Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Short selling in India

The Securities and Exchange Board of India has put out a discussion paper
recommending that all market participants should be permitted to short sell
shares and that a transparent system of securities lending should be introduced.
These are recommendation that I enthusiastically agree with.

However, I see no reason why short selling should be restricted to stocks
on which derivative contracts are permitted. Short selling should be seen as a defence
against market manipulation and therefore a measure to improve market integrity. It is
therefore more necessary in stocks that are prone to market manipulation. On the
other hand, derivative contracts are typcially not permitted on
precisely the stocks on stocks that are prone to market manipulation. The proposal
is therefore best seen as a convenient resting point on the path to allowing short selling
in all stocks.

The other critical issue is of regulatory risk that retail short sellers have faced
in the past. Though short selling by individuals has been permissible most of the time,
SEBI has on certain occasions banned short selling peremptorily in response to market
fluctuations. An assurance that this would not happen again would be welcome. Any
future restriction on short selling should only be after due process of consultation
and with a reasonable transition arrangement

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