The Sebi Board, which met in Mumbai on Thursday has decided to allow short-selling by financial institutions. The Board has decided that short-selling will be allowed, exactly as outlined in the Budget.
Commenting on the market regulator's decision, Managing Director of Kotak Investment Banking, Falguni Nayar said she believes that short-selling will create liquidity and deepen the market. She also adds that futures have only certain liquidity, which can be increased by short-selling.
Excerpts of CNBC-TV18's exclusive interview with Falguni Nayar:
How important is it to set up a credible, viable stock lending and borrowing mechanism before short-selling and all these other steps become successful mechanisms?
The Securities Exchange Board of India's intention to move towards introducing a system that allows short-selling is good because it will create more liquidity and deepen the market.
Investors also have been asking for it because even if they have a long account. Sometimes they have a strong view that certain sectors are going to correct they should be able to profit from it. The institutional investors including FIIs and mutual funds have been wanting this.
Otherwise, it was a one-way trade for them that is why it was a good measure. It is very good but details of stock lending and how it is going to work it is going to be very important, which we don't have now. It is a great measure.
Globally there are practices, which are already put in place. So I don't think it is a big deal for us to be able to put it in place. We have to study it right. Sebi has to just put in place for something that works and it works easily and works for investors.
Just to understand this from an FII perspective, if say a certain FII is negative on a particular stock, say Hindustan Lever, he is at liberty to go out and sell, Hindustan Lever futures in the market so why would short-selling make a big difference?
Because futures have only certain liquidity, they won't be beyond a point. There may not be enough liquidity in the futures and also there is then difference between cash spot and the future price. If the spot price stays higher, then the buyers are not coming in the spot like all long accounts always don't trade in futures. This will make the spot and future market trade close to each other. There shouldn't be such a big difference in futures and spot market.
I am just trying to understand further, if this FII owns Hindustan Lever, he is at liberty to sell it but if he does not own Hindustan Lever yet he has got a negative view and he wants to sell it, are you trying to say if he doesn't want to sell it on the futures market, then he would need to borrow that stock to sell?
Yes, he would have to borrow. He would borrow from, for instance LIC or any of the mutual funds, who may want to continue to hold the stock and they will sell it, and then whenever that original investor wants to actually sell his stock, he can call back. Globally, there is a call back allowed, it is done through brokers. So when the lending is done through brokers and then when the call back is allowed, at that point, Indian institutions, mutual funds or LIC asks the stock back, then the FII has to return the stock. They have to close their trade so they will have to buy it back in the market and return the stock and that is how it works. There are very small charges for stock lending, there is also some margin also collected for that. It is a very good mechanism.
Isn't that part of the equation, not quite worked out then, who they might be able to lend from and why they should be able to lend or borrow rather only from a mutual fund or an LIC, like you said?
No, it will be from anyone. I just gave you an example of LIC and mutual fund, it can also be an FII, the custodians of the FIIs hold that stock, so the broker can borrow from the custodian. This whole practice works very well internationally; globally in the US, it works very well. There is a certain percentage, what will happen as a result is that if there is a large holding of a mutual fund, they will only lend about 80% of their own holding, they won't lend 100% so that they are also free to sell their stocks. But if they still want to sell the rest of the stock, callbacks are allowed, in which case, the hedge funds are allowed to close their position. So I think the market adjusts. But yes, the detailed guidelines have to work.
Just to get the other issue that was raised by the Sebi on real estate IPOs, do you think that will provide a lot more clarity in terms of new paper that will come in from the real estate side now?
Yes, I think what Sebi is asking is pretty fair and I think informally they have been guiding on the IPOs to have that information that is on the land ownership, look at it from the perspective of what is actually owned and paid for and where there is only arrangements to acquire. So I think some amount of additional disclosure there will be worthwhile.
Secondly, what they are saying is that just besides looking at it from a future value perspective, look at it from current price perspective and that could be the additional disclosures. So I think yes, these are positive measures.
Also on the IPO grading, they are talking about, I have some view. So I think these are all positive measures but as you always say that the devil lies in the detail and we need to put some of the detailing in place, specially vis-à-vis Short-selling . But on real estate IPO, I think it is a good measure because it will differentiate the different business models that are there in the market, there are some high quality business models and then there are some which are not and I think the investors were not able to differentiate.
Is IPO grading a good idea?
Today IPO grading is a little bit prevalent now it is going to be made mandatory but I think it has to be looked at differently from recommending or share. I think the way the grading works is that the grading is going to be done on a number of qualitative factors and these will include corporate governance, quality of the management, things like the quality of the disclosure and these are the factors, which are going to be grading an IPO. So if you have a poor quality grading, then it is like a flag off to retail investors that watch out and do your homework on this deal to decide whether you really want to play it.
There are some risks in terms of the business maturity of the company and that is what the grading is reflecting. So if it is a high quality grading then the business maturity is higher and it is a qualitative factor to that extent. But besides that, you have to make an equity call just because it is a high quality business model in terms of how it runs, the business systems and the corporate governance and the management that still won't make it a good equity investment.
So an equity call has to be looked at differently from grading. In our market, a retail investor will benefit from grading to the extent of atleast having a flag-off on poor quality issue but they should not read everything into grading. That is what I am trying to say that the equity decision has to be over and above a grading. Grading is more like a hygiene factor, and over and above that, you need to make an equity call.
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