Rajib Ranjan Borah, co-founder and CEO of high-frequency and algorithmic trading firm iRage, acknowledges that regulators have a legitimate concern in steering retail investors toward long-term wealth creation.

The increase in India’s securities transaction tax on derivatives is clearly designed with that objective in mind, and that intent deserves recognition, Borah noted.

However, he believes the simultaneous implementation of the tax hike and the Reserve Bank of India’s (RBI) revised lending norms amount to a “double whammy” on the derivatives market.

"The changes create unintended challenges, particularly for domestic trading firms, that merit careful consideration," said Borah. "The irony of both landing on April 1 is not lost on the industry."

The RBI’s revised lending norms, effective April 1, prohibit banks from lending for proprietary trading and require 100% collateral for other broker funding.

“With bank funding for prop trading cut off entirely, brokers’ trading styles will change dramatically," said Borah. "Nimble firms could find short-term opportunities as participant behaviour changes."

However, with two major regulations going live on the same day, pinpointing which one caused what impact could be difficult to ascertain.

"And if the side effects turn out to be severe, course-correcting without the ability to pinpoint the cause could be tricky,” said Borah.

The second-order impact deserves careful attention.

"Domestic firms possibly operate with their net worth nearly fully deployed," said Borah. "With additional bank funding now restricted, their ability to scale could be constrained."

Many international firms, by contrast, can access capital from their global parent entities as trading opportunities show up in the Indian markets, he noted.

"The regulation, while well-intended, could inadvertently tilt the playing field," said Borah.

According to Borah, domestic firms are possibly already near full utilisation of their net worth. With extra funding now restricted, they simply cannot scale up quickly.

"International firms might not necessarily face this constraint as their global parents can wire in capital the moment they spot an opportunity,” said Borah.

The Indian government's derivatives tax hike, which also comes into place April 1, is increasing the securities transaction tax on equity futures and options. The tax on equity futures will rise from 0.02% to 0.05% while the tax on options premium and exercise of options will increase from 0.1% and 0.125% to 0.15% respectively.

Borah anticipates spreads in futures instruments to possibly widen as the market adjusts to the increased transaction costs.

More than the increased bid-ask spreads, there is a risk that excessive controls could push capital towards unregulated or alternate venues.

Borah noted that after the November 2024 changes of increased lot sizes, position limits and tighter weekly options restrictions, crypto exchanges targeting Indian traders reported a rapid surge in activity.

For instance, CoinDCX exchange saw a rise in trading volume of $200 million (£150m) from June to October to $800 million in November 2024.

With a broad, thriving universe of diverse derivatives and cash equities, and a strong regulatory ecosystem, Borah believes India has a genuine competitive advantage in exchange-traded markets.

"Differentiated regulation is the smarter path: raise margins for retail participants, mandate real-time loss alerts and full disclosure of all transaction costs by brokers, build in mechanisms to flag and restrict overtrading, and hold finfluencers to proper regulatory standards," he said. "The goal should be to ring-fence the vulnerable, not to shrink the playing field for everyone."

An India-based executive at an international bank supports recent regulatory measures to create better institutional flows and stricter risk controls for retail investors.

SEBI chair Tuhin Kanta Pandey said market volatility should not be simplistically attributed to futures and options trading.