Meesho short-selling shares under auction: Nithin Kamath explains how investors can participate and earn profit

The Indian stock market, a dynamic and crucial component of the nation's economy, operates on intricate mechanisms designed to ensure fair play, transparency, and efficient settlement. Among these, the 'short delivery auction' is a critical, albeit often misunderstood, process that significantly impacts market dynamics, particularly in the post-listing phase of Initial Public Offerings (IPOs). Zerodha CEO Nithin Kamath's explanation sheds light on how these auctions can lead to sharp post-listing gains, punishing speculative short sellers and rewarding diligent shareholders.

**Background Context and What Happened:**

At its core, a stock market transaction involves a buyer and a seller, with a promise of delivery and payment. India, like many global markets, operates on a T+1 settlement cycle (Trade date plus one working day), meaning shares bought today must be delivered by the seller and received by the buyer by the end of the next trading day. A 'short delivery' occurs when a seller, who has sold shares, fails to deliver them to the buyer on the settlement date. This can happen for several reasons: genuine operational errors, technical glitches, or, more commonly, a speculative 'naked short sale' where a trader sells shares they do not own and has no immediate means to borrow or acquire, hoping to buy them back at a lower price before settlement.

When a short delivery occurs, the clearing corporation (e.g., NSE Clearing Limited or BSE Clearing Corporation) steps in to resolve the non-delivery. It conducts a 'short delivery auction' on the T+1 day itself. In this auction, the clearing corporation invites other market participants to offer the shares that were short-delivered. The shares are bought back at the lowest price offered in the auction, which can go up to 20% above the closing price of the previous day, or even higher, depending on the availability and demand. The short-delivering seller is then obligated to pay this auction price, often significantly higher than their original selling price, leading to substantial losses. Conversely, existing shareholders who participate in the auction and offer their shares stand to gain, as they can sell at a premium.

**Key Stakeholders Involved:**

1. **Short Sellers:** These are the traders who sell shares they don't own, hoping to profit from a price decline. When they fail to deliver, they are penalized by the auction mechanism.

2. **Buyers:** The original buyers of the shares who did not receive their due delivery. The auction mechanism ensures they eventually receive their shares, protecting their interests.

3. **Existing Shareholders:** These are investors who already own the shares and can offer them in the auction. They benefit by selling at a premium, as the auction price is typically higher than the prevailing market price.

4. **Stock Exchanges (e.g., NSE, BSE):** They provide the platform for trading and facilitate the auction process.

5. **Clearing Corporations (e.g., NSE Clearing Limited):** These entities are central to the settlement process. They guarantee settlement, manage risk, and conduct the short delivery auctions to resolve non-delivery issues. They play a crucial role in maintaining market integrity.

6. **Regulators (SEBI):** The Securities and Exchange Board of India (SEBI) frames the rules and regulations governing market conduct, including settlement procedures, short selling norms, and auction mechanisms, to ensure investor protection and market efficiency.

**Significance for India and Historical Context:**

Historically, India's settlement cycles have evolved from longer periods (e.g., T+5, T+3) to the current T+1, a move aimed at enhancing liquidity, reducing counterparty risk, and improving capital efficiency. This transition, completed in January 2023, was a significant reform spearheaded by SEBI. The short delivery auction mechanism is a crucial part of this robust settlement framework. It acts as a deterrent against reckless short selling and ensures the sanctity of the delivery process. For IPOs, where initial demand and supply imbalances can be acute, and price discovery is in its nascent stages, short delivery auctions can exacerbate price volatility. If many traders short sell a newly listed stock, anticipating a fall, and the stock instead rises, a cascade of short deliveries and subsequent auction buying can push prices even higher, creating a 'short squeeze' that fuels sharp post-listing gains. This mechanism protects the integrity of the market by ensuring that trades are honored, thereby building investor confidence.

**Future Implications and Related Policies:**

The prevalence of short delivery auctions, particularly in newly listed IPOs, underscores the importance of understanding market mechanisms for investors. It promotes market discipline, as traders are incentivized to engage in covered short selling (selling shares they have borrowed) rather than naked short selling, which carries higher risks. SEBI continuously reviews market regulations to adapt to evolving market conditions. The **Securities Contracts (Regulation) Act, 1956 (SCRA)**, and the **SEBI Act, 1992**, are foundational legislations empowering SEBI to regulate stock exchanges, securities contracts, and market intermediaries. The **SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003**, also play a role in preventing market manipulation, including through improper short selling practices. The short delivery auction, while a technical aspect, reinforces the broader goal of a fair and orderly market, aligning with India's economic policy objectives of fostering robust capital markets for economic growth and wealth creation. Future implications include potentially increased investor awareness regarding these market nuances and continued regulatory vigilance to ensure that such mechanisms are not exploited for manipulative purposes, while still allowing legitimate price discovery and trading activities. It is a testament to the dynamic nature of financial markets and the continuous efforts to balance liquidity, efficiency, and investor protection.