Sebi’s discomfort with the lending activity overseas is understandable. With overseas lending, it has no control on issues such as position limits, as FIIs are practically free to lend to whoever and in whatever quantity they have. If the lending were to happen onshore, Sebi’s prescribed position limits and other risk-management norms, such as margining, would apply. It is natural that Sebi would prefer the market to move onshore.

But then, it has itself to blame for faulty design of the onshore securities lending market. Right from the time it put a discussion paper on the subject, it got enough and more feedback from all quarters of the market that the proposed format wouldn’t work. Sebi is now saying that it’s reviewing the difficulties in the use of the onshore securities lending facility and will be taking steps to make this mechanism more effective.

Still, the regulator’s intent seems to be to curb short-selling by overseas investors, more than shifting the lending activity onshore. It says, “Sebi disapproves of the overseas lending/borrowing activity of FIIs and the consequent selling pressure in the cash market in India." This is strange, coming from a regulator that recently said there is no need to ban short-selling.

In any case, even a ban on overseas lending wouldn’t stem short-selling of Indian stocks. The overwhelming majority of short-selling happens through the single stock futures market. Between October 2007 and September 2008, unregistered overseas investors had no access to this market because of restrictions on participatory note (PN) issuances. (In fact, the market for stock lending would have picked up overseas, primarily because of the PN curbs.) But now, these restrictions have been removed, and it’s much easier for overseas investors to short-sell using the stock futures market, rather than go through the cumbersome process of borrowing stock and then short-selling it.

In sum, Sebi’s missive to FIIs will have little impact on short-selling.

Also Read “Securities lending may not fly"

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