The Securities and Exchange Board of India (SEBI) has announced major reforms in the trading rules to curb market manipulation and enhance transparency. The regulator has reiterated its ban on naked short selling, where the seller does not own the stock at the time of the trade, and has prohibited day trading by institutional investors, where they square off their transactions intra-day. The regulator has also opened short selling to all investors, subject to certain conditions, and has introduced a scheme for securities lending and borrowing (SLB) to facilitate short selling.
What is Short Selling?
Short selling is a trading strategy that involves selling a borrowed security with the intention of buying it back later at a lower price. Short sellers profit from the price decline of the security they sell. Short selling can help balance the market against overvalued stocks, prevent speculative bubbles, and correct market mispricing.
However, short selling also involves risks and challenges. Short sellers face unlimited losses if the price of the security they sell rises instead of falls. They also have to pay fees or interest for borrowing the security, and they have to deliver the security at the time of settlement. If they fail to do so, they may face penalties or legal action.
What is Naked Short Selling?
Naked short selling is a type of short selling where the seller does not own or borrow the security at the time of the trade. Naked short sellers sell securities that they do not have, hoping to buy them later at a lower price or to cover their position through other means. Naked short selling can create artificial supply of securities in the market, distort price discovery, and undermine investor confidence.
Naked short selling is illegal in most markets, including India. SEBI has banned naked short selling since 2008, after allegations of insider trading contributed to a crash in stock prices. SEBI has clarified that all investors would be required to mandatorily honour their obligation of delivering the securities at the time of settlement.
What is Day Trading?
Day trading is a type of trading where investors buy and sell securities within the same trading day, without holding any positions overnight. Day traders aim to profit from short-term price movements and market fluctuations. Day trading can offer high returns in a short time, but it also involves high risks and costs.
Day trading is allowed for retail investors in India, subject to certain margin requirements and disclosure rules. However, SEBI has banned day trading by institutional investors since 2008, as part of its framework for short selling. SEBI has said that no institutional investor shall be allowed to do day trading i.e., square off their transactions intra-day. The regulator has said that all transactions would be grossed for institutional investors at the custodians’ level and the institutions would be required to fulfill their obligations on a gross basis.
What is Securities Lending and Borrowing?
Securities lending and borrowing (SLB) is a mechanism that enables investors to borrow or lend securities for a specified period of time, for a fee or interest. SLB can facilitate short selling by providing a source of securities for borrowing. SLB can also benefit lenders by generating income from their idle securities.
SEBI has introduced a scheme for SLB in 2008, simultaneous with the introduction of short selling by institutional investors. The scheme allows all classes of investors to participate in SLB, subject to certain eligibility criteria and operational guidelines. The securities traded in futures and options segment are eligible for SLB. SEBI may review the list of stocks that are eligible for SLB from time to time.
What are the Disclosure Rules?
SEBI has mandated that all investors who engage in short selling must disclose their transactions at the time of order placement or by the end of the trading day. The institutional investors must disclose upfront whether the transaction is a short sale, while retail investors can make a similar disclosure by the end of the trading hours on the transaction day.
The brokers are required to collect the details on scrip-wise short sell positions, collate the data and upload it to the stock exchanges before the commencement of trading on the following trading day. The stock exchanges then consolidate such information and disseminate it on their websites for public information on a weekly basis.
The disclosure rules are aimed at enhancing transparency and monitoring of short selling activities in the market. The frequency of disclosure may be reviewed by SEBI from time to time with its approval.
What is the Impact of These Rules on Investors?
These rules are intended to protect investors from unfair practices and promote fair and efficient markets. By banning naked short selling and day trading by institutional investors, SEBI aims to prevent market manipulation, reduce volatility, and ensure timely delivery of securities. By allowing short selling by all investors and introducing SLB, SEBI aims to increase liquidity, improve price discovery, and offer new opportunities for profit making. By mandating disclosure of short sell positions, SEBI aims to increase accountability, deter fraud, and provide market information.