SEBI aims to safeguard retail investors through curbs on derivatives trading
July 28, 2023
India's market regulator, the Securities and Exchange Board of India (SEBI), plans to link the amount of equity derivatives trading allowed for retail investors to their overall wealth. This move aims to mitigate risks for smaller investors who incur losses in derivatives markets.
India's market regulator is planning to propose a measure to mitigate risks for retail investors by linking the permissible amount of equity derivatives trading to their overall wealth. This move comes as Indian stock prices reach record highs, attracting greater interest from retail investors. The regulator is concerned that smaller investors may incur losses on derivatives if market volatility increases.
Data from the Securities and Exchange Board of India (SEBI) reveals a significant surge in retail investor participation in the equity derivatives market, which has increased by 500% over the past three years until March. A SEBI study conducted in January found that nine out of ten individual traders, predominantly in their 30s, experienced losses in the previous fiscal year, with average losses amounting to approximately 110,000 Indian rupees ($1,300).
In the past, SEBI has required brokers to prominently disclose the risks associated with trading in derivatives on their websites. However, the regulatory body is now contemplating more stringent actions. Sources reveal that SEBI is currently in discussions to implement measures aimed at monitoring and regulating "disproportionate trading" in order to protect retail investors. These measures would involve linking the value of futures and options trades to the investors' income and net worth. The sources preferred to remain anonymous as they are not authorized to speak to the media. SEBI has not yet responded to a media inquiry sent via email.
"SEBI is examining whether stock brokers can be made responsible for reporting net worth and income of individual traders to exchanges," one source said. Determinations would be based on information disclosed in tax returns.
After the disclosure of an investor's net worth and income by a broker, exchanges would have the ability to track the individual's involvement in futures and options contracts across different brokerage firms, according to the second source. The trading activities would be limited to a specific threshold, which, as mentioned by the first source, is expected to be a multiple of the investor's net worth. The regulatory process will commence with the issuance of a discussion paper, marking the initial phase in the formulation of regulations, as per the sources.
SEBI had previously introduced a similar framework in 2017, but it was abandoned due to brokers expressing difficulties in evaluating their clients' net worth, as mentioned by the sources. However, the regulator has reconsidered implementing these restrictions in response to a study revealing significant losses in equity derivatives trades.
The concept of product suitability standards is prevalent in many markets, typically targeting high-risk investments such as venture funds, hedge funds, and commodity and equity derivatives, according to the first source.
In 2011, South Korea's financial markets regulator introduced entry barriers for retail investors participating in equity derivatives trading, including mandatory training and a minimum deposit. These restrictions were later relaxed in 2019.
As per the latest available data, the total number of derivatives contracts traded in India reached 5.56 billion as of June, with options trading accounting for 98% of these contracts.
[Reuters]
