India’s Markets Regulator Proposes Tighter Rules on Stock Derivatives Amid Surge in Trading Activity

The Securities and Exchange Board of India (SEBI) has unveiled a proposal for stricter regulations on trading in individual stock derivatives. This move aims to mitigate risks of market manipulation following a significant surge in options trading, particularly driven by retail investors.

The proposal, detailed in a discussion paper published on SEBI’s website on Sunday, highlights the need for derivatives contracts on individual stocks to have adequate liquidity and trading interest from market participants. These requirements are currently mandatory only for contracts on indexes.

According to SEBI’s proposed criteria, for a stock to qualify for futures and options (F&O) trading, it must have traded for at least 75% of trading days, although the specific period for this requirement was not disclosed. Additionally, 15% of active derivatives traders must have traded the stock, with an average premium daily turnover of 1.5 billion rupees ($18 million). The average daily turnover should range between 5 and 15 billion rupees, and the maximum number of open F&O contracts permitted for the underlying stock should be between 12.5 and 17.5 billion rupees.

The proposal follows revelations from two sources familiar with the matter, who informed Reuters in April that India’s top financial regulators would establish a committee to evaluate stability risks stemming from the burgeoning derivatives market. The explosive growth in options trading over the past five years has been primarily fueled by retail investors. The notional value of index options traded more than doubled in the fiscal year 2023-24, reaching $907.09 trillion, according to the National Stock Exchange (NSE).

India’s stock exchanges have been aggressively attracting investors with new products and lower fees, intensifying competition for a share of the rapidly expanding derivatives market. Data from the Futures Industry Association indicates that of the 108 billion options contracts traded globally in 2023, a staggering 78% were on Indian exchanges. Retail investors now constitute 35% of the derivative trading volume in the country.

Financial services firm IIFL has noted that if SEBI’s proposals are implemented, as many as 25 out of the 182 stocks currently eligible for F&O trading could be disqualified. This potential reduction underscores the impact the new regulations could have on the trading landscape.

A discussion paper represents the initial step by Indian regulators to consider policy or rule changes. This proposal indicates SEBI’s commitment to ensuring market integrity and protecting investors amidst the rapid growth and increasing complexity of derivatives trading.

As the discussion around these proposed rules unfolds, stakeholders across the financial sector will be keenly watching how these changes might shape the future of India’s derivatives market.

Financial Desk