Jane Street is a wakeup call for India's financial market reforms

The revelations in this recent case should lead to a reassessment of the foundations of India's financial markets

Arbitrage refers to the practice of simultaneously buying and selling an asset in different markets to profit from tiny price differences caused by market inefficiencies. Arbitrage plays a role in making financial markets more efficient by bringing the prices of the same asset closer to parity across markets. Market abuse, on the other hand, refers to a range of unethical and illegal activities that can undermine the integrity of financial markets. 

Whether Jane Street’s actions were legal arbitrage or market abuse is the core question in the enforcement action initiated recently by the Securities and Exchange Board of India (Sebi). While Sebi’s order is public, it is prudent to suspend final judgment until Jane Street’s defence is presented and the matter is finally decided by the prescribed judicial fora. But this episode offers a critical moment for sober deliberation. 

Beyond this specific case, however, lies a more profound imperative: A rigorous examination of the current health and future trajectory of India’s financial markets. 

Well-functioning financial markets serve as the central nervous system of the economy, efficiently processing information, allocating capital, and facilitating essential risk transfer. Among India’s economic reforms, the development of our equity spot and derivatives markets stands as perhaps the most significant and undisputed success. Yet, this very success now exhibits symptoms of distress, necessitating a focused and intellectually honest assessment to ensure its continued vitality. 

Our attention must be directed towards the primary concern that poses a substantial risk to the future efficacy and integrity of the Indian financial system: The pervasive inhibiting influence of the spot market, compounded by critical issues in regulatory practice. 

A robust and liquid equity spot market is the bedrock of any sophisticated financial ecosystem. It provides genuine price discovery and underpins the integrity of all derivative instruments. Regrettably, the Indian equity spot market currently displays characteristics of constrained activity, largely attributable to the cumulative impact of the securities transaction tax (STT) and a multitude of Sebi regulations. While these measures may have been conceived with laudable objectives, their practical implementation has often yielded unintended and counterproductive consequences. 

Empirical evidence substantiates this observation. The turnover ratio, defined as annual trading volume divided by market capitalisation, serves as a direct indicator of market liquidity. Historically, this ratio for the Indian market frequently exceeded unity, signifying healthy trading engagement. For instance, in financial year 2008-09, it stood at 1.24. In stark contrast, for the most recent three financial years, and specifically for firms within the top decile by market capitalisation, the turnover ratio has diminished markedly, registering values of 0.50, 0.47, and 0.64, respectively. This consistent decline offers compelling evidence of reduced activity and liquidity in the spot segment. 

  The most concerning structural distortion arising from this policy amalgam has been the pronounced —and arguably excessive — emphasis on the options market. Unlike developed financial markets globally, which typically exhibit a balanced interplay between spot, futures, and options segments, India’s market structure is characterised by an overwhelming dominance of options, alongside notably weaker futures, and spot markets. This asymmetry is not a natural market evolution. It is a direct consequence of the overarching framework of state intervention, a confluence of Sebi’s regulatory stipulations and the Ministry of Finance’s (MoF) fiscal policies. When the foundational spot segment is rendered less attractive due to elevated transaction costs, market activity will inevitably gravitate towards segments perceived as less encumbered, irrespective of their fundamental economic efficiency. 

One factor that shapes the liquidity and market efficiency of the financial market system is the quality of regulation. Financial market players will invest more in building systems, processes and knowledge when they have greater confidence in Sebi as a modern capable regulator that has commercial sense, that only undertakes enforcement against genuine malfeasance. This is the causal chain from better working of Sebi to a more liquid and efficient financial market system. 

In this regard, inter alia, Sebi’s increasing resort to what can only be described as “disguised legislation” is an area of serious concern. The Sebi Act vests the regulator with authority to promulgate regulations through a transparent and consultative process involving public comments and parliamentary oversight. This is a mechanism designed to ensure accountability and democratic legitimacy. In reality, Sebi frequently circumvents these established safeguards by issuing a proliferation of instruments, including circulars, glossaries, and guidelines, which, in practical effect, impose substantive and binding obligations upon market participants. 

This circumvention directly undermines the procedural safeguards enshrined in the statute. The net result is a fragmented, unpredictable, and often opaque legal framework, rendering it very challenging for regulated entities to comprehend and comply with applicable laws. This climate of regulatory uncertainty inevitably stifles innovation and elevates the cost of doing business in India’s financial markets. 

There is an urgent need for a fundamental programme of reform aimed at building robust state capability within the regulator.  This comprehensive reform must comprise: 

1. Rewriting Sebi Prohibition of Fraudulent and Unfair Trade Practices (FUTP) Regulations to provide clearer definitions and establish higher evidentiary thresholds; 

  2. Building internal manuals for FUTP investigations outlining standardised procedures and investigative techniques; and 

  3. Training Sebi staff on manual implementation to foster evidentiary discipline and analytical precision. 

This tripartite approach is fundamental for constructing state capability, ensuring regulatory actions are legally sound and perceived as just. 

The Jane Street case, therefore, serves as a mere diagnostic indicator to draw our attention to the more profound and enduring challenge in the systematic, structural advancement of India’s financial system. The foundational theory of change remains constant: Superior knowledge leads to superior policy actions. India’s most significant strides in financial sector reform occurred during periods characterised by a cohesive partnership — a synergistic coalition comprising the MoF, Sebi, the exchanges, and independent intellectual thought. 

To re-establish this collaborative ethos, the MoF, as the ultimate custodian of the nation’s economic destiny, must champion an environment where rigorous analysis, open and informed dialogue, and an unwavering commitment to evidence-based policy formulation are paramount. Only through such concerted effort can we ensure that India’s financial markets fulfil their indispensable role. 

The author is an honorary senior fellow at the Isaac Centre for Public Policy, and a former civil servant