India’s market regulator is devising a proposal to reduce risks for retail investors by correlating the permissible amount of equity derivatives trading with their overall wealth. This step comes amidst soaring Indian stock prices, drawing increased interest from retail investor. The regulator fears that smaller investors may face losses on derivatives in times of market volatility.
According to data from the Securities and Exchange Board of India (SEBI), there has been a remarkable surge in retail investor participation in the equity derivatives market, experiencing a 500% growth over the past three years until March. A SEBI study conducted in January revealed that nine out of ten individual traders, mostly in their 30s, incurred losses in the previous fiscal year, averaging around 110,000 Indian rupees ($1,300).
In the past, SEBI has already mandated brokers to prominently disclose the risks associated with derivatives trading on their websites. However, the regulator is now contemplating more stringent actions. Sources suggest that SEBI is currently discussing measures to monitor and regulate “disproportionate trading” to safeguard retail investors. These measures may involve linking the value of futures and options trades to the investors’ income and net worth. The sources prefer to remain anonymous as they lack authorization to speak to the media. SEBI has not yet responded to media inquiries via email.
One source stated, “SEBI is examining whether stock brokers can be made responsible for reporting net worth and income of individual traders to exchanges.” These determinations would be based on information disclosed in tax returns.
Following the disclosure of an investor’s net worth and income by a broker, exchanges would be able to track the individual’s involvement in futures and options contracts across various brokerage firms, as per the second source. Trading activities would be limited to a specific threshold, expected to be a multiple of the investor’s net worth. The regulatory process will commence with the issuance of a discussion paper, marking the initial phase in the formulation of regulations.
Previously, SEBI had introduced a similar framework in 2017, but it was abandoned due to brokers expressing difficulties in assessing their clients’ net worth, as stated by the sources. However, in light of a study revealing substantial losses in equity derivatives trades, the regulator is reconsidering the implementation of these restrictions.
The idea of product suitability standards is prevalent in many markets, particularly focusing on high-risk investments like venture funds, hedge funds, and commodity and equity derivatives, as the first source pointed out.
In 2011, South Korea’s financial markets regulator introduced entry barriers for retail investors participating in equity derivatives trading, mandating training and a minimum deposit. These restrictions were later eased in 2019.
As per the latest available data, the total number of derivatives contracts traded in India reached 5.56 billion as of June, with options trading accounting for 98% of these contracts.
