India aims to make it easier to short by nearly doubling stocks eligible for borrowing, sources say

MUMBAI: India’s markets regulator aims to make it easier for investors to short stocks by nearly doubling the number of shares eligible for lending and borrowing and by cutting collateral requirements, two people with direct knowledge of the plans said.

The changes are aimed at boosting the cash equities market and drawing investors away from the country’s far larger derivatives market, which has seen explosive growth but carries far larger risks for retail investors in particular.

Stock scam scandals led India to develop strict requirements for its cash equities market, with rules tightened in the early 2000s and then again in the period 2017 to 2020.

That has meant that while the National Stock Exchange, which accounts for about 95% of India’s cash equities market, has some 2,600 companies listed, only 176 are currently eligible for borrowing and lending.

By nearly doubling that number, Indian authorities hope to include the majority of liquid shares, the people said.

The three main criteria determining eligibility include liquidity, trading volume and the stock’s ability to support exposure to derivatives trading.

For example, a stock must have an average monthly trading turnover of at least 1 billion rupees ($10.5 million) over the previous six months and be large enough to support derivatives exposure of at least 1 billion rupees across the market. There are also rules relating to how much of a stock should be held by public shareholders.

“Deliberations are on relaxing the two thresholds,” said one of the people, without specifying which thresholds.

Details are likely to be finalised by the end of this year, said the sources, who were not authorised to speak to media and declined to be identified.

A representative for the Securities and Exchange Board of India (SEBI) did not respond to a request for comment.

SEBI last year flagged that a working group has been set up to review borrowing and lending rules, but the plans to nearly double the pool of stocks eligible and to cut collateral requirements have not previously been reported.

Cash versus derivatives

It was not clear by how much collateral requirements might be cut. In India, the amount of collateral needed under borrowing and lending rules can be as high as 130%, while in the U.S. and Europe, the amount is around 100%.

With India’s economy growing at a rapid 6-7% for the past 10 years excluding the pandemic, so too has interest in stocks. The market value of National Stock Exchange shares has surged from about $1 trillion a decade ago to over $5 trillion now.

But growth in India’s derivatives market — the world’s largest — has been even bigger. Capital deployed in derivatives is about three times that of the cash market, and the gross contract value is nearly 500 times larger — far higher than in major global markets.

Nearly 90% of retail investors trading derivatives make losses, SEBI has said. Derivatives trading is seen as far more risky as contracts are leveraged and losses can theoretically be unlimited. In the cash market, risks are more contained as the trading position is backed by actual shares and collateral.

The Indian government has also taken steps in the last 18 months to raise the cost of derivative trading.

India is different from Western markets in that stock lending and borrowing must be conducted on exchange platforms and not through a broker.

Though foreign investors have lobbied for this rule to be changed, SEBI is unlikely to budge on this, said one of the sources, adding that the regulator believes that all trading activity should be done via exchanges to pool liquidity.