SEBI’s New Proposals: Revamping Rules for Stock Derivatives Trading

The Securities and Exchange Board of India (SEBI) has released a consultation paper aimed at revising the eligibility criteria for stock derivatives in line with the evolving market conditions. This move is pivotal for enhancing price discovery and market liquidity while mitigating risks associated with market manipulation, volatility, and compromised investor protection. Here’s a detailed breakdown of the proposed changes and their implications.

Background

Derivative markets are crucial for price discovery and liquidity. However, they come with risks if the underlying cash market lacks depth. To address these concerns, SEBI had last established a framework in 2018, setting criteria for stocks eligible for derivatives trading. These criteria included parameters such as market capitalization, traded value, order size, and delivery value. Given the market’s growth, SEBI now proposes to update these criteria to better reflect current market conditions.

Current Criteria

Currently, for a stock to be eligible for derivatives trading, it must meet several criteria consistently for six months:

1. Average Daily Market Capitalization and Traded Value (ADTV)**: Among the top 500 stocks.
2. Median Quarter Sigma Order Size (MQSOS): At least Rs 25 lakh.
3. Market Wide Position Limit (MWPL)**: At least Rs 500 crore.
4. Average Daily Delivery Value (ADDV): At least Rs 10 crore.

If a stock fails to meet these criteria for three consecutive months, it exits the derivatives segment, though existing contracts may continue until expiration.

Need for Review

Since the last review in 2018, the market has seen substantial growth. For instance:

•       The Nifty 50 and SENSEX indices have increased by over 100%.
•       Market capitalization has grown by 178%.
•       Daily average turnover has surged by 253%.
•       Daily average delivery value has more than tripled.

Given these changes, SEBI recognizes the need to update the eligibility criteria to keep pace with market dynamics. The proposed changes aim to ensure that only high-quality stocks with sufficient size, liquidity, and market depth are available for derivatives trading.

Proposed Changes

SEBI proposes the following revisions:

1. MQSOS: Increase from Rs 25 lakh to a range between Rs 75 lakh and Rs 100 lakh.
2. MWPL: Raise from Rs 500 crore to between Rs 1,250 crore and Rs 1,750 crore.
3. ADDV: Boost from Rs 10 crore to between Rs 30 crore and Rs 40 crore.
4. Product Success Framework (PSF): Introduce criteria similar to those for index derivatives to ensure liquidity and widespread participation. This includes:

•       At least 15% of trading members active in all stock derivatives or 200 members, whichever is lower, must trade in any derivative contract on the stock.
•       Trading on a minimum of 75% of trading days.
•       Average daily turnover of at least Rs 150 crore.
•       Average daily open interest of between Rs 500 crore and Rs 1,500 crore.

Rationale

The rationale behind these changes is to align the eligibility criteria with the significant growth in market parameters since 2018. By increasing the thresholds for MQSOS, MWPL, and ADDV, SEBI aims to ensure that only stocks with adequate market activity and liquidity qualify for derivatives trading. The introduction of PSF for stock derivatives will help maintain market integrity and prevent manipulation by ensuring that derivative contracts attract sufficient interest from diverse market participants.

Public Comments

SEBI is seeking public comments on these proposed changes. Stakeholders can submit their feedback by June 19, 2024, through SEBI’s online platform or via email.

Conclusion

SEBI’s proactive approach in revising the eligibility criteria for stock derivatives is a commendable step towards enhancing market robustness. By aligning the criteria with current market conditions, SEBI aims to ensure that the derivatives market remains efficient, liquid, and secure for all investors. This review will likely bolster investor confidence and contribute to the continued growth of India’s securities market.

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