Market regulator SEBI has told the Supreme Court that it is inquiring into allegations made in the Hindenburg report against the Adani Group as well as the market activity immediately preceding and post the publication of the report to identify any violations of its regulations. It has also told the apex court hat it has a “robust set of frameworks and market systems” to ensure seamless trading and deal with the volatility in stock exchanges, while asserting that developed securities markets world over recognise short selling as a “legitimate investment activity”.

The Securities and Exchange Board of India (SEBI) on Monday filed the 23-page written note before a bench headed by Chief Justice DY Chandrachud, which was hearing two PILs relating to the recent Adani Group shares crash, and said it was “already enquiring into both, the allegations made in the Hindenburg report as well as the market activity immediately preceding and post the publication of the report, to identify violations of SEBI Regulations...short selling norms, if any.” Asserting that the recent impact on the securities market due to the Adani Group shares crash did not have “significant impact”, the regulator said, “Indian markets have seen far higher turbulent times in the past, especially during the Covid pandemic period, where Nifty fell by around 26 per cent during the period of March 2, 2020, till March 19, 2020 (13 trading days). In view of the heightened market volatility, SEBI, on March 20, 2020, reviewed its existing market mechanisms and introduced a few changes”.

The SEBI said as the matter was in early stages of examination, it may not be appropriate to list details about the ongoing proceedings at this stage.

While listing out available legal and other frameworks to deal with wrong-doings in the securities market, it said, “SEBI has a robust set of frameworks and market systems to ensure seamless trading and settlement including frameworks for volatility management and restrictions on short selling including by foreign institutions.” It gave the details as to what constitutes short selling and said the country follows the policy of “regulated short selling” and has framed its regime accordingly.

Short selling usually involves investors borrowing shares and selling them, expecting to buy them back later at a lower price before returning them to the lenders and making profits on the difference between the higher sale price initially and the lower purchase price subsequently, it said.

“Securities market regulators in most countries, and in particular, in all developed securities markets, recognise short selling as a legitimate investment activity. Such jurisdictions also have an active market for equity derivatives which includes stock futures.

"Thus, in all major jurisdictions, instead of prohibiting short sales per se the regulators have permitted it to take place within a regulated framework. The International Organisation of Securities Commissions (IOSCO) has also reviewed short selling and securities lending practices across markets and has recommended transparency of short selling, rather than prohibiting it,” it said.

Referring to the facts of the recent events, the regulator said that Hindenburg is a short seller research company amongst other such companies in the US that do research on companies that they believe have governance and/or financial issues.

“Their strategy is to take a short position in the bonds/shares of such companies at the prevailing prices, (i.e., sell the bonds/shares without actually holding them) and then publish their reports. If the markets believe the reports, the prices of the bonds/shares start to fall. Once the fall starts, other institutions who have ‘stop loss limits’, also start selling their holdings of bonds/shares irrespective of whether they believe the report or not thus triggering a downward spiral in the bond/share prices.

“The short sellers then buy the shares/bonds at the lower prices, thus making a profit. The more the market believes their reports, and the more that 'stop loss limits' get triggered, the more the prices of the bonds/shares fall and the more money they make,” it said.

On Adani firms, it said the group has a number of “USD denominated bonds listed in overseas market” and the Hindenburg in its report has stated that its short positions in the Group are in USD bonds in overseas markets and non-Indian traded derivatives.

“The events that are the subject of the PIL are related to one set of entities in the market and have not had any significant impact at the systemic level. While the shares of the Group have seen significant decline in prices on account of selling pressure, the wider Indian market has shown full resilience. The combined weight of the Group companies in Sensex is zero and in Nifty is below 1 per cent,” it said.

Even during such turbulent times, SEBI did not resort to banning short selling, even though there were demands for banning it, the note said, adding markets continued to function in a robust manner, recovering far faster that other global markets Investor wealth.

“The market capitalisation of all listed companies which was around Rs 145 lakh crore in Feb 2020 has almost doubled to about Rs 270 lakh crore now. Further, overall market volatility in India is on par or lower than that in major developed markets,” it said.

The PILs relate to events that are localised to a single group of companies and that there is no significant impact at a market wide level, it said.

The issues have had a significant impact on one group of companies and warranted a detailed examination by the SEBI, the note said.

“The SEBI Act, 1992, the SCRA and Depositories Act..., provide SEBI with powers to regulate the securities market, by framing appropriate regulations and updating them, as and when required, in response to the dynamic nature of the markets and the new types of behaviour that the market exhibits,” it said.

The top court is scheduled to hear the two PILs alleging exploitation of innocent investors and "artificial crashing" of the Adani Group's stock value on February 17 when it will consider setting up a panel to consider strengthening the regulatory framework.

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