The finance ministry and the Securities and Exchange Board of India have decided to allow 'for the time being' only domestic financial institutions to short-sell and also enter into stock lending and borrowing.
Foreign institutional investors would have to wait till certain legal hassles are removed. While stock lending and borrowing is a pre-requisite for short-selling, it involves certain violations of the Foreign Exchange management Act in its present form. Therefore, Fema needs to be amended before FIIs are allowed to short-sell.
Earlier during its discussions with the ministry, the Reserve Bank of India had conveyed that said stock lending and borrowing practices create an anomaly vis-a-vis Fema.
The law does not allow foreign institutions to borrow funds for investing in the equity market.
There were also fears of breach of ceiling on foreign direct investment being breached because of short-selling. Short-selling of securities means selling the security before having it in one's possession.
Since FDI is not allowed up to 100 per cent in all sectors, short sales might lead to tripping the limit in sectors where FDI limit is less than 100 per cent.
This is because FIIs will have to get involved in borrowing and lending shares to meet delivery. Moreover, intra-day monitoring to keep the track of the FDI levels was not possible.
RBI had also informed Sebi that even if it intends to allow institutional investors to short-sell, the permission should be restricted to shares in those sectors where foreign investment is allowed up to 100 per cent, including limits under foreign direct investment and foreign institutional investment route.
Therefore, regulators have first decided to allow short-selling and stock lending and borrowing to be undertaken by domestic institutional investors.
This is also expected to help the regulator assess the impact and identify any shortcomings before FIIs are allowed to participate in these products.