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Did FIIs short-change SEBI?

Posted by Yogesh on Saturday, 18 October, 2008

MUMBAI: Did SEBI underestimate the extent of short selling that foreign funds were doing outside of India through participatory notes (P-Notes) on Indian stocks?

That is the question many brokers and dealers are asking after the market regulator on Friday released the first set of short sales data by FIIs through P-Notes, also called offshore derivative instruments.

SEBI data showed that between October 10 and October 14, total short-selling by 17 FIIs who shared the data was worth about Rs 500 crore. The regulator has also asked for outstanding short sale data till October 9.

Top officials at broking houses dealing with FIIs said there were over 50 such FIIs who also undertook broking business outside India. And it was this particular set that allowed P-Note-based short selling to their clients, called FII sub-accounts.

“This data seems to confirm the view held in the market that very large short-selling positions are being created overseas,” a top official at a local brokerage said. “In the current market scenario in which not only are there very few buyers, but FIIs too are continuously selling at distress levels, part of this selling is not sale by actual sellers but by those who have created synthetic short-selling positions,” the official added.

Brokers said the cumulative short selling positions by FIIs could be in billions of dollars although no estimate by SEBI was out yet.

How does this short-selling work? Short-selling is facilitated by FIIs who issue P- Notes to their clients. Under P-Note transactions, an FII buys stocks in the Indian market for its client, “A”. As client A is unwilling to hold the shares in its name, the FII keeps the shares in its own name. Now, this FII also has client “B”, who wants to go short on some Indian stocks.

So, the FII lends stocks bought on behalf of client A to client B who wants to take a short position by writing derivative contracts. This short selling affects the price of the stock in which client B has created a short position.
A section of the market players has been asking SEBI to ban short-selling through this route and argued that if such a step is taken, a number of FIIs will be forced to cut their short positions by buying in the Indian market.

As a result of this buying, huge FII inflows will be seen almost immediately. Such inflows, estimated to be in billions, will help the equity market as well as the country’s reserves. Even individuals who profit from short-selling in intra-day trades will stop such speculative activities, helping the market recover, institutional dealers say. Source The Economic Times

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