Single stock futures and promoter share pledges
December 17, 2012
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I participated in a discussion on CNBC TV18 about the trading of single stock futures on companies whose promoters have pledged a significant portion of their shareholding. (You can watch this show here(Part 10) though I participated only by audio).
The discussion was about a proposal that companies whose promoters have pledged a significant fraction of their shareholding should be punished by stopping trading in single stock futures in the shares of these companies. My views were as follows:
- Allowing trading of single stock futures should not be seen as a mark of prestige for the company or any form of a reward or seal of approval. The single stock future exists to meet the need of investors and not the needs of the companies or of the exchanges.
- Single stock futures are the easiest way to short shares, and so banning single stock futures would be a mild form of banning short selling. Short selling is an absolutely essential counterweight for the leveraged long. Restricting short selling when the promoters are leveraged long would essentially be a way of bailing them out and protecting them from sharp falls in their share prices.
- Large leveraged longs create a cliff risk for the share price – if the price falls far enough to produce large margin calls for the leveraged buyers, then the price can just fall off a cliff due to distress liquidation of the pledged shares by the lenders. The answer to this is more stringent margins when cliff risk is high either because of a large leveraged long position (or on the opposite side, because of a large short interest).