India's SEBI to Tighten Derivative Rules, Limit Options Expiries

India's Securities and Exchange Board of India (SEBI) is set to implement stricter regulations on derivative trading, aiming to curb speculative activities by retail investors in high-risk contracts. This move comes as part of the regulator's efforts to protect small investors and maintain market stability.

SEBI, established in 1992 to oversee India's securities market, plans to limit the number of options contract expiries to one per exchange per week. Additionally, the minimum trading amount is expected to be nearly tripled, significantly raising the entry barrier for traders. These changes align closely with proposals made in July 2023, despite opposition from traders and brokers.

The regulator's decision follows a substantial increase in derivatives trading volume. In August 2023, the monthly notional value of derivatives traded reached a staggering 10,923 trillion Indian rupees ($130.13 trillion), the highest globally. This growth has been particularly pronounced in options contracts linked to major stock indices like the BSE Sensex and NSE Nifty 50.

Notably, the share of individual investors in index options has surged from 2% six years ago to 41% in the financial year ending March 2024. This dramatic shift has raised concerns among authorities about the potential risks associated with speculative trading by retail investors.

SEBI's approach also includes a review of some earlier proposals, such as increasing margin requirements and monitoring intraday trading positions. The regulator received nearly 10,000 comments on its July proposals, largely from traders and brokers arguing that the new rules would negatively impact trading profits and market liquidity.

The final rules, expected to be released this month, will likely maintain the proposed increase in the minimum trading amount to between 1.5 million and 2 million rupees ($18,000-$24,000) from the current 500,000 rupees. This significant hike aims to discourage small investors from engaging in high-risk derivative trading.

SEBI's actions follow concerns raised by India's finance minister in May 2023 about the potential long-term consequences of unchecked retail investor participation in the derivatives market. These concerns encompass market stability, investor sentiment, and household finances.

The regulator's decision to tighten derivative rules reflects its commitment to investor protection and market stability. As India's derivatives market continues to evolve, SEBI's proactive approach aims to strike a balance between fostering market growth and safeguarding the interests of retail investors.

"A key objective was to put an end to the large and rising speculative volumes in index options contracts close to expiry. The regulator believes that this warrants additional measures both for small investor protection and for ensuring continued systemic stability."

As the Indian financial markets continue to mature, these regulatory changes are likely to have a significant impact on trading patterns and market dynamics. Market participants and observers will be closely watching the implementation of these new rules and their effects on India's rapidly growing derivatives market.