Reserve Bank widening bond lending may shield bears from short squeezes

Indian central bank’s plan to allow a broader set of investors, including insurers and asset managers, to borrow and lend government debt securities may shield bond bears from short squeezes.
 

The change in the rule proposed by the Reserve Bank of India could prevent episodes of the so-called ‘repo squeezes,’ seen in the government bond market when some large state-run banks refuse to lend the securities to those running overnight outright short positions forcing them to cover it at losses.

Under the current rules, only banks can lend securities via the so-called Clearcorp Repo Order Matching System, an electronic anonymous order matching platform that facilitates dealing in market repos of government securities. Government bonds held by insurance companies and duration mutual funds were not available for short sellers to cover shorts, according to a State Bank of India note.

RBI’s move “will facilitate better price discovery, and this creates a level playing field for bulls and bears,” said Naveen Singh, head of trading at ICICI Securities Primary Dealership Ltd. “This was a long-standing demand from market participants to increase market depth, hopefully, help a pick-up in market activity and prevent episodes of short squeezes.”

The RBI said on Wednesday that it would be issuing draft guidelines for the measure which will add depth and liquidity to the government securities market, aiding efficient price discovery. The move is expected to facilitate broader participation in the securities lending market by providing investors an avenue to deploy idle securities and enhance portfolio returns, it said.

Some entities like insurance companies are not permitted to borrow money but have a large stock of securities and the move will enable them to lend bonds, RBI Deputy Governor T. Rabi Sankar said on Wednesday.

“This move could also allow some fee to be earned by life insurers by becoming lenders of government bonds,” said Madhavi Arora, lead economist at Emkay Global Financial Services. Banks are the biggest holders of government bonds, having 38.3% of the outstanding stock, while insurance companies have 25.9%, as per end-September data from the finance ministry.