What Is ‘Short Selling’ Proposed by the Securities Board and Its Impact on Nepal’s Capital Market
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Stakeholders have adopted a cautious approach toward a proposed new financial instrument that supposedly allows profit-making even from a declining market.
While it may bring new dynamics to the market, they believe significant challenges exist in its implementation.
The Securities Board of Nepal (SEBON) has recently announced proposals aiming to introduce some specific financial instruments into Nepal’s capital market. Among them, ‘short selling’ has garnered considerable attention.
The instrument, which allows earning profit even during market declines, is seen by the regulatory body as a means to maintain market equilibrium and manage risk.
However, experts question the readiness of Nepal’s controversial yet developing market to adopt such specialized financial tools.
There is also a risk that the tool could be misused to artificially damage the market given the potential to profit from market downturns.
For context, during the global financial crisis of 2008, the United States temporarily banned short selling.
What Is Short Selling?
Typically, investors in the stock market buy shares at a certain price and profit by selling them at a higher price as their value rises.
However, share prices do not always increase.
Short selling is the concept of making profits even when prices fall.
“There are two types of market investors. One group buys shares expecting price appreciation and sells after gains, known as a ‘long position.’ The other group borrows shares they do not own to sell at a higher price when anticipating a fall and later buys them back at a lower price to return them, thereby profiting; this is called a ‘short position,'” explained Dr. Gopal Prasad Bhatt, Chairman of SEBON.
Currently, all investors in Nepal’s capital market take only ‘long positions’; the new regulation will introduce the facility for ‘short positions.’
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“In essence, short selling means selling shares you do not own. If you expect a share’s price to drop, you borrow and sell it, then repurchase later at a lower price to return it,” explained Murhari Parajuli, Information Officer at Nepal Stock Exchange (NEPSE).
“For example, if someone anticipates a share priced at NPR 500 will fall, they borrow and sell it, then buy it back when the price drops to NPR 400 and return it.”
“The lender charges a certain fee, and the borrower retains the remaining profit.”
Why Is It Necessary?
Sebon
Currently, profits occur only when the market rises, not when it falls. This practice breaks that imbalance and creates a two-sided market.
Last week, SEBON released a concept paper to gather feedback on new financial services in the market.
The proposal includes policy, legal, structural, and technical frameworks specifically for margin lending, securities lending and borrowing, and short selling.
This year’s budget also announced plans to phase in instruments such as intraday trading, short selling, and derivatives.
“This will change the condition where profits can only arise when the market rises. It will divide the market into two segments: those who expect the market to decline will profit from short selling, while the others will continue earning profits through traditional methods,” said Chairman Bhatt.
He added that short selling has made capital markets more dynamic in many countries.
“It shifts the market from a one-sided to a two-sided structure, increases trading volumes, and lays the groundwork for other financial instruments in the future,” Bhatt noted.
Is the Nepali Market Ready?
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Bhaktiram Ghimire, General Secretary of Nepal Stock Broker Association, believes that implementing short selling tools introduced by SEBON will be a major milestone for Nepal’s capital market.
“Before implementation, clarity on regulations, laws, and tax issues is essential,” he said.
However, Revat Bahadur Karki, former chairman of SEBON, thinks the current market lacks readiness, though small-scale implementation might be possible.
“We need upgrades in capacity, software, infrastructure, regulation, and especially financial literacy among average investors. While 20-22% of investors in India are financially literate, in Nepal, it is below 17-18%,” he said.
Other experts emphasize the need for improvements in current legal frameworks to support instruments like short selling.
“Small investors who invest in the stock market by selling livestock or goods raise questions about the necessity of such instruments,” one expert stated.
“Since this involves selling assets one does not own, serious discussion is required on how to repay borrowed shares if prices do not fall, or what to do if shares aren’t available when needing to buy back.”
Nonetheless, the Securities Board considers introducing such tools necessary in the phased expansion of the capital market.
“We will proceed gradually, starting with margin lending, intraday trading, securities lending and borrowing (SLB), and then short selling,” said Chairman Bhatt.
Learning from global practices, SEBON is preparing to implement a covered short selling system.
“Complete processes and regulations are being developed, IT systems need to be established, and brokers, NEPSE, and CDSC must be prepared.”