The Impact of Regulatory Scrutiny on Prop Trading Firms in India

India's financial markets have undergone a seismic shift in regulatory oversight between 2023 and 2025, with the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) introducing sweeping reforms to curb speculative practices, enhance transparency, and safeguard investor interests. For proprietary trading firms and fintech-driven trading platforms, these changes present both existential risks and transformative opportunities. This analysis examines how regulatory scrutiny is reshaping the landscape for prop trading in India, with a focus on long-term investment implications.

SEBI's Algorithmic and Derivatives Reforms: A Double-Edged Sword

SEBI's 2023–2025 regulatory overhaul has targeted algorithmic trading, a cornerstone of modern prop trading. Algorithms are now classified as "white box" (fully transparent) or "black box" (proprietary logic), with the latter requiring mandatory registration and exchange approval before deployment, as explained in the TradeBrains' summary. Every algorithmic order is tagged with a unique identifier, enabling real-time monitoring to detect market manipulation, according to a Maheshwari & Co. analysis. While these measures reduce systemic risks and enhance market integrity, they also impose significant operational costs on firms. Brokers and algo providers must now invest in compliance infrastructure, including emergency systems to disable rogue algorithms and robust authentication protocols, as detailed on the Tradetron blog.

In the derivatives market, SEBI raised the minimum contract size for index derivatives to ₹1.5 million and limited weekly options contracts to one per exchange, as reported in an Economic Times report. These changes aim to curb speculative trading by retail investors but inadvertently raise barriers for small prop firms reliant on high-frequency strategies. However, the same reforms may foster a more stable environment for institutional players, attracting long-term capital by reducing volatility, a point echoed in the RBI annual report.

RBI's Forex and Hedging Regulations: Navigating Liquidity Constraints

The RBI's 2024 forex derivative restrictions have further complicated the operating environment for prop trading firms. Forex derivatives are now permitted only for hedging purposes, with trading limits capped at $100 million for domestic participants, according to a Motilal Oswal explainer. While these rules mitigate currency risk for corporates, they constrain arbitrage opportunities for prop firms, particularly those leveraging cross-border strategies. Additionally, the RBI's Self-Regulatory Framework for Fintechs (SRO-FTs) mandates stricter governance, including independent directors on fintech boards and adherence to industry standards, as noted in Global Legal Insights. Though compliance costs rise, this framework could enhance investor trust by aligning Indian fintechs with global regulatory benchmarks, as discussed in an ELP Law commentary.

Financial Performance and Investor Confidence: A Mixed Picture

The regulatory tightening has coincided with a "funding winter" for Indian fintechs, as venture capital inflows declined in 2023, per Statista data. Compliance burdens, particularly under SEBI's tiered deposit system and CSR norms for firms exceeding ₹5 crore in net profit, have forced some prop firms to restructure as LLPs to mitigate costs, according to a TaxGuru analysis. However, firms adapting to these changes-such as Paytm, which secured RBI approval to operate as a full-fledged payment aggregator in 2025-have seen renewed investor confidence, evidenced by a 13.25% stock price surge year-to-date, as reported by TechCrunch.

Long-Term Opportunities: Stability and Innovation

Despite short-term challenges, the regulatory environment is fostering a more resilient ecosystem. SEBI's AI-driven surveillance tools and RBI's emphasis on transparency are likely to deter insider trading and fraud, enhancing market credibility, according to a Cyril Amarchand blog. For prop firms, the shift toward structured, compliant operations could attract global investors wary of volatility. Moreover, the push for ESG alignment and digital asset oversight under RBI and SEBI frameworks may open new revenue streams in sustainable finance and blockchain-based trading, as argued in a Harvard Law analysis.

Conclusion

The regulatory scrutiny of prop trading in India is a double-edged sword. While compliance costs and operational constraints pose risks, they also drive long-term stability and investor trust. Firms that embrace innovation within these frameworks-leveraging AI for compliance, diversifying into ESG-aligned assets, or adopting offshore structures-will likely thrive. For investors, the key lies in balancing short-term volatility with the promise of a more transparent, resilient market.