Short selling to be effective from April

The Securities and Exchange Board of India (Sebi) on Wednesday said short-selling and securities lending and borrowing will be operationalised from April 21.

The circular asked stock exchanges and depositories to make necessary amendments to the relevant bye-laws, rules and regulations for the implementation of the decision, bring the provisions of the circular to the notice of the member brokers/clearing members, depository participants and communicate to the Sebi the status of the implementation of the provisions of the circular in the monthly development report submitted to the market regulator.

Sebi had come out with a circular on December 20, 2007, specifying the broad framework for short selling by institutional investors and a full-fledged securities lending and borrowing scheme for all market participants.

Short selling for Institutional investors from Feb 1 2008

Securities and Exchange Board of India (Sebi) today said it would allow institutional investors to start short selling, which was banned way back in 2001 in the aftermath of the Ketan Parekh scam, from February 1.

Reserve Bank of India (RBI) has given its nod to FIIs for short selling, and now Sebi will allow it for all institutional investors from February 1, Sebi chairman M Damodaran told reporters on the sidelines of a conference on corporate governance here.

It would be for all institutional investors - FIIs and domestic institutions like mutual funds, Damodaran said.

Damodaran's comments came a day after the Reserve Bank allowed foreign institutional investors and their sub-accounts to short sell shares.

Retailers are already allowed to short sell - selling shares they do not own and cover the trade at a later date.

What is short selling?

What is short-selling?

Short-selling, in the context of the stock market, is the practice where an investor sells shares that he does not own at the time of selling them. He sells them in the hope that the price of those shares will decline, and he will profit by buying back those shares at a lower price. In India, there is no prohibition on short-selling by retail investors. Institutional investors —domestic mutual funds and foreign institutional investors registered with the Securities and Exchange Board of India (Sebi), banks and insurance companies — are prohibited from short-selling and are mandatorily required to settle on the basis of deliveries of securities owned and held by them.

How is short-selling beneficial?

Short-selling is considered an essential feature of the securities market not just for providing liquidity, but also for helping price corrections in over valued stocks. Supporters of short-selling claim its absence distort efficient price discovery, gives promoters the unfettered freedom to manipulate prices and favours manipulators than rational investors. Securities market regulators in most countries, and in particular, all developed securities markets, recognise short-selling as a legitimate investment activity. The International Organisation of Securities Commissions (IOSCO) has also reviewed short-selling and securities lending practices across markets and has recommended transparency of short-selling, rather than prohibit it.

Are there any drawbacks of short-selling?

Critics of short-selling feel selling, directly or indirectly, poses potential risks and can easily destabilise the market. They believe that short-selling can exacerbate declining trend in share prices, increase share price volatility, and force the price of individual stocks down to levels that might not otherwise be reached. They also argue that declining trend in the share prices of a company can even impact its fund raising capability and undermine the commercial confidence of the company. In a bear market in particular, short-selling can contribute to disorderly trading, give rise to heightened short-term price volatility and could be used in manipulative trading strategies.

Will institutional investors in India be allowed to short-sell securities?

Sebi is working on a proposal to introduce a stock borrowing and lending mechanism. This will allow institutional investors to short-sell by borrowing shares. Under this arrangement, an investor A, who feels that a certain stock is overpriced, borrows those shares for a charge from investor B, who is willing to lend those shares. Investor A then sells those shares in the market, hoping that the price declines so that he can buy cheap and return them to investor B.

What is the difference between covered short sales and naked short sales?

Covered short sales are those in which the seller arranges for the delivery of shares he has sold by borrowing them. Naked short sales are those in which the seller does not intend to provide for the delivery of shares he has sold. Most international securities market regulators have prohibited naked short-selling and require the client to have documentary evidence of borrowing/tie-up with lenders before executing the sale transaction. This is because naked short sales in huge quantities can destabilise the market.

How does the stock lending and borrowing mechanism function in other markets?

World over, securities lending and borrowing transactions are, by and large, over-the-counter (OTC) contractual obligations executed between lenders and borrowers. International securities market regulators do not directly regulate the lending and borrowing transactions. In many international markets, entities like custodians and depositories run the lending and borrowing scheme and have their own screens for meeting the demand and supply of securities from their clients.

Via ET

Short selling to be allowed for all investors

Short-selling will be back after a gap of six years, with the Securities and Exchange Board of India (Sebi) on Thursday allowing all classes of investors, including institutional ones, to sell stocks that they do not own at the time of trade.

Sebi also proposes to introduce the Securities Lending & Borrowing (SLB) scheme along with short-selling, which will allow traders to borrow stocks and honour their sales. All classes of investors will be allowed to participate in the stock lending and borrowing programme.

Short-selling, which is an essential feature of all developed markets, refers to the sale of securities that an investor does not own.

Investors sell short when they feel that share prices are overvalued and that the prices of shares they have sold will come down.

"Shorting will provide liquidity and help price corrections in over-valued stocks," said an analyst with a foreign brokerage. Restrictions on short-selling, according to its votaries, distort efficient share price discovery.

At present, there is no prohibition on short-selling by retail investors. Institutional investors — foreign institutional investors, mutual funds, banks and insurance companies — are, however, prohibited from short-selling, under different regulations, and are currently required to settle trades on a delivery basis in the cash markets.

The regulator did not specify any date for the implementation of short-sale, but has asked stock exchanges and depositories to put "fool-proof systems" in place for the new products.

Some of the features of the rules include a ban on naked short-selling. This means all short-sellers would be required to mandatorily honour their obligation of delivering the securities at the time of settlement. They can honour the trades by borrowing the securities through the proposed SLB scheme.

No institutional investors will be allowed to do day trading. This virtually prohibits squaring off of their transactions intra-day.

All shares that are in the futures and options (F&O) segment will be eligible for short-selling. There are currently 200-odd stocks available in F&O on the National Stock Exchange. Sebi said it will review the list of stocks that are eligible for short-selling from time to time.

A key feature of the SLB scheme is that the lending/borrowing will be for a tenure of seven days, to begin with. There will also be fixed standardised contracts for the securities under the SLB.

The settlement cycle on SLB will be on a T+1 basis. This means, investors are required to settle their transactions a day after their trades.

Securities lending and borrowing, which is considered a necessary ingredient for short selling, will be introduced simultaneously with short selling.

Sebi has been preparing the ground for short-selling and it had invited comments from market players on short sales in January 2006.

The regulator banned short sales in the Indian securities market in early 2001 following the Ketan Parekh scam, which saw a crash in stock prices under the weight of heavy short-selling by big operators. The new rules are expected to plug the loopholes in the earlier system.

In a circular, Sebi asked stock exchanges to establish systems to operationalise short-selling and SLB. The exchanges were also asked to ensure all appropriate trading and settlement practices as well as surveillance and risk containment measures, before their introduction.

On SLB, the capital markets regulator said, to begin with, the scheme will be operated through Clearing Corporation and stock exchange clearing houses that have nationwide terminals. At present, only BSE and NSE have nationwide terminals.

These clearing agents will be required to be registered as Approved Intermediaries (AI) under the Securities Lending Scheme.

Stock lending and borrowing will also be allowed only in F&O stocks.

Sebi said the borrowers and lenders should access the platform for lending/borrowing set up by the AIs through the clearing members (which include banks and custodians), who are authorised by the AIs for the process.

To follow the Know Your Client (KYC) norms, Sebi said AIs should allot a unique ID to each client, which would be mapped to the Permanent Account Number of the respective clients.

“AIs shall put in place appropriate systematic safeguards to ensure that a client is not able to obtain multiple client IDs,” the regulator said.