Proposal to Nearly Double Eligible Stocks and Ease Collateral Requirements Could Boost Liquidity, Improve Price Discovery and Reduce Dependence on Derivatives

SEBI Moves to Strengthen India's Cash Equity Ecosystem

The Securities and Exchange Board of India (SEBI) is reportedly working on a major overhaul of the country's Stock Lending and Borrowing (SLB) framework, a move that could significantly reshape the Indian equity market. The regulator is considering expanding the pool of stocks eligible for lending and borrowing while also reviewing collateral requirements to make the mechanism more efficient and attractive for investors.

The proposed reforms are aimed at encouraging greater participation in the cash market, improving liquidity across listed companies and creating a more balanced market structure at a time when derivatives trading has grown at an unprecedented pace.

Market participants believe the initiative reflects SEBI's long-term strategy to strengthen the fundamentals of India's equity market while promoting healthier investment practices.

Expanding the Universe of Eligible Stocks

At present, only around 176 listed companies are eligible for stock lending and borrowing despite the National Stock Exchange (NSE) having more than 2,600 listed securities.

The existing framework allows participation only for companies that satisfy stringent requirements related to liquidity, trading turnover, public shareholding and derivatives exposure.

According to market sources, SEBI is considering relaxing some of these eligibility conditions, which could nearly double the number of stocks available under the SLB mechanism.

A larger eligible universe would provide investors with more opportunities to lend idle securities, borrow shares for settlement or hedging purposes and execute legitimate short-selling strategies.

What is Stock Lending and Borrowing?

Stock Lending and Borrowing (SLB) is a regulated mechanism through which investors temporarily lend their shares to other market participants in exchange for a lending fee.

Borrowed shares are commonly used for:

• Short selling

• Hedging investment portfolios

• Meeting settlement obligations

• Arbitrage trading

• Enhancing market liquidity

After the agreed lending period ends, the borrower returns the shares to the original owner along with the agreed lending fee.

The mechanism plays an important role in improving market efficiency by facilitating smooth settlement and enabling investors to express both bullish and bearish market views.

Relaxation in Collateral Norms Under Consideration

Another important proposal under discussion involves reducing collateral requirements for securities lending transactions.

Currently, participants may be required to provide collateral of up to 130% of the value of borrowed securities. Industry participants have often argued that such high collateral requirements increase capital costs and discourage wider participation.

Internationally, many developed markets typically operate with collateral requirements closer to 100%, making securities lending more efficient.

If SEBI reduces collateral requirements while maintaining appropriate risk controls, it could improve capital efficiency and attract greater institutional as well as retail participation.

Reducing India's Dependence on Derivatives

One of the key objectives behind the proposed reforms is to strengthen India's cash market relative to its rapidly expanding derivatives segment.

India has emerged as the world's largest derivatives market by trading volume, with futures and options activity growing at a much faster pace than cash equity trading.

The regulator has repeatedly highlighted concerns regarding excessive speculative participation, particularly among retail investors.

Studies published by SEBI indicate that a significant majority of retail traders in derivatives incur losses over time, underscoring the need for greater participation in lower-risk cash market investments.

By making stock lending and borrowing more accessible, SEBI hopes to encourage investors to utilise cash-market-based investment and hedging strategies instead of relying heavily on leveraged derivatives.

Why Liquidity Matters

A broader securities lending market offers several benefits to the capital market ecosystem.

Higher liquidity generally leads to:

• More efficient price discovery

• Reduced bid-ask spreads

• Lower market volatility

• Better execution for institutional investors

• Improved settlement efficiency

• Greater participation from foreign institutional investors

As India's capital markets continue attracting domestic and global capital, improving market depth remains an important regulatory priority.

India Continues to Follow an Exchange-Based Model

Unlike several international markets where stock lending transactions can take place through brokers or over-the-counter arrangements, India currently mandates that all securities lending and borrowing transactions be conducted through recognised stock exchanges.

This framework enhances transparency, standardises settlement procedures and enables regulators to monitor transactions more effectively.

Industry experts believe SEBI is unlikely to alter this fundamental structure despite introducing broader reforms, as the exchange-based model has helped maintain robust market surveillance and reduce systemic risks.

Potential Impact on Investors

If implemented, the proposed reforms could create opportunities for various categories of investors.

Retail Investors may gain access to a wider range of securities for lending while benefiting from improved market liquidity.

Institutional Investors could enjoy greater flexibility for hedging, portfolio management and settlement efficiency.

Long-Term Investors may earn additional income by lending idle shares without permanently selling their holdings.

Market Participants could benefit from more efficient short-selling mechanisms and enhanced overall market efficiency.

Boost for Market Efficiency

A deeper securities lending market can contribute to healthier financial markets by allowing prices to reflect both positive and negative market views more efficiently.

Short selling, when conducted within a transparent regulatory framework, often improves price discovery and reduces excessive market distortions.

Greater availability of borrowable securities also supports smoother settlement and lowers the risk of delivery failures during volatile market conditions.

Key Developments to Watch

Market participants will closely monitor several aspects of the proposed reforms, including:

• Final eligibility criteria for additional stocks

• Revised turnover and liquidity thresholds

• New collateral requirements

• Implementation timeline

• Impact on trading volumes

• Institutional participation

• Further regulatory measures supporting the cash market

Investment Outlook

SEBI's proposed reforms represent another important step in modernising India's capital markets while strengthening the cash equity ecosystem. By expanding the Stock Lending and Borrowing framework, easing participation requirements and improving capital efficiency, the regulator aims to create a more balanced market structure that supports long-term investment and efficient price discovery.

If implemented successfully, these measures could enhance liquidity, broaden investment opportunities and reduce excessive dependence on speculative derivatives trading. As India's equity markets continue to mature, a stronger securities lending framework is expected to play an increasingly important role in supporting institutional participation, improving market efficiency and reinforcing investor confidence.