Sebi Proposes Key Reforms for Index Derivatives to Enhance Market Stability and Investor Protection

News Mania Desk/Agnibeena Ghosh/31st July 2024

The Securities and Exchange Board of India (Sebi) has recently unveiled a series of proposals aimed at revamping the framework for index derivatives, including futures and options (F&O). Announced on July 30, 2024, these measures are designed to boost investor protection, stabilize the market, and ensure sustainable capital formation. The consultation paper outlines seven key reforms that could reshape the landscape of index derivatives trading in India.

One of the primary proposals is the rationalization of strike prices for options. Currently, Nifty and Bank Nifty options cover approximately 7-8 percent of index movement per day, with additional strikes added as necessary. The new proposal suggests limiting the number of strikes to a maximum of 50 at the time of contract launch, with intervals set around 4 percent of the prevailing price, potentially extending up to 8 percent if required. This change aims to simplify the strike price structure and enhance market efficiency.

Another significant change involves the upfront collection of options premiums. At present, while margins are collected for futures and short options positions, options buyers do not need to pay premiums upfront. The proposed rule would mandate upfront collection of these premiums, aligning with practices in futures trading and potentially reducing default risks.

Sebi also proposes the removal of calendar spread margin benefits on expiry day. Under current regulations, calendar spreads, which involve positions with different expiries, benefit from reduced margin requirements. The new proposal seeks to eliminate these benefits for contracts expiring on the same day, thereby addressing potential risks associated with last-minute trading strategies.

The consultation paper suggests a shift to intraday monitoring of position limits. Currently, position limits are assessed at the end of the trading day by clearing corporations and stock exchanges. The new framework proposes monitoring these limits on an intraday basis, introducing a short-term fix with a plan for full implementation. This change aims to improve real-time risk management and market oversight.

Another proposed reform is the adjustment of minimum contract sizes. Since 2015, the minimum contract size has been set between Rs 5-10 lakh. The new proposal suggests increasing this to Rs 15-20 lakh at the contract’s introduction, with a further increase to Rs 20-30 lakh after six months. This move is intended to curb excessive speculative trading by requiring higher capital for participation.

Sebi also plans to rationalize weekly index products. Currently, weekly expiries for index derivatives result in expiries occurring every day of the week across various indices and exchanges. The proposal aims to limit weekly expiries to one benchmark index per exchange, potentially reducing market noise and focusing trading activity.

Finally, the proposal includes an increase in margin requirements near contract expiry. While no additional margin is currently required in the last two trading days, the new framework suggests implementing an Extreme Loss Margin (ELM) of 3 percent starting on the penultimate day, increasing to 5 percent on the final day. This change is designed to enhance market stability and mitigate last-minute volatility.

These proposed measures come in response to concerns over excessive speculation and significant losses in derivatives trading. Sebi’s chief, Madhabi Puri Buch, highlighted a macro concern involving annual losses of Rs 50,000-60,000 crore of household savings through derivatives, which could be redirected into more productive investments.

The consultation paper invites public comments and suggestions by August 20, 2024. Experts suggest that these reforms could impact trading volumes, especially with changes to weekly expiries. The broader regulatory framework, including transaction charges and higher securities transaction tax (STT), may also influence market behavior in the future.