The capital market regulator is currently in the process of overhauling its rules for derivatives trading amid concerns over suitability of these ‘complex and risky’ products for individual investors.
Sebi had initiated a public consultation in July for framing the new rules, while noted that the trading turnover in these products has seen a sharp surge of over ten-fold over the past decade and the ratio of trades in equity derivatives to that of equity cash market has risen to over 15-times.
Replying to the consultation call, the Association of National Exchanges Members of India (ANMI), a pan-India body of trading members across leading exchanges including NSE and BSE, has submitted that “the NSE publishes options data by stating ‘notional’ turnover (as opposed to premium turnover), thus grossly overstating the total quantum of business in the futures and options segment”.
It has said that the turnover in equity derivatives is 15.59 times of that in cash market, whereas this ratio after taking the only premium is only 2.53 times, which “clearly falls within the global exchange norms”.
In its discussion paper inviting comments from all stakeholders, Sebi had said, “The ratio of turnover in derivatives to turnover in cash market is around 15 times. To what extent the drivers of this ratio in India are comparable with other markets.”
Derivative in financial markets typically refers to a forward, future, option or any other hybrid contract of pre- determined fixed duration, linked for the purpose of contract fulfilment to the value of a specified real or financial asset or to an index of securities.
Broadly, there are two types of derivative contracts — futures and options. A futures contract means a legally binding agreement to buy or sell the underlying security on a future date, while options contract gives the buyer or holder of the contract the right (but not the obligation) to buy or sell the underlying asset at a predetermined price within or at end of a specified period.
In fiscal 2016-17, the total turnover in equity cash market stood at about Rs 60.5 lakh crore, whereas the same for equity derivatives was a staggering Rs 944 lakh crore.
While the cash market has grown at an annual compounded growth rate of 11 per cent since 2004-05, the same for equity derivatives is over 35 per cent.
ANMI, however, said a vanilla reading of derivatives on notional basis to cash segment volume ratio is a highly imperfect measure of assessment of the derivatives market in India vs the world.
According to Sebi, while large number of individual investors are active in derivatives segment, it has been observed that these investors may or may not have adequate financial capability to withstand risks posed by complex derivative instruments.
Sebi is also seeking to address, with the new norms, any inefficiencies present in the market and any regulatory arbitrage that needs to be plugged.
The ANMI, on the other hand, said the average Indian investor and trader has a superior knowledge of the derivatives space than his foreign counterpart.
It also said that globally OTC contracts are permitted in the derivatives market, and consequently, much of the derivatives trade takes place bilaterally outside the exchange platform and escapes capture, thus suppressing derivatives volumes.
In India, OTC (over the counter) derivative contracts are not permitted to be traded outside the exchange platform.
As per ANMI’s submission to Sebi, cash/derivatives arbitrage trading in India is a zero risk, low-medium return trading strategy and many arbitrage funds are also operating on this strategy in the mutual fund space.
“It affords a debt like return to the investor. Cash- futures arbitrage provides a stable income stream to a risk averse investor. How does this work? One has to buy cash-sell futures and keep rolling over the futures from month to month so as long as there is positive cost of carry.
“Thus, in a year, a simple cash/future arbitrage involves one cash market trade and 24 futures trades (12 months — sell/buy for each month). Simply read as a turnover ratio, it means 24:1. Does that mean there is excess interest in derivatives market? Certainly not!,” it said.
Opposing any restrictions, the ANMI said “uninformed or naive” traders need to be properly educated before undertaking derivatives trading, but this cannot be achieved by putting physical barriers to trade, as they will be pushed towards Dabba or illegal trading.
The association also refuted the notion that derivative market is subject to lower taxes and said these trades are actually subject to double tax.
“Derivatives are important and that is why the government is encouraging international exchanges which are meant for derivatives only on which there is no STT, stamp duty etc. Already around 40-50 per cent volume and open Interest of Nifty has shifted to Singapore,” it said.
ANMI pitched for NRIs being allowed to participate on the non-repatriation basis with normal retail participants.