In the Indian stock market, derivatives trading has grown rapidly over the past few years, while investor participation in the cash equity market has remained relatively low. Now, market regulator SEBI is preparing to take a major step to improve this balance.
According to reports, SEBI is working on changes to the Stock Lending and Borrowing (SLB) framework to make short selling easier. The proposed changes aim to include more liquid shares in the system and make it easier for investors to participate.
Let us understand these proposed changes in detail and their potential impact on the market.
What’s Happening?
Short selling is an investment strategy in which an investor aims to profit when the price of a share falls. Under this strategy, the investor first borrows a share and sells it in the market. Later, if the price declines, the investor buys it back at a lower price and returns it to the lender. For example, if a share is sold at Rs 1,000 and later bought back at Rs 900, the investor earns a profit of Rs 100. However, if the share price rises instead, the investor has to buy it back at a higher price, resulting in a loss.
To expand the use of this strategy, SEBI is considering nearly doubling the number of shares eligible for short selling. Currently, out of around 2,600 companies listed on the National Stock Exchange (NSE), only 176 shares are eligible under the Stock Lending and Borrowing (SLB) framework. After the proposed changes, many more liquid shares could become eligible.
Along with this, the regulator is also considering reducing the existing collateral requirement of up to 130% under the SLB framework. In comparison, markets such as the US and Europe typically require collateral of around 100%. However, SEBI has not yet clarified the extent of the proposed reduction.
Why is there Emphasis on Strengthening the Cash Market?
SEBI’s primary objective is to encourage investors to shift from the highly leveraged derivatives market towards the cash equity market. Over the past few years, derivatives trading has expanded rapidly, but the associated risks have also increased.
According to SEBI, nearly 90% of retail investors trading in derivatives incur losses. At the same time, the capital deployed in derivatives is around three times that of the cash market, while the total contract value is nearly 500 times larger, significantly higher than in most major global markets.
To address this imbalance, the government and SEBI have introduced several measures over the past 18 months, including increasing the cost of derivatives trading. The proposed changes to the SLB framework are another step towards making the cash market more competitive and attractive.
What Changes are Possible in the Rules?
Under the current rules, a share must meet several criteria, including liquidity, trading volume, and derivatives exposure, to qualify for the SLB framework. For example, it must have an average monthly trading turnover of at least Rs 1 billion over the previous six months. In addition, its derivatives exposure across the market must also be at least Rs 1 billion.
According to sources, SEBI is considering relaxing some of these eligibility criteria so that more liquid companies can become part of the framework. However, one key rule is likely to remain unchanged, stock lending and borrowing will continue to take place only through the exchange platform. In many Western markets, this facility is also available through brokers.
What Does This Mean for Investors?
If the proposal is implemented, investors will have access to a larger pool of shares for short selling. A lower collateral requirement could also make the process more accessible and efficient. This may improve liquidity and support better price discovery in the cash market.
However, the objective of these changes is not to replace derivatives trading but to make the cash equity market more active. Investors should remember that short selling carries significant risks. Therefore, understanding the strategy and managing risk effectively remain essential before making any investment decisions.
What’s Next?
India’s economy has maintained a strong growth rate of 6-7% over the past decade, excluding the pandemic period. During the same time, investor participation in the stock market has also increased significantly. One of the biggest indicators of this growth is that the total market capitalisation of the National Stock Exchange (NSE) has risen from around $1 trillion nearly a decade ago to more than $5 trillion today. This reflects the growing strength of India’s capital markets and rising investor confidence.
Going forward, the final rules and details related to the proposal are expected to be decided by the end of the year. If implemented as planned, these changes could further strengthen the Indian stock market while creating new opportunities for both domestic and foreign investors.
Disclaimer: This article is for educational and informational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. The companies mentioned are cited as examples within the context of market developments. Investors are advised to conduct their own due diligence and consult their financial advisor before making any investment decisions.
Investments in the securities market are subject to market risks. Read all related documents carefully before investing.
