Global Traders Oppose SEBI's Proposed Rule Changes

The Securities and Exchange Board of India’s (SEBI) initiative to curb volatility in the derivatives market is encountering resistance from a major global trading association that represents firms like Jane Street and Citadel. This organization has raised concerns about potential liquidity constraints and even the risk of "price manipulation" in its response to SEBI’s proposals.

In its feedback on SEBI’s consultation paper dated February 24, the Futures Industry Association (FIA)—a well-known global trader lobby group—argued that the suggested measures could negatively impact liquidity, raise trading expenses, and add operational complexities. In a letter submitted to SEBI on March 13, FIA cautioned that these changes might unintentionally lead to market inefficiencies, increasing the possibility of price manipulation.

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FIA, which advocates for the interests of major foreign trading entities like Citadel, IMC Financial Markets, and Jane Street Capital, has voiced concerns over SEBI’s plan to discourage traders from purchasing deep out-of-the-money options or futures contracts. The regulator’s discussion paper proposes a shift in the methodology for calculating open interest (OI) by incorporating delta-based limits—an adjustment of significance since OI plays a crucial role in determining market-wide position limits (MWPL).

A Moneycontrol report from January 15 had previously indicated that SEBI was considering such a move.

FIA, in its March 13 letter, stated, “As currently structured, these measures could dampen market liquidity, increase trading costs, and introduce operational complexities. They may lead to wider bid-ask spreads, heightened market volatility, and reduced participation from institutional investors, ultimately impacting market depth and efficiency.”

The organization further highlighted that implementing delta-adjusted thresholds would necessitate multiple layers of calculations, monitoring, and dissemination across the trading ecosystem, potentially increasing operational burdens and the likelihood of errors.

Under current regulations, MWPL for a stock is either 20% of its market capitalization or 30 times its average daily traded turnover, whichever is lower. If open interest reaches 95% of MWPL, the stock enters the F&O ban list until OI declines below 80%.

At present, open interest is calculated by summing the outstanding futures and options contracts for a specific stock. However, SEBI’s proposal introduces a weightage-based calculation. Under this framework, options contracts would be assigned delta values between 0 and +1, while futures contracts would be assigned a value of +1. Specifically, long calls and short puts would have delta values ranging from 0 to -1.

In the options market, contracts that are closer to the strike price would be assigned values near +1, whereas contracts that are significantly out of the money would receive a weightage of 0.

Although FIA acknowledges SEBI’s goal of mitigating excessive volatility, it has pointed out that no other global market currently employs a delta-based OI system.

“While the Gross Delta limit aims to enhance risk management, it may not fully achieve its intended objective. An entity could still take large positions in short-term out-of-the-money (OTM) options with low Net and Gross Delta but high Gamma, causing rapid fluctuations in Future Equivalent (FutEq) Delta as the market moves. This could introduce risks that a Gross Delta limit alone may not effectively address,” FIA noted.

Gamma risk, which refers to the rate of change between an option’s delta and the underlying asset’s price, is a secondary risk factor.

In its February 24 discussion paper, SEBI asserted that the current notional-based approach to calculating OI fails to provide an accurate representation of market activity and may be susceptible to manipulation.

“A key objective of moving to a Future Equivalent (FutEq) or Delta-based OI is to address the limitations of notional-based OI, particularly its lack of meaningful aggregation across futures and options. Under a purely notional approach, there is potential for manipulation, such as artificially pushing a scrip into the ban period or obscuring the true risk exposure of certain positions,” FIA stated.

Market Impact and Industry Reactions

Experts believe that SEBI’s proposed changes, if implemented, could significantly alter market dynamics in India’s derivatives segment. While the regulator is aiming to make the market more transparent and reduce manipulation, some traders and market participants argue that the measures may have unintended consequences.

One major concern raised by market participants is the potential reduction in liquidity. By discouraging deep out-of-the-money options trading, SEBI may limit participation from proprietary traders and high-frequency trading (HFT) firms, who play a crucial role in maintaining market liquidity. Lower liquidity could lead to wider bid-ask spreads, making it costlier for investors to enter and exit positions efficiently.

Another key issue is the complexity of the proposed system. The delta-based calculation method introduces an additional layer of operational burden on brokers, clearing members, and market participants. As FIA noted, the constant recalculations and monitoring required for delta adjustments may create inefficiencies, leading to increased costs and higher risks of errors.

Additionally, some experts argue that the new framework may not completely prevent market manipulation. While the delta-based approach intends to provide a more accurate reflection of risk exposure, traders could still exploit gamma risk by taking large positions in short-term options, thereby creating sudden market fluctuations.

Despite the criticism, some market analysts believe that SEBI’s move is a step in the right direction. By shifting away from a purely notional-based open interest system, the regulator aims to create a more robust and transparent framework that reflects actual market risk. Proponents of the new system argue that while initial challenges exist, the long-term benefits could outweigh the drawbacks.

SEBI is expected to review feedback from various stakeholders before finalizing the proposed changes. Market participants are eagerly awaiting further clarifications on the implementation framework and whether any modifications will be made based on industry feedback.

The debate over SEBI’s proposed derivatives reforms highlights the ongoing challenge of balancing market stability with liquidity and efficiency. Whether the new regulations will ultimately benefit the Indian derivatives market or introduce new risks remains to be seen.