Ok, let me clarify. I’m attempting to give you a summary of what happens as a practice in general and then will answer the specific case.
As you’ve rightly said, there are 2 forms of shortages - internal shortage & exchange level broker shortage. A shortage is when a client sells stocks but doesn’t deliver.
You must know that the settlement of stocks happens at a broker level on a net basis. Positions are net off at client level, then at TM level and then the net deliverable/receivable obligation is calculated. If client A sells 100 shares of RIL (and does not deliver) and client B of the same broker buys 100 shares of RIL, then the net deliverable obligation of the broker to the CC is 0. This is a case of internal shortage since there’s no deliverable obligation on part of the broker. In a usual case of internal shortage, the policy is to take part in a facility offered by the Stock exchange called “Voluntary auction”. We upload a file to the exchange on T+1 (settlement date) and ask them to buy securities in the auction market. In the auction market, the exchange is filling the buy side, whereas the sell side can be filled by investors including Zerodha clients. If the exchange is able to procure shares in the auction market, then on T+2, the shares are credited to the broker and the auction settlement amount is debited from the broker’s account. The broker will then proceed with crediting securities to the investor who bought them and did not get delivery (credit to investor on T+2), and will debit the short delivering client with the auction settlement amount.
If the exchange is not able to buy securities in the auction market, then the exchange notifies broker of the same. The broker is required to handle it internally (since it’s a case of internal auction) and the usual process is to close out the trade where you give credit to the buying client (instead of securities) & debit the short selling client. We follow the exchange’s policy of closing out trades which is: “Close out shall be at the highest price prevailing across the Exchanges from the day of trading till the auction day or 20% above the settlement price on the auction day, whichever is higher.”
If it’s not a case of internal shortage, the Exchange just carries out an auction on T+1, settlement of which is done on T+2. Same policy applies as stated above ^ except that the Exchange closes out the trades and debits the obligation sum themselves which the broker then passes on to the short delivering client.
In the case of IREDA, we did not take part in the voluntary auction. This is because, the stock was hitting upper circuits continuously and we were not hopeful of being able to obtain the shares in the voluntary auction (at the time of uploading files to voluntary auction, the stock had hit upper circuit already). Hence, the team decided to buy the securities in the open market, post the purchase obligation to the short delivering client & then deliver the securities to the purchasing clients on T+2. Since we had a large quantity of shortage, we were not able to find a fill for all securities at the desired price and thus had to resort to closing out. Would we have procured shares in the auction market? It’s anybody’s guess, but at the moment, we did what we thought was in the best interest of our client. You must note that Zerodha does not stand to gain anything by posting the close out price to the short delivering client, the credit is received by the client who purchased securities and did not get it.
You’re looking at it from the seller’s side. Put yourself in the shoes of the buyer. You’ve bought securities on T day, the stock has hit upper circuit (which is good for you as a buyer). On T+1, the seller defaults. On T+1 too, the stock hits upper circuit. As a buyer, you’re to get delivery of your securities, but you don’t. Ultimately, if you don’t end up getting securities at all, aren’t you losing out on the opportunity of being able to sell securities at a price much higher than what your original price was? If the client had plans of holding on to the securities, shouldn’t they be compensated to the extent that they can buy securities at increased prices?
Would I be disappointed if I suffered a loss - absolutely, given the sum involved is higher. But there’s a degree of risk that comes with trading the markets, especially when someone’s trading in scrips which have circuit limits, in large quantities. We understand the grievance of the investor and have also offered a fair and transparent resolution process.