Sebi bets on trading reforms to reverse outflow of foreign capital

The proposed changes include lower collateral requirements in cash equities and measures to encourage longer-dated derivatives as foreign ownership hits a 17-year low

India's markets regulator is set to overhaul decades-old rules and stem soaring outflows of foreign funds, three sources said, in a move some investors say would help the South Asian nation beef up its weighting in global stock market indexes.

The changes, if finalised, will come as foreign ownership of Indian stocks has hit ​a 17-year low and the rupee, down about 6 per cent this year, ranks among one of Asia's worst performers, hit by worries about ​a steeper import bill and anemic capital flows.

The reforms planned by the regulator, the Securities and Exchange Board of India, include lowering collateral requirements in cash equities and encouraging ‌longer-dated derivatives, three regulatory sources said.

"That suggests Sebi has listened to the institutional investment community and focused on the practical issues investors face," said Steve Lawrence, CIO of US-based Balfour Capital Group, which manages more than $463 million in assets.

The measures, being reported for the first time, will add to plans to boost the cash equities market by making shorting of stocks easier, nearly doubling the number of shares eligible for lending and borrowing.

The regulator plans to roll out the changes in nine months, after consultation with industry and giving market participants time to change existing systems, added the sources, who warned of short-term disruptions stemming from some changes.

The sources spoke on condition of anonymity as the talks are confidential.

Sebi did not respond to a Reuters request for comment sent on Wednesday.

India wants to increase its weightage in global stock market indices and the reforms now being considered stand to benefit its ratings and re-ratings, said one of the sources.

Foreigners' selling of equities crosses $50 billion

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.

From October 2024 until June 2026, foreigners' selling of Indian equities crossed $50 billion, National Stock Exchange data showed.

Foreign investors have sought the proposed reforms for some time as a way to pull India in line with major regional markets such as China, ‌South Korea and Taiwan, which already have mature securities lending and borrowing arrangements and closing auction to determine prices.

Global index provider MSCI said that it would monitor the planned reforms and their effectiveness through feedback from market participants for future global accessibility reviews.

"Measures relating to closing-price formation, margin and collateral efficiency, stock lending, short-selling and hedging tools are relevant to market accessibility for international institutional investors," MSCI said in an email.

Boosting cash equities, longer term options

A key change being considered in Sebi's advanced discussions is cutting collateral requirements for trades in highly liquid stocks, a move that could reduce upfront capital by 15 per cent to 20 per cent, two of the sources said.

It is also weighing lower upfront collateral requirements for derivatives contracts expiring after a year.

This is a change driven by feedback from overseas asset managers who say the existing system favors weekly derivatives contracts and discourages longer hedging strategies, the two sources added.

Liquidity tends to be higher in short-tenure contracts across markets, but in India's case longer contracts ​face near-zero liquidity, exchange data shows.

The push to deepen institutional participation follows a two-year effort by Sebi to curb speculative retail derivatives trading activity as they incurred losses five years in a ‌row.

Regulatory sources say the watchdog would like the composition of derivative markets, in terms of retail and institutional participation, to more closely reflect developed markets.

Retail investors make up more than 35 per cent of trading activity in India, NSE data shows, versus about a fifth in the United States, where institutional and professional investors dominate market volumes.

The reforms, once adopted, could help draw larger foreign ​institutional capital, including passive funds, two ‌foreign investors said.

Reducing costs and friction "will make it easier for global investors to translate interest in India into long-term investment," said Tracey Wingate of Investment Company Institute, a US-based association for global investors.

Short term volatility

Some ‌of the reforms being considered may be hard to implement, however.

The regulator, for example, is currently navigating the fallout from a new method for calculating closing prices for stocks with derivatives contracts, an established practice in major global markets.

The bumpy rollout of the move, which some large foreign asset managers had sought, led to sharp volatility in India's benchmark Nifty 50 ‌index in its first ​week, with limited ​participation from market makers and investors.

"Early participation in the closing auction session has been relatively modest," said Angela Lan, a senior strategist at State Street Investment Management, which manages $6.3 trillion in assets.

Despite initial turbulence, Sebi has signalled it intends to stay the course as markets adapt to new systems.

Over time such changes should help reduce execution frictions, ‌which are typically one component of a broader ​set of considerations for global investors, Lan said.

"We do not expect them, on their own, to drive a meaningful increase in passive allocations to India."