FIIs ALLOWED TO SHORT-SELL, LEND AND BORROW SHARES, WITH RIDERS

By Anup Roy, Mumbai
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The Reserve Bank of India (RBI) has signed off on allowing foreign institutional investors (FIIs), registered with the Securities and Exchange Board of India (Sebi), to short-sell, lend and borrow Indian shares, albeit with certain conditions.

Investors use short-selling to profit from the falling price of a stock. For example, if a particular stock is overvalued and an investor expects the stock to fall after sometime, he might consider selling the shares now, even if he doesn’t own any stock. In doing so, he has to cover his position, or buy the number of shares that he sold short when the price does fall. Effectively, he is selling a stock in a high-price scenario and buying it back in a low-price scenario, thus making a profit.

RBI’s latest move comes after consultation with the government and the capital market regulator, Sebi, which, on 20 December, allowed all classes of investors to short-sell shares. Earlier, only retail investors were allowed to sell short.

While allowing FIIs to short-sell, borrow and lend equity shares, RBI has put in certain strict conditions too. In a notification posted on its website, the banking regulator said such FII participation will be subject to the current foreign direct investment policy and short-selling by FIIs shall not be permitted for equity shares that are under the banned or caution list of the bank.

Borrowing of equity shares by FIIs shall only be for the purpose of delivery into short sales, the RBI said. It also said that the margin, or collateral, should be maintained by FIIs only in cash. No interest is allowed on such margin and collateral. The RBI also instructed designated custodian banks to separately report all transactions pertaining to short-selling, lending or borrowing of shares by FIIs in their daily reporting.

Some experts said allowing short-selling will not have a significant impact on the overall market. “This has got no major implication, except in increasing the depth of the market. Earlier also, firms could borrow stocks overseas and sell it here. A certain segment of the investors are thinking that the market is overvalued and they might welcome the decision. But, otherwise, no major impact,” says A. Balasubramanian, chief investment officer of Birla Sun Life AMC Ltd.

A senior executive with an FII, who didn’t want to be identified, predicts short-selling will not pick up in India, as there are not enough large sellers of stocks. “I don’t think it will pick up much in India. You need to have a large stockholder, like the Life Insurance Corp. of India, who is willing to sell when you cover your position. It’s very difficult to cover your position unless you have a huge stock-bank willing to sell,” he said.

Indian markets witnessed more than $17 billion of net FII flow into the country in 2007. Almost half of it came after the US Federal Reserve cut its interest rate by 50 basis point to 4.75% in September. Since then, Fed has brought down its policy rate to 4.25%.

FII investments in 2007 touched a record $17.98 billion through mid-October, before Sebi’s curbs on participatory notes, an instrument through which FIIs used to invest in India largely anonymously.

FIIs sold more than $2.14 billion worth of Indian stocks until the end of November. But, the trend reversed and in December, FII flows slowed considerably. However, 2007 ended with the highest ever net FII investment in Indian stocks since the markets were opened to foreign investments. The previous best was $10.7 billion in 2005.