Exclusive: SEBI gets serious on F&O trading, forms working group to suggest measures for investor protection and efficient regulation

Amid a lot of buzz around the growing turnover of equity derivatives on Dalal Street, market regulator Securities and Exchange Board of India (SEBI) has constituted a 15-member working group, three people confirmed to Zee Business. According to one of the sources aware of the development, the terms of reference for the working group "will include suggesting near-term and medium-term measures to 1) enhance investor protection in exchange-traded derivatives (ETDs), and 2) improve risk metrics and risk architecture of ETDs, with a view to enhance market development and regulation".

The working group will be headed by renowned expert and former executive director of the Reserve Bank of India,  G Padmanabhan. Over a phone call, Padmanabhan confirmed the development to Zee Business but didn’t elaborate on terms of reference and other details.

However, a person from the industry and aware of the issue said: “The working group is comprising of members from the broking industry, exchanges officials, clearing corporations officials, one independent personal finance expert, one representative from a mutual fund, one from a big corporate house and 2 IIM professors with specialization in finance and risk management are also part of the working group.” 

Although the decision to form a working group was taken a few weeks back, the communication was sent to the members on Monday. 

The working group is expected to submit its report in three months.

Based on the recommendation of the working group, SEBI will go back to the committee that advises on the secondary market and then come up with a public consultation paper before taking the issue to the board for approval.

Asked about retail participation, a third source said: “The working group may also look if the retail frenzy in F&O can be restricted through investor awareness or any other suitable measure is required.”

Although the regulator has implemented a strong margin system as a measure to deal with possible risks, it still wants to assess the impact of the spillover of derivatives in the cash segment.

In recent months, Finance Minister Nirmala Sitharaman, RBI Governor Shaktikanta Das and Chief Economic Advisor V Anantha Nageswaran have commented on equity derivatives volumes. "In 2017, V Anantha Nageswaran, then an Adjunct Senior Fellow at Gateway House, called derivatives "cholesterol". In an article co-authored with Praveen Chakravarty, Nageswaran wrote, “Derivatives are like cholesterol in the human body—useful in moderate amounts, dangerous in excess.”

The main concern is with respect to the volume of options. The options premium volume, including stocks and indices, had been increasing over the years but a significant jump came only after COVID-19. In 2018-19, the options premium volume was around Rs 8.5 lakh crore, which went up to Rs 13 lakh crore in FY20, and Rs 32 lakh crore by the end of FY21, and more than doubled from there to Rs 69 lakh crore in FY22. In FY23, the options premium turnover saw a big jump to Rs 119 lakh crore and FY24 closed with a premium volume of Rs 151 lakh crore.

In recent months, SEBI has been deliberating on lots of ideas to measure and control the risk in case of spillover from derivatives to cash.

The ideas so far under deliberations include a review of the open interest formulation mechanism as the current one is prone to misuse. So, SEBI is considering the concept of Future Equivalent Open Interest or FutEQ OI, where the delta (a unit change in the underlying)-adjusted open positions across futures and options will be considered across portfolios and exchanges will share the FutEQ OI data like the existing OI. 

Similarly, the rescaling of the Market Wide Position Limit (MWPL) on account of Fut EQ OI is also under consideration. FutEQ OI is generally expected to be less than Notional OI. SEBI believes this will create room for more positions within the existing limit. MWPL is linked to the free float of shares and is limited to 20 per cent of the number of shares on a free float basis.

Restricting overheating in derivatives with linkage to cash volume, SEBI is also thinking of linking FutEQ OI with Average Daily Delivery Value (ADDV) in the cash market. SEBI believes the underlying cash market should have sufficient liquidity compared to the open position in the derivatives segment so that any shock of excess demand or excess supply can be absorbed. Also, positions created in the derivatives segment should have an in-built mechanism to slow down further position building.

Relooking the intraday MWPL monitoring mechanism, SEBI may also come up with an intraday monitoring mechanism of MWPL. Currently, combined open interest is computed at the end of the day across exchanges and clearing corporations to check if it is breached. SEBI is of the view that Fut EQ OI intraday should be monitored four times a day along with risk computation measures.
 
Fixing individual positional limits for single stocks

The regulator is also discussing the idea of a review of individual position limits for single stocks. SEBI is concerned that in case of high MWPL but less OI, there is a scope of concentration of open positions with single or few entities. SEBI is considering the idea of linking the position limits in single stocks to total OI in the scrip across all exchanges.

Although the concern of a huge gap in the cash segment and future and options trades is not a new issue, SEBI had floated a paper in 2017 as well that suggested a product suitability framework for those who wish to participate in equity derivatives. However, things could not move forward due to various reasons.