Comments on

SEBI Discussion Paper on

Growth and Development of Equity
Derivative Market in India

Rajib Ranjan Borah

 Background
On 12 July 2017, SEBI released a discussion paper
on growth & development of equity derivative
market in India (link)
On 07 September 2017, SEBI released an
addendum to the above paper (link)
SEBI sought comments and suggestions to these
papers by 25 September 2017. This presentation
contains my personal viewpoints on the points
mentioned in the papers (in the format
prescribed by SEBI)
Name of entity / person / intermediary/ Organization: Rajib Ranjan Borah
Sr. No. Issues Suggestions Rationale
1. As per my understanding after i. Reduce transaction
Ratio of turnover in discussions with market participants, costs in equity segment.
derivatives to the problem is not high volumes in
turnover in cash equity derivatives but low volumes in ii. Improve stock lending
market is around 15 equities. and borrowing systems.
times. To what extent
the drivers of this Low volumes in equities is because of
ratio in India are (i) comparatively higher transaction
comparable with costs in equities, and (ii) lack of a
drivers in other robust stock lending & borrowing
markets. system.
Absence of robust stock lending and
borrowing means that market
participants who have a contrary
viewpoint use derivatives to express
that viewpoint.
If stock lending and borrowing system
evolves, volumes in the cash segment
will grow multifold and the calculated
ratio will change drastically.
2.
What are the global
best practices and
experience in
international markets
to align cash and
derivative markets
Name of entity / person / intermediary/ Organization: Rajib Ranjan Borah
Sr. No. Issues Suggestions Rationale
3.
Considering the
participants profile,
what measures would
be required to create
balanced
participation in equity
derivatives market.
4.
Taking into account
trading of individual
investors in
derivatives, especially
options, is there a
need to introduce a
product suitability
framework in our
market.
Name of entity / person / intermediary/ Organization: Rajib Ranjan Borah
Sr. No. Issues Suggestions Rationale
5. i. The suggestion to increase lot sizes to reduce i. Increase in lot size to
Considering individual investor participation might make the products
participants backfire small individual investors with riskier and therefore
profile, product fundamental viewpoints will be then forced to keep small individual
mix and take bigger positions and thereby take bigger investors away might
leverage in risks. instead see small
equity ii. If lot size is increased, small Individual individual investors take
derivatives, investors who hedge with derivatives will bigger risks instead
what could be then be forced to increase the size of their reduction in lot sizes will
the guiding holdings in both equity and derivatives reduce the risks that the
principles for segment to stay hedged. small individual investors
setting iii. Since the long term goal is to have physical take.
minimum settlement of derivatives alienating
contract size individual investors from derivatives will ii. Equity participation of
and open shift ownership trends of Indian equities individual investors in
position limits towards big institutions and foreign entities. India is extremely low
for equity Thus, this will indirectly lead to transfer of this should be
derivatives. Indian assets to foreign hands. encouraged. This will
iv. Creating hurdles for individual investors happen when the entire
towards participating in equity derivatives market evolves and
will reduce volumes in both equity grows both equity and
derivatives and thereby in equity markets as equity derivatives.
well. This will thus create hurdles towards
Indian households participation in equity
(which is already abysmally low) and earn
better returns on their savings.
Name of entity / person / intermediary/ Organization: Rajib Ranjan Borah
Sr. No. Issues Suggestions Rationale
6.
Whether there is a
need to review
existing criteria for
introduction of
derivatives on
stocks or
derivatives on
indices.
7. The margin mechanism in India is the same
Taking in to (or rather slightly stricter) as used globally.
account the
margin levied in In fact, for proprietary market makers, and
the derivative arbitrageurs who ensure price correctness -
segment and the current margin system is already
consequent stringent. For a totally hedged option
leverage, is the portfolio, the SOMC (short option minimum
present margin charge) is a margin component that is
framework extremely excessive and redundant given
adequate. Is there the hedged nature of the portfolio.
a need to review
trading and risk
management
framework for
derivatives.
Name of entity / person / intermediary/ Organization: Rajib Ranjan Borah
Sr. No. Issues Suggestions Rationale
8.
Whether there are
any inefficiencies
in the market that
needs to be
addressed.
9. High Transaction costs & high costs of Reduce costs like STT, Stamp
Whether there is regulations in India is shifting volumes in Duty on exchange
any regulatory Indian assets to foreign markets. Shifting of transactions. This might in
arbitrage that price discovery of Indian assets to venues fact lead to higher volumes
needs to be outside India will (a) marginalize Indian and thereby higher revenue
addressed. exchanges, (b) dilute ability of Indian collection by the
regulators, (c) reduce revenue of Government
Government, (d) increase impact cost in
domestic markets, (e) lead to brain drain of
Indian talent
Name of entity / person / intermediary/ Organization: Rajib Ranjan Borah
Sr. No. Issues
10. i. Physical settlement of equity
Whether derivatives cannot work without a
there is a proper stock borrowing and
need to lending scheme/system. This is
have already acknowledged by
compuls everyone (including SEBI).
ory ii. Indian equity markets has a
physical unique problem of having low
settleme free float of shares with the non
nt in promoters this makes short
stock squeezes even more likely (even
derivativ when stock lending and borrowing
es systems are built).
contracts iii. I understand that from a taxation
? perspective, hedgers can offset
the gains in their derivative trades
done for hedging purpose (if they
own the underlying) because of
the fact that there is no delivery
of shares. In case physical
settlement happens, taxation
rules will have to be changed
otherwise hedgers will start
getting a taxation liability.
iv. Position limits in stocks will have
to be modified to (position limits
in stocks) + (latent positions in
stocks through derivatives)
Suggestions Rationale
i. Multiple studies have shown that volatility in
both the cash and derivatives markets either
increase when shifting from cash settlement
to physical settlement or vice versa (i.e.
reduce when shifted from physical settlement
to cash settlement). For e.g. (although two of
the three papers referred below are in the
field of commodities, but the concept applies
for equities): (a) Donald Lien and Yiu Kuen Tse
( Physical delivery versus cash settlement: an
empirical study on the feeder cattle contract,
Journal of Empirical Finance, November 2002)
(b) Nabil Chaherli and Robert Hauser,
(Delivery Systems versus Cash Settlement in
Corn and Soybean Futures Contracts, SSRN
working paper. February 1995) (c) Donald Lien
and Li Yang, (Alternative settlement methods
and Australian individual share futures
contracts, Journal of International Financial
Markets, Institutions and Money December
2004)
ii. In my short stint of one year in Europe, I had
observed two cases of short squeezes in the
highly liquid German stock market (namely in
Altana and Volkswagen) precipitated by
physical settlement requirements. In case of
India with low free float shares, this problem
is going to be more frequent and more acute.
Name of entity / person / intermediary/ Organization: Rajib Ranjan Borah
Sr. No. Issues Suggestions Rationale
11. Because of low free float of
Whether physical shares (with non-
settlement should be promoters) in Indian
done in a phased equities, in my personal
manner starting with opinion, I would not
stock options followed recommend physical
by stock futures? settlement of stock
derivatives.
Thank you