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Short selling will reduce volatility
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July 07, 2006

The Securities and Exchange Board of India committee will meet today to discuss whether and in what form stock lending and short selling might come through. It is a long overdue move and it may structurally alter how trading happens. It is very important and critical to have a vibrant stock lending mechanism in the market.

Siddharth Shah, director, JGA Shah Share Brokers believes that this will definitely impart more liquidity and will reduce volatility. He further says that if short selling is allowed in a transparent manner, the investor at large is aware of the total short sold positions in the market.

Excerpts from CNBC-TV18's exclusive interview with Siddharth Shah:

Explain to us, how this new system maybe different from the erstwhile product, which the NSE had, which was the Automated Lending and Borrowing Mechanism, ALBM, which has got thrown out unceremoniously after the last time there were a few scams, which erupted.

Earlier, ALBM of NSE and the 'badla' system of BSE had combined. One can carry for the long and short positions as well, since now this component of the share lending and the financing base are one product. These are differentiated as the F&O market provides one to carry for the long and short position and at the same time it separates the lending and borrowing system outside the market.

So one can borrow and lend and at the same time the returns of security is guaranteed within seven days. This is a major difference, so that the market cannot be manipulated by keeping everything in one product, which is one of the basic differences.

Apart from this, if one talks of specifically short selling, in the 'badla' system there were no proper disclosures.

Here, there will be a 100% disclosure at the end of the day. People who have sold the shares, not only retailers but also institutions and mutual funds are also supposed to disclose the same to the exchange, which will be uploaded on the website of both the exchanges and known to the members or to the investors at large. These are the two differences, which I feel I can read in the Sebi report.

What is the technical problem if at all that needs to be crossed at this point?

One point is the return of securities, which one has borrowed, my understanding on that is that one has to return the securities within seven days because lending and borrowing is allowed only for one week, that is seven working days.

If a person who has borrowed the security, cannot give those securities back in time, then the person who has lent the security will be assured that when he lends the security, he will get the security back within seven days, those things are to be addressed.

My understanding is that the clearing houses of both the exchanges will have some kind of an agreement signed with the mutual funds, so that they have a guarantee that they can ask for the security, which in turn is the cost of borrowing of that security.

The second thing will be that the cost will be borne by the person who has defaulted, who has borrowed and not returned the security back. These are one or two small issues, which we need to address.

Do you think that including just stocks, which stayed in the futures might not do a lot to reduce the volatility?

No, to a certain extent, I think that this facility should only be available to F&O stocks. I do not say that this should be available across the market. Prior to the 'badla' system, we had a list of scrips and only on those scrips, one could carry forward positions.

This will definitely impart more liquidity and will reduce volatility because if short selling is allowed in a transparent manner, the investor at large is aware of the total short sold positions in the market.

If the institutions are allowed to short sell, then it will be definitely a plus point for the market, because that will add more and more liquidity, and at the same time, a proper mechanism will be in place again for borrowing and at the same time shares will be returned within time.

My understanding is that the report also said that there could be a penalty of violating any of these guidelines, which could be a very harsh penalty. So keeping everything in a macro situation, I think that it will be a great product if introduced the way the committee has recommended it.

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