Short sales make a come back in India – will it work?

India saw the reintroduction of the short sales and corresponding stock borrowing and lending program on 21^st April 2008 which had so famously been banned in 2001 after the stock market scams. For the uninitiated, short sales refer to selling stock without holding it and buying back later. To complete the settlement the player doing the short can borrow stock and hence the need for stock borrowing and lending program. However, that’s not the only utility of the SLBM (stock lending and borrowing mechanism).

I had been following this news for quite some time as the discussion has been happening for some years now. However, when the final picture came out, I was a touch disappointed. It is therefore no surprise that more than a week later, we see that the program hasn’t taken off at all with absolutely no interest in the SLBM (check www.nseindia.com for daily trades under this category). Much of the focus in the recent past has been on the earnings (as this is not just the quarter end but year end as well), inflation, monetary policy and the derivatives losses that companies are facing (along with the courtroom drama), that’s not the only reason for short selling and SLBM to escape the eye of the big investors.

To start with, short selling is allowed only in selected scrips which are also traded in the F&O section. The SLBM is a exchange traded order driven mechanism unlike its OTC counterparts in many parts of the world. Trading is allowed only 1 hour everyday in the morning and there is a fixed settlement cycle of T+7. To add to that margins apply to the institutional investors as well (to bring them to a level playing field with retail investors). The question is when F&O are available, what extra benefit would short sales and SLBM bring especially in the light of complex margin requirements. One of the reasons could be reverse arbitrage where prices in the cash market are at a discount to the futures prices in which one would like to borrow securities, sell in cash market and buy in the futures market. However, this is not possible as SLBM works only for 1 hour in the morning and it cannot be anticipated whether reverse arbitrage opportunities would be present. Also, in these uncertain times, no one would like to commit to a fixed settlement time frame of T+7

I also read that banks and insurance companies are not allowed to short as this amounts to speculation. That further takes away a large chunk.

So, it is hard to imagine the SLBM taking off in the current shape and though SEBI and exchanges are calling them teething issues similar to the ones faced at the time for compulsory demat trading, I believe more would have to be done to bring the players to the table.

- Saurabh Bagrodia
Student, Business Management (2007-09)

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