[Dhaval Bothra and Anoushka Das are law students at Symbiosis Law School, Pune]
On January 24, 2023, Hindenburg Research LLC released a report accusing the Adani group of fraudulent activities and market manipulation, leading to a significant decline in the share value of Adani companies. The Hindenburg report had a substantial impact on the Indian securities market, causing a stock plunge and prompting the Adani Group to counter the allegations. Criticism arose against the Securities and Exchange Board of India (“SEBI”) for its regulatory oversight and amendments to the SEBI (Foreign Portfolio Investments) Regulations, 2014 (“FPI Regulations”) and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) which, it was alleged, allowed for Adani group’s actions to remain undetected. The Supreme Court of India thereafter formed an expert committee to investigate the allegations and market volatility whilst allowing SEBI to concurrently continue its probe. The Expert Committee submitted its findings on May 6, 2023, while SEBI sought an extension until August 14, 2023, after its two-month deadline.
The ensuing uncertainty caused by the aforementioned market volatility led petitioners to approach the Supreme Court, urging for other investigative bodies to handle the probe. In its January 3, 2024 judgment, the Supreme Court assessed SEBI’s investigation efficacy and considered whether there existed the need to transfer the inquiry to other agencies.
Allegations against SEBI and the Expert Committee
The petitioner sought two main directions: the establishment of a court-monitored Special Investigation Team (“SIT”) to oversee SEBI’s investigation into the Adani group, emphasizing SEBI’s failure in proving regulatory non-compliance and legal violations, and the revocation of amendments to FPI and LODR Regulations. Allegations were made against certain expert committee members for conflicts of interest. The Supreme Court, after investigating, dismissed claims of market manipulation by the Adani group, affirming SEBI’s autonomy and emphasizing the limited role of judicial review. The Court rejected calls to revoke the amendments passed by SEBI. However, the Court recognized the areas where lapses in SEBI’s functioning concerning the present case. It urged expedited ongoing probes, emphasized transparency, and acknowledged an expert committee’s recommendations for reforms in investor awareness, short-selling regulations, and SEBI’s structure. Ultimately, the judgment reaffirmed SEBI’s policy-framing authority whilst encouraging its responsiveness to investor needs. Although this judgment reaffirms faith in SEBI as the guardian of the securities market, there still exists a plausible apprehension that several areas of concern continue to exist in India’s securities regulation.
The Adani crisis cast a harsh spotlight on India’s short-selling regulations, exposing gaps that potentially enabled market manipulation. Seizing this opportunity for reform, SEBI’s October 2023 Master Circular unveiled a new framework aimed at increasing transparency and safeguarding investor interests.
Key Features of the Framework
The framework extends short-selling privileges to all investors, unlike the previous restriction to qualified institutional investors. This democratization of access aims to create a more dynamic market but raises concerns about potential misuse by retail investors. To address risks, the framework imposes strict disclosure requirements, necessitating upfront disclosure of short positions for institutional investors and end-of-day disclosure for retail investors. Settlement obligations are rigorously enforced to prevent naked shorting and ensure the timely delivery of borrowed securities.
Furthermore, in a bid to curb speculative practices and promote long-term perspectives, the framework imposes a ban on institutional day trading, prohibiting the squaring off of short positions within the trading day. Additionally, the introduction of a dedicated securities lending and borrowing scheme aims to enhance market efficiency and transparency by facilitating easier access to borrowable stocks for short sellers.
Lastly, to bolster market monitoring, the SEBI mandates brokers to collect and upload scrip-wise short positions, which are then aggregated and publicly disseminated by exchanges on a weekly basis. This increased transparency empowers investors to make informed decisions while acting as a deterrent against manipulative practices.
Implications and Comparisons
Compared to the previous regime, the new framework represents a significant shift towards transparency and investor protection. The ban on naked shorting and stricter disclosure requirements address loopholes exploited in the Adani case. However, concerns remain about the ability of retail investors to navigate the complexities of short-selling responsibly. The framework’s success will hinge on effective investor education and robust market surveillance.
While potentially fostering market efficiency, the new framework’s impact on manipulation attempts requires careful observation. Increased short-selling activity could expose genuine weaknesses in companies, but could also be misused by coordinated groups to drive down prices artificially. Regulatory vigilance and investor awareness will be crucial in distinguishing legitimate short selling from manipulative tactics.
The Adani crisis served as a stark reminder of the vulnerabilities inherent in opaque markets. SEBI’s new framework, with its emphasis on transparency and investor protection, is a step towards a more robust and resilient Indian securities landscape. However, its effectiveness will be contingent on diligent implementation, ongoing market monitoring, and continued regulatory refinement in light of evolving dynamics.
Recommendations
To bolster the success of SEBI’s new short-selling framework, we recommend prioritizing the following:
Robust Market Surveillance and Enforcement
Strengthening technological capabilities would empower SEBI to effectively monitor short positions, identify suspicious trading patterns, and detect potential market manipulation. By investing in advanced data analytics tools and artificial intelligence algorithms, SEBI can enhance its ability to track and analyze large datasets related to short-selling activities. For instance, the US SEC Analysis and Detection Centre (“ADC”) uses advanced analytics and algorithms to sift through massive trading data in real-time. It identifies suspicious patterns and potential manipulative schemes across diverse financial instruments, including short-selling activity. Similarly, SEBI could also consider intensifying audits and inspections on brokers and market participants, ensuring strict compliance with the new framework and imposing more severe penalties for non-compliance and violations. In fact, SEBI has shown intent in the same through its expression of interest concerning “Implementation of Data Analytics Projects and Building of Data Models.” This signifies a clear commitment to proceed with the implementation of such initiatives.
Continued Refinement and Adaptation
While the regulator does have the SEBI’s Complaint Redress System (“SCORES”) that empowers individual investors with its grievance redressal platform, SEBI’s future lies in a broader feedback mechanism. Inspired by UK FCA’s Project Innovate, India could establish a dedicated “Short Selling Framework Feedback Group.” Comprised of investors, market participants, academics, and consumer groups, this group would regularly convene to analyze the framework’s impact on market dynamics, investor behaviour, and potential manipulation risks. By delving into emerging trends and proposing regulatory refinements in collaboration, this diverse body can inform and guide SEBI towards a more effective and responsive short-selling landscape. Leveraging existing forums and ensuring transparency through published summaries and recommendations, such a mechanism fosters trust, market efficiency, and ultimately, investor confidence in the Indian securities market.
Independent Oversight and Transparency
While SEBI exercises primary regulatory oversight over India’s capital markets, the establishment of an independent “Short Selling Oversight Committee” (“SSOC”) could significantly fortify transparency and accountability within the short-selling framework. Similar to the Financial Stability Board’s Standing Committee on Assessment and Implementation (“SACOI”) acting in tandem with the International Monetary Fund, SSOC could operate as a distinct entity, providing regular, independent assessments of SEBI’s performance concerning short-selling regulations. This committee, composed of eminent financial experts, legal professionals, and independent public figures, would not only review SEBI’s adherence to established standards but also proffer valuable recommendations for continuous improvement. Such a structure, echoing international models, would not only bolster public trust and investor confidence in SEBI’s decision-making but also enhance India’s international standing within the global financial community.
Conclusion
The Adani-Hindenburg saga exposed vulnerabilities in the Indian securities market, prompting a regulatory response led by the SEBI. The Supreme Court’s recent judgment affirmed SEBI’s autonomy while acknowledging lapses in its functioning and endorsing reforms proposed by an expert committee. The subsequent unveiling of SEBI’s new short-selling framework represents a commendable shift towards transparency and investor protection. However, concerns persist about potential misuse and the ability of retail investors to navigate the complexities responsibly. To ensure the framework’s success, robust market surveillance, continued refinement, and independent oversight are crucial. The effectiveness of these measures will depend on diligent implementation, ongoing monitoring, and regulatory adaptation to evolving market dynamics, ultimately contributing to a more resilient and trustworthy Indian securities landscape.
– Dhaval Bothra & Anoushka Das
