JAIPUR: Amid continued selling by foreign investors in Indian equities, market regulator SEBI is working on a series of changes to the trading framework aimed at making India’s equity market more efficient and accessible for global institutional investors.
The proposed reforms include reducing collateral requirements for highly liquid cash equities, encouraging longer-dated derivatives, improving the securities lending and short-selling framework, and strengthening the closing auction mechanism. According to a Reuters report, SEBI is looking to advance these reforms within around nine months, following consultations with market participants.
The move comes at a time when foreign ownership of Indian equities has fallen to around a 17-year low. Between October 2024 and June 2026, foreign investors have pulled more than $50 billion from Indian equities. During the same period, India’s weight in the MSCI Emerging Markets Index also fell below 12%.
But the bigger question is: Can changes in trading rules actually bring foreign investors back to India?
Why Does SEBI Want to Change the Trading Framework?
India’s stock market has grown significantly in terms of size and liquidity and is now among the world’s major equity markets. However, for some institutional investors, the cost and operational complexity associated with trading, hedging and securities borrowing remain challenges.
Global funds do not simply buy shares and hold them. They hedge portfolios, take short positions, borrow securities and use derivatives to manage risk.
That is why SEBI is now looking at areas where India’s market structure could become more efficient and competitive compared with other major Asian markets.
1. Collateral Requirements Could Fall for Highly Liquid Stocks
One of the key proposals under consideration is a reduction in collateral requirements for highly liquid cash equities.
According to Reuters, discussions have included the possibility of reducing upfront capital or collateral requirements by around 15–20%.
In simple terms, institutional investors may not have to block as much capital upfront for certain trades as they currently do.
That could improve capital efficiency.
A global fund could potentially manage its positions more efficiently with the same amount of capital. For a large equity market such as India, this could support greater institutional participation.
2. Push for Longer-Dated Derivatives
Another major focus is the derivatives market.
SEBI is looking at ways to make longer-dated derivative contracts more attractive. Such instruments can be particularly useful for global investors because large funds often need to hedge portfolio risks over longer periods rather than relying only on short-term contracts.
If liquidity in this segment improves, India’s derivatives market could become more useful for institutional investors.
However, there is an important challenge here.
Simply making longer-term contracts available will not be enough.
If trading volumes and liquidity remain low, the practical benefit of these instruments could remain limited.
3. Changes in Stock Lending and Short Selling
Another important area of focus for SEBI is the Securities Lending and Borrowing Mechanism, or SLBM.
Stock lending allows an investor to lend securities to another market participant for a specified period. The borrower can use those securities for strategies such as short selling.
India’s securities lending market remains relatively small.
That is why SEBI is considering ways to expand the number of eligible stocks and strengthen the securities lending ecosystem. According to Reuters, the proposed reforms are aimed at making short selling and stock lending more efficient.
However, an important question remains:
If the stock-lending market itself is not deep enough, how much additional liquidity can be created simply by making short selling easier?
A recent Moneycontrol Pro analysis has also raised questions around the effectiveness of SEBI’s proposed SLBM reforms.
This means regulatory reform may be necessary, but strengthening market infrastructure and participation will be equally important.
4. Closing Auction System Also Under Review
SEBI introduced the Closing Auction Session (CAS) in selected stocks from August 3, 2026, with the objective of improving price discovery at the market close.
However, questions emerged during the initial implementation regarding liquidity and price volatility.
Following this, SEBI asked brokers to accept orders during the 3:15 PM to 3:20 PM transition window. The change is expected to take effect from September and is aimed at improving liquidity and price discovery during the closing auction.
The development also shows that the regulator is not simply implementing a new mechanism and stopping there. It is adjusting the framework based on feedback from market participants.
How Significant Is This for FII Inflows?
This is where investors need to understand an important distinction.
There is no direct one-to-one relationship between trading reforms and FII inflows.
Foreign investors will not necessarily invest in India simply because collateral requirements have been reduced.
Their investment decisions are influenced by several other factors, including:
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Indian market valuations
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Corporate earnings
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Rupee movement
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US interest rates
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Global bond yields
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Geopolitical risks
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Taxation
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India’s economic growth
Therefore, SEBI’s reforms can act as a catalyst for FII participation, but they are not a guarantee of foreign capital returning.
Domestic Investors Have Been Supporting the Market
As foreign participation has declined, domestic institutional investors have become an increasingly important source of support for Indian equities.
This shift is significant because foreign flows previously had a much larger influence on market direction.
Mutual funds, insurance companies and other domestic institutions have helped create a stronger domestic liquidity base.
However, global institutional participation remains important.
Foreign investors do not just bring capital. Their participation also affects market liquidity, research coverage, hedging activity and price discovery.
What Does It Mean for Retail Investors?
For retail investors, the impact of these reforms will largely be indirect.
If market liquidity improves, investors could benefit from:
Better liquidity → Better price discovery → More efficient markets
However, greater institutional activity in short selling and derivatives could also increase short-term volatility in some stocks.
Therefore, retail investors should not interpret SEBI’s reforms as meaning that short-term trading will suddenly become easier or safer.
Will FII Selling Stop Immediately?
Probably not.
If global yields remain elevated, pressure on the rupee continues or foreign investors continue to view Indian equities as expensive, trading reforms alone are unlikely to stop FII selling.
SEBI’s initiative is more structural and long-term in nature.
The regulator is trying to improve the competitiveness of India’s market so that when global investors decide to deploy capital in India, they face fewer trading and risk-management frictions.
Aurelius Business View
SEBI’s FII-focused reform package is not simply an attempt to bring foreign investors back. The broader objective appears to be bringing India’s equity market closer to global standards.
Potentially lower collateral requirements, longer-dated derivatives, a stronger securities lending and short-selling framework, and improvements to the Closing Auction System could collectively strengthen market efficiency and institutional participation.
However, investors should not expect the impact to appear overnight.
The real test will come after these reforms are implemented, when investors can assess whether foreign participation, trading volumes and capital flows show sustained improvement.
And this is perhaps the most important takeaway from the entire development:
SEBI can make the Indian market easier for FIIs to trade in, but India still needs to remain attractive enough for FIIs to invest in.
That means investors will need to watch not just SEBI’s regulatory changes, but also corporate earnings, valuations, the rupee, global interest rates and foreign fund flows over the coming months.
Disclaimer: This article is for informational and educational purposes only. It does not constitute personal investment advice or a recommendation to buy or sell any stock, index or financial instrument. Investors should consult a qualified financial adviser before making investment decisions.
