The Nairobi stock exchange (NSE) will soon give investors the ability to short sell stocks of publicly listed companies thanks to Treasury Cabinet Secretary Henry Rotich giving the green light.
For investors who may not be familiar with what short selling entails, it is basically selling stocks that are not owned by the seller or have been borrowed, motivated by the belief that the stock’s price will decline. If right, this will allow the seller to buy the borrowed shares back and make a profit at the same time.
While more developed markets have had the pleasure of short selling securities for a long time, Kenyans have had to miss out on this opportunity due to a couple of reasons. Apart from the regulatory hurdles previously in place, only a fraction of investors seemed to understand the upside to short selling.
In addition to this, it seems that the overall sentiment about shorting was negative taking into account the fact that regulators and politicians in both the U.K and U.S blamed such aggressive speculative plays for aggravating the 2008 financial crisis.
If you want to understand the process of shorting a stock, here is a simple example. A trader believes that Safaricom shares currently trading at Ksh. 28 per share will decline. He therefore decides to borrow 100 shares and sell them which now makes the seller ‘short’ Safaricom shares.
After some time, the trader decides to close out the position but the shares are now trading at Ksh. 38 per share. Here, the trader will have made a loss of Ksh. 10 per share or a total Ksh. 1000 since the shares would have to be bought back at a higher price.
According to Geoffrey Odundo the chief executive of NSE, short selling will enhance market sensitivity to both announcements and performance of publicly listed companies on the exchange, while the Capital Markets Authority (CMA) lauded the move based on the expectation that it would boost liquidity by increasing the amount of securities available for trading.
“Making the Kenyan capital markets highly vibrant and liquid is a key priority for the capital markets industry and the Securities Lending, Borrowing and Short-Selling Regulations are expected to facilitate this,” said Paul Muthaura, chief executive of regulator CMA.
Currently, the new law restricts short selling to only regulated investors which means that only large financial institutions and fund managers will be able to do this trade and will also have to provide collateral to cover the short position.