SEBI Eyes Major Shake-Up to Boost India's Cash Market

The Securities and Exchange Board of India plans to nearly double the number of shares eligible for lending and borrowing. The regulator also aims to cut collateral requirements to make short selling easier, Reuters reported citing two sources.

The changes aim to boost the cash equities market and draw investors away from the country's far larger derivatives market, which has seen explosive growth but carries massive risks for retail investors.

Derivatives trading is highly risky because contracts are leveraged, meaning losses can theoretically be unlimited. In contrast, cash market risks are contained because actual shares and collateral back the trading positions.

Currently, only 176 of the roughly 2,600 companies listed on the National Stock Exchange—which accounts for about 95 per cent of India's cash equities market—are eligible for borrowing and lending.

By nearly doubling that number, authorities hope to include the majority of liquid shares. SEBI did not respond to a request for comment, but details are likely to be finalised by the end of this year.

Relaxing Eligibility Thresholds

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

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 Rs 100 crore ($10.5 million) over the previous six months.

It must also be large enough to support derivatives exposure of at least Rs 100 crore across the market. Rules also govern how much of a stock public shareholders must hold.

"Deliberations are on relaxing the two thresholds," one of the people said, in remarks reported by Moneycontrol.

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

Cash Versus Derivatives

It is 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 per cent, while in the US and Europe, the amount is around 100 per cent.

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

But growth in the 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.

Nearly 90 per cent of retail investors trading derivatives make losses, SEBI stated. To curb these risks, the Indian government has taken steps over the last 18 months to raise the cost of derivative trading.

India differs from Western markets because stock lending and borrowing must be conducted on exchange platforms rather than through a broker. Although foreign investors have lobbied for this rule to be changed, SEBI is unlikely to budge. 

The regulator believes that all trading activity should be done via exchanges to pool liquidity, one of the sources said.