The short sales ban drama and its implications

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: At the moment, there is considerable rabble being roused over the fact that the Securities & Exchange Board of India (Sebi) will be banning short sales. Matters started boiling up when the regulator asked overseas investors who are allowed to issue participatory notes (P-note) to furnish data regarding their lending of shares in the overseas market for short sales or related synthetic short sales (read derivatives). When the data was available, for 33 of the 34 FIIs from October 10 till 17, it could be seen that foreign institutional investors (FIIs) had lent shares in excess of Rs 600 crore in the overseas market, the regulator issued a communication expressing its disapproval of this practice, and they have been directed not to take any fresh positions in the overseas markets.

This is seen by many as a precursor for banning short sales in India. The reasoning is based on the fact the markets have witnessed a huge slide thanks to some incessant shorting by certain sections of the market. Moreover, with many other regulators resorting to banning of short sales, it is perceived that the Indian regulator would also follow suit.

The ban

Earlier this month, when the restrictions on the P-note issuances were done away with, Sebi chairman Chandrakant Bhaskar Bhave had categorically mentioned that they had not seen any alarming signs in the market place and that the system was operating well. “In the Indian market you have delivery-based short sales, not like other countries which have banned short sales,” he mentioned in the post-board meeting conference.

“Banning short sales would be interfering in the market mechanism of effective price discovery,” says Motilal Oswal, chairman Motilal Oswal Securities. And this is the sentiment that most market denizen have expressed. And most do not think that the regulator would take action on this front.

The reasoning is that it is quite not required. “Every bear is a potential bear and every bear a potential bull,” reckons Parag Parikh, chairman of PPFAS and a bestselling author. The market when ‘shorted’ would require the person to cover the short sale and therefore buy the shares. Similarly, when you investors go ‘long’, they also have to sell to make good their commitments. “It has a balancing effect and eventually the market finds its own levels, high or low,” adds Parikh. Tampering with it is tampering with the market mechanism.