Proposed changes to collateral norms, securities lending, short-selling and longer-dated derivatives are aimed at reducing trading friction and making Indian markets more accessible to global institutional investors

The Securities and Exchange Board of India (Sebi) is preparing a significant overhaul of India’s trading framework as the regulator seeks to address persistent foreign investor outflows and strengthen the country’s position in global equity markets.

The proposed reforms are focused on improving market accessibility for institutional investors and could include lower collateral requirements for highly liquid cash-equity stocks, expansion of the securities lending and borrowing framework, easier short-selling and measures to encourage longer-dated derivatives.

The move comes at a time when foreign ownership of Indian equities has fallen to a 17-year low. Foreign investors have also sold more than $50 billion of Indian equities between October 2024 and June 2026, according to National Stock Exchange data cited in the report.

Why Sebi is pushing for trading reforms

India has attracted substantial foreign capital over the past decade as its economy and corporate earnings expanded. However, the investment environment has become more challenging as global investors compare Indian equities with other emerging markets.

India’s weighting in the MSCI Emerging Markets Index has fallen below 12 per cent from a peak of 21 per cent in September 2024.

Sebi’s proposed changes are intended to address some of the structural concerns raised by international investors, particularly around the cost of trading, hedging flexibility, securities lending and price discovery.

The regulator is also seeking to bring India's market infrastructure closer to that of other major Asian markets, where institutional investors have access to deeper securities-lending and short-selling mechanisms.

Lower collateral requirements could free up institutional capital

One of the key proposals under consideration involves reducing collateral requirements for trades in highly liquid stocks.

Sources cited in the report indicated that the change could potentially reduce upfront capital requirements by around 15-20 per cent for eligible cash-equity transactions.

For large foreign funds, this could make capital deployment more efficient. Lower collateral requirements could allow investors to deploy the same pool of capital across a larger number of positions or strategies.

However, the reduction in collateral requirements would need to be carefully managed. Margins are an important protection against counterparty and market risks, particularly during periods of sharp volatility.

The effectiveness of the reform will therefore depend on how Sebi balances capital efficiency with adequate risk buffers.

Securities lending and short-selling set for expansion

Sebi is also looking to deepen India’s securities lending and borrowing ecosystem.

The regulator has been working on measures that could significantly increase the number of stocks eligible for lending and borrowing.

A more developed securities-lending market would make short-selling easier for institutional investors and improve their ability to hedge portfolios.

At present, restrictions and limited availability of securities can make such strategies more difficult than in several other developed and emerging markets.

For foreign institutional investors, improving these mechanisms could make Indian equities easier to trade from both bullish and bearish perspectives.

Focus shifts towards longer-term derivatives

Another important part of the proposed reforms is the push towards longer-dated derivatives.

India’s derivatives market has become heavily concentrated in short-duration contracts, particularly weekly options. While this has created enormous liquidity, it has also raised concerns over excessive speculative activity among retail investors.

Sebi is reportedly considering lower upfront collateral requirements for derivatives contracts with maturities beyond one year.

The objective is to encourage greater participation in longer-term hedging strategies.

For institutional investors, longer-dated derivatives can be particularly useful for managing portfolio risk over several months or years rather than relying primarily on short-term contracts.

Retail dominance remains a concern

The proposed reforms also reflect Sebi’s broader effort to change the composition of India’s derivatives market.

Retail investors account for more than 35 per cent of trading activity in India, according to NSE data cited in the report. By comparison, institutional and professional investors account for a much larger share of activity in mature markets such as the United States.

Sebi has spent the past two years attempting to curb speculative retail derivatives activity after individual traders recorded losses for several consecutive years.

The latest reforms suggest that the regulator wants India’s derivatives ecosystem to increasingly support institutional hedging and investment strategies rather than being dominated by short-term speculative trading.

Foreign investors could benefit from lower trading friction

For global asset managers, market accessibility is about more than simply being able to buy Indian stocks.

Investors also need efficient mechanisms to hedge risk, borrow securities, execute large trades and determine closing prices.

Reducing friction in these areas could make it easier for global investors to increase their allocation to Indian equities.

Passive funds could also benefit over time. If India’s weighting in global indices rises, funds that track those benchmarks could be required to increase their holdings of Indian securities.

That could potentially create a more stable source of foreign capital.

MSCI to monitor effectiveness of reforms

The proposed changes could also influence India’s future representation in global equity indices.

MSCI has indicated that it will monitor the reforms and assess their effectiveness based on feedback from international market participants.

Issues including margin and collateral efficiency, securities lending, short-selling, hedging tools and closing-price mechanisms are important components of international investors’ assessment of market accessibility.

Successful implementation could therefore strengthen India’s case for a higher weighting in global emerging-market benchmarks.

Implementation remains the biggest challenge

While the long-term objective is to make the market more efficient, regulatory changes can create short-term disruption.

Recent changes to the closing-price mechanism for stocks with derivatives contracts resulted in volatility during the initial phase as market participants adjusted to the new framework.

The experience highlights the importance of a gradual transition.

According to the report, Sebi is considering a rollout period of around nine months, giving exchanges, brokers, institutional investors and other market participants time to upgrade systems and adapt trading strategies.

Reforms cannot solve every foreign-investor concern

Despite their potential benefits, the proposed changes alone may not be enough to reverse foreign selling.

Global investors also consider the relative valuation of Indian equities, corporate earnings, economic growth, currency movements, taxation, interest rates and geopolitical risks.

India’s comparatively high valuations have remained a consideration for foreign investors, particularly when other emerging markets offer cheaper alternatives.

Therefore, structural reforms could improve the attractiveness of the Indian market, but sustained foreign inflows will ultimately depend on a combination of market accessibility and investment returns.

What it means for Indian stock markets

The proposed Sebi reforms could gradually improve liquidity and market efficiency, particularly in the cash-equity and institutional derivatives segments.

Large-cap and highly liquid stocks are likely to be among the biggest beneficiaries if collateral requirements are reduced.

Expansion of securities lending could also improve price discovery by allowing investors to express negative views more efficiently.

However, retail investors should not interpret easier access to derivatives or short-selling as an invitation to increase speculative trading.

The reforms are primarily designed to improve market structure and attract institutional capital. For individual investors, company fundamentals, earnings growth, valuations and disciplined risk management will remain the key drivers of long-term returns.

Market Outlook

Sebi’s proposed trading reforms come at a critical juncture for Indian equities. With foreign ownership at a 17-year low and overseas selling having crossed $50 billion over the period cited, improving market accessibility has become increasingly important.

Lower collateral requirements, a deeper securities-lending market and greater availability of longer-dated derivatives could bring India closer to international market practices and reduce some of the friction faced by global investors.

However, the impact is likely to be gradual. Successful implementation, rather than the announcement of reforms alone, will determine whether India can regain a larger share of global institutional capital.

For investors, the reforms are structurally positive for the Indian capital-market ecosystem, but near-term volatility cannot be ruled out as market participants adjust to new systems and trading rules. Over the medium to long term, a more efficient and institution-friendly market could improve liquidity, strengthen price discovery and potentially support higher foreign participation in Indian equities.