Securities and Exchange Board of India (Sebi) is planning to make it easier for investors to short sell stocks by expanding the stock lending and borrowing framework and reducing collateral requirements, according to a Reuters report. If the proposals go through, investors will be able to short sell more stocks with lower upfront collateral.
The changes are part of the market regulator's broader effort to deepen participation in the cash equity market and encourage investors to move away from derivatives, where retail investors have suffered heavy losses in recent years, the report said.
What Is Short Selling And How Does It Work
Short selling is a strategy investors use when they believe a stock's price is likely to fall. Instead of buying a stock first, they borrow shares, sell them in the market, and buy them back later.
For example, if an investor borrows a share and sells it for Rs 1,000, then buys it back later for Rs 900, the Rs 100 difference becomes the profit (before charges). The borrowed share is then returned to the lender.
The trade can also go the other way. If the stock climbs to Rs 1,100 instead of falling, the investor still has to buy it back before returning it. That means a Rs 100 loss. Since there is no cap on how high a stock can rise, losses in short selling can keep increasing, making it much riskier than simply buying a stock and holding it.
More Stocks Could Be Available for Short Selling
As of now, investors can borrow and short sell only 176 stocks out of nearly 2,600 companies listed on the National Stock Exchange (NSE).
Sebi aims to widen that list by relaxing some of the eligibility rules, two sources familiar with the matter told the publication. The aim is to bring more actively traded stocks under the stock lending and borrowing scheme (SLBS).
NSE Clearing had launched the SLBS on April 21, 2008.
To qualify, a stock must meet several conditions, including minimum trading volumes, liquidity and derivatives activity. For instance, it must have recorded an average monthly trading turnover of at least Rs 100 crore over the previous six months. Reuters reported that Sebi is considering easing some of these requirements, although the final criteria are yet to be decided.
According to the report, the regulator is expected to finalise the proposals by the end of this year.
In other words, derivatives trading was roughly 373 times larger than cash market trading on a notional basis, far higher than in many major global markets.
Sebi has repeatedly raised concerns over excessive retail participation in derivatives. According to the regulator, about 91 per cent of retail traders in the segment lose money. The government has also introduced measures over the past 18 months to increase the cost of derivatives trading in an effort to curb excessive speculation.
By making short selling easier in the cash market, Sebi hopes more trading activity shifts towards transactions backed by actual shares rather than leveraged derivative positions, the report said.
Lower Collateral Requirement Under Consideration
Apart from expanding the list of eligible stocks, Sebi is also examining whether collateral requirements can be reduced.
Currently, investors may have to provide collateral of up to 130 per cent of the value of borrowed shares. In comparison, collateral requirements in markets such as the United States and Europe are generally around 100 per cent, according to the report.
What It Means for Investors
If the proposals are approved, investors could gain access to a wider range of stocks for short selling. Institutional investors and experienced market participants may find it easier to hedge their portfolios or take positions when they expect stock prices to decline.
Investors who lend their shares through the stock lending and borrowing mechanism could also have more opportunities to earn additional income.
For retail investors, however, short selling remains a high-risk strategy. Unlike buying a stock, where the maximum loss is limited to the investment amount, losses from short selling can theoretically be unlimited if share prices continue to rise.
