Badla back, but with a change

Short selling is back, after a gap of six years. The Securities and Exchange Board of India (SEBI) announced yesterday 20 December that all classes of investors, including institutional, will be allowed sell stocks that they do not own at the time of trade.
 
Along with short selling, SEBI also proposes to introduce the Securities Lending and Borrowing (SLB) scheme, 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 is an essential feature of all developed markets. It allows investors to sell securities that they do 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.
 
Analysts say short selling will provide liquidity and help price corrections in over-valued stocks. Restrictions on short selling, say its advocates, distort efficient share price discovery.
 
At present, short selling is allowed for retail investors. However, institutional investors - including foreign institutional investors, mutual funds, banks and insurance companies - are prohibited from short selling and are presently required to settle trades on a delivery basis in the cash market.
 
The regulator did not specify the date for the implementation of short selling, but it has asked stock exchanges and depositories to put ''fool-proof systems'' in place. This includes a ban on naked short selling.

Short sellers will be required to mandatorily honour their obligation of delivering the securities at the time of settlement, by borrowing securities through the proposed SLB scheme. No institutional investor will be allowed to do day trading. This means they cannot square off transactions in the cash market on the same day.
 
All shares that are in the futures and options (F&O) segment will be eligible for short selling. Stock lending and borrowing will also be allowed only in F&O stocks. There are currently 200-odd stocks available in F&O on the National Stock Exchange (NSE). SEBI has 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 term of seven days, to begin with. There will also be fixed standardised contracts for 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 the trade.
 
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. It had invited comments from market players on short sale in January 2006.
 
The regulator banned short selling in the Indian securities market in early 2001 following the Ketan Parekh scam, which saw a crash in stock prices after heavy short-selling by big operators. The new rules are expected to plug the loopholes in the earlier system.
 
In a circular, SEBI has 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.
 
The capital markets regulator said that to begin with, the SLB scheme will be operated through the Clearing Corporation and through stock exchange clearing houses that have nationwide terminals. At present, only the BSE and NSE have nationwide terminals. Clearing agents will have to be registered as Approved Intermediaries (AI) under the Securities Lending Scheme.
 
SEBI said the borrowers and lenders should access the platform for lending and borrowing set up by the AIs through the clearing members (which includes banks and custodians) authorised by the AIs.
 
AIs have to allot a unique ID to each client, which would be mapped to the Permanent Account Number of the respective clients, to maintain Know Your Client (KYC) norms. ''AIs shall put in place appropriate systematic safeguards to ensure that a client is not able to obtain multiple client IDs,'' the regulator adds.