Why Revised Short Selling and Market Making Rules Will Boost Capital Market Activities
At the 2016 Review/2017 Outlook briefing by NSE DG Oscar Onyeama, he stated that short selling was now open to retail investors. He also announced that the market making policy would be revised for greater effectiveness.
Short selling hitherto had been open to institutional investors only. Short selling simply means borrowing a stock I don’t own to pay back later in exchange for a fee. This is based on the premise that the stock will trade lower at the point I am returning to the lender.
For example, I could short sell shares of United Capital and sell at its current price of N3.25 naira. Hoping to return to the lender at a price of say N2.25 kobo. The N1.00 naira difference is my profit as a short seller. Short selling will increase liquidity in the market, as investors will prefer to short sell a stock, than keep it for months with little or no trading activity.
Revised market making rules will also ginger market activities. Market makers are stockbroking firms selected by the Nigerian Stock Exchange (NSE) and the Securities and Exchange Commission (SEC) to provide liquidity in the market. They do this by buying stocks when there is a glut and selling them when there is scarcity. The scheme has been largely limited to a handful within the NSE 30 that are already highly liquid on the exchange such as banking stocks.
Short selling like most investments have inherent risks. By short selling a stock an investor is betting against the value of the stock, suggesting that it is over priced. They also sometimes bet against the viability of a business predicting lower profitability or even losses in the future. These sort of ventures can sometimes bring markets down as the ensuing panic created by a notorious short seller can lead to massive sell-offs.
The introduction of short selling in the Nigerian Stock Exchange includes several positives despite the apparent risk. It instigates transparency among companies and forces executives to engage more with retail investors. It will be interesting to see how this works and how the NSE and SEC plans to regulate its activities. How they deal with market infringement, security of borrowed shares, record keeping of transactions etc.will be critical it ensuring success.