More power to short selling

The government’s decision to explore ways to curb market volatility, including permitting institutional short sales, is welcome. But these measures would have only a limited impact as long as derivatives remain a predominantly retail phenomenon, and long-term sources of savings such as pension monies are prevented reasonable access to equities. The recent market volatility has yet again exposed the systemic shortcomings of the market. For one, it continues to swing to the flow of FII money, more so on the downside. This is largely because of the skewed make-up of the local investment community. LIC is perhaps the only large institution in the market with a long-term orientation. The rest, including mutual funds, which are quasi retail and high net worth (HNI) categories, are largely sentiment driven. The problem is even more acute in the derivatives segment, which now dominates price discovery. Nearly two-thirds of trading in derivatives is non-institutional (mostly HNI). Such investors had taken to derivatives because of the unidirectional market, which yielded good speculative gains. There was very little institutional check on this runaway speculation as FIIs and MFs are subject to position limits that caps their exposure to the various exchangetraded derivatives products. The resultant huge build-up of uninformed exposure in the derivatives is to an extent responsible for the increased volatility.
The proposed measures such as institutional short sales, delivery-based settlement of options and higher margins in futures are fixes that would work only when the market has more depth. Short sellers are needed to curb irrational exuberance. But we need investors with long-term orientation — who would step in if stock prices are hammered below their fair value — to prevent these short sellers from destabilising the market. Permitting a greater flow of retirement savings to equities through pension reforms is certainly a lasting solution. And the imbalance in the derivatives market needs to be corrected by giving greater play to institutional players.


-- The Economic Times Editorial