India Allows Institutional Short-Selling; HSBC First to Clear

May 19, 2008
Mayur Pahilajani

HSBC last month became the first bank in India to offer clearing services to institutional investors executing securities lending and borrowing transactions.

The announcement came on April 21, the same day that India's regulators permitted foreign and domestic institutions to begin short selling. Previously, only retail investors could sell equities short. The Securities and Exchange Board of India (SEBI) announced the so-called securities lending and borrowing, or SLB, scheme in December.

According to Vikramaaditya, head of Mumbai-based HSBC Securities Services India, the National Stock Exchange of India and Bombay Stock Exchange have already set up trading systems for the transactions.

"There are some clients who are currently in discussions with us and are looking to utilize this scheme," said Vikramaaditya. "While there were no specific opportunities for testing, the SLB clearing service is similar in some respects to what we are quite successfully doing in the futures and options segment, where we are a leading clearing member. We have therefore leveraged some of our capabilities from that side."

When the SEBI unveiled the SLB scheme it instructed financial institutions to put the necessary systems in place--but did not specify an implementation date. "I am surprised that HSBC has managed to get it out so fast," said Ajay Shah, senior fellow in Mumbai for the Delhi-based National Institute of Public Finance and Policy. "Generally in India, when there is a [tight] deadline ... the surrounding infrastructure is not up." Typically, he added, "the clearing banks take time to catch up with the market developments."

Ironing Out the Kinks

Although letting institutional investors short sell is a positive move by the SEBI, said Shah, the mechanisms will need to be refined. "One of the difficulties is that the regulator has only allowed short sales and securities lending where there is derivatives trading, whether it is an individual stock future or an individual stock option," he said. "That, in my mind, is a sham because when the derivatives are there, you don't need borrowed securities to short the stock--you could just short the future."

While institutional investors are required to disclose at the time of the order whether the transaction is a short sale, retail investors can provide that information in the last few trading hours on the day of the transaction. Also, the SEBI is mandating that the transactions be settled on the day after the trade, or T+1, limiting the lending and borrowing window for investors, which Shah characterized as too rigid.

HSBC entered the Indian securities services sector in 1993, when the market was first opened to foreign institutional investors (FIIs). In its role as a custodian bank, HSBC accounts for about 40 percent of all FII assets in the country and provides similar services to local institutional investors. On the cross-border trading front, HSBC competes with international banks such as Deutsche Bank, Citigroup and Standard Chartered, as well as domestic banks including HDFC Bank, ICICI Bank and Axis Bank.

"The FIIs' experience in the Indian market has been one of success," said Shah. "There are thousands of FIIs and there are very large [investment] flows in India." Other than the restrictions on the percentage of an Indian company a single foreign investor can own, there are no limits on the transfer of money in and out of the country for foreign investors, according to Shah. "India's FII framework is certainly much more open than China's framework," he added. "It is 16 years old and it has worked pretty well."