The RBI announced a very boring credit policy with no changes to CRR or Interest rates. But one thing it did say was that:
13. Review of Short Selling Directions – Introduction of short selling in Government Securities (G-sec) in 2005 with the objective of encouraging diversity in interest rate views has resulted in a more active G-sec market. Smoother settlement of short sale transactions is necessary for orderly functioning of the market. Towards this end, it has been decided that (i) a short seller need not borrow securities for ‘notional short sales’, wherein it is required to borrow the security even when the security is held in the held-for-trading/available-for-sale/held-to-maturity portfolios of banks; and, (ii) over-the-counter (OTC) G-sec transactions by FPIs may be contracted for settlement on a T+1 or T+2 basis. Directions in this regard will be issued by end-October 2017.
Why is this interestng? Well, we wrote about this in a post: There’s a short squeeze in the Bond market as PSU Banks outwit Sophisticated Foreign Bank Desks.
Now you could do short sales in the bond market, but when you did, you still had to “deliver” the bonds for settlement. Notional short sales are where banks set up a short sale on their books, but could still own the security itself – and it really intends to square off the position. (Versus a naked sale where it doesn’t own the security) Due to complex issues, RBI doesn’t allow a notional short sale to be carried overnight by actually delivering the security in the banks’ portfolio – it has to be borrowed through repo on the CROMS market, where you borrow specific securities.
A squeeze engineered by PSU banks cut off the supply in the CROMs market of some securities and the short sales had to be unwound sharply, resulting in a panic fall in yields (rise in bond prices). A foreign bank that even owned securities in their portfolio couldn’t do notional short sales, because they had to borrow and the borrow wasn’t happening with PSU banks unwilling to lend their bonds.
RBI’s plugging this loophole by allowing banks to keep notional short sales “open” as long as they own the securities elsewhere.
Retail Trading: Another Go? Primary Auctions Too.
Every week, the RBI auctions bonds and T-Bills. Retail investors could buy – at non-competitive bids – but there’s no easy way to do it. Now there might be, with the RBI moving to allow stock exchanges (NSE, BSE) to allow investors into primary auctions.
Think of this. There was a time when T-Bills were going at 11% in 2013, but no one in retail could buy because no one would sell it to them! Even now, there’s no way to get a good fixed rate of return for a 30-40 year period – no bank will sell you that long a deposit.The government 30-40 year bonds trade about 7.2% today, and the only way to buy them will be to bid on the RBI auctions. Hopefully exchanges will allow this soon.
RBI now wants to put a framework that allows electronic platforms to have a simple system of authorization for trading in RBI regulated instruments like T-Bills and G-Secs. That means anyone will be able to build a platform for such trading.
Our View: Show Us
The RBI needs to actually do something. Retail trading is nice, but we haven’t seen this take off yet in terms of external players being provided access. What would be nice is to see a framework where, in order to be a platform or a player, you don’t need to already be a bank.
The short squeeze rules are much appreciated. Yields are going up now, with the 10 year at 6.72% (Was at 6.42% about two months back) They should get a reprieve after the new increase in FII limits in government bonds, but the trajectory seems to have changed. However, it does deserve to go up.
We look forward to reading more when the RBI releases the notes.