SEBI Proposes New Measures to Strengthen Derivative Market Regulations

India’s securities regulator, the Securities and Exchange Board of India (SEBI), has proposed tightening regulations for derivatives trading by reducing position limits for equity stock derivatives and imposing stricter norms for index derivatives. These measures aim to curb excessive speculation and minimize systemic risks in the market.

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Background and Rationale

The latest proposals build upon regulatory changes introduced in October 2024, where SEBI raised the entry barriers for trading in derivatives and made it more expensive for retail investors. These steps were taken to ensure that only well-informed and financially capable participants engage in derivatives trading, thereby reducing undue risks.

The move also comes in response to growing concerns that volatility from the futures and options (F&O) segment is spilling over into the broader stock market. After hitting record highs in September 2024, Indian equity markets have witnessed increased fluctuations, raising fears of heightened instability due to speculative trading in derivatives.

Key Proposals for Stock and Index Derivatives

In a consultation paper released on Monday, SEBI suggested linking the market-wide position limits for single-stock derivatives to the liquidity and size of the underlying stock in the cash market. The proposed cap would be the lower of 15% of a stock’s free-float market capitalization or 60 times its average daily delivery value. This change aims to prevent excessive speculative positions and ensure that derivatives trading remains aligned with actual market fundamentals.

For index derivatives, SEBI proposed that only indices meeting specific structural criteria should be eligible for trading. Apart from widely tracked benchmarks like the BSE Sensex and NSE Nifty 50, other indices must satisfy the following conditions:

• A minimum of 14 constituent stocks
• The top three stocks should not collectively exceed 45% of the index weight
• No single stock should have a weightage of more than 20%
   

These measures are intended to prevent a small number of stocks from exerting disproportionate influence over index-based derivatives, reducing the risks of market manipulation and excessive volatility.

Introduction of a Pre-Open Session for Futures

In another significant move, SEBI proposed introducing a pre-open session for the futures market, similar to what exists in the cash segment. This mechanism would help in price discovery and reduce market shocks at the opening of trade. Initially, SEBI plans to roll this out for current-month futures contracts on both single stocks and indices.

By implementing a pre-open session, SEBI aims to smoothen price fluctuations caused by overnight news, global events, or speculative activity. A controlled price discovery phase before full-fledged trading can help in stabilizing markets and providing investors with more reliable price signals.

Market Implications and Industry Feedback

The proposed changes are expected to have significant implications for traders, institutional investors, and retail participants. By reducing the scope for large speculative bets, SEBI intends to create a more balanced and less volatile trading environment.

However, some market participants may express concerns that these regulations could reduce market liquidity or limit hedging opportunities. Stricter criteria for index derivatives may also affect the availability of new derivative products in the market.

SEBI has invited feedback from market stakeholders on these proposals, with the consultation period open until March 17, 2025. The final decision will likely be made after considering industry responses and balancing regulatory concerns with market efficiency.