Detox From Derivatives: Here’s What Brokers Are Saying…   Sep 06, 2017


The Securities Exchange Board of India (SEBI) is trying its best to make capital markets here in India a much safer place for individual investors. Apparently, the capital market regulator is looking to overhaul the existing framework.

Recently, it released a discussion paper on growth and development of the equity derivatives market in India.

It made an important observation—“Derivatives products by nature are complex instruments. The valuation of derivatives such as options depends on many variables and option writers are exposed to significant risk if that do not have corresponding position. Therefore it is important that investors have a good understanding of derivatives and the ability to absorb the risk of their position. Indian market does not have the concept of product suitability framework. Investors may not have adequate understanding and financial capability to withstand risk posed by complex derivative instruments.”

Other important observations mentioned in the discussion paper are as follows:

  • The ratio of notional turnover in equity derivatives to equity cash segment shot up 10 times over the last 12 financial years
  • As far as the composition of the various trading segment is concerned, options which account for 83.61%, dominate the total trading turnover in derivatives
  • Nearly 14% of individual investors who contribute about 2.5% of the total turnover of the equity derivatives segment don’t trade in the cash segment. Individual investors who have greater than Rs 1 Crore exposure in cash market contribute over 50% trading in the derivative segment in the category


On this backdrop, SEBI had invited comments and suggestions from the stakeholders on the following:

 

  • Is the turnover in derivatives vis-à-vis the cash market consistent with the global trend? And to what extent are the drivers of increased turnover in derivatives in-sync with the drivers in the other countries?
  • Measures to be taken to align cash and derivatives markets
  • Measures to be taken to improve the balance participation profile of the derivatives market.
  • As far as option markets are concerned, is there a need to establish a product suitability framework in Indian markets?
  • Do we need to revisit trading guidelines and eligibility criteria?
  • Is there any lacuna in the regulatory framework that needs to be addressed to strengthen the market?


PersonalFN is of the view that SEBI has posed some legitimate questions, seeking responses of all stakeholders, before it tightens the existing rules and introduces the new ones.

However, it seems the discussion paper has made the brokers and a section of the trading community perhaps anxious. The Association of National Exchanges Members of India (ANMI) has vehemently contested the argument of an asymmetrical growth in the turnover of the derivatives markets vis-à-vis the cash market. ANMI believes the rise in the derivatives volumes is “grossly overstated”. It raised concerns about the double taxation (it claims) the derivatives contracts are subject to. ANMI also differed in view, with the capital market regulator, on the maturity of the market participants. It believes, an average Indian trader has more knowledge about derivatives market as compared to his foreign counterparts. They haven’t provided any evidence to back this argument. ANMI opposed the idea of imposing any restriction on the derivatives market participation.

The one point of view that bridges ANMI and SEBI is educating the "uninformed or naive" traders and investors.

Surprisingly, ANMI hasn’t offered any concrete or constructive views regarding individual investors indulging in the speculative derivatives trading. It has merely opposed restrictions and pointed out the discrepancies, thereby not serving the intended purpose of a ‘discussion paper’. It talks about treating derivatives market as an important constituent in arbitrage trading, which is considered a lot more reliable, but refrained from offering views or suggestions on how participants can be persuaded not to treat derivatives as a separate asset class or an independent avenue.

It is advisable for brokers to step forward with valid suggestions that spell high fiduciary standards, which is in the long-term interest of investors.

The legendary investor Warren Buffet says, “Derivatives are weapons of mass destruction”.

Individual investors shall take this as a piece of free personal advice. Derivatives are the hedging tools, they are not meant for profiting. Hence, if these are used to rampantly trade in the endeavour to earn quick money, it can be hazardous to one’s wealth and health. Moreover, derivative strategies need to be correctly practiced for effective hedging, or it may prove to be a futile exercise.

 

 

 

 

 

 



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