Sebi meets market players to discuss derivatives overhaul

Topics Sebi

The Securities and Exchange Board of India (Sebi) has initiated discussion with various stakeholders, including brokers, exchange officials and foreign investors, for overhaul of the derivatives segment.

According to sources, Sebi officials met representatives of exchanges and select brokerages to discuss possible changes in futures and options (F&O).

Last week, the market regulator issued a discussion paper titled ‘growth and development of equity derivatives market in India’. In this, it raised concern over the high turnover in derivatives, relative to the cash market, calling for “alignment” between the two. It also raised concern over the growing participation of individual, less-wealthy, investors in this high-risk segment.

“Most brokerages are planning a detailed reply soon to the discussion paper. However, there have been informal meetings between Sebi and industry players,” said a source.

Sources say Sebi is primarily concerned over small investor participation in the space. It believes most of them don’t understand the risks and don’t use derivatives for its intended purpose of hedging.

According to the paper, around 14 per cent of individual investors who trade in derivatives do not deal in the cash segment. They account for nearly 10 per cent of total individual investors’ turnover.

“Most retail (individual) investors entering the space don’t understand the risk. Sebi should look to reduce the number of stocks in the F&O space, as most counters don’t have volumes. It can also consider increasing the lot sizes further to discourage retail investors,” says B Gopkumar, chief executive, broking and distribution, Reliance Capital.

Recently, the regulator had increased the lot size from Rs 2 lakh to Rs 5 lakh. In the paper, Sebi has mulled whether it should further change the minimum contract sizes and open position limits.

“One of the key risks in the derivatives space is the high number of illiquid and volatile individual stocks, which might pose a risk for retail investors. Sebi should increase the inclusion criteria to avoid such stocks from qualifying into the derivatives segment. Further, increasing the lot size from Rs 5 lakh to Rs 10 lakh could keep retailers away from leverage instruments,” says Yogesh Radke, associate director at Edelweiss Securities.

Illustration: Ajay Mohanty
Sebi has highlighted the unusually high derivatives-to-cash turnover for the domestic market. At 15 times, it is one of the highest in the world. The highest is in South Korea, at 24 times. Market players, however, say India’s ratio appears high as the F&O turnover is calculated on a notional basis. For instance, if a Nifty call option with a strike price of Rs 10,000 is traded for a premium of Rs 100, the turnover is reported as Rs 10,100, while the international practice is to report the value of the contract, which is Rs 100.

“The derivatives–to-cash turnover ratio might look larger at 15 times, as it considers the notional value of option trades. If one looks at the futures-to-cash turnover, which is around three times, this could be considered a more reasonable mix,” says Radke.

Sectoral players say if one compares actual derivatives turnover and cash turnover, the growth over 10 years has been in sync.

“In some global markets, including the US, a lot of derivatives trades take place outside the exchange platform, due to high presence of over-the-counter trades and dark pool. As a result, the derivatives turnover in the Indian market might appear high. However, most derivatives trading in India happens on the stock exchange platform. Also, our risk management systems are best in the world,” says a broking official, asking not to be named.

Broking players also say less than 15 per cent of individual investors who open a trading account deal in derivatives. There are, they say, enough checks and balances, such as signing of risk disclosure documents to help small investors understand the risk.

“There are KYC (know your customer) norms to help investors understand risks while on-boarding. However, most investors might not read the fine print. Sebi can have a net worth criteria, which can keep out retail investors with low risk profile from entering the derivative space,” says Radke.

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