BAN OF NAKED SHORT SELLING IN INDIA

Introduction:

The Securities and Exchange Board of India states short sale as the sale of a security that the seller
does not possess or any transaction that concludes by the handing over of the security. Short-sellers
engage in the trade when they anticipate a decline in a security's value and sell the borrowed shares
presently at a premium price in order to repay their lender with shares whose worth is set to
diminish in the future. Selling securities that one is not the owner of has long been a matter of
debate. Short-selling of assets has been a topic of discussion between shareholders, traders,
authorities, and different market players since the 1600s. It continues to be controversial to sell
securities that the seller does not consider to be the actual proprietor of. Since the 1600s, the issue
of shorting assets has been discussed by investors, traders, policymakers, and various market
participants. When traders sell the shares, they do not own and have not obtained verification
regarding their ownership rights, this is known as naked short selling.

Conflicting opinions and widespread criticism:

Since the seller has no real accessibility to the shares, the trade may not be completed within the
specified closing time if it is necessary to execute the short in order to fulfil the requirements of the
holding. Although there is a great deal of risk involved, the technique could result in very substantial
rewards. Regulators became concerned that short selling might deepen the recession since it had
such a significant impact on the banking sector globally. Due to the widespread criticism of naked
short selling many national authorities have imposed short-term limits on short sells in an effort to
lessen market volatility in their respective stock markets. Most of these limitations were put in place
as a result of an emergency. Due to the crisis of sovereign debt, which followed the instability in the
financial markets, the detrimental feeling against short selling has once again reached a peak. It had
previously partially subsided as the economy appeared to be recovering from the crisis.

It is notable nevertheless, that given the differing trains of thought, short selling has been accepted
as a respectable form of investing by most country's financial sector authorities, and specifically by
those in all established securities markets. These nations also have a thriving derivatives of stocks
market, including futures for stocks. In certain jurisdictions, authorities have even allowed naked
short sells to take place inside a regulated system rather than outlawing them since they can be
advantageous in some situations. The International Organization of Securities Commissions, or
IOSCO, additionally investigated the procedures of securities lending as well as short selling on
several markets and has advocated transparency rather than outright banning short selling.

Scenario in India:

The South Asian countries outlawed short selling for a significant portion of the initial decades of the
21st century. In India, the Securities Exchange Board of India (SEBI), ordered the suspension of naked
short selling on the Indian stock market. The restriction was put in place in part as a result of stock
prices plummeting after claims of Anand Rathi, then-president of the Bombay Stock Exchange (BSE),
had profited by using confidential data obtained by the exchange's intelligence division and raised
volatility. Finally, in July 2007, SEBI released regulations for financial institutions on short-selling.
Both investors, private and public, have the choice to sell short in 2008, seven years after this
practice was outlawed.

Despite the fact that the Indian government has removed the limitations on short sales, naked
shorting is still prohibited. When the seller refuses to deliver the shares inside the payment window,
a situation arises. Some believe short selling to be a beneficial and required characteristic of the
stock market since it offers liquidity and aids price modifications in overpriced stocks. Thus, any
limitations on short selling in general may distort effective price discovery, give promoters full
authority to manipulate costs, and favor manipulators throughout logical investors, who regard it as
a not desirable activity that thrives upon distressed selling and is susceptible to it possess kind of
manipulation.

According to SEBI regulations, short selling is the act of selling an investment that the person selling
it does not really possess at the time of the sale. Short sales are allowed for all investor groups,
including both private and public investors. Pursuant to a note issued by SEBI, the stock exchanges
are required to put up the requisite universal preventative provisions and to take suitable measures
upon brokerage firms for failing to deliver shares at the point of settlements. At the moment of
development, all investors had to fulfil their promise to supply the shorted securities. Due to the
year's crisis, Indian securities authorities once more enforced a brief moratorium on short-selling in
March 2020.

SEBI ultimately made a decision on this scenario and issued a statement in which all investors were
compelled to fulfil their commitment of delivering securities at the time of settlement. Also, no
major investor shall be permitted to engage in day trading, often known as square-offing their trades
during the day. The frequency of the disclosure has to be reviewed from over time to time with their
approval. In a nutshell, corporate investors' transactions would be all amounted to on the trustee
level, and the financial institutions would be expected to meet their commitments on a basis of gross
revenue. However, the banks were going to continue settling their shipment payments via the stock
provides on a basis of net value. While placing an order, financial institutions must declare up front
whether or not the transaction in question is a short transaction. Retail shareholders, however,
would be allowed to make a comparable statement before the end of the trading session. Before the
start of trade on the next day of trading, the brokers are required to gather details regarding
the short sell positions, compile the information, and submit it to the respective stock exchanges.
The exchanges that trade stocks must then compile this information and make it available to the
general public on weekly schedules via their official websites then with SEBI's consent, the duration
of such disclosures can at times be revised.

Conclusion:

Short selling could be a great method for traders to increase their earnings. However, reviewers
argue that this approach may cause issues with the market. Although the United States perceives
short selling greater liberally, nations such as India are going so far as to outright prohibit it. India
prohibited short selling for seven years, from 2001 to 2008, and once more in 2020. It also continues
to prohibit naked short-selling of securities. According to the government, it assists in keeping the
economy fair across every competitor.

SHORT SELLING RISKS

Short selling is a really risky business to do. In short, sellers must recognize an arbitrage opportunity,

borrow shares from the stock market loan market, put collateral and pay the loan fee every day
the arbitration is closed. In addition to the usual risks of many traders, such as margin requirements

and due to legislative changes, short sellers also face the risk of foreclosure and loan modification

loan payments In the literature so far, these risks have been considered static costs of short sellers,

and empirical papers have shown that static barriers to short selling play an important role

asset prices and efficiency. if selling short is expensive, sell short

sellers are unlikely to trade; and as a result prices may be biased or less efficient (eg

Miller (1977), Diamond and Verrecchia (1987) and Lamont and Thaler (2003). Short selling can be
understood with the help of the following example.

Consider two stocks - A and B - that are identical in every respect except for short selling

risk In particular, Stock A and Stock B have the same fundamentals and the same loan

fees and the number of shares available today. However, future loan fees and equity availability are
more

more uncertain for stock B than for stock A. In other words, there is a great risk that in the future

Stock B's borrowing fees are higher and Stock B's stock futures are not available

by borrowing. Because higher borrowing costs reduce profits from short sales and restricted stock

availability may force short sellers to close out their positions before the arbitrage ends

the seller wants to short A because it has less risk of being shorted.

Short selling is a trading strategy in which you borrow shares of stock and sell them in the market
while waiting for the price to drop. In short, the seller's goal is to buy back the shares at a lower
price, return them to the lender, and pocket the difference as profit. While short selling can be a
profitable trading strategy, it comes with significant risks that investors must understand and
manage.

One of the most important risks associated with short selling is the possibility of unlimited losses.
When investors buy stocks, the biggest loss they can take is the amount invested. However, if an
investor short a stock, the potential loss is unlimited because there is no limit to the price of the
stock. If the stock price goes up instead of down, the short seller must buy back the stock at a higher
price, resulting in a loss.
A study by Grinblatt and Keloharju (2001) found that short sellers experience significantly greater
losses than long-term investors, and this is especially true for very short-term stocks. This suggests
that short sellers must be extra vigilant in risk management to avoid large losses. Short selling can
also cause market volatility and worsen bearish trends. When a significant number of investors short
a particular stock, this can create a negative feedback loop where selling pressure pushes the price
even further down. This could lead to increased volatility and a possible severe price drop.

Boehmer et al. (2019) found that short selling increases the probability that the stock price will fall
sharply. The study analyzed short selling data and price changes of 5,000 stocks between 2004 and
2014 and found that short selling significantly predicts future price declines. This suggests that
investors who are heavily invested in short positions should be extra vigilant in risk management to
avoid heavy losses.

Another risk associated with short selling is the possibility of market manipulation. Short sellers may
spread negative rumors or use other tactics to drive down the stock price, which could harm the
company and its shareholders. While short selling is a legal trading strategy, market manipulation is
illegal and can lead to serious legal and ethical issues. Desai et al. (2004) found evidence of
manipulative behavior by short sellers, including spreading false rumors and leaking negative
information about the company. The study analyzed the relationship between short selling and
market manipulation in 179 firms between 1990 and 1999 and found that short sellers were
significantly more likely to engage in manipulative activity than long investors. This highlights the
importance of regulating short selling to prevent market manipulation and protect investors.

Finally, short selling can create liquidity and operational risks for investors. In short, sellers who
cannot find stock to borrow or have to return unexpectedly can face serious challenges in meeting
their obligations. This can cause market disruption and operational difficulties for investors,
especially those who have invested in many short positions.

For example, in 2021, a short-lived push by a group of individual investors on video game retailer
GameStop caused significant market disruption and forced several brokers to limit trading in the
stock. Short sellers were unable to cover their positions, which led to a significant increase in the
stock price and significant losses for short sellers.

In short, short selling is a trading strategy that involves significant risks. While this can be a useful
tool for some investors, it's important to understand the potential downsides and take steps to
mitigate them. Investors who engage in short selling should carefully consider the risks and exercise
caution when entering these trades.
 Investors can reduce the risks associated with short selling by implementing risk management
strategies such as placing stop-loss orders, diversifying the portfolio and monitoring the opening of
short positions.

SHORT SELLING RISKS

Short selling is a really risky business to do. In short, sellers must recognize an arbitrage opportunity,

borrow shares from the stock market loan market, put collateral and pay the loan fee every day

the arbitration is closed. In addition to the usual risks of many traders, such as margin requirements

and due to legislative changes, short sellers also face the risk of foreclosure and loan modification

loan payments In the literature so far, these risks have been considered static costs of short sellers,

and empirical papers have shown that static barriers to short selling play an important role

asset prices and efficiency. if selling short is expensive, sell short

sellers are unlikely to trade; and as a result prices may be biased or less efficient (eg

Miller (1977), Diamond and Verrecchia (1987) and Lamont and Thaler (2003). Short selling can be
understood with the help of the following example.

Consider two stocks - A and B - that are identical in every respect except for short selling

risk In particular, Stock A and Stock B have the same fundamentals and the same loan

fees and the number of shares available today. However, future loan fees and equity availability are
more

more uncertain for stock B than for stock A. In other words, there is a great risk that in the future

Stock B's borrowing fees are higher and Stock B's stock futures are not available

by borrowing. Because higher borrowing costs reduce profits from short sales and restricted stock

availability may force short sellers to close out their positions before the arbitrage ends

the seller wants to short A because it has less risk of being shorted.

Short selling is a trading strategy in which you borrow shares of stock and sell them in the market
while waiting for the price to drop. In short, the seller's goal is to buy back the shares at a lower
price, return them to the lender, and pocket the difference as profit. While short selling can be a
profitable trading strategy, it comes with significant risks that investors must understand and
manage.

One of the most important risks associated with short selling is the possibility of unlimited losses.
When investors buy stocks, the biggest loss they can take is the amount invested. However, if an
investor short a stock, the potential loss is unlimited because there is no limit to the price of the
stock. If the stock price goes up instead of down, the short seller must buy back the stock at a higher
price, resulting in a loss.

A study by Grinblatt and Keloharju (2001) found that short sellers experience significantly greater
losses than long-term investors, and this is especially true for very short-term stocks. This suggests
that short sellers must be extra vigilant in risk management to avoid large losses. Short selling can
also cause market volatility and worsen bearish trends. When a significant number of investors short
a particular stock, this can create a negative feedback loop where selling pressure pushes the price
even further down. This could lead to increased volatility and a possible severe price drop.

Boehmer et al. (2019) found that short selling increases the probability that the stock price will fall
sharply. The study analyzed short selling data and price changes of 5,000 stocks between 2004 and
2014 and found that short selling significantly predicts future price declines. This suggests that
investors who are heavily invested in short positions should be extra vigilant in risk management to
avoid heavy losses.

Another risk associated with short selling is the possibility of market manipulation. Short sellers may
spread negative rumors or use other tactics to drive down the stock price, which could harm the
company and its shareholders. While short selling is a legal trading strategy, market manipulation is
illegal and can lead to serious legal and ethical issues. Desai et al. (2004) found evidence of
manipulative behavior by short sellers, including spreading false rumors and leaking negative
information about the company. The study analyzed the relationship between short selling and
market manipulation in 179 firms between 1990 and 1999 and found that short sellers were
significantly more likely to engage in manipulative activity than long investors. This highlights the
importance of regulating short selling to prevent market manipulation and protect investors.

Finally, short selling can create liquidity and operational risks for investors. In short, sellers who
cannot find stock to borrow or have to return unexpectedly can face serious challenges in meeting
their obligations. This can cause market disruption and operational difficulties for investors,
especially those who have invested in many short positions.
For example, in 2021, a short-lived push by a group of individual investors on video game retailer
GameStop caused significant market disruption and forced several brokers to limit trading in the
stock. Short sellers were unable to cover their positions, which led to a significant increase in the
stock price and significant losses for short sellers.

In short, short selling is a trading strategy that involves significant risks. While this can be a useful
tool for some investors, it's important to understand the potential downsides and take steps to
mitigate them. Investors who engage in short selling should carefully consider the risks and exercise
caution when entering these trades.

Investors can reduce the risks associated with short selling by implementing risk management
strategies such as placing stop-loss orders, diversifying the portfolio and monitoring the opening of
short positions.

Short selling is a trading strategy that enables investors to benefit from the decline in the price of a
security. It is a process where investors borrow shares of a security from a broker and sell them, with
the intention of buying them back at a lower price in the future. This strategy is commonly used by
institutional investors but is also utilized by individual investors or retail investors.

Short selling is often seen as a controversial practice due to its potential impact on the market, and it
is subject to various rules and regulations. Despite this, short selling has been a popular trading
strategy for decades and has been employed by investors to achieve various objectives. It is
important to understand the potential benefits and drawbacks of short selling to make informed
investment decisions.

This report will examine the question of whether retail short selling is preferable or not. It will
analyze existing literature on the advantages and disadvantages of retail short selling, as well as its
potential impact on the market. This report aims to provide a comprehensive understanding of retail
short selling, its advantages, disadvantages, and regulatory framework, to help investors make
informed investment decisions.

Short selling can be used to create a false impression of demand and supply for a particular stock.
This is achieved through a process called "naked short selling," which involves selling a stock that has
not been borrowed or actually owned by the short seller.

When a short seller engages in naked short selling, they effectively increase the supply of a particular
stock in the market, which can lead to a decrease in the stock's price. This can create the impression
of weak demand for the stock, which can further drive down the price.
At the same time, the short seller can also engage in other manipulative practices, such as spreading
false rumors or engaging in coordinated trading with other investors, to create a false impression of
weak demand for the stock. This can further exacerbate the decline in the stock's price and create a
self-fulfilling prophecy of weak demand.

On the other hand, short sellers can also use these same manipulative practices to create a false
impression of strong demand for a particular stock. This is achieved by engaging in "pump and
dump" schemes, where the short seller artificially inflates the price of a stock through coordinated
buying, false rumors, or other manipulative practices. Once the price reaches a certain level, the
short seller then sells their position, causing the price to collapse and leaving other investors with
significant losses.

It is worth noting that naked short selling is illegal in most jurisdictions and can lead to significant
penalties for those who engage in it. Furthermore, short selling in general is subject to strict
regulations and can only be conducted under certain conditions and with proper disclosure.

Lamens Brothers Holdings Inc. was a global financial services firm that filed for bankruptcy in 2008.
One of the contributing factors to its downfall was the impact of naked short selling on its stock
price.

In 2008, it was revealed that a number of hedge funds had engaged in naked short selling of Lehman
Brothers' stock. This led to an increase in the supply of Lehman's shares in the market, which drove
down the stock's price.

The decline in Lehman's stock price, combined with other factors such as exposure to the subprime
mortgage market, created a crisis of confidence in the firm. Investors began to withdraw their funds
and Lehman was unable to meet its obligations. The firm ultimately filed for bankruptcy on
September 15, 2008, in what was one of the largest bankruptcies in U.S. history.

The impact of naked short selling on Lehman Brothers' stock price was significant and contributed to
the firm's downfall. However, it is worth noting that naked short selling was not the sole cause of
Lehman's bankruptcy, but rather one of several factors that contributed to it.

In India, mutual funds can engage in short selling under certain conditions and subject to regulatory
oversight. Mutual funds use short selling as a means to manage their portfolio risk, enhance returns,
and increase liquidity.
In the Indian context, mutual funds are permitted to engage in short selling of equity shares, equity
derivatives, and government securities subject to certain conditions. For instance, short selling can
only be conducted on a delivery basis, meaning that the securities must be available for delivery to
the buyer on the settlement date. Additionally, mutual funds are required to maintain adequate
collateral and follow strict risk management practices to minimize their exposure to potential losses.

The Securities and Exchange Board of India (SEBI), the country's regulatory body for the securities
markets, has established guidelines and regulations for mutual fund short selling activities. These
regulations include rules for margin requirements, disclosure requirements, and reporting
obligations.

Mutual funds may also use short selling as a way to hedge against their existing long positions in the
market. For instance, if a mutual fund holds a portfolio of long positions in a particular sector or
industry, it may engage in short selling of securities in that same sector or industry to hedge against
market risk.

Overall, the link between mutual funds and short selling in India is one of risk management and
portfolio optimization. While short selling can increase the returns of a mutual fund, it also involves
significant risk and must be conducted within the bounds of regulatory oversight and prudent risk
management practices.