Editorial: A level-playing field
The authorities have done well to stop some of the damage being done to Indian stock prices by foreign institutional investors (FIIs) operating in the Indian market. FIIs have been using participatory notes (p-notes) to play between the cash and futures markets in India, with the advantage of stock lending which is in effect denied to Indian investors (because the stock lending programme is so structured that it has not worked). By asking for greater transparency on this account, the Securities and Exchange Board of India (Sebi) may succeed in stopping a practice that has put needless pressure on stock prices in the cash market. The problem arose in the first place because India allows futures trading in single stocks, which many markets do not. However, this is not enough. The fact is that overseas hedge funds, who cannot go short in many other markets, have the ability to do so in India means that funds that go long in other markets hedge their positions by going short in India—something that depresses Indian stock prices because of global play. This practice too should be looked at closely for what it does to the Indian market. Indeed, it is just as well that the Sebi chairman, Mr Bhave, has taken these steps after somewhat needlessly undoing recently action that had been taken by his predecessor, Mr Damodaran, with regard to international players and futures trading in India. Whatever the merits or demerits of the decision, it was certainly bad timing.
As a part of developing the system, it would now be a good idea for Sebi to have short-sale transactions in the futures and options (F&O) segment settled in shares rather than in cash, as is being done currently. India is one of the few countries in the world where sellers are not yet allowed to settle their transactions by delivering the shares. Such a move would result in greater ease of transactions because a seller, who starts out initially shorting a counter and decides, towards the close of the series, that he wants to exit the stock, can simply deliver the shares in the F&O segment rather than be forced to enter into a parallel transaction to sell the physical shares in the cash market. That would make the cash and futures markets more seamless.
Short-selling has come under a cloud in other markets as well, with the Securities Exchange Commission banning it for a short period for nearly 7,800 stocks, in the exceptional circumstances that have prevailed in New York recently. But it is also incorrect to blame short sellers for all the damage, as Richard Fuld, the former Lehman Brothers chief executive, did during his testimony to a Congressional committee after one of the biggest bankruptcies in US history. Mr Fuld merely echoed the testimony of another victim of the credit crisis, Alan Schwartz, the former chief executive of Bear Sterns, who too said short sellers had helped create a run on the bank, sapping Bear Sterns’ liquidity and eventually forcing it into a shotgun marriage with JP Morgan Chase. With due respect to both gentlemen, however, short sellers cannot be made scapegoats for over-leveraging and irresponsible lending. Ultimately, even short sellers are putting their necks on the line because, if the fundamentals don’t support the direction of the trade, and buyers come in believing there is value in the stock, they could lose their shirts. Short selling adds to transaction volumes, thereby imparting greater depth and liquidity to a market, and aids price discovery.