Short Selling of Government Securities
Short Selling and Notional Short Selling
Short selling is the sale of a security one does not own. It is done when it is anticipated that the price of the concerned security shall decrease in the future. This way, the participant can earn a profit by selling it now at a higher price and purchasing it later when the price falls. For this purpose, they might have to borrow the security in which a charge may be incurred.
A 'notional' short sale is where a bank can sell a security short from an HFT (Held For trading) book. The resultant 'notional' short position would be subject to the same regulatory requirements as in the case of a short sale.
The short-selling of central government securities (G-Secs) was introduced in February 2006. It was done with an intention to provide the participants with a tool to express a two-way view on interest rates and thereby enhance price discovery. Before the revised guidelines, scheduled commercial banks, primary dealers, and only certain well-managed urban cooperative banks were permitted to undertake short sale transactions.
However, in the revised guidelines the RBI has made room for other participants with a proper regulatory nod. Now, any entity which has the approval of the respective regulator, including the Securities and Exchange Board of India (SEBI), Pension Fund Regulatory and Development Authority (PFRDA), NABARD, National Housing Bank (NHB) and the Insurance Regulatory and Development Authority of India (IRDAI), will be eligible to undertake such short-selling positions. Gilt Account holders are not permitted to undertake short sale transactions.
There were entity-wise and security-wise (liquid/ illiquid) limits for undertaking short sale transactions earlier. But it was proposed to relax the participant’s eligibility based on these two criteria in order to deepen the G-Sec and repo market.
The limits and cover
For liquid securities, the maximum face value or amount of the security that can be short sold is capped at 2% (which was 0.5% earlier) of the total outstanding stock of each security or ₹500 crores, whichever is higher. For other securities, the limit is 1% (which was 0.25% earlier) of the total outstanding stock of each security or ₹250 crores, whichever is higher.
Short sales, including notional short sale, should be covered within a period of 3 months, including the date of the transaction. The cover should be through the outright purchase of the security either in the secondary market or in the primary auction or even in the when-issued market.
What is ‘When Issued’ market?
The “when Issued” market securities refer to those securities that have been authorized for issuance but have not yet actually been issued. Such a trade takes place for the time lag that exists between the announcement of a Government Security for issuance and the actual issue of the said security.
All such transactions are on an 'if' basis or simply a conditional basis. This means it is to be settled if and when the actual security will be issued. Both new and reissued Government securities issued by the Central Government are eligible for ‘When Issued’ transactions.
When Issued transactions can only take place after the issue of the security has been notified by the Central Government, and the position would be squared off on the date of the actual issuance or auction. All ‘When Issued’ transactions will be due for settlement on the date of the issue.
When Issued’ transactions are to be undertaken only on the Negotiated Dealing System-Order Matching (NDS-OM) platform. However, an existing position in a ‘When Issued’ security may be closed either on the NDS-OM platform or through the Over-the-Counter (OTC) market.
A written policy on ‘When Issued’ trading is required to be in place for all participants, which should be approved by the Board of Directors or equivalent body.