Sebi expresses concern over high derivatives-to-cash turnover

The Securities and Exchange Board of India (Sebi) has expressed concern over high equity derivatives turnover vis-à-vis cash turnover.

For every one rupee of cash turnover, Rs 15.6 (notional value) of derivatives is traded. The derivatives-to-cash turnover in India is the world's second highest, after South Korea, where it is 24 times. Australia, Japan and Spain have a derivatives-to-cash ratio of less than five.

The markets regulator has also raised concern over a lot of individual investors dealing in the derivatives space without understanding the risks.

Sebi on Wednesday issued a discussion paper on 'Growth and development of the equity derivatives market in India'. “Orderly growth, development and alignment of both cash and derivatives markets is important,” it has said. “The discussion paper has been prepared to undertake an assessment of the derivatives market in India, to evaluate whether there is a need to further strengthen the regulatory framework.”

Sebi has asked market participants to respond till August 10. It will collate the feedback and possibly announce steps to develop the derivatives market. Such measures could impact the National Stock Exchange, where a little more than 95 per cent of equity derivative trading in India takes place.

The regulator has, for one, invited public feedback on the high proportion of derivatives trading. It has asked whether there is a “need to align the cash and derivatives market”. It has asked what measures could be taken to “create balanced participation in equity derivatives”.

Given the huge presence of individual investors in the derivatives space, it has said, it wishes to know if there is a need to have a product suitability framework. This would restrict specified investors from dealing in certain derivatives contracts. Sebi is also mulling if the minimum contract size and open position limits for equity derivatives need to be changed. And, if there is “any regulatory arbitrage that needs to be addressed”.

“A large number of individual investors are active in the derivative segment. Going by their trading pattern in the cash segment, it is observed that these investors may or may not have adequate financial capability to withstand the risks posed by complex derivative instruments,” Sebi says.

It had recently conducted a survey which showed a third of investors believe equity markets are less risky than the debt market. And, a large portion of survey respondents said the derivatives markets were safer than debt markets

According to Sebi, around 570,000 individual investors currently deal in the derivatives segment and account for nearly 30 per cent of the total turnover here. However, nearly 15 per cent of the individuals who trade in derivatives have never traded in the cash segment.

While Sebi acknowledges the role of “speculators” as “counter party hedgers”, it says derivatives ideally should be used for hedging purposes. It says “a soundly-based derivatives market requires the presence of both hedgers and speculators”.