SEBI Tightening May Impact F&O Volumes and Earnings of Bourses

SEBI Tightening May Impact F&O Volumes and Earnings of Bourses

Sub: Eco

Sec: Capital market   

Background:

• The Securities and Exchange Board of India (SEBI) has proposed measures to curb excessive trading in equity derivatives.

Potential Impact:

• Reduction in F&O Volumes:
  • The proposed regulations could lead to a 30-40% reduction in equity derivatives volumes.
  • This reduction is expected to affect exchanges and brokers who focus heavily on retail investors.
• Earnings Impact:
  • The impact on earnings will likely be significant for the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE):
  • NSE: The options segment contributes approximately 60% of NSE’s revenue, based on estimates for FY25. The earnings impact for NSE could be 25-30% by FY26.
• BSE: The options segment accounts for 40% of BSE’s revenue. The projected earnings impact for BSE is 15-18%.
• MCX: No impact is expected on the Multi Commodity Exchange (MCX) from these regulations.
• NSE IPO Concerns:
  • A reduction in earnings could impact NSE’s pricing power for its anticipated IPO.

Key SEBI Proposal:

• One major proposal from SEBI is to restrict weekly options to a single contract per exchange.

Concentration of Turnover:

• On the BSE, the majority of the notional turnover occurs on expiry days (96-97%), while for the NSE’s Nifty and Bank Nifty, it is 64% and 62% respectively.

Expert Opinions:

• BSE’s Strategy: The BSE may need to drop one index, likely the Bankex, due to lower income from derivatives compared to the NSE.
• Market Share Gap: The measures may reduce BSE’s chances of closing the market share gap with NSE in the derivatives segment.

Conclusion:

• The proposed SEBI regulations aim to temper the frenzied trading activity in the derivatives market, which could lead to significant shifts in market dynamics and earnings for major Indian exchanges like the NSE and BSE. The full impact will depend on the implementation of these measures and the market’s response.

Understanding Derivatives:

• Financial contracts deriving value from an underlying asset (stocks, commodities, currencies).
• Types: Futures and options.
  • Futures: Obligation to buy/sell an asset at a predetermined price on a specific date.
  • Options: Right, not obligation, to trade an asset at a specific price on a specific date.

SEBI’s Proposed Measures:

• Minimum Contract Size:
  • Increase to ₹15 lakh – ₹20 lakh; after six months, possibly ₹20 lakh – ₹30 lakh.
  • Current Size: ₹5 lakh – ₹10 lakh.
• Upfront Collection of Option Premium:
  • Brokers to collect premiums upfront from clients.
  • Current Practice: Only short options require margin; long options require premium payment.
• Intraday Monitoring of Position Limits:
  • MIIs (Market Infrastructure Institutions) to monitor intraday limits.
  • Current Practice: Monitored at end-of-day, potential for undetected intraday positions.
• Rationalisation of Weekly Index Products:
  • Provide weekly options on a single benchmark index per exchange.
  • Current Practice: Weekly contracts across different indices, resulting in speculative movement.
• Removal of Calendar Spread Benefit on Expiry Day:
  • No margin benefit for positions expiring on the same day.
• Rationalisation of Options Strikes:
  • Uniform strike intervals up to a 4% coverage near the index price, increasing as it moves away.
  • Limit: Not more than 50 strikes at contract launch.
• Increase in Margin Near Contract Expiry:
  • Increase Extreme Loss Margin (ELM) by 3% the day before expiry, and 5% on expiry day.

Rationale for Measures:

• Union Budget 2024-25:
  • Securities Transaction Tax (STT): Doubled for F&O of securities, effective October 1, 2024.
  • Increased to 0.02% and 0.1%, respectively.
• Market Impact:
  • 92.50 lakh unique individuals and firms traded in the NSE index derivatives, incurring a cumulative trading loss of ₹51,689 crore in FY 2023-24.
  • Only 15% of investors made a net profit.