FIIs Short Selling? - (MoneyLIFE, Issue 28 Aug 08)
August 11, 2008
Edited by SUCHETA DALAL
Exclusive news, the stories behind the headlines and the truth between the lines
FIIs Short Selling?
Sometime at the end of July, the Securities & Exchange Board of India (SEBI) asked for details of Participatory Notes (PNs) issued by foreign institutional investors (FIIs) over the past nine months. These are offshore derivative instruments that represent one or more underlying securities purchased in India by an FII. Media reports suggest that this is an exercise to verify compliance with SEBI’s disclosure norms relating to PNs. Apparently, SEBI also wants to verify whether some FIIs have been borrowing stocks to sell short certain shares. FIIs were shorting the stocks of at least four companies in the last week of July. Will SEBI’s queries expose short-selling, if any? It may, provided SEBI officials know where to look and want to ask the right questions.
The first question is why would FIIs want to short stocks by borrowing when they can easily bet on the derivatives segment. Well, because these are liquid stocks that are not in the stock futures segment or the market-wide limits have been exhausted. Our sources say that they have specific information of such short-selling in Reliance Infrastructure, Unitech, Indiabulls and Ranbaxy through their FII sources. Although market regulators have elaborate insider trading regulations, the close relationship between leading brokers, top FII traders and many CEOs and CFOs of corporate India is an open secret. It allows the big traders to get a heads up on major corporate actions and, in return, they willingly share market information.
What helps them is the fact that the government is still not serious about eliminating non-transparent investment through PNs. If anything, the recent decline in stock prices has provided plenty of headroom for issuance of more PNs. How does the short-selling work? Suppose an FII has a large holding of, say, ABC Limited, purchased for an overseas investor against the issue of PNs. Another investor, who wants to short-sell ABC Limited, can borrow the stock. The FII simply issues another PN to the borrower, who sells the shares in the market. Since both positions are held by the same FII, that too as non-transparent PNs, the market has no information, except when one of those involved talks about the transaction. The FII and stock lender share the income generated by lending the shares. How can SEBI get to the bottom of such short-selling? It will have to ask the following question: If you have bought a specific stock by writing an offshore derivative contract (PN) for Investor ‘A’, have you also written a PN that resulted in short-selling by Investor ‘B’ of the same stock? Some sources think that large FIIs, who have been involved in lending shares, will not fudge the information because the risk is too high. However, going by past experience, we are not so optimistic, unless chairman CB Bhave sends a strong signal that he is willing to do everything necessary to ensure compliance. If SEBI fails to check such short-selling, domestic investors will be forced to deal with sudden price volatility.
The hottest corporate action these days is the rush to set up new bourses. On the one hand, several entities, including Anil Ambani, Indiabulls, Religare and even NCDEX, would like to topple market leader MCX from its perch before it consolidates its position with a successful listing. Meanwhile, Jignesh Shah of MCX continues to pull ahead of the competition with international successes. He set up the Dubai Gold & Commodity Exchange (through Financial Technologies), recently launched the Singapore Mercantile Exchange, has been invited to set up a pan-Asian commodity exchange located in Mauritius and recently launched the Multi-commodity Exchange, Africa. He is also the only serious contender so far, apart from the NSE (National Stock Exchange) for the Currency Futures Exchange that will be regulated by SEBI. Many believe that the commodities race will ultimately be between Anil Ambani and MCX. ADAG (Anil Dhirubhai Ambani group) is working hard to catch up with the MCX/ FT combine after its tie up with the Ahmedabad-based National Multi Commodity Exchange (NMCE). It is now in the process of setting up other intermediaries. For instance, Reliance Money and NMCE will set up a spot exchange for agro-commodities called the National Agriculture Produce Marketing Company of India (National APMC). FT’s spot exchange called National Spot Exchange (NSEL) will be launched at the end of August. ADAG also has a counter plan in place for FT/MCX’s National Bulk Handling Corporation.
Inside Information Works
Why do fund managers need to know CEOs and corporate honchos? Well, a study by the US-based non-profit National Bureau of Economic Research probably has an answer. Researchers (NBER Working Paper No 13121) Lauren Cohen, Andrea Frazzini and Christopher Malloy in their study titled “The Small World of Investing: Board Connections and Mutual Fund Returns” find that there is a direct correlation between the two. In effect, they say that “Who you know, is a big part of investment success, at least for professionals who manage mutual funds. University connections – especially Ivy League ones – are common and profitable.” Not only do fund managers invest more in ‘connected companies’ (where they have a batch-mate connection) but the study finds that they make their biggest returns around “news events such as mergers that boosted the stock price.” Such holdings in connected companies outperform those in non-connected companies by as much as 8.4% a year (statistically very significant), because it gives fund managers an ‘informational advantage’, conclude the authors. Does that tell you something? Informational advantage can be a euphemism for something more sinister as well and it is difficult to distinguish between the two. There are plenty of such ‘connections’ between Indian and foreign fund managers with Indian CEOs and all very profitable too.
Floors and Caps
Bosch Chassis Systems India Limited, which failed in its first attempt to get its shares de-listed from the bourses, has come up with an interesting trick this time. SEBI’s reverse book-building rules give ordinary investors a say in the exit price, when companies want to go private again. Now, Robert Bosch GmbH, which already holds 80% of the equity, wants to go private. In April 2008, it failed in its attempt to de-list the company because it was unwilling to pay the discovered price (which is that bid by the maximum number of shareholders) of Rs750. On 17th July, it announced another round of delisting, but it is clear that it will still not pay what the investors want. This time, its announcement says that it is willing to pay up to Rs600 per share as the exit price. Some investors argue that reverse book-building does not provide for such an indicative cap on the price. They have written to the regulator complaining that investors are likely to be misled into bidding at the indicative price. It will be interesting to see if retail investors are indeed misled and blindly bid at the indicative cap. What is, however, clear is that Bosch’s offer is unfair to investors. The shares were traded at a high of Rs724 on 31st March. Clearly, the discovered price of Rs750 that investors wanted included only a slight exit premium. Since then, the price has dropped 18% to Rs592.25 on 5 August 2008. It is not clear how and why the price has fallen so much, but it does seem as though it is geared to make Bosch’s indicative price of Rs600 look very attractive. This is, indeed, a fit case for the regulator to take a close look at – and investigate why investors are willing to accept a lower price in the secondary market rather than bid higher in the reverse book-building process.