The Securities and Exchange Board of India (“SEBI”) in a recent Circular prohibiting ‘naked short selling’. This Circular marks a significant step in the regulation of short selling in Indian securities markets, and is prompted by ongoing Supreme Court proceedings related to alleged market manipulation involving Adani Group stocks. This regulatory update, building upon the Master Circular for Stock Exchanges and Clearing Corporations issued in October 2023, signifies a comprehensive effort to align with evolving market dynamics.
Understanding Key Provisions
SEBI's definition of short selling as the act of selling stocks not owned at the time of trade underscores the regulator's intent to bring clarity to this investment strategy. The inclusion of all categories of investors in short selling, with specific restrictions on institutional investors, adds a layer of control. Institutional transactions being grossed at the custodians' level emphasizes the need for institutions to fulfil their obligations on a gross basis, reducing the potential impact on market dynamics.
The prohibition of naked short selling, reiterated by SEBI, is a crucial move. Naked short selling, where the seller fails to borrow the stock, has been a concern globally due to its potential to force prices down beyond what is feasible in legitimate short-selling conditions. SEBI's commitment to maintaining the restriction aligns with international standards and aims at curbing manipulative practices.
The proposed introduction of a securities lending and borrowing scheme, coinciding with institutional investors entering short selling, is a noteworthy development. This move is aimed at facilitating and incentivizing short selling, providing a structured framework for securities lending and borrowing.
SEBI's permission for short selling in the F&O segment, coupled with its reserved right to review the list of eligible stocks, indicates a cautious approach. This flexibility allows SEBI to adapt to changing market conditions and reassess the suitability of stocks for short selling transactions.
Addressing Associated Risks
The risks associated with short selling, including the potential for significant losses, market manipulation, and challenges during exceptional circumstances, are duly acknowledged. SEBI's proactive measures during the COVID-19 pandemic, such as the temporary ban on short selling, demonstrate a commitment to market stability during periods of heightened volatility.
Analyzing the Present Framework
The transparency introduced by the updated framework, mandating the disclosure of all short sales, is a significant enhancement. This provision allows retail investors to closely monitor institutional trades, potentially acting as a deterrent to manipulative practices by powerful institutional players. The emphasis on disclosure aligns with global best practices and promotes a more transparent and accountable market environment.
The continued restriction on naked short selling, coupled with SEBI's plan to implement a Securities Lending and Borrowing framework, showcases a holistic approach to risk mitigation. The SLB framework not only ensures the honouring of short positions at settlement but also provides clear guidelines on borrowing/lending contracts and position limits, contributing to market stability.
SEBI's proactive intervention during periods of exceptional volatility, as evidenced by the temporary restriction on short selling during the COVID-19 pandemic, highlights its commitment to maintaining market integrity.
Our Take
While concerns about potential drawbacks are acknowledged, the regulator emphasizes the legitimacy of short selling as a tool for market efficiency. SEBI's commitment to a regulated framework, along with its proactive stance on market stability, showcases a commendable balance between investor protection, market development, and effective regulation. This approach positions India's securities markets on a path that aligns with global standards while addressing specific market dynamics.
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