Did a Tsunami of short selling bets ‘outside India’ trigger the $100 billion rout in the share price of Adani Group? An initial probe by government agencies has revealed that the bear cartel targeted Adani companies through the use of structured product derivatives (SPDs) - potent stock market instruments, tailor-made by foreign brokers for large clients in offshore jurisdictions. These SPDs are similar to the controversial participatory notes in many ways since the identity of the actual clients stays hidden, unless the regulators lift the veil.

As per India’s tax and SEBI laws, short selling of domestic stocks outside the country’s jurisdiction is illegal unless they are listed on any exchange. But the probe reveals that billions of dollars worth of trading took place in Adani group stocks outside the country, which had a domino effect on India-listed shares as the volatility increased. The biggest clue of the overseas short selling in Adani stocks came from Hindenburg, which claimed to have targeted the group citing fraud and sky high valuations. 

On January 24, Hindenburg revealed: “held short positions in Adani companies through bonds and non-Indian-traded derivative instruments.”

While Adani bonds are listed on the US exchange, Hindenburg’s reference to the ‘non-Indian-traded derivatives’ raised the alarm for Indian regulators. Sources told businessline that these non-Indian-traded derivatives are nothing but SPDs. If not for these derivative instruments, which triggered the rout, there was no chance of heavy selling in Adani shares in India that could have wiped out $100 billion in less than a week, since more than 90 per cent of the float was held by promoters, entities close to them and domestic institutions. It is an open secret that the dream run in Adani stocks was fuelled by this demand-supply mismatch.

Short selling begun ahead

The probe also shows that the operation to short sell Adani shares and Indian markets may have begun several weeks ahead of the Hindenburg report, which was published on January 24, just a day ahead of the monthly derivative market expiry in India and a few sessions ahead of the Union Budget, when volatility is usually high. Reports can spoil the sentiments but for a fall of the magnitude seen in Adani companies, huge positions were required.    

When foreign brokers sell SPDs on Indian underlying to their confidential clients in tax havens and offshore jurisdictions, they themselves or through their associates registered as foreign portfolio investors (FPIs) in India try to partly hedge their positions on Indian exchanges. This hedge of the FPIs, who had shorted Adani stocks overseas, led to rise in bearish bets on Indian markets. 

Also read: SC agrees to hear Friday plea seeking probe into Hindenburg report on Adani firms

Data reveals there was frantic trading in NSE’s equity options segment starting from December 2022 up to the Union Budget. As a result, the ratio of Put options, which investors buy when they anticipate a market crash, kept rising steadily and touched a 13-year high on January 24: the day Hindenburg published its report. 

On January 23, the Put and Call ratio stood at 0.73 (73 Puts against 100 Calls) and touched 0.74 the next day, which is the highest reading since the peak of the Great Financial Crises in March 2009, when the ratio touched 0.75. It simply means that Puts were being added frantically in the Indian markets up to the Union Budget even as the global stock markets were steady or rallying. Probe also shows there was high action seen in out-of-the-money Put options of Adani stocks, which means some were anticipating a sharp fall. 

On February 1, the Sensex rose by 1200 points as the Finance Minister announced tax breaks and higher exemptions in her budget. But short selling by FPIs ensured that the markets closed in the negative and Adani stocks crashed even before the news came out of the group calling off its follow-on public offer. 

Domestic angle

The probe also shows that New York-based Hindenburg is not a registered research firm with any market regulator. In the report, Hindenburg claims to have received information on SEBI investigations into Adani stocks via the right to information (RTI) application. But SEBI never shares any investigation-related info via RTI. Investigations show that Hindenburg’s report follows the exact same financial and other metrics that were followed by a leading Indian market researcher in his ‘Bespoke’ reports on listed companies that were sold for $20,000 to $50,000 to private clients.

What are SDPs?

The use of derivative ‘options’ is the most powerful strategy for short selling stocks and SPDs wield them most effectively. If trader “A” is bearish on a particular stock or market but does not want to take direct position, he may approach a foreign broker, who after a thorough risk assessment, will sell him the Put options of the underlying with some spread and higher than usual brokerage commission.

Also read: MSCI reviews ‘free float’ status of Adani stocks amid investor concerns

SPDs can consist of anything in the debt, equity, and commodity universe for short selling and are sold for one-three month periods. Strategies like ‘total return swap’ consisting Puts, or selling Calls are popular. When the price of the underlying asset falls, trader A will benefit without any direct position in India. Instead, the broker who sold the SPD to the client will take position in India through various entities in a way that does not raise any alarm. Investigators suspect Hindenburg played this game of dealing in “non-India-traded derivatives of Adani.” The colossal weight of this overseas short selling fell on Adani stocks in India, which, despite extremely low floating stock, suffered a historic rout.