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The shorting game continues, despite Sebi ban

BS Markets Bureau

Despite the Securities and Exchange Board of India's ban on short sales invoked on March 7, 2001, investors are continuing with short selling under the specified group stocks.

They can do this due to the provision of carrying forward their short sale position by borrowing securities under the borrowing and lending mechanisms of the exchanges. According to the Sebi order, any sale transaction has to be 'backed' by securities. 'Backing' means having physical possession of the demat receipt or share certificate.

This is where the catch lies. 'Backing' means a seller need not own the stock that he wants to sell. After executing the sale order (without having physical possession of the share) and later borrowing it at the end of trading cycle to 'back' the transaction, he can postpone the settlement. This can go on endlessly.

The Sebi rule is that a broker or client has to have concurrent, equal buy and sell positions, which does not have to be on the same stock exchange.

But brokers circumvent this curb too, by classifying the transaction as sale on account of arbitrage.

Despite the provision that first a purchase position has to be created in order to execute a sell position on another stock exchange, the different trading cycles and the borrowing and lending mechanism help the brokers to juggle the transactions.

In line with Sebi's move to ban naked short sales, the Bombay Stock Exchange had issued circular on March 8 which said, in case a member or his client has an outstanding purchase position under the modified carry forward system or the automatic borrowing and lending mechanism on the bourses, they could enter into sale transactions in the normal market on the BSE.

For example, on Wednesday, at the beginning of the settlement cycle on the National Stock Exchange, a member can create a purchase position by lending money and borrowing securities, which automatically translates into a sell position for the next settlement - as the borrowed securities have to be returned.

The system automatically creates two transactions for him - a buy position in the previous settlement for the borrowed shares and a sell position in next settlement for the same shares at a slightly higher price, which is the standard lending price indicative of the interest component.

Against this ALBM transaction (remember it is a buy position in the previous settlement), the member can (short) sell on the BSE on Wednesday, since the Sebi maintains that a purchase position should precede a sell position.

Remember, the member already has a sell position on the NSE. Thus, with one buy order on the NSE, he maintains two sell positions on both the NSE and the BSE. Now, if the price of the share held by the member goes down by Friday, which is the last day of the settlement on the BSE, the member can cover his position and carry forward the financing position on the ALBM for the next week.

But when the price rises, the member can postpone the settlement of his sell position by borrowing under borrowing and lending of securities scheme of the BSE till the price is in his favour.

Since the amount of interest earned on money lent under ALBM/BLESS is fixed at the time of entering into the transaction, the short-seller gains if the price of particular stock falls on or before Friday.

Thus, the short-seller would get interest on money lent under ALBM, plus the price differential between sell and buy transactions on the BSE. This is normally called having the cake and eating it too.

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