Securities Lending and Borrowing on the NSE: What It Unlocks for Market-Makers

Securities Lending and Borrowing is the kind of infrastructure that determines whether a capital market can host institutional flow at scale. Without it, a market maker who takes a short position has no way to deliver shares at settlement, an ETF authorized participant cannot do a redemption against a basket they do not hold long, and a derivatives counterparty with a physical-settlement obligation has no path to source the underlying. With it, all of those operations become routine.

The Nairobi Securities Exchange and CDSC have built out the SLB framework that the Kenyan market needs. This post walks through what the framework actually does, where it sits in the regulatory architecture, and why the screen-based model that the Central Depository and Settlement Corporation has been piloting under the CMA Regulatory Sandbox is the piece that makes the operating model genuinely workable for an institutional market-maker.

What SLB actually is

Securities Lending and Borrowing is a temporary transfer of shares from a lender to a borrower in exchange for a fee. The lender retains the economic interest in the security, including any dividends or corporate actions during the borrow period. The borrower receives the shares to use for a defined purpose (delivery against a sale, settlement of a derivatives obligation, ETF creation or redemption, or another operational need) and returns them at the agreed date or on recall by the lender.

The CDSC framework operates two models. Bilateral SLB is what the original 2017 Capital Markets (Securities Lending, Borrowing and Short selling) Regulations contemplated: two counterparties find each other, agree the terms, and CDSC settles the resulting transfers. Screen-based SLB is the newer model under the Central Depositories Rules. It operates the lending pool as a centrally matched book, with CDSC visible to all participants and acting as the operational guarantor of each transaction. The screen-based model is the one currently piloting under the CMA Regulatory Sandbox.

Both models route activity through SLB Agents, a designated subset of Central Depository Agents appointed by CDSC. The agent transacts on behalf of underlying clients, which include fund managers, collective investment schemes, individual and institutional investors, and brokers and dealers acting for themselves or their clients.

The Kenyan regulatory framework

The overarching law is the Capital Markets Act, with the operative regulations being the Capital Markets (Securities Lending, Borrowing and Short selling) Regulations 2017. The screen-based model adds the Central Depositories Act, the Central Depositories (Securities Lending and Borrowing) Rules, and the corresponding operational procedures. The Capital Markets Authority is the overall regulator; CDSC is the operating infrastructure and counterparty guarantor.

The eligible-securities universe at launch is the NSE 20 share index constituents, updated as the index composition changes. Securities to be lent must be on deposit at CDSC and free of any existing balance encumbrance. The deliberately narrow starting universe reflects how every functioning SLB market begins: with the most liquid names, where the supply of lendable inventory and the operational discipline of the participants are already tested.

Accepted collateral is cash in Kenya shillings, Government of Kenya securities, or bank guarantees from creditworthy tier-one banks. Collateral has to equal the full notional value of the borrowed securities, with a 10% initial margin on top to cover intraday price movement. CDSC marks the borrowed positions and the non-cash collateral to market daily and issues margin calls as needed. Cash collateral is held in interest-bearing deposits, with the interest accruing to the borrower.

Who does what

The SLB ecosystem on the NSE has five clear roles. Each carries its own accountability, and the discipline of the framework is that each role is constrained to do only what its mandate allows.

The Capital Markets Authority sits over the entire framework as the regulatory overseer, with periodic reporting from CDSC and the agents. The Central Bank of Kenya is the settlement bank for cash legs through the CBK-operated payment system.

How the risk is managed

Six distinct risks are explicitly mapped in the Kenyan framework, with concrete mitigants on each. Credit risk is contained by full collateralization (100% of the notional value of borrowed shares plus a 10% initial margin), pre-funded collateral before any borrowing request can be placed, daily mark-to-market with margin calls, and the Settlement Guarantee Fund backstopping the system. Liquidity risk is bounded by restricting the eligible universe to the NSE 20 constituents at launch, limiting acceptable collateral to cash and government securities, prohibiting collateral reuse, and giving lenders a 14-day notice window when recalling shares.

Collateral investment risk is constrained: cash collateral can only be reinvested in interest-bearing deposits, and government-securities collateral can only be repo-ed overnight, both at tier-one bank counterparties. Operational risk sits inside CDSC under documented rules and procedures, with indemnification mechanisms in the SLB Rules and the agent contracts. Market risk on the borrowed-security side is handled by daily mark-to-market, the 10% initial margin buffer, and the restriction on collateral reuse. Legal risk is mitigated by the regulatory sandbox arrangement for the screen-based pilot and by standardized master agency agreements.

The combined effect of these mitigants is a framework where counterparty default does not produce loss to the non-defaulting side. If a borrower fails to return shares, CDSC executes a buy-in against the posted collateral. If the buy-in produces a shortfall, the Settlement Guarantee Fund covers it. The lender either gets the shares back or gets cash compensation against the cash-equivalent value. The operational guarantee is what makes the framework usable for serious participants.

Why this matters for a market maker

For a cash-equity market maker, SLB is the difference between a real two-sided book and a one-sided book pretending to be two-sided. A maker quotes a bid willing to buy and an ask willing to sell. The sell side of the quote is only operationally honest if, when the ask is hit, the maker can deliver shares at settlement even if it has no inventory at the moment of the fill. That delivery is what an intraday borrow through the SLB framework enables.

For an ETF market maker, SLB enables the creation and redemption mechanic that keeps the secondary price anchored to iNAV. When secondary demand pushes the ETF above iNAV, the maker creates new shares by delivering the basket to the issuer. If the maker is short any constituent at that moment, SLB closes the gap so the basket delivery is operationally clean. Without SLB, creation activity is bottlenecked by which constituents the maker happens to be long, which is not the right binding constraint.

For a derivatives market maker, SLB matters because physical settlement of single stock futures and similar contracts requires either pre-existing long inventory or the ability to source shares for delivery on the settlement date. Even in jurisdictions that begin with cash settlement (as NSE NEXT currently does), the migration to physical settlement is the standard development arc. SLB is the infrastructure that lets a derivatives maker operate cleanly through that migration.

Across all three lines of activity, the SLB framework also serves a more mundane operational purpose: covering settlement fails. A maker who is at a net debit position at end of day on a counter can borrow to deliver, rather than fail and incur penalties. The settlement-fail-coverage use case alone makes the framework worth participating in.

What full SLB unlocks for the venue

A capital market that has functioning SLB looks materially different from one that does not. Short selling becomes economically viable, which means hedge funds, long-short managers, and convertible arbitrage strategies have a reason to participate. Index arbitrage between cash and futures becomes operationally clean. ETF creation and redemption can scale because primary-market activity is not capped by the authorized participant’s prevailing inventory. Settlement failures on the broader cash market decline because participants have a route to cover temporary shortfalls.

For institutional lenders, the framework is income on inventory that was otherwise sitting still. Pension funds, insurers, and long-only fund managers with substantial domestic equity allocations can earn lending fees on positions they had no plan to sell anyway, without needing to find borrowers themselves or manage collateral directly. CDSC handles both. For the market overall, the additional commission and transaction-levy income is real, and the deepening of secondary liquidity it enables is larger still.