The Hindu Business Line : `Short-selling will create liquidity, deepen market'

Individual and institutional investors will welcome the move, as they can profit from short-term corrections. — MS FALGUNI NAYAR, MANAGING DIRECTOR OF KOTAK INVESTMENT BANKING

The SEBI board, which met in Mumbai on Thursday, decided to allow short-selling by financial institutions, as outlined in the Budget. Commenting on the market regulator's decision, the Managing Director of Kotak Investment Banking, Ms Falguni Nayar, said she believes that short-selling will create liquidity and deepen the market. She added that futures have only certain liquidity, which can be increased by short-selling.

Excerpts of CNBC-TV18's interview with Ms Nayar:

How important is it to set up a credible, viable stock lending and borrowing mechanism before short-selling and other steps become successful mechanisms?

Sebi's intention to move towards introducing a system that allows short-selling is good because it will create more liquidity and deepen the market. Investors have also been asking for it because, even if they have a long account, sometimes they have a strong view that certain sectors are going to correct and that they should be able to profit from it. Institutional investors, including FIIs and mutual funds, have also been wanting this, as otherwise, it was a one-way trade for them.

It is a good measure but details of stock lending and how it is going to work are going to be very important, which we don't have yet. Globally, such practices are already in place. And I don't think it is a big deal for us to be able to put them in place too. We have to study it right, and Sebi has to implement something that works easily, especially for investors.

Just to understand this from an FII perspective, if a certain FII is negative on a particular stock — say, Hindustan Lever — he is at liberty to go out and sell Hindustan Lever futures in the market, so why would short-selling make a big difference?

Because futures have only a certain level of liquidity. There may not be enough liquidity in the futures and there is also the difference between cash, spot and the future price.

There shouldn't be such a big difference in futures and spot market.

If this FII owns Hindustan Lever, he is at liberty to sell it but if he does not, yet he has a negative view and he wants to sell it, are you trying to say if he doesn't want to sell it on the futures market, then he would need to borrow that stock to sell?

Yes, he would have to borrow. He could borrow from, for instance LIC or any of the mutual funds, which may want to continue to hold the stock and they will sell it, and then whenever that original investor wants to actually sell his stock, he can call it back.

Globally, there is a call-back allowed; it is done through brokers. So, when the lending is done through brokers and when the call-back is allowed, at that point, Indian institutions, mutual funds or LIC asks for the stock back, then the FII has to return the stock. They have to close their trade so they will have to buy it back in the market and return the stock; that is how it works. There are very small charges for stock-lending, there is also some margin collected for it. It is a very good mechanism.

Isn't that part of the equation not quite worked out then? Who they might be able to lend to and why they should be able to borrow only from a mutual fund or an LIC, like you said.

No, it will be from anyone. I just gave you an example of LIC and mutual fund, it can also be an FII. The custodians of the FIIs hold a particular stock, so the broker can borrow from the custodian. This whole practice works well internationally; globally, in the US, it works very well.

If there is a large holding in a mutual fund, it will only lend about 80 per cent of its own holdings, not 100 per cent, so that it is also free to sell its stocks. But if it still wants to sell the rest of the stock, call-backs are allowed, in which case, the hedge funds are allowed to close their position. So I think the market adjusts. But, yes, the detailed guidelines have to be worked out.

On the other issue raised by Sebi on real-estate IPOs, do you think that will provide a lot more clarity in terms of new paper that will come in from the real estate side now?

Yes, I think what Sebi is asking is pretty fair and I think informally they have been guiding on the IPOs to have that information that is on the land ownership, look at it from the perspective of what is actually owned and paid for. So I think some amount of additional disclosure there will be worthwhile.

Second, what they are saying is that just besides looking at it from a future value perspective, look at it from a current price perspective and that could be the additional disclosures.

So I think these are positive measures. But the devil lies in the detail and we need to put some of the detailing in place, especially vis-à-vis short-selling. But on real estate IPOs, I think it is a good measure because it will differentiate the various business models in the market; there are some high quality business models and some which are not, and I think investors are often not able to differentiate.

Is IPO grading a good idea?

Today IPO grading is more prevalent and it is going to be made mandatory but I think it has to be looked at differently from recommending a share. I think the way the grading works is that it will be done on a number of qualitative factors, including corporate governance, quality of management, and quality of disclosure, and these are the factors that are the basis of grading an IPO.

So, if an IPO has a poor grading, it is like a flag to retail investors saying `watch out and do your homework on this deal to decide whether you really want to play it'.

There are some risks in terms of the company's business maturity and that is what the grading reflects. So, if it is a high quality grading then the business maturity is higher and it is a qualitative factor, to that extent. But, besides that, you have to make an equity call.

Just because it is a high quality business model in terms of how it runs the business systems and the corporate governance and the management, that still won't automatically make it a good equity investment.

So an equity call has to be looked at differently from a grading