New Delhi: Even as markets regulator Securities and Exchange Board of India (SEBI) has unleashed a slew of new rules aimed at restricting retail participation in India’s derivatives market, brokerages operating in this space are already indicating a pivot away from this segment, while others are discarding their popular zero-brokerage models.
SEBI Tuesday evening issued a circular announcing new rules for the futures and options (F&O) markets in India, which together comprise the derivatives market (one where financial instruments derive their value from underlying assets).
The new rules include increasing the minimum size of options contracts that can be bought, and reducing the number of weekly opportunities to buy such contracts.
These changes had first been mooted in a consultation paper released by SEBI in July. However, earlier that month, the markets regulator also introduced another change to the mechanism of how stock exchanges charge the brokerages for using their platform.
Since coming into effect Tuesday, this change has already led some brokerages to increase what they charge their customers. Others have said this change, along with the ones SEBI proposed in its consultation paper, will mean “the best for the Indian broking industry may well be behind us”.
SEBI’s concerns over the high retail participation in the F&O segment stemmed from the fact that it found 93 percent of these traders lost money in this segment in the three-year period from 2020-21 to 2022-23. The cumulative value of this loss was Rs 1.8 lakh crore.
Additionally, SEBI found that brokerages had cornered most of the money from F&O trades, while hedge funds and foreign portfolio investors—using sophisticated algorithmic trading techniques—had been earning most of the profits.
Those who had lost money were largely low-income youth from smaller cities, new to trading, and unaware of the rules and intricacies.
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What are SEBI’s latest changes
In its consultation paper, SEBI said it found the sellers of options contracts often allowed buyers to delay the payment of the premium amount associated with such contracts. What this resulted in, the paper said, was that buyers often bought contracts worth more than the collateral they currently held, leading them to borrow to finance the purchase.
To curb this practice, the new SEBI rules say that the options premia must be collected upfront from the options buyer. This change will be effective 1 February 2025.
Another major change to the options contract framework is an increase in the minimum size of these contracts, in an effort to ensure that smaller retail participants get excluded.
“The current stipulation is for such contracts to have a value between Rs 5 lakhs and Rs 10 lakhs,” the SEBI circular said. “This limit was last set in 2015. Since then, broad market values and prices have increased by around three times. Given this, it has been decided that a derivative contract shall have a value not less than Rs 15 lakhs at the time of its introduction in the market.”
This step will be enforced from 20 November, 2024.
Another significant step is with regard to the monitoring of position limits—the threshold for the number of derivative contracts a trader can hold at any given time.
At the moment, adherence to these limits is monitored by the stock exchanges or clearing houses (financial institutions serving as mediators between two entities involved in a financial transaction) at the end of each trading day.
SEBI found, however, that especially on days when large amounts are traded, there is a possibility that traders hold contracts that exceed the permissible limits.
To address this, SEBI has now mandated that such position limits will be reviewed during the trading day on four separate occasions. This new mechanism will be effective 1 April 2025.
Currently, the stock exchanges offer options contracts that expire on every day of the week. The SEBI consultation paper noted that there was “hyperactive trading” in index options on the day the contract was due to expire, accompanied by high volatility in the value of that index through the day.
This has implications for investor protection and market stability, “with no discernible benefit towards sustained capital formation”, it added.
“Accordingly, in order to specifically address this issue of excessive trading in index derivatives on expiry day, it has been decided to rationalise index derivatives products offered by exchanges which expire on a weekly basis,” Tuesday’s circular said. “Henceforth, each exchange may provide derivatives contracts for only one of its benchmark index with weekly expiry.”
This measure will be effective 20 November this year.
Previous steps already having an impact
In July, SEBI had said that exchanges must charge the brokerages a ‘True to Label’ fee for using their platforms, instead of the existing system of a slab-based structure. Under the slab-based structure, brokerages paid a fee to the exchanges based on the volume of business transacted on the exchanges. Brokerages with higher volumes paid lower fees.
However, these brokerages charge their customers an amount that is higher than what they pay the exchanges. As discount brokerage Zerodha has explained in a blog post, the difference between what it charges customers and what it pays the exchanges is in essence a rebate for the brokerages.
Under a ‘True to Label’ fee system, which came into effect Tuesday, brokerages will have to pay the exchanges whatever they collect from customers. Zerodha said about 10 percent of its revenues came from the rebate from the earlier system, adding that brokerages might have to re-evaluate their business models once the change is implemented.
Angel One, another prominent discount brokerage, has already implemented changes to the charges it collects from customers, due to the shift to a ‘True to Label’ system. One of the reasons behind the popularity of discount brokerages was that they charged zero brokerage fees from the customers, as opposed to full-service brokerages, which charged a fee.
In a statement released Tuesday, Angel One indicated it was effectively abandoning this zero brokerage model for cash and equity delivery transactions.
Zerodha, however, said Tuesday it was retaining its zero brokerage model for the time being. However, in a post on X last week, the company’s founder and CEO Nithin Kamath said that the company was going to pivot away from the F&O market.
In the post, Kamath highlighted SEBI’s ‘True to Label’ rules, the consultation paper on index derivatives, the Union Budget announcement of an increase in the Securities Transaction Tax on F&O, increasing competition in the broking industry, and “ever-present” threat of markets falling. “This perfect storm means big hits to the business,” he wrote.
Adding, “The best for the Indian broking industry may well be behind us. The goal now is to pivot and reduce the reliance on F&O for revenue.”
(Edited by Radifah Kabir)
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