SEBI plans regulatory overhaul to stem foreign capital outflows and boost index weights

The Securities and Exchange Board of India (SEBI) is preparing to overhaul several legacy rules in an effort to stem soaring outflows of foreign funds and improve India's weighting in global stock market indexes, according to regulatory sources.

The planned changes come at a time when foreign ownership of Indian stocks has reached a 17-year low. Meanwhile, the rupee has declined about 6% this year, ranking among Asia's worst-performing currencies amid worries over a steeper import bill and weak capital flows. National Stock Exchange data shows that foreign investors sold more than $50 billion of Indian equities between October 2024 and June 2026. Furthermore, India's weighting in the MSCI emerging markets index dropped below 12%, down from a peak of 21% in September 2024.

To address these challenges, the market regulator is considering lowering collateral requirements for trades in highly liquid stocks. Two sources indicate this could reduce upfront capital by 15% to 20%. SEBI is also weighing lower upfront collateral requirements for derivatives contracts expiring after a year. Exchange data shows that while liquidity tends to be high in short-tenure contracts, longer contracts in India face near-zero liquidity. Overseas asset managers have noted that the existing system favors weekly derivatives contracts and discourages longer hedging strategies.

In addition, the proposed measures aim to boost the cash equities market by making the shorting of stocks easier and nearly doubling the number of shares eligible for lending and borrowing. Global index provider MSCI stated that it will monitor the planned reforms and their effectiveness through market participant feedback for future global accessibility reviews.

The regulatory push to deepen institutional participation follows a two-year effort by SEBI to curb speculative retail derivatives trading activity, after retail investors incurred losses for five consecutive years. NSE data indicates that retail investors make up more than 35% of trading activity in India, compared to about a fifth in the United States, where institutional and professional investors dominate market volumes. Regulatory sources stated that the watchdog wants the composition of derivative markets to more closely reflect developed markets.

Implementing some of these changes may present challenges. For example, the regulator is currently navigating the fallout from a new method for calculating closing prices for stocks with derivatives contracts. The rollout led to sharp volatility in the Nifty 50 index during its first week, accompanied by limited participation from market makers and investors.

Regulatory sources noted that SEBI plans to roll out the changes in approximately nine months, following industry consultations and allowing market participants time to update existing systems. The sources also warned of potential short-term disruptions stemming from the adjustments.

"SEBI's proactive move to address institutional concerns and lower collateral requirements is a crucial step toward rebuilding foreign investor confidence in the Indian market. By aligning domestic trading mechanisms with global standards, particularly in derivatives and stock lending, the regulator is laying the groundwork for deeper institutional participation and long-term capital stability." — Dr. Shishir Gupta, Founder & CEO, StartupLanes