Stock derivative volumes that cross a set threshold in six months need to be discontinued: SEBI

The Securities and Exchange Board of India (SEBI) has announced major regulatory changes for the equity derivatives arena that would lead to a significant change in the manner in which stocks are selected for the futures & options (F&O) segment.

The board of the capital market regulator, which met in Mumbai on Thursday, approved a framework that, as per the watchdog, would ensure a link between the cash market and derivative segment volume.

Among other factors, a stock will be eligible for entry in the F&O segment only if the average daily delivery value in the cash market over the previous six months would be at Rs 35 crore – earlier it was pegged at Rs 10 crore.
Further, the stock’s market wide position limit on a rolling basis will have to be at least Rs 1500 crore from the earlier Rs 500 crore.

“With a view to ensuring the continued development of a vibrant securities market ecosystem with appropriate regulation and investor protection, the Board has approved a revision in eligibility criteria for entry and exit of stocks in the derivatives segment of exchanges,” stated the SEBI release.

The board also introduced product success framework for stock derivatives. Buch in the press meet said that this has been introduced to reduce the possibility of market manipulation through illiquid securities. The trading volumes will be watched for six months and if they do not cross a threshold, then the derivatives will be discontinued.

“The total number of stocks in F&O segment will go up by a handful,” she said.

Buch said, “In terms of regulatory thinking behind it, it is in two parts. First, in order to ensure that there is a healthy linkage between cash market and F&O market many years ago we had said that there will be physical delivery of open positions on expiry. Second step is today to say that criteria of which stocks will be permitted in F&O basis on how the shares behave in the cash segment… we need to adjust these parameters.”

She added, “Secondly, we are introduce or extend the concept of product success framework. In indices, we have this.. which means that exchange can introduce a new index for F&O trading but if it does not pick up in volumes, then it has to be discontinued. This is because if it has thin volumes, it is very very vulnerable to manipulation.”

Sebi’s decision assumes significance as the stock selection criteria for the F&O segment had come under heavy criticism from a large section of market participants who felt that the existing framework led to many illiquid stocks entering the fray.

The Sebi decisions come close on the heels of the watchdog issuing a discussion paper to review the eligibility criteria for stock selection for the F&O segment.

“Without sufficient depth in the underlying cash market and appropriate position limits around leveraged derivatives, there can be higher risks of market manipulation, increased volatility, and compromised investor protection,” stated the SEBI discussion paper issued on June 8.

The last time such a review was done was in 2018. “Since then, market parameters reflecting the size and liquidity of the cash market, viz., market capitalization and turnover have moved up considerably,” stated the SEBI paper.

Incidentally, the SEBI decisions come at a time when the National Stock Exchange (NSE) and BSE are already occupying the world’s top two positions in terms of F&O volume, with the combined volume of the two Indian stock exchanges accounting for more than 80% of the global turnover in the month of April.

Data from the Futures Industry Association shows that a total of 8,484 million contracts were traded on NSE in April, which was the highest among all global bourses. NSE was followed by BSE that saw a little over 2,224 million contracts changing hands in April.

Further, if the year-on-year growth is taken into account, then NSE registered a 92 percent rise. BSE’s rise is not exactly comparable as the bourse saw an uptick in its F&O trading turnover only from May last year – prior to that it was hovering around near-zero levels.