SEBI Announces Disclosure Norms for Short Sale Transactions

  • January 6, 2024
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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SEBI Announces Disclosure Norms for Short Sale Transactions

Subject: Economy

Section: Capital Market

The Securities and Exchange Board of India (SEBI) has issued new guidelines pertaining to the disclosure of short-sale transactions by institutional and retail investors. The move comes in the wake of a Supreme Court directive to investigate alleged Adani Group stock manipulation.

Key Points:

  1. Mandatory Disclosure:
    • Institutional Investors: All institutional investors are required to disclose short sale transactions upfront at the time of placing orders.
    • Retail Investors: Retail investors must make a similar disclosure by the end of the trading day.
  2. Supreme Court Ruling:
    • The SEBI’s decision is prompted by the Supreme Court’s order to investigate potential market manipulation related to short positions during the publication of the Hindenburg report on Adani Group stocks.
  3. Transparency and Informed Decision-making:
    • The move is expected to enhance transparency in the market and facilitate informed decision-making among market participants.
  4. Aggregate Short Interest Display:
    • Exchanges will display aggregate short interest data for each stock daily, providing visibility into short selling activity.
  5. Process Details:
    • Brokers are mandated to collect and upload scripwise short sell positions to exchanges before the next trading day.
    • This process aims to increase visibility into short-selling activity, enabling better monitoring by regulators and contributing to more stable prices.
  6. Introduction of Securities Lending and Borrowing (SLB) Scheme:
    • SEBI plans to introduce a comprehensive SLB scheme concurrently with institutional investors engaging in short selling.
    • The SLB scheme is intended to provide the necessary infrastructure to support short selling activities.

Short Selling:

Short selling is a trading strategy where an investor sells borrowed securities with the expectation that the price will decline. The investor intends to buy back the same securities later at a lower price, returning them to the lender and profiting from the price difference.

Example:

  1. Borrowing Shares: An investor borrows 100 shares of Company X from a broker.
  2. Selling Shares: The investor sells these borrowed shares in the market at the current market price.
  3. Waiting for Price Decline: The investor anticipates that the stock price of Company X will decrease.
  4. Buying Back Shares: If the stock price falls as expected, the investor buys back 100 shares at the lower price.
  5. Returning Borrowed Shares: The investor returns the 100 shares to the broker, completing the short sale transaction.

Profit or Loss:

  • If the stock price falls, the investor makes a profit by buying back the shares at a lower price.
  • If the stock price rises, the investor incurs a loss as they need to buy back the shares at a higher price than they sold them.

Naked Short Selling:

Naked short selling occurs when an investor sells shares without actually borrowing them or ensuring that they can be borrowed. This practice is generally considered illegal or highly regulated in many markets due to its potential for market manipulation.

Example:

  1. Selling Shares without Borrowing: An investor sells 100 shares of Company Y without actually borrowing them from a broker.
  2. No Ownership or Borrowing Agreement: The investor doesn’t own the shares and hasn’t entered into any borrowing agreement.
  3. Market Impact: This creates artificial selling pressure in the market, potentially influencing the stock’s price.
  4. Buy-In Requirement: If the shares are not delivered by the settlement date, the broker may be forced to buy them in the open market to fulfill the delivery requirement.

Key Differences:

  • In short selling, shares are borrowed before selling, while in naked short selling, shares are sold without borrowing.
  • Short selling is a legitimate trading strategy, while naked short selling is often prohibited or strictly regulated to prevent market manipulation.

Securities Lending and Borrowing (SLB):

Securities Lending and Borrowing (SLB) is a financial arrangement where one party (the lender) temporarily lends securities to another party (the borrower) in exchange for a fee. This arrangement allows investors to earn additional income by lending their securities to those who need them, typically for short-selling purposes.

  1. Lender and Borrower:
    • Lender: The entity or investor who owns the securities and is willing to lend them.
    • Borrower: The entity or investor who borrows the securities for a specified period, usually to sell them in the market.
  2. Collateral:
    • The borrower provides collateral to the lender to secure the loan. This collateral is usually in the form of cash or other securities and serves as a guarantee against any default by the borrower.
  3. Fee or Interest:
    • The borrower pays a fee or interest to the lender for the right to borrow the securities. This fee compensates the lender for the temporary transfer of ownership.
  4. Loan Period:
    • SLB transactions have a specified loan period, after which the borrower must return the borrowed securities to the lender.
  5. Securities Transfer:
    • The securities are transferred from the lender’s account to the borrower’s account for the duration of the loan.
  6. Risk Management:
    • SLB transactions include risk management measures to protect both parties, such as the requirement for collateral and the return of securities at the end of the loan period.

Purpose of SLB:

  1. Facilitate Short Selling:
    • Borrowed securities are often used by investors who engage in short selling. The borrower sells the borrowed securities with the expectation that their price will fall, allowing them to buy them back at a lower price.
  2. Liquidity Enhancement:
    • SLB contributes to market liquidity by making additional securities available for borrowing, supporting various trading and investment strategies.
  3. Income Generation:
    • Lenders earn additional income by charging fees or receiving interest for lending their securities.
  4. Arbitrage Opportunities:

Traders may engage in SLB to exploit price differentials between the cash and derivatives markets, taking advantage of arbitrage opportunities.

economy SEBI Announces Disclosure Norms for Short Sale Transactions