Context: Compared to stock markets of the world which have done well this week, Indian stock markets are down with a drop of 5% in the Nifty 50 so far.
More about the news:
- Worldwide stock market scenario this week: The US markets were up about 6%, while key European markets were up 5-7%. Most of the Asian markets shown rise as well.
- Regulatory measures by SEBI this week:
- It’s interesting that the Indian market is down, when most other markets are up as downfall came after the imposition of some curbs on short- selling this week by the market regulator.
- The tighter framework introduced by SEBI
- Norms for Future and Options(F&O)trade made stringent.
- In the case of volatile shocks limits available for trading were halved.
- Penalties for various operations were raised 10 times.
The correlation of short- selling curbs and underperformance of the Indian stock markets
- Possibility of backfiring of SEBI’s Short-selling curbs:
- Short-selling curbs are considered as a double-edged sword.
- If they create the impression that the market is being artificially propped up, then those who want to bottom-fish will tend to stay away as it is considered that prices haven’t yet fallen to their true levels.
- Ultimately this can result in the lack of buying support when stocks are falling.
- Earlier experiences
- During the global financial crisis of 2008, the US Securities Exchange Commission (SEC) had banned short-selling in financial stocks. It had later noted that the costs of such a move appear to outweigh the benefits.
- India had not curbed the short selling in stocks during the 2008 financial crisis.
- A research paper by the Centre for Economic Policy Research suggests that bans and regulatory constraints on short-selling during the financial crisis are detrimental for market liquidity and slowed price discovery.
- Induced decrease in market liquidity:
- The ban-induced decrease in market liquidity is especially serious because it came at a time when bid-ask spreads were already high as a result of the crisis and investors were desperately seeking liquid security markets because of the freeze in many fixed-income markets.
About Bid-ask spreads
- The bid-ask spread is essentially the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept.
- The spread is the transaction cost.
- Price takers buy at the ask price and sell at the bid price but the market maker buys at the bid price and sells at the ask price.The bid represents demand and the ask represents supply for an asset.
- The bid-ask spread is the de facto measure of market liquidity.
About short selling in stock markets
- It is the practice where an investor sells shares that he does not own at the time of selling them.
- He sells them in the hope that the price of those shares will decline, and he will profit by buying back those shares at a lower price.
Regulations in India:
- In India, there is no prohibition on short-selling by retail investors.
- Institutional investors —domestic mutual funds and foreign institutional investors registered with the Securities and Exchange Board of India (Sebi), banks and insurance companies — are prohibited from short-selling and are mandatorily required to settle on the basis of deliveries of securities owned and held by them.
About Securities and Exchange Board of India(SEBI)
- SEBI is a statutory body established on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992.
- The basic functions of the Securities and Exchange Board of India is to protect the interests of investors in securities and to promote and regulate the securities market.