Editorial. Enforcement of SEBI’s short-selling rules crucial

Short selling, which involves selling a stock which is not owned by the investor at the time of the trade, has received much attention since the recent Supreme Court judgment in the Adani-Hindenburg case. The circular issued by the market regulator last week outlining the framework for short selling immediately follows the Supreme Court’s directive to improve investor awareness and check violation of existing laws by short sellers. The rules governing short selling and securities borrowing and lending mechanism were originally framed in October 2007. These rules were reproduced verbatim in the master circular on stock exchanges and clearing corporations issued in October 2023.

Surprisingly, the circular issued last week is once again an exact replica of the 2007 rules. The regulator may be right in not tampering with the existing framework, which appears quite adequate. But enforcement of some of the facets of short-selling rules can be improved. Short selling is a legitimate investment activity, and all regulators agree that curbing this activity can distort market functioning and price discovery. The existing framework in India does a good job of regulating this activity without imposing unnecessary curbs. It allows both retail and institutional investors to short sell, provided they can supply the security to the buyer during the settlement. Naked short-selling, which is more risky and can cause sharp downward swings, is however banned in India, thus protecting markets from a bear attack. Similarly, large institutions are not allowed to do intra-day trading in the cash segment. Short selling is available in only select stocks, with higher liquidity, which are also traded in the futures and options segment. This ensures that short sellers do not target stocks with poor liquidity.

However, enforcement can be improved. For instance, the regulations require that institutional investors should inform the broker upfront that they are entering a short-selling transaction and retail investors need to inform their broker towards the end of the day. Since institutions typically take short positions in the derivatives market, these rules governing institutional investors may not be necessary. Making investors aware about stocks with large outstanding short-sale positions is a good way to warn them about the risk in these stocks. While brokers are required to collate details of scrip-wise short-sale positions and upload them on the exchange website before the beginning of trading the following day, exchanges are told to disseminate this information on their websites on a weekly basis. This delay in making the information available makes it useless. Making the information available on exchange websites the next day may help.

The stock lending and borrowing mechanism needs an overhaul. While a full-fledged securities lending and borrowing scheme was operationalised in April 2008, the scheme is yet to take off. Mutual funds, insurance companies and retail investors have also stayed away due to a complex process. SEBI needs to consult with all stakeholders to make this scheme functional.

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