Direct Market Access for Foreign Investors: What it Means for Indian Traders and the Future of Stock Market

The Indian stock market has seen its share of ups and downs lately. Foreign investors have been pulling back—offloading over $3.5 billion in just the first half of March and nearly $29 billion over the last six months.

The reasons behind this shift are layered. A weakening rupee and global uncertainty are part of the picture. In addition, changing regulations, such as adjustments in investment limits, disclosure requirements, and tax compliance, have made it harder for foreign investors to navigate the system.

That’s where things might be about to change. Securities and Exchange Board of India (SEBI) is now looking to introduce Direct Market Access (DMA) for foreign investors. The policy change aims to simplify processes, improve transparency, and bring more capital into Indian markets.

If this goes through, it could be a big moment. One that not only changes how foreign investors participate—but also brings fresh opportunities for Indian traders and investors.

What is Direct Market Access?

Direct Market Access, or DMA, is an electronic trading infrastructure that allows investors to interact directly with the order books of financial market exchanges. This eliminates the need for intermediaries such as brokers or market-making firms. Institutional investors like mutual and hedge funds primarily use DMA. It not only provides greater control over trade execution but also minimises information leakage while reducing transaction costs.

Currently, foreign investors are allowed to invest in India through the Foreign Portfolio Investor (FPI) route. According to the norms, FPIs are required to register with SEBI via a custodian bank. The regulator categorises FPIs into two groups:

• Category I: Includes low-risk entities like sovereign wealth funds, pension funds and foreign government entities.
• Category II: It includes corporations, trusts, partnership firms and individual investors.

SEBI allows FPIs to invest in listed shares, debentures, treasury bills, exchange-traded derivatives and other securities. The investment must be made in Indian Rupees and routed through SEBI-registered brokers. However, they cannot hold more than 10% of a listed company’s paid-up capital. If this threshold is exceeded, the investment is classified as FDI, which comes with additional restrictions.

Key Challenges in Implementing the Proposal

According to media reports, SEBI has proposed allowing DMA to retail foreign investors. The primary objective behind this is to spread the risk involved in local assets by expanding the ownership base.

If SEBI proceeds with the proposal, the Indian stock market could see significant investment and trading transactions from ultra-high-net-worth individuals from cities like Singapore, London and New York. However, the proposal is not without challenges. Here’s why.

• Firstly, SEBI will need to ensure a strong surveillance mechanism to prevent market manipulation and excessive volatility. This may sound contradictory, but yes, it is a key concern.

• SEBI will also need to address infrastructural disparities, as smaller brokers and investors may struggle to compete with larger and better-resourced entities.

• Additionally, SEBI has to implement specific rules and define brokers’ and bankers’ responsibilities to ensure that foreign investors pay the appropriate taxes in India before repatriating any gains.

• To date, restricted investment flow in Indian equities has ensured that foreign investors adhere to anti-money laundering norms and know-your-client (KYC) checks. However, post-DMA, adhering to these regulations could become more challenging.

Impact of Direct Market Access on Indian Market and Local Investors

Despite potential short-term fluctuations in the market, DMA will offer several long-term benefits:

Increased Liquidity: Liquidity in the stock market refers to how quickly and easily you can sell or acquire shares without significantly affecting their price. A highly liquid market has many sellers and buyers, which allows trades to happen smoothly and helps maintain stable prices. When foreign investors get DMA in India, they can trade in real-time using automated systems without relying on local brokers. This can increase trading activity, especially in large-cap and popular stocks.

Price Discovery: Price discovery is the process by which market participants determine the price of a financial instrument based on its demand and supply. With DMA, foreign investors will be able to respond to real-time global and local market cues, enabling them to adjust quickly to new information. And the result? This will reduce price discrepancies, ensuring the stock prices reflect actual market conditions.

Exchange of Knowledge: Foreign investors often bring advanced trading strategies, technological expertise and a deeper understanding of global market trends. Indian brokers and market participants could benefit by observing and adapting these methods to suit local conditions. For example, a foreign investor using algorithmic trading in India might collaborate with a local brokerage to fine-tune the system based on Indian market behaviour.

Conclusion

If the government allows DMA for foreign investors to trade directly in Indian markets, this process will positively impact market efficiency and reduce transaction costs. It will also increase liquidity and market depth, attracting more foreign capital. For traders, this increased participation could lead to better price discovery and tighter spreads. However, it may also increase competition and market volatility. Since the entire process is still in its preliminary stages, it is better to wait and watch before drawing any solid conclusions.