Introduction
Imagine working on a puzzle to complete it, only to discover one piece is missing. Short delivery is similar to this situation but in a financial context. It occurs when a seller only provides part of the services agreed upon with the buyer. This can have negative implications, leaving enterprises attempting to fix things up. Let’s decode short delivery and its impact on the businesses and the customers they engage with.
What is a Short Delivery?
Short delivery is an event when a trader fails to deliver the required number of shares on the settlement date. There are various reasons why this scenario might occur. One can be the loaned shares' inaccessibility or errors committed during the settlement process. Another reason could be when stocks hit the upper circuit, resulting in a lack of liquidity.
Open Trading Account and Start Trading!
What does stock hitting the upper circuit mean?
Stock exchanges establish the upper circuit at a pre-set price level to control sharp price swings in a stock. A stock's price is said to have climbed drastically when it reaches the upper circuit for the trading day session. It occurs frequently with a strong demand or a bullish market.
How does this procedure work?
Short delivery can result in a shortage of shares around the market if a seller doesn't deliver the total amount of stocks intended to be sold. The stock price may rise quickly due to this unavailability and lead to a higher purchasing demand.
When stocks touch the upper circuit as a result of short delivery, market liquidity gets affected. It becomes more difficult for buyers and sellers to transact at targeted prices. This happens as there are fewer stocks accessible for trading.
How does this work in the Indian scenario?
India's stock markets run on a T+2 rolling settlement schedule. Here, T is the transaction date, often known as the day of the transaction. The settlement, or the transfer of funds, occurs two days after the transaction date. If the deadline remains unmet, the trader can face fines, the loss of trading licenses, or legal action.
Investors may withdraw money only on the settlement date and the sale date is not eligible for carrying out any transaction.
What is the T+2 settlement cycle in short delivery?
Let’s consider a company (broker) that is a big manufacturer of electronic devices. A retailer (investor) has ordered 500 units of one of their high-selling smartphone model. Payment and delivery are expected two business days following the trade date.
On Day 1, the company accepts the order from the retailer and begins shipping the 500 units. However, due to an inventory error in calculation, only 400 units are available for delivery on Day 3, i.e., the settlement day. This directly results in a shortage of 100 deliverables.
What are the effects of short delivery on the buyer?
With short delivery, the retailer’s financial performance, reputation, and lost sales will all be negatively impacted. It will be beneficial to contact the company immediately to report the inadequate delivery and discuss alternate solutions.
The retailer can find a different supplier to supply the final 100 units. Alternatively, they can settle on expedited priority shipping to meet client requirements. Open communication with customers can help as well. The retailer can discuss the potential of alternatives and timely resolution of the issues.
What are the effects of short delivery on the seller?
The short seller missing the due delivery date will be accountable for the additional costs of selling the shares. The exchange, acting as a counterparty guaranteeing the trades, will auction the short delivery shares. A third party will make up the difference in shares delivered through an auction bid. Although the exchange auction occurs on T+2 days, the pending shares are only given out on T+3 days.
To conclude
Both investors and brokers must identify and rectify short-delivery concerns swiftly. It can help maintain faith, uphold regulatory compliance, and guarantee the efficient operation of the stock market. Short deliveries can be avoided by implementing effective inventory management procedures and cultivating strong supplier relationships.
Related Articles: Using futures as a form of Margin Trading in Stocks | What is Mark to Market Margin in Futures and Options and when is it Applicable? | The importance of operating margins for a company