The Hindu Business Line : Reverse overseas stock lending deals, FIIs told

New Delhi/Mumbai, Oct. 23 The Union Finance Minister, Mr P. Chidambaram, on Thursday said SEBI has asked foreign institutional investors to reverse transactions that involved overseas lending of Indian stocks to offshore entities.

Such a practice had often led to the creation of short-sale positions on the Indian stocks that were borrowed by the offshore entities through the participatory notes route. There is a belief that short-selling had added to the selling pressure seen in the local markets in recent weeks on account of the global financial turmoil.

“This is a matter with SEBI. The board is addressing it. It has found one misuse of the window, may be not misuse but one use of the window which is not quite appropriate. Namely, that FIIs are lending to offshore entities. SEBI has told them now that it disapproves of that lending to offshore entities and asked them to reverse those transactions,” Mr Chidambaram told reporters here.

He was responding to queries on whether the Government was looking into short-selling by foreign institutional investors.

“I am told that those transactions are likely to be reversed in the next few days”, Mr Chidambaram added.

The Securities and Exchange Board of India (SEBI) had on Monday told FIIs that it disapproved of lending and borrowing of Indian stocks abroad. On Wednesday, 12 FIIs met SEBI and were told again of the capital market regulator’s disapproval of overseas lending and borrowing of Indian stocks by them.

Some legal experts contend that the capital markets regulator is on a weak legal wicket and that its recent moves including expressions of “displeasure” and “disapproval” were more in the nature of tough talk or constituting moral suasion.

“There is no prohibitive SEBI regulation regarding short selling by FIIs overseas,” said an official with a law firm that advises FIIs. “There is no regulation which deals with what FIIs can do abroad. It is very difficult for SEBI to take a position that is why the regulator has just made a statement.”

Typically, SEBI would have issued a directive or a circular under Section 11 B; now it is going about it indirectly by way of suggestions, in this case only oral suggestions to FIIs, said another legal expert on securities regulations.

However, SEBI does have the powers to make the necessary laws, said the official with the law firm: “It can amend the regulations and make such lending of securities illegal. Short of that it cannot do anything else.”

Monitoring such lending is a different matter, and an “extremely difficult” exercise, he said.

Legal circles held that the request to FIIs to reverse their short positions generated through lending of Indian securities through participatory notes is a knee-jerk emergency measure.

Marketmen said it would only add to the panic in the markets.

There is going to be a lot of short covering by FIIs and the markets may only temporarily gain, said a broker.

But afterwards, since a manner of short selling has been removed, traders will start pruning their positions in the market and that will push volumes down, he said.

Net sales by FIIs in Indian equities in 2008 have exceeded $ 12 billion so far.