The latest circular from the regulator allows institutions to short stocks and introduces a borrowing & lending scheme. However, mandatory upfront disclosure of short trades may expose institutions to short squeezes.
A recent circular issued by the Securities and Exchange Board of India (Sebi) has brought significant changes to the landscape of short selling in the Indian equity markets. This shift aims to open up the avenue for institutions to engage in short selling practices, signaling a departure from the existing norms.
Expanding Horizons
The circular not only allows short selling in equities but also extends this provision to the futures & options (F&O) segment. However, it explicitly maintains the prohibition on naked short selling, emphasizing the importance of acquiring securities before initiating a sale. While the immediate impact of these changes may seem limited, they pave the way for potentially streamlined short selling processes in the future.
Introducing New Mechanisms
In addition to permitting institutional short selling, Sebi has introduced a borrowing and lending scheme aimed at facilitating such transactions. Furthermore, the circular mandates institutional sellers to disclose whether a sale offer pertains to short selling at the time of order placement. Moreover, institutions are barred from squaring off positions on the same day, promoting adherence to the settlement of transactions with actual stock deliveries.
Understanding Short Selling
Short selling involves the strategy of selling borrowed stocks with the anticipation of repurchasing them at a lower price in the future. This practice enables traders to profit from a decline in stock prices. It involves borrowing the stock, selling it, and then repurchasing it at a lower price, thus generating a profit from the price differential.
Navigating Complexity
The process of short selling brings forth complex dynamics, including intricate tax implications, warranting meticulous attention. Notably, the party lending the stock may be liable to pay taxes on the loan fee while being exempt from capital gains tax, provided that the stocks are returned within a specified period. Implementing an institutional lending and borrowing mechanism could offer opportunities for institutions with long-term portfolios to earn additional income by lending stocks, while simultaneously providing traders with transparent channels for borrowing stocks.
Sebi’s New Requirements for Brokerages
The Securities and Exchange Board of India (Sebi) has mandated brokerages to gather information on short-sells, and upload this data to stock exchanges before the next trading session. The intent is to publish this information on the stock exchange websites weekly.
Potential Implications of New Regulations
However, the concern lies in the potential loss of confidentiality regarding short sales. This could lead to short-squeezes, especially for stocks with low floats, wherein known short-sellers might face challenges due to abrupt price surges caused by high-volume buying.
Market Dynamics and Risks for Short-sellers
In India’s T+1 market, where cash trades are settled in the next session, the possibility of transitioning to a T+0 market poses increased risk for known short-sellers. Rampant price increases for short periods can compel short sellers to ensure delivery and return the stock, intensifying their vulnerability.
Balancing Act for Market Stability
While challenges and risks persist, a robust short-selling mechanism could enhance price discovery and contribute to the stock market’s development. Simultaneously, it’s vital to ensure investor protection amidst these changes.
In Summery
The recent Sebi circular reflects a significant shift in the policy landscape governing short selling in Indian equity markets. This pivotal change not only grants institutions the permission to engage in short selling but also introduces new mechanisms aimed at facilitating such transactions. Furthermore, it emphasizes the need for transparency and adherence to regulations, setting the stage for potential improvements in the realm of short selling processes.
