SEBI Circular

SEBI Circulars: Framework for Short Selling in Financial Markets

The SEBI circular, specifically identified as SEBI/HO/MRD/MRD-PoD-3/P/CIR/2024/1, dated January 05, 2024, serves as a fundamental document outlining the comprehensive framework for short-selling practices within the Indian securities market. This directive represents a meticulous effort by SEBI to delineate clear guidelines and regulations governing the conduct of short-selling activities by various market participants.

The primary objective behind the issuance of this circular is to offer a structured framework that not only defines short selling but also delineates the permissible movements, regulations, and obligations associated with the buying and selling exercise. SEBI’s objectives are to foster surroundings wherein short selling, whilst performed within prescribed limitations, contributes to marketplace liquidity without compromising on integrity or investors with this trading practice. SEBI aims to foster surroundings wherein short selling, while conducted inside prescribed boundaries, contributes to marketplace liquidity without compromising on integrity or investor safety.

This circular caters to a diverse audience encompassing a spectrum of market participants, including retail and institutional investors, stock exchanges, clearing corporations, depositories, brokers, and custodians. It is a critical guiding document that ensures a level playing field for all participants while safeguarding the interests of investors and maintaining market stability.

By setting forth explicit rules and parameters for short selling, SEBI endeavours to instil confidence among investors, enhance market transparency, and minimize systemic risks associated with speculative trading practices. The guidelines laid out in this circular are aimed at fostering responsible and informed investment decisions while mitigating potential risks that might arise from short-selling activities.

Elements of the Framework

The SEBI circular underscores a clear definition of short selling within the context of the Indian securities market. It defines short selling as the act of selling a stock that the seller does not possess at the time of the trade. This practice involves a speculative strategy wherein an investor anticipates a decline in the stock’s price and aims to profit from this downward movement.

One of the important aspects emphasized in the circular is the significance of owning stocks at the time of trade. In traditional stock transactions, investors buy shares, owing them outright before selling them for a profit. However, short selling operates on a different premise, allowing investors to sell shares they do not own with the intention of buying them back at a lower price in the future to cover the short position.

The circular emphasis on owning stocks at the time of trade aligns with regulatory efforts to ensure transparency, fairness, and accountability in the market. It serves as a safeguard against speculative practices that might lead to market manipulation or systemic risks. By requiring investors to possess the shares they sell, it promotes responsible trading practices and discourages unfounded or excessive speculation that could adversely impact market stability.

This definition serves as a cornerstone in the framework for short selling, establishing a clear boundary for market participants and delineating permissible actions while curbing practices that might potentially undermine market integrity. Understanding and adhering to short selling, establishing a clear boundary for market participants and delineating permissible actions while curbing practices that might potentially undermine market integrity. Understanding and adhering to this definition is important for investors engaging in short selling, as it sets the fundamental premise upon which the regulatory guidelines and obligations are structured within the Indian securities market landscape.

Comprehending the essence of short selling and its definition, as outlined in the SEBI circular, is crucial for investors, brokers, and other market participants. It not only provides clarity on permissible actions but also underscores the need for responsible and informed decision-making to ensure the integrity and stability of the market. In the subsequent sections, we will further explore the implications and specific provisions of the circular.

Permitted Investors and Limitations

The SEBI circular outlines the inclusivity of short selling, permitting participation from various categories of investors, including both retail and institutional investors. This broad allowance acknowledges that short selling can be a strategy adopted by investors across different segments of the market, catering to diverse investment objectives and risk appetites.

Retail and Institutional Investors

The circular explicitly permits both retail and institutional investors to engage in short-selling activities within the Indian securities market. This inclusivity enables individual retail investors, as well as larger institutional entities, such as mutual funds, banks, and financial institutions, to employ short selling as a strategic component of their investment portfolios.

Prohibition of Naked Short Selling

Notably, the circular expressly prohibits naked short selling within the Indian securities market. Naked short selling refers to the practice of selling stocks without possessing or borrowing them, leading to potential market manipulation and risks. SEBI’s stringent prohibition on naked short-selling services is a protective measure to maintain market integrity and prevent speculative activities that could potentially disrupt market equilibrium.

By allowing participation from both retail and institutional investors while firmly prohibiting naked short selling, SEBI aims to strike a balance between market inclusivity and risk mitigation. This regulatory stance not only safeguards against abusive trading practices but also ensures that short selling, when conducted within prescribed boundaries, contributes positively to market liquidity and price discovery without compromising market stability.

Regulations for Institutional Investors

The SEBI circular introduces specific regulations and restrictions tailored for institutional investors engaging in short-selling activities within the Indian securities market. These regulations aim to govern the conduct of institutional investors, such as mutual funds, banks, insurance companies, and other financial entities, ensuring responsible and accountable participation in short selling while upholding market integrity.

Prohibition of Day Trading

One notable restriction outlined in the circular is the explicit prohibition of day trading by institutional investors. Day trading refers to the practice of buying and selling financial instruments within the same trading day to capitalize on short-term price fluctuations. In the context of short selling, this restriction implies that institutional investors are not permitted to engage in intra-day square-off transactions.

Obligations at the Custodians’ Level

Another significant regulation pertains to the obligations placed on institutional investors at the custodian’s level. The circular mandates that all transactions conducted by institutional investors would be grossed at the level of custodians. This means that institutions are required to fulfil their obligations on a gross basis through their custodians.

While institutions are mandated to settle their deliveries on a gross basis, the custodians, in turn, continue to settle their deliveries on a net basis with the stock exchanges. This arrangement ensures a systematic and structured approach to settlement obligations while maintaining transparency and accountability at the custodial level.

These regulations for institutional investors within the framework of short selling are designed to impose necessary restrictions and obligations aimed at ensuring responsible trading practices and minimizing market risks. By prohibiting day trading and mandating gross settlement obligations at the custodians’ level, SEBI aims to instil discipline among institutional investors, fostering a stable and fair market environment.

Comprehending and adhering to these regulations is pivotal for institutional investors operating within the Indian securities market. These guidelines not only govern their actions but also underscore the importance of accountability and prudence in their short-selling activities. As we navigate through the intricacies of SEBI’s framework, further insights will be provided on the implications and specific obligations imposed on institutional investors, illuminating their role in shaping the dynamics of short selling within the market landscape.

Deterrent Provisions and Securities Lending Scheme

The SEBI circular introduces robust deterrent provisions and initiatives aimed at maintaining market discipline and ensuring timely settlement of securities transactions, particularly concerning short-selling activities. These measures are designed to prevent and address instances of failure to deliver securities while also facilitating a Securities Lending and Borrowing (SLB) scheme to support the short-selling process.

Deterrent Provisions by Stock Exchanges

The circular mandates stock exchanges to implement and enforce stringent deterrent provisions against brokers or market participants failing to deliver securities at the stipulated time of settlement. These provisions act as a strong deterrent, compelling adherence to settlement obligations and discouraging any laxity or intentional default in fulfilling delivery commitments.

Stock exchanges are tasked with framing necessary uniform deterrent provisions and taking appropriate action against brokers or entities failing to honour their obligations promptly. These measures act as a safeguard, ensuring that market participants abide by their commitments, thus promoting trust and credibility within the market ecosystem.

Introduction of Securities Lending and Borrowing (SLB) Scheme

In conjunction with facilitating short selling, the circular introduces the concept of a Securities Lending and Borrowing (SLB) scheme. This scheme is envisaged to provide the necessary infrastructure and mechanism to support short-selling activities in the market.

The SLB scheme enables market participants to lend their securities to those in need, thereby facilitating the borrowing of stocks for short-selling purposes. This initiative enhances market liquidity and efficiency by creating a platform for the temporary transfer of securities between lenders and borrowers, aligning with the requirements of short-selling strategies.

The introduction of deterrent provisions and the SLB scheme is pivotal in fortifying the regulatory framework surrounding short selling. These measures not only discourage any potential defaults or non-compliance but also facilitate a structured mechanism for borrowing and lending securities, bolstering the short-selling process.

Eligible Securities and Disclosures

The SEBI circular delineates specific guidelines regarding the eligibility of securities for short selling, with a particular focus on securities traded within the Futures and Options (F&O) segment. Additionally, it outlines disclosure requirements mandated for both institutional and retail investors when engaging in short-selling transactions within the Indian securities market.

Securities Eligible for Short Selling, Especially in the F&O Segment

The circular specifies that securities traded in the Futures and Options (F&O) segment are eligible for short selling. This segment typically includes a wide array of stocks and derivatives that are subject to futures and options contracts. These securities, due to their nature and trading activity, are considered conducive to short-selling strategies.

SEBI reserves the right to review and update the list of stocks eligible for short-selling transactions periodically. This review process ensures that the list remains dynamic, considering market conditions and changes in the financial landscape, thereby aligning with evolving market dynamics.

Disclosure Requirements for Institutional and Retail Investors

The circular mandates distinct disclosure requirements for institutional and retail investors engaging in short-selling activities:-

Institutional Investors: Institutional investors are required to disclose upfront, at the time of order placement, whether the transaction is intended as a short sale. This disclosure requirement ensures transparency and clarity regarding the nature of the transaction and the intent behind it.

Retail Investors

Retail investors have a slightly different disclosure timeline. They are permitted to make a similar disclosure, indicating that the transaction was a short sale, by the end of the trading hours on the transaction day. This provision allows retail investors to disclose their short sale transactions within the specified timeframe, enabling market transparency while catering to retail investors’ operational feasibility.

These guidelines regarding eligible securities and disclosure requirements play a crucial role in fostering transparency and accountability among market participants engaging in short selling. The delineation of eligible securities facilitates a structured approach to short-selling strategies, focusing on securities known for their active trading and derivatives activity. Simultaneously, the disclosure requirements ensure that both institutional and retail investors adhere to transparency norms, thereby contributing to market integrity and investor confidence.

Reporting and Disclosure Mandates

The SEBI circular lays down explicit reporting requirements for brokers pertaining to their short-sell positions and mandates specific timelines for information dissemination and disclosure to the public. These mandates aim to ensure transparency, enhance market oversight, and provide stakeholders with timely access to relevant information regarding short-selling activities within the Indian securities market.

Reporting Requirements for Brokers on Short Sell Positions

Brokers engaging in short-selling activities are mandated to collect details on a scrip-wise basis regarding their short-sell positions.

This requirement necessitates brokers to gather comprehensive data on their short-sell positions across different securities, ensuring accurate reporting and tracking of their exposure in the market.

Subsequently, brokers are obligated to collate this data and upload it to the stock exchanges before the commencement of trading on the following trading day.

Information Dissemination and Disclosure Timelines to the Public

Upon receiving the data from brokers, stock exchanges play a pivotal role in consolidating and disseminating this information to the public.

The stock exchanges are required to consolidate the broker-provided information on short-sell positions and disseminate the same on their websites.

This information is intended for public access and serves as a means to enhance transparency and market oversight.

The circular specifies that this information should be made available to the public on a weekly basis, allowing stakeholders to review and analyze short-selling activities within a specified timeframe.

These reporting and disclosure mandates established by SEBI ensure that market participants, particularly brokers engaged in short selling, adhere to rigorous reporting standards. By requiring comprehensive and timely reporting of short-sell positions, SEBI aims to facilitate better oversight, risk assessment, and regulatory supervision within the securities market.

Furthermore, the dissemination of consolidated information to the public on a weekly basis fosters market transparency and provides stakeholders, including investors and analysts, with valuable insights into short-selling activities. This transparency is critical in instilling investor confidence, enabling informed decision-making, and promoting a well-informed and vigilant market ecosystem.

Legal Basis and Conclusion

The issuance of the SEBI circular, SEBI/HO/MRD/MRD-PoD-3/P/CIR/2024/1, dated January 05, 2024, is rooted in the robust legal framework governing the Indian securities market. This framework empowers SEBI to regulate and oversee market activities, ensuring investor protection, market integrity, and the smooth functioning of the financial ecosystem.

The circular is issued in exercise of the powers conferred under Section 11(1) of the Securities and Exchange Board of India (SEBI) Act, 1992¹. Additionally, it operates in conjunction with Regulation 51 of the Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018, Section 26(3) of the Depositories Act, 1996, and Regulation 97 of the Securities and Exchange Board of India (Depositories and Participants) Regulations, 2018.

This legal framework provides SEBI with the authority to promulgate guidelines and circulars, such as the one under discussion, aimed at protecting investors’ interests, ensuring market stability, and fostering the development of a fair and transparent securities market.

In conclusion, the circular serves a pivotal role in safeguarding the interests of investors operating within the Indian securities market. It delineates a comprehensive framework for short selling, encompassing guidelines, restrictions, and reporting mechanisms. By doing so, the circular aims to achieve several crucial objectives:

Investor Protection

The circular seeks to safeguard investors’ interests by establishing clear guidelines and mechanisms to prevent market manipulation, enhance transparency, and ensure fair practices in short selling.

Market Integrity

By setting stringent rules and disclosure requirements, the circular aims to maintain market integrity, mitigate risks associated with short selling, and foster a level playing field for all market participants.

Regulatory Oversight

It facilitates robust regulatory oversight by mandating reporting, disclosure, and adherence to prescribed guidelines, allowing SEBI to monitor market activities and ensure compliance.

In essence, the circular’s purpose is to provide a structured framework that not only regulates short-selling practices but also promotes responsible and informed decision-making. It underscores SEBI’s commitment to maintaining a well-regulated, transparent, and investor-friendly securities market.

Conclusion

The SEBI circular on short selling, SEBI/HO/MRD/MRD-PoD-3/P/CIR/2024/1, dated January 05, 2024, summarizes a comprehensive framework designed to regulate and govern short selling activities within the Indian securities market. Key takeaways from this directive highlight the following crucial aspects:

Structured Guidelines

The circular provides a structured set of guidelines, defining short selling, describing eligible securities, specifying disclosure requirements, and imposing obligations on market participants.

Investor Protection

 With a focus on safeguarding investors’ interests, the circular introduces measures to enhance transparency, mitigate risks, and foster responsible conduct in short selling.

Regulatory Oversight

 It emphasizes the role of regulatory oversight by mandating reporting, disclosure, and adherence to the prescribed guidelines, ensuring compliance and market integrity.

Adherence to the Guidelines

As investors navigate the complexities of the securities market, adherence to the guidelines that have been outlined in the SEBI circular is important. By complying with the new regulations, investors can make better decisions, mitigate associated risks, and can contribute to a fair and transparent market environment.

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1. https://www.sebi.gov.in/sebiweb/home/HomeAction.do?doListing=yes&sid=1&ssid=1&smid=0