RBI may okay short sales in debt market by July 25

MUMBAI: Primary dealers can look forward to begin short selling in the local debt market by trading in when-issued securities.

The market for trading in when-issued securities is likely to start functioning shortly, before July 25, when the Reserve Bank of India (RBI) would unveil its quarterly review on its monetary and credit policy.

‘When-issued’ is an abbreviated term for ‘when, as and if issued’. It indicates the transaction of a security, which is conditional and is authorised to be issued, but not yet issued in actual terms. Market participants feel that the move would provide primary dealers (PDs) an access to price discovery mechanisms and a sense of the total demand for a security to be issued prior to the issuance.

That apart, it is expected to add the much-needed depth to the government securities market. This in turn would help reduce market volatility associated with the days when auctions are held.

Traders see this as a move that represents a major step towards enabling short selling in debt markets. RBI had initially allowed intra-day short selling in gilts and with a when issued market, it actually enhances the cause by allowing short sales of to-be-auctioned papers.

According to the guidelines issued by RBI in May ’06, any such transaction must have a PD as a counterparty. RBI guidelines also clarified that players who are non-PDs cannot act as a buyer and seller in a single transaction.

Accordingly, RBI has decided to permit such operations only in re-issued Central government securities, on the negotiated dealing system-order matching platform.

SR Kamath, Securities Trading Corporation’s general manager, said, “The central bank is looking at launching the when-issued segment before the quarterly policy review. These securities are definitely poised to add more depth to the market apart from improving the levels of transparency in the system and facilitating better communication between banks and primary dealers.”

The current guidelines permit PDs to short sell only 10% of the notified amount of the auction. With the when-issued market, securities could be traded from the next day of the announcement of the auction with settlement, following the day of auction.

Nitin Jain, head-fixed income at ICICI Securities, says that such a market would allow PDs to get a better understanding of what amount they need to underwrite in an auction. It also gives them a better idea of what would be the likely yields for the security and thus they can bid accordingly. PDs avoid the possibility of sitting on illiquid stock post-auction and exiting at higher yields, he said.

In the when-issued segment, only 5% of the total notified amount can be acquired by a single entity. Hence, this would give way for wider distribution of the stock, compared to the normal auction route where there is a likelihood of a single entity picking up the entire issue.

On the other hand, few players expressed concerns over the large concentration of paper held by single entities, making it difficult to deliver. PDs would need to buy back a sold paper from the market and this could be at a higher price, given the illiquidity of the stock, a dealer said.

However, participants expect these issues to be addressed before the system goes online. The move, dealers agreed, was more in line with the RBI’s incremental and gradual approach to revive the debt market.