India's burgeoning stock market, fueled by increasing retail participation and a growing economy, faces a critical test: how to safeguard investor confidence against the backdrop of rising attacks from foreign short-sellers. These entities often release critical reports that trigger stock crashes, from which they profit, raising concerns about market integrity and regulatory oversight.
The heart of the issue lies in the business model of certain foreign short-sellers. These firms take short positions in Indian companies and then publish adverse research reports, which often lead to significant drops in the targeted stocks. The resulting panic can be highly profitable for the short-sellers but detrimental to ordinary investors. A report by InGovern highlighted that these firms often operate outside the direct jurisdiction of Indian regulators, making it difficult to hold them accountable.
The Securities and Exchange Board of India (SEBI) has established a regulatory framework for research analysts to protect investor interests and promote market integrity. However, these regulations primarily apply to domestic entities. Foreign research firms not registered with SEBI can publish reports on Indian companies without being subject to Indian regulatory scrutiny, even when their actions directly impact Indian investors and markets. This regulatory gap is a major point of concern, as highlighted by InGovern.
Several instances of foreign short-seller attacks have recently shaken the Indian market. The most notable was Hindenburg Research's report against the Adani Group in January 2023, which triggered significant volatility and prompted regulatory investigations. More recently, a report by Viceroy Research alleging governance issues at Vedanta led to a considerable intraday stock plunge. While short-selling is a legitimate and regulated activity that aids market liquidity and price discovery, these incidents underscore the potential for misuse and the need for enhanced regulatory measures.
Finance Minister Nirmala Sitharaman has emphasized SEBI's role in addressing manipulative actions, such as motivated short selling, and highlighted that the effective use of regulatory tools could contribute to enhanced corporate governance. In response to these concerns, SEBI has taken steps to tighten disclosure rules for short selling. The regulatory body has also banned naked short selling, where an investor sells short without having borrowed or located the shares to be sold. Furthermore, SEBI has stated that all stocks that trade in the futures and options segment are eligible for short selling and may review the list from time to time.
To further strengthen investor protection and boost transparency in capital markets, SEBI could consider formulating regulations to address manipulative short sellers and make reporting more transparent, similar to the measures taken by the U.S. Securities and Exchange Commission (SEC). The SEC has rolled out new rules requiring investors to report their short positions and companies that lend shares to report that activity.
The challenge for SEBI is to strike a balance between allowing legitimate short-selling activities, which contribute to market efficiency, and preventing manipulative practices that erode investor trust. Experts suggest that improving the ease of shorting stocks in the Indian markets could also aid price discovery. Greater regulatory parity and increased surveillance are needed to ensure market stability and protect investors from the adverse impacts of unregistered foreign entities.
