India’s securities regulator is considering a broad set of trading reforms as foreign investors continue to reduce their exposure to Indian equities, according to people familiar with the discussions. The proposed changes are aimed at making the country’s cash and derivatives markets easier for large international investors to access, while addressing structural weaknesses that can increase the cost of entering, hedging and exiting positions.

The timing is important. Foreign portfolio investors have been persistent sellers of Indian equities, while India’s share of major global emerging-market indexes has fallen from its recent peak. Regulatory data has also shown sustained foreign selling during 2026, even as domestic institutions have provided an increasingly important counterweight. The proposed reforms therefore reflect an attempt to improve the market’s accessibility rather than relying only on India’s long-term economic growth story to attract capital.

The measures under consideration include reducing collateral requirements for highly liquid shares, expanding securities lending and borrowing, making short selling easier and encouraging greater use of longer-dated derivatives. These changes address practical issues that institutional investors face when they attempt to implement large investment or hedging strategies in India.

The central challenge for the regulator is that attracting foreign capital is not simply a question of making markets bigger. It requires making them sufficiently liquid, predictable and efficient for global investors to operate at scale.

Foreign Selling Has Exposed Market Frictions

India remains one of the world’s largest emerging equity markets, but its size alone does not guarantee that international investors will maintain high allocations. Large institutions compare markets according to a wide range of factors, including liquidity, transaction costs, access to hedging instruments, settlement arrangements, stock lending facilities and the ease with which positions can be established or unwound.

Foreign investors have sold more than 50 billion dollars of Indian equities over the period identified in the latest market data. Several factors have contributed to the selling, including concerns about valuations, corporate earnings, currency weakness and stronger opportunities elsewhere. India’s falling share of global emerging-market indexes is therefore not attributable solely to regulatory shortcomings.

However, market structure can influence whether an investor chooses to maintain or increase exposure once the broader investment decision has been made. A market may offer strong economic growth and attractive companies, but institutional investors can still face higher costs if they cannot hedge efficiently or borrow securities easily when needed.

This is where the proposed reforms become significant. Rather than trying to persuade investors through promotional measures, the regulator appears to be targeting specific trading obstacles that can affect investment decisions.

Lower Collateral Could Release More Institutional Capital

One of the most important proposals involves reducing collateral requirements for trades in highly liquid shares. According to people familiar with the discussions, the reduction could lower the amount of capital required upfront by roughly 15 percent to 20 percent for eligible transactions.

For large institutional investors, the significance of such a change can extend beyond the immediate saving. Capital tied up as collateral cannot simultaneously be deployed elsewhere. Lower requirements can therefore improve capital efficiency and make it easier for global funds to manage multiple positions across markets.

The proposal also reflects a recognition that the same risk controls do not necessarily need to be applied identically to every security. Highly liquid shares are generally easier to buy or sell without causing substantial price disruption, making them potentially more suitable for differentiated collateral treatment.

The challenge will be determining eligibility carefully. If collateral requirements are reduced too broadly, the change could increase risk during periods of severe market stress. If the rules are too restrictive, the reform may provide little practical benefit to the institutional investors it is intended to attract.

The objective therefore is not simply lower collateral. It is more efficient collateral without weakening the protection built into the trading system.

Longer-Dated Derivatives Could Change How Investors Hedge

Another proposed change concerns derivatives with longer maturities. India’s derivatives market has developed enormous trading volumes, but activity is heavily concentrated in short-duration contracts. Longer-dated contracts have comparatively limited liquidity, making them less useful for investors seeking to hedge portfolios over extended periods.

That creates an important difference between the interests of short-term traders and those of long-term institutional investors. A fund investing in Indian equities for several years may need protection against market declines over months rather than days. If longer-term derivatives are illiquid or expensive, the investor may have fewer practical ways to manage that risk.

Encouraging longer-dated contracts could therefore make India’s derivatives market more useful to pension funds, asset managers and other institutions with longer investment horizons. It could also reduce the market’s dependence on very short-term derivatives activity.

This is consistent with the regulator’s broader effort to change the composition of India’s derivatives market. Authorities have been concerned about excessive participation by individual investors, particularly after studies showed substantial losses among retail derivatives traders over several consecutive years.

The goal is not necessarily to reduce derivatives activity altogether. Instead, the policy direction appears to favour a market in which professional and institutional hedging plays a larger role relative to highly speculative short-term trading.

Securities Lending Is Central to a Deeper Cash Market

The proposed expansion of securities lending and borrowing addresses another long-standing issue. Short selling requires investors to borrow shares before selling them, but limited availability of securities can make such strategies difficult or expensive.

A deeper lending market can improve price discovery because investors who believe a stock is overvalued can express that view more efficiently. More importantly for institutional investors, the ability to borrow shares provides another tool for hedging and managing portfolios.

The regulator is considering almost doubling the number of shares eligible for securities lending and borrowing. Combined with measures intended to make short selling easier, the move could increase the flexibility of India’s cash equity market.

However, expanding the list of eligible securities will not automatically create deep liquidity. Lenders must be willing to make shares available, borrowers must have sufficient demand, and pricing must be competitive. The infrastructure supporting the transactions must also function reliably.

The reform therefore needs to be viewed as part of a broader market-development effort rather than as a single regulatory adjustment.

The Closing Auction Shows Why Implementation Matters

The regulator’s current reform agenda also faces a practical complication: India’s recent experience with the new Closing Auction Session.

The mechanism was introduced to bring India’s closing-price process closer to practices used in major international markets and improve price discovery. Yet its early implementation produced volatility and concerns about limited participation and liquidity. Regulators have subsequently sought adjustments to improve the transition into the auction and strengthen participation.

That experience offers an important lesson for the wider reform programme. A rule can be theoretically sound and still produce unexpected consequences when introduced into a market with different liquidity patterns and participant behaviour.

The closing auction is particularly relevant to foreign investors because closing prices affect portfolio valuation, index tracking and derivatives settlement. If participation is insufficient or the transition is poorly understood, the mechanism can create short-term execution problems even when its long-term objective is sound.

Recent regulatory efforts to improve the auction process suggest that the authorities are willing to refine market structures rather than abandon reforms when implementation difficulties emerge.

Reforms Cannot Reverse Foreign Outflows Alone

The proposed changes could reduce some of the friction faced by international investors, but they cannot by themselves reverse foreign selling. Investment flows depend on factors far beyond market mechanics, including corporate earnings, valuations, economic growth, interest rates, currency movements and relative opportunities in other countries.

This distinction is important because India’s foreign capital challenge should not be interpreted simply as a regulatory problem. International investors can withdraw money even from highly accessible markets when valuations appear unattractive or when another market offers better expected returns.

What trading reforms can do is remove avoidable disadvantages. If India becomes easier and cheaper to hedge, borrow securities, execute large transactions and manage collateral, foreign investors may find it easier to translate an investment decision into actual capital deployment.

That could also matter for India’s representation in global indexes. Greater market accessibility can support international participation, but index weightings ultimately depend on market capitalization, free float, liquidity and other criteria rather than regulatory reform alone.

The regulator’s approach therefore represents an attempt to improve the infrastructure beneath India’s investment story. The country’s economic growth may continue to attract international interest, but converting that interest into sustained institutional capital requires markets capable of handling sophisticated global strategies efficiently.

The proposed reforms indicate that Indian regulators increasingly recognise this distinction. The next test will be whether lower trading friction, deeper securities lending, more useful derivatives and better closing-price mechanisms can produce a market that is not merely large, but genuinely easier for global investors to use at scale.

(Adapted from Reuters.com)

Categories: Economy & Finance, Regulations & Legal, Strategy