The short sales ban drama and its implications

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: the International Organisation of Securities Commissions (IOSCO) also note that short selling plays an important role in the market for a variety of reasons, including providing more efficient price discovery, mitigating market bubbles, increasing market liquidity, facilitating hedging and other risk management activities and, more importantly, upward market manipulations.

The talk of banning short sales probably emanates from the action taken by other regulators who have or had banned short selling. The US authorities had banned short selling for a period, but have taken away the ban. Analysts have a mixed reaction over this. Some reckon that the ban was ineffective and therefore was revoked, and the others believe that the ban was a temporary one, anyway meant to cool things and when the objective was met it was revoked. However, some markets, like Australia, still continue to have the ban in place.

The IOSCO also notes that the short-selling may be problematic in the midst of a loss in market confidence. For example, in the context of a credit crisis, where some entities face liquidity challenges but are otherwise solvent, a decrease in their share price induced by short selling may lead to further credit tightening for those entities, possibly resulting in bankruptcy. In addition, there are circumstances in which short-selling can be used as a tool to mislead the market.

For example, short selling can be used in downward market manipulation, whereby, a manipulator sells the shares of a company short and then spreads lies about the company’s negative prospects. This harms issuers and investors as well as the integrity of the market.

At the moment, there is no large credit crisis in the notice. Yes, there are concerns, but not of the scale witnessed in the West. And yes, there have been instances of alleged market manipulation, especially in the case of ICICI Bank, where the bank has taken action against a section of market intermediaries for rumour mongering. But, at the moment, instances are few.

Overseas factor

The concern therefore goes back to the overseas investors and their short selling activities overseas. At the moment, the regulator has asked them not to take any fresh positions at the moment and may ask them unwind their overseas positions as data becomes available.