Institutions can short-sell... for a price

MUMBAI: The Securities and Exchange Board of India’s secondary market advisory committee says margins must be slapped on institutional short-sales, too, just like in retail margin-account transactions, once the regulator allows institutions to go short.

The committee has said that the current regulatory restrictions on institutional investors from short-selling must be removed.

Institutional investors currently pay for the stock they buy and deliver the stock they sell within two days after the trade, since India follows a T+2 cycle.

The committee’s proposal says that they would have to now pay a margin on every short-sale.

The impact of this move will be on frontline shares where institutional investors would like to hedge their positions by shorting. Also, the counters would have to have a great amount of liquidity to digest institutional-level shorting.

“What Sebi’s trying to do is perhaps get the futures & options contract deliveries settled. Under this regime, once you sell a future, unless you square it up like in the Multi-commodity Exchange, there will be compulsory delivery,” said an analyst.

The move is expected to expand stock lending activity in India even as it curbs reckless shorting by just paying an upfront margin.

Under stock lending, when one goes short, one pays a margin on the futures. At the end of settlement, the seller borrows the shares to complete delivery by making another payment to the stock lender. “This means only serious short-sellers will come into play,” says Vijay Bhambwani, a stock market analyst.

Once the institutions are allowed to short, he says, there will be a lot of buffer available.

“The markets will behave in a more organised fashion and volatility will come down. Larger spikes in prices will be curtailed. I dare say the markets will mature,” says Bhambwani.

The Sebi panel move is part of the big changes that the capital markets regulator is planning, including borrowing ideas from the strictest watchdog of them all, the US Securities and Exchange Commission, and tying up with global exchanges.

The extension of the short- selling facility to institutional investors, from only retail investors currently, is aimed at creating a level-playing field for all investors.

However, the secondary markets committee has proposed putting in place a number of safeguards.

The regulator initially wants short selling to be restricted to stocks with derivatives products, but this will be reviewed in a phased manner.

This will prevent misuse of short-selling facility to distort the prices of illiquid stocks, it said.

The panel has also proposed that naked short selling and day trading by institutional investors should not be permitted.  Accordingly, it has recommended framing of a uniform penalty structure by stock exchanges for naked short-selling.

The big catch, however, is that the panel wants institutional investors to disclose upfront whether a transaction is a short sale or otherwise. “This could defeat the very purpose of shorting and there could be some front-running,” feels another analyst.

It has placed the onus on brokers to document details of short-selling by clients and the ability of clients to borrow and deliver securities on settlement.

“If a broker wants to retain his clients, he’d rather not front-run,” says Bhambwani.

The panel also said the lending and borrowing scheme must be exempted from taxes.

With inputs from Crisil MarketWire