MUMBAI, Nov 11: Sebi is planning a clampdown on "naked", or "blank", short-sales for both cash and carryforward transactions. Naked short-sales are sales made by brokers who neither own the shares they have sold nor have borrowed them for delivery. The Sebi move, which stops short of a complete ban on short-selling, forms part of its efforts to regulate short-selling and prevent its misuse. Sebi's executive director in charge of secondary markets, Pratip Kar, has circulated a note calling for regulating short-sales to the BD Shah committee which is looking into the issue.The committee met in Bombay on Wednesday. Although Kar declined to comment on the note, he said that the committee was of the view that there was a need to regulate short-sales. Apart from the proposed ban on naked short-sales, the other issues discussed at the meeting were the need for tighter disclosure norms, differential margins and whether one should designate securities where short-selling will be permitted. The committee will bemeeting again on November 27. A copy of the note, which is available with The Financial Express, reveals that Kar has made a strong pitch for clamping down on naked short-sales.
After comprehensively outlining the practices adopted in various markets like the US, Hongkong, Malaysia, Canada and Brazil, Kar has stated that none of these markets allowed naked or blank short-sales. A short-seller must arrange for delivery at the end of the settlement.
This makes stock borrowing a pre-condition for going short on a security by the client member. Some markets also have the concept of designated securites for short-selling.
"In the context of the Indian markets, due to the feature of account period settlement, a short sale may either be squared-off or carried forward (in exchanges where carryforward is permitted) and thus need not result in compulsory delivery at the end of the account period.
This fact is compounded by the absence of uniform settlement cycles which makes it possible for the marketoperators to move positions between exchanges which have carryforward transactions and others which don't. This begs the question whether naked short-sales should be allowed to continue in our markets", states the note prepared by the policy division of Sebi.
The note further adds: "The facility of naked short-sales has also affected stocklending activity. This activity has not yet picked up because it is unlikely that in a situation where a market operator can sell short without a cost (on the contrary he can receive badla charges through the carryforward mechanism) that he would resort to stock borrowing, which is at a cost".
Taking note of the fact that the market could react adversely to such a development, the note states: "Any regulation on short-sales is bound to have an impact in the short run on the turnover on exchanges, as not more than 20 per cent of the turnover results in delivery. It would also have an impact on the present modified carryforward system".
Five critical issues have beenthrown up by Sebi to the committee. These are:
Should short-sales be regulated beyond mere disclosures?
Should there be a concept of designated securities as it exists in several markets? The international experience is that such identification of securities is essential for market integrity. The scrips in which short-sales can take place are designated on the basis of sufficiency of floating stock, market capitalisation and liquidity.
Should there be price regulation on short-sales? This happens, for example, in the US markets where short-sales on the downtick are not permitted; they can take place only at a price higher than the previous transaction price. This downtick rule, however, calls for a proper monitoring apparatus at the stock exchanges, which will need appropriate software for implementing the downtick rule.
Should blanked short-sales be allowed? This would imply that no member can sell short on his own account or as an agent unless he has made arrangements to makedelivery on the settlement date. The short-seller would have to do this by borrowing stock.
Should there be additional reporting of short-sales in which members/clients would have to indicate upfront whether the transaction is a short/long purchases.The BD Shah committee, which was set up in November 22, 1996, had earlier come out with a set of recommendations. Sebi had subsequently decided to bring in disclosures in short-sales by asking brokers to submit their net short-sales and long purchase positions on 60 scrips on a daily basis.
"However, there is a view in the market that the disclosures are not accurate as these are made on the basis of mere declarations by the members and the exchanges concede that the members may not be reporting their exact positions. The figures are thus just as accurate as the disclosure by the members", the note states.
"The committee was of the firm view that short-sales provide liquidity and competitive price formation in the stockmarket and there was no casefor a blanket ban on short-sales. At the same time it was also recognised that excessive short-sales have serious negative impact in depressed market conditions and generally work to the disadvantage of investors at large. Excessive short-sales exacerbate market volatility and provide a mechanism for bear-hammering", the note adds.
"Drawing upon the experience of several developing and developed markets on the subject of short-sales it may be said that while all markets recognise the need for and allow short-sales, short-sales take place in a regulated framework", the note further states.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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