Some of these brokerages that are lending PNs for short- selling own Indian stocks worth billions of dollars on behalf of their PN clients and many of them have multiple FII accounts through their arms.
This inventory of PNs, which used to be worth at least $20 billion, has come down to about $15 billion after Sebi imposed regulations on such offshore derivative instruments last October. The meltdown in Indian stock markets has trimmed their value further this year.
In a research report in June, analysts Nemkumar (he uses only one name) and Ashutosh Datar at the institutional broking wing of India Infoline Ltd had noted that foreign funds accumulating such short positions had gone up so high that there was a shortage of PNs inventory available for such trades.
According to broking executives familiar with such transactions, FIIs had lent more than 50% of the available inventory to short sellers. Infrastructure, real estate and banking stocks have been in demand for short-selling.
“There was a continuous demand for this activity, as many investors were willing to bet on a drop in Indian stocks during the second quarter of this year,” said a Hong Kong-based executive of a large foreign brokerage.
Sebi scrutiny
According to a senior Sebi official who did not wish to be named, the regulator is looking closely at this offshore activity that had caused intense bearishness in Indian markets. The Economic Times last week reported that the stock market regulator is asking FIIs details on their offshore clients.
However, there is nothing illegal about the activities. An executive with a foreign brokerage, who does not want to be identified as he is not authorized to speak to the media, blamed the failure of securities lending and borrowing mechanism in India for such offshore activities. Sebi introduced this mechanism in April for enhancing liquidity and price discovery, but it has not yet taken off for some technical reasons. “Since you can’t do this onshore, you are doing it offshore,” the executive said.
This parallel market in Hong Kong may have hugely offset the positive view taken on Indian stock valuations by many FIIs in India and the original foreign PN clients, who are mostly long-only funds.
Long-only funds typically do not take a short-term view on a market. Nor do they indulge in short-selling as their mandate is to manage capital for a longer term with lower risk.
India’s own securities lending and borrowing mechanism has flopped because of excessively restrictive regulations. The large stock lending activity in a parallel market overseas indicates that there is a genuine demand for stock lending and borrowing.
The trend of borrowing PN stock inventory has taken another part of the Indian market offshore. Sebi’s PN restrictions have also led to the export of a large chunk of Nifty futures trading to the Singapore Exchange, where foreign investors (registered and unregistered) can participate without restriction.
According to a head of institutional equities in India at one of these foreign brokerages who does not want to be named, many of the short positions were reversed after mid-July, when crude oil prices started correcting.