Short selling is a way investors try to make money by borrowing stocks they think will go down in value. They sell these borrowed stocks to others who are willing to pay the current market price. Later, if the stock price drops, the investor buys back the stocks at the lower price, gives them back to the lender, and makes a profit from the difference.
The Colombo Stock Exchange (CSE) has introduced a system for regulated short selling (RSS) through a stock borrowing and lending (SBL) mechanism. This allows investors to borrow certain stocks, as decided by the Central Depository Systems (CDS).
For a short sell transaction to happen on the Automated Trading System (ATS), the seller must have borrowed the shares through an SBL transaction before selling them or initiated a short sale first and then must borrow the shares through an SBL transaction before the end of the trading day.
Investors with CDS accounts can engage in SBL transactions as lenders or borrowers through a participant (like stockbrokers or custodian banks). They need to have an SBL agreement with that participant. Investors can choose to conduct SBL transactions through these participants using pooled lending/borrowing orders or by placing orders directly with the CDS through a participant.
Lenders earn fees from borrowers, calculated and paid when the securities are returned. Lenders also get all corporate benefits during the lending period and can recall the lent shares if there are corporate actions or voting events (with at least 3 market days’ notice to the borrower).
Some safeguards are in place:
- The borrowing participant must meet the margin and collateral requirements set by CDS.
- If the value of a stock eligible for RSS drops by over 10% in one day, the uptick rule applies to new short-selling orders. These orders must be placed at a price at least one tick size (ie minimum price increment) above the stock’s most recent trading price.
- If a stock’s price decreases by 20%, RSS won’t be allowed until the price recovers.
With regulated short selling, shareholders with inactive portfolios can earn fees by lending their shares. Speculators can also take advantage of market ups and downs to potentially make profits. Regulated short selling can contribute to the efficiency of the CSE by considering the opinions of short sellers in stock valuation, aligning prices with intrinsic value (price discovery), and reducing bid-ask price differences, lowering trading costs and boosting market liquidity.
For further information, please contact:
Ramesh Perera, D.L.&F. De Saram.