Short-Selling Will Be Back

Short-selling will be back after a gap of six years, with the Securities and Exchange Board of India (Sebi) on 20 December 2007 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.