Exclusive: SEBI may limit concentration of top stocks in index with derivatives

To allay the fears in the mind of the market ecosystem, capital market regulator Securities and Exchange Board of India (Sebi) is considering reducing the weightage of top stocks in the sectoral index with derivative contracts. The regulator has appointed an expert working group led by the former executive director of the Reserve Bank of India (RBI), G Padmanabhan, comprising officials from exchanges, clearing corporations, brokers, personal finance experts, and people from academia as the members.

What’s the proposal?

According to one source, “The proposal is at an early stage, and it is being discussed if top constituent weightage can be limited to 20-25 per cent and similarly, the top 3 can be limited to a maximum of 50-60 per cent." Also, it's being deliberated that if a certain absolute difference in the weightage of the top 5 constituents is required to have the gradation, the condition of a minimum of 10 stocks may be mandatory for such indices. It's proposed that for existing indices, a new index could be created to meet the new conditions to offer derivatives on them.

Sebi’s whole-time member (WTM) and head of the Market Regulation Department, Ananth Narayan G, also indicated the move.

While delivering his speech on derivatives at the Sebi-Nism symposium, he said, “Structurally, we are considering—subject to inputs from all stakeholders—whether the overall trust in the ecosystem can be better served by placing some limits on the level of individual stock concentration in indices on which derivatives are offered."

What are the existing rules?

As per existing practice, the top constituent should be less than 35 per cent and the top 3 constituents should have a weightage of less than 65 per cent.

As per existing rules, benchmark and sectoral indices are permitted for derivatives if 80 per cent of the constituents are eligible for (futures & options) F&O trading.

It also says that no ineligible stock should have a weightage of more than 5 per cent.

The case of Nifty Bank, the popular index derivative, as of December 31, 2024.

Top constituent HDFC Bank holds 28.11 per cent weightage, ICICI Bank holds 24.98 per cent weight, Kotak Mahindra Bank has 8.80 per cent weightage, Axis Bank has 8.54 per cent weightage, and SBI has around 8.45 per cent weightage.

The top 3 banks constitute around 62 per cent of the weightage.

Why is Sebi considering reviewing the rules?

In recent times, on multiple occasions, traders on social media raised the concern of manipulation by large players in a few indices, especially on expiry days.

At the SEBI NISM Samvad event, Sebi, WTM, Ananth Narayan G, said, “It is not unusual for a market participant to trade in both cash and derivative markets concurrently. But as a matter of course, every exchange and regulator guards against unfair trading practices. For instance, a burst of outsized market moving activity by a large player in the cash market to engineer moves and hence ensure large profits in the derivative market could be a case of unfair trading practice and manipulation."

He assured that exchanges and clearing corporations have excellent surveillance ecosystems.

Proposal and consequences

The ETF investments may get impacted due to changes in indices constituents, so it has to be deliberated at length before any final view is taken.

It also needs to be deliberated whether rebalancing will be a good idea or whether a new sectoral index, especially for derivatives, can be created based on the proposed criteria, which will be better.

What will happen to the continuity of contracts also needs to be sorted before any final view is made.

Sebi has assured that as per its policy-making process, the issue will be extensively consulted, and only then will it be tweaked.