Single stock futures and promoter share pledges

I participated in a discussion on CNBC TV18 about the trading of single stock futures on companies whose promoters have pledged a significant portion of their shareholding. (You can watch this show here (Part 10) though I participated only by audio).

The discussion was about a proposal that companies whose promoters have pledged a significant fraction of their shareholding should be punished by stopping trading in single stock futures in the shares of these companies. My views were as follows:

1. Allowing trading of single stock futures should not be seen as a mark of prestige for the company or any form of a reward or seal of approval. The single stock future exists to meet the need of investors and not the needs of the companies or of the exchanges.
2. Single stock futures are the easiest way to short shares, and so banning single stock futures would be a mild form of banning short selling. Short selling is an absolutely essential counterweight for the leveraged long. Restricting short selling when the promoters are leveraged long would essentially be a way of bailing them out and protecting them from sharp falls in their share prices.
3. Large leveraged longs create a cliff risk for the share price – if the price falls far enough to produce large margin calls for the leveraged buyers, then the price can just fall off a cliff due to distress liquidation of the pledged shares by the lenders. The answer to this is more stringent margins when cliff risk is high either because of a large leveraged long position (or on the opposite side, because of a large short interest).

Posted at 9:18 pm IST on Mon, 17 Dec 2012         permanent link

Categories: corporate governance, derivatives, short selling

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