveillance, enforcement and more information on the trading trends in the ALBM and BLESS markets. There can be no denying the scope for excesses in these markets, though the clearing mechanism of the NSE (which has a clearing corporation) and BSE (which has a trade guarantee fund) serve as a cushion against small troubles.

In the ALBM, the National Securities Clearing Corporation Ltd (NSCCL) stands as a counter-party between the contracting market players for both funds and securities.

Push the futures: With the BSE also moving to a scheme that could become well-tailored for borrowing and lending and attracting more participants, the NSE, BSE and SEBI should look at pushing the futures market. The introduction of options and index futures on a select and small number of stocks could pave the way for a more healthy outlet for speculation and hedging.

If there is progress on this front, the markets may move towards three good pegs -- a cash market that is not diluted as it is now by the mix of carryforward trades, a lending/borrowing market and a futures market -- and make for a better system for the Indian markets.