Sebi panel to discuss linking F&O exposure limits with individual risk profiles

The group could look at aspects such as the risk profile of the trader, the net worth, quantum of trading and overall exposure among other things to ascertain the limits for the cumulative exposure of an individual trader

At a time when the equity derivatives volume is witnessing a significant jump with an increasing number of investors entering the arena, the Securities and Exchange Board of India (Sebi) has formed an expert working group that will, among other things, look into aspects like enhanced investor protection and better risk metrics while evaluating if a framework based on product suitability needs to be put in place.

This assumes significance as earlier this month, the capital market watchdog released a discussion paper to review the norms for selecting stocks in the futures & options (F&O) segment.

The working group, however, will work on other aspects – though focused on the F&O segment – and examine whether any rules need to be put in place to link the profile of the trader to the trading limits.

Simply put, the group could look at aspects such as the risk profile of the trader, the net worth, quantum of trading and overall exposure among other things to ascertain the limits for the cumulative exposure of an individual trader.

Also Read: SEBI proposes tighter rules for derivatives trading on individual stocks to avert risk of market manipulation

The group will be headed by former executive director of the Reserve Bank of India (RBI) G Padmanabhan and will have representations from various categories of market participants, including stock exchanges, brokerages and industry bodies representing market players.

Interestingly, some of the terms of reference of the working group have their roots in an old discussion paper floated by SEBI way back in 2017, titled ‘Discussion Paper on Growth and Development of Equity Derivatives Market in India’.

The aim of the discussion paper, among other things, was to get market feedback on the participant’s profile, leverage related matters and product suitability framework to further strengthen the segment.

In other words, the aim was to understand the profile of the trader or investor and put in place certain rules to ascertain how much an individual could be allowed to take exposure in the F&O segment, given the risks attached to derivatives trading.

The feedback that the capital market regulator got was that one could look at norms for linking the exposure limits to the net worth of the trader or in regulatory parlance, a “product suitability framework”.

More importantly, the origins of this approach go further back to 1996 when a committee under L C Gupta – an academician and a former member of the SEBI board – came out with a comprehensive report recommending the introduction of equity derivatives in India.

It was noted that a concept of product suitability framework for clients that exists in many other countries is not present in India.

Though the regulatory framework has evolved significantly since then, the huge jump in the F&O volumes in India and the risks associated with the segment have once necessitated deliberations related to the link between a trader’s profile and trading quantum.

The National Stock Exchange (NSE) and BSE are the world’s top two bourses in terms of F&O volume and the turnover has reached such levels that the combined turnover of the two Indian stock exchanges accounted for more than 80% of the global turnover in April.

Also Read: Amid regulatory concerns, India corners 81% of global F&O volume

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

The deliberations have also been necessitated because a SEBI study last year found that nine out of 10 individual traders in the equity derivatives segment incurred net losses in FY19 and FY22 even as the number of such traders jumped 500% between the two fiscals.