SEBI’s Announcement: Short- Selling A Double-Edged Sword?
[By Zoya Farah Hussain & Vasundhara Mukherjee] The authors are students of National Law University Odisha. INTRODUCTION The volatile nature of the Indian securities market has effected various changes in the regulations overseeing the sector but despite the existence of this structured mechanism, there are numerous trading methods undertaken by investors for profit maximisation. In light of the recent announcement by SEBI, we aim to analyse the phenomenon of one such method, called, short-selling. In a scenario where an investor borrows shares from someone else, sells them at the current market price, and then buys them back later at a lower price, he can pocket the difference as profit. It’s like betting against a stock’s performance, and it can help bring balance to the market by reflecting both positive and negative sentiments. This is called short-selling. But there is a riskier version called naked short-selling whereinstead of borrowing shares, investors sell stocks they don’t even own. It’s like promising to deliver something you do not have — a practice that can introduce chaos and uncertainty into the market. This creates a potential for abuse and market manipulation, as it generates counterfeit shares that don’t exist. Short-selling, when done responsibly, can improve market efficiency by reflecting true market sentiment. It adds liquidity and helps in price discovery, but when things get out of hand — especially with naked short-selling — it can wreak havoc. Excessive short-selling can lead to wild swings in stock prices, erode investor confidence, and even destabilize the entire financial system. Here, we understand the possible implications of the recent announcement by SEBI regarding short-selling. UNDERSTANDING SEBI’s GUIDELINES SEBI initiated discussions on short-selling in 1996 through a committee chaired by Shri B.D. Shah who defined short-sale as the sale of shares without physical control until settling prior purchases or countering ongoing deliveries. The ban on short-selling was short-lived, as SEBI introduced a Securities Lending and Borrowing (SLB) framework later in December 2007, following recommendations from the Secondary Market Advisory Committee, permitting both retail and institutional investors to engage in short-selling again, with certain conditions. The Adani-Hindenburg saga unfolded against the backdrop of, Hindenburg, a US-based financial research agency, who short-sold some shares of Adani Group accusing them of engaging in deceptive practices and inflating the value of its companies. Consequently, the ED carried out an investigation directed by the apex court of India which observed that no substantive losses were faced by the investors, implying that SEBI regulations were well in place, but keeping in view the current rise in the stock market trend of price manipulation, SEBI being an independent regulatory authority was directed to formulate further guidelines to ensure a proper framework for short-selling activities so that no investor is at a risk of being victim to violation of market practices. Making Room for Everyone This new framework opens the door for a wide spectrum of investors. but with the doors wide open, we also need to be more careful. Novice retail traders entering this complex arena face the risk of exacerbating market volatility and becoming susceptible to manipulative tactics. To ensure a fair playing field for all, SEBI must prioritize comprehensive investor education and diligent monitoring. This step could include understanding the investing capacity and the trading intention of new investors and equipping them with the requisite knowledge of the operations of the market and official financial information of the listed companies, by registered securities educators or mentors, enabling them to make an informed decision. Cracking Down on Risky Business SEBI has put in place an important rule: if you’re selling shares you borrowed, you’ve got to deliver those shares. This is meant to stop naked short-selling which is a risky move that can mess with stock prices, just like when Porsche tried to short-sell Volkswagen in 2008. When Volkswagen’s price shot up, Porsche could not deliver the shares it owed, causing a lot of problems for hedge funds and making the market go crazy. SEBI’s mandatory delivery requirement aims to prevent similar scenarios by promoting responsible short-selling and curbing predatory behaviours. Being Transparent About Trades SEBI has also mandated transparency through disclosure requirements. Institutional investors have to disclose upfront if they’re making a short sale, while regular retail investors like us have to make a similar disclosure by the end of the trading day. Additionally, brokers have to keep track of all the short-selling positions for each stock and upload this data to the stock exchanges before the next trading day commences. IMPACT OF THE ANNOUNCEMENT It’s undeniable that the most recent SEBI short-selling rules have two sides. One may argue that naked short-selling is a good thing for the financial markets. Additionally, they opine that it may enhance the way the securities markets for borrowing and lending operate. The primary contention is that the issue of who serves as the lender is the sole distinction between covered and naked short sales. In contrast to naked shorting, when the lender is the new buyer, covered shorting involves the lender as the present owner of the stocks. It’s possible that this will not have a big impact on determining the fair price, but they also present the counter-argument that the new buyer might not be aware of it and will not voluntarily enter into the lending relationship he/she will not even get paid for it. Nonetheless, the new buyer is in a secure position and may even profit from the interest on the money that is held until the assets are delivered, thanks to the clearing houses’ centre-counterparty arrangement and the option to start the buy-in process. The suddenness of the share price drop invites investors involved in naked short selling to sell even the unborrowed shares to benefit from it at least in the short-run. This creates competition in the market for security lending by allowing a new buyer to provide the service of being owed the share rather than allowing only the current owner to do so. Naked short-selling may be good for the financial markets
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