BY MICHAEL EBOH

The Nigerian Stock Exchange, NSE, has exempted dealing members in the secondary segment of the Nigerian capital market from engaging in naked short selling.

According to the NSE’s rule on short selling, made available to Vanguard, only market makers will be allowed to undertake naked short selling when the practice becomes fully operational in the market.

Naked short selling is an advanced form of short selling. Short selling or selling short involves the selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short.

In Short selling, the investor is aiming to profit from an anticipated drop in the price of a commodity, financial instrument, or security, either by borrowing and selling it now, or by selling a firm promise (futures contract) to deliver it on a later date at the current or a specified price.

Naked short selling or naked shorting, on the other hand, is the practice of short-selling a financial instrument without first borrowing the security or ensuring that the security can be borrowed, as is conventionally done in a short sale.

In naked short selling, when the seller does not obtain the shares within the required time frame, the result is known as a ‘fail to deliver’. The transaction generally remains open until the shares are acquired by the seller, or the seller’s broker settles the trade. This type of transaction is used to anticipate a price fall, but exposes the seller to the risk of a price rise.

Naked shorting has been attributed as the cause for several instances of market manipulation.

The NSE, however, noted that naked short selling contributes to market liquidity in some circumstances.

For example, according to the NSE, broker-dealers that make a market in a security generally stand ready to buy and sell the security on a regular and continuous basis at a publicly quoted price, even if where there are no other buyers and sellers.

“Thus, market makers must sell a security to a buyer even when there are temporary shortages of that security available in the market. This may occur, for example, if there is a sudden surge in buying interest in that security, or if few investors are selling the security at that time. Because it may take a market maker considerable time to arrange to borrow the security, a market maker engaged in bona fide market making, particularly in a fast –moving market, may need to sell the security short without having arranged to borrow shares. This is especially true for market makers in thinly traded, illiquid stocks,” the NSE said.

To guide against irregularities associated with short selling and naked shorting, the NSE declared that listed security will be sold short at a price below the last sale price, adding that dealing member will not accept a short sale order in any security from another person, or effect a short sale in any equity security for its own account, unless the Dealing member has, “Borrowed the security, or entered into a bona-fide arrangement to borrow the security which will be delivered on the date of delivery, which is three days after transaction date (T+3); or a reasonable ground to believe that the security can be borrowed so that it can be delivered on the date delivery is due, which is, T+3,” the NSE stated.

Mr. Oscar Onyema, Chief Executive Officer, NSE, said the NSE, is already collaborating with stakeholders to ensure a smooth take off of short selling and securities lending.

He lamented the fact that traders only make money in Nigerian market today when the market goes up, saying that participants should be able to make money whether the market is up or down if they can short securities.