Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

US SEC abolishes the uptick rule

The US SEC has finally decided to
abolish the rule that prohibited shares being shorted except on an
uptick. The surprising thing is that it has taken 70 years (almost
three generations) to get rid of a stupid idea that entered the
statute book in 1938.

Of course, in a balancing act, the SEC also tightened rules on
“naked short selling”. There is a genuine problem that
these rules are trying to address, but this problem is not short
selling, it is failed settlement. Though the US has a three day
settlement cycle, an unacceptably large proportion of trades fail to
settle for several days beyond that date.

It is really fortunate that India avoided importing the system of
“continuous net settlement” which is the root of the
settlement problem in the US. The Indian approach of ruthless
penalties for settlement failures is the right solution to this
problem. Instead the SEC wants to look at the whether the failure was
intentional or unintentional. It uses silly notions like
“abusive short selling” to decide which settlement
failures ought to be penalized. It is much better to focus on
consequences and penalize all failures regardless of intention. The
Indian system has the additional advantage of using a civil liability
to deal with a contractual violation. The US system tries to elevate a
contractual violation to the level of a fraud.

At a deeper level, the problem of naked short selling is a failure
of the securities lending system. The US has a highly developed system
for this, but even this system does not work well for all
stocks. India faces the challenge of building a securities lending
system from scratch, but without any past baggage, it has the
potential to build a system with universal access.

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