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Sunday, Nov 24, 2002

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Where derivative markets should go

SEBI Advisory Committee on Derivatives under the chairmanship of Prof. J.R. Varma submitted its report on the "Development and Regulation of Derivative Market in India" with the following recommendations:

Derivative Products: SEBI and RBI should move on with trading in futures, options and swaps using a variety of underlyings, such as (a) INR-USD rate, (b) the short-end interest rate, (c) long-end interest rate, (d) MIBOR, etc. Position Limits: The majority views is that the member-wise position limit should be 20 per cent of the market-wide position limit in the stock where the market-wide position limit is less than or equal to Rs 250 crore. It should be Rs 50 crore plus 7.5 per cent of the excess of the market-wide position limit over Rs 250 crore where the market-wide position limit exceeds Rs 250 crore.

There should be a scrip-wise limit and an overall cap in respect of position across various equity based derivative products. The scrip-wise limit should be Rs 5 crore if market-wide open interest is up to Rs 50 crore. It should be 10 per cent of the market-wide open interest or Rs 20 crore, which ever is lower if market wide open interest crosses Rs 50 crore. The overall member-wise limits across all equity based derivatives contracts should be Rs 75 crore.

Criteria for Derivatives: SEBI should lay down only broad eligibility criteria and the exchanges should be free to decide on stocks and indices on which futures and options could be permitted. The broad eligibility criteria should be: (i) the stock should be among the top 500 stocks in terms of market capitalisation and average daily volumes, and (ii) the median quarter-sigma order size over the last six months should be at least Rs 0.5 million. The eligibility criteria laid down for single stock derivatives can be extended to narrow stock indices as well.

Minimum Contract Size: The minimum contract size in value terms should be done away with.

Corporate Actions: The task of deciding on adjustments for corporate action should be left to the exchanges with the stipulation that: (a) The basis for any adjustment for corporate action shall be such that the value of the position of the market participants on cum and ex-date for corporate action would continue to remain the same as far as possible; (b) The exchanges would take into account best practices followed internationally; (c) The exchanges must act consistent with SEBI's circular on adjustment for corporate action as well as the decisions of the erstwhile subgroup on corporate actions; and (d) The exchanges must consider the circumstances of the particular case and the general interest of investors in the market.

Cross Margining: Cross margining should be implemented at the client level without commingling the cash and derivative segments. No cross margining should be permitted between positions in index options and a basket of positions in options on constituent stocks in the index, between two indices even if they are highly correlated and between two stocks even if they are highly correlated.

Market Structure and Governance: The areas in the derivatives segment which should be separate from the cash segment for the present are: (i) the legal framework governing trading, clearing and settlement, (ii) TGF/SGF, (iii) membership, and (iv) the governing council/clearing council/executive committees.

SEBI should be open to any proposal from the exchanges for assimilating sub-brokers into the market structure so long as these are consistent with the twin requirements of client level gross margins and regulation of sales practices at client level.

Inspection: The exchange should work out an appropriate inspection strategy in consultation with SEBI. The strategy should lay down: (a) the criteria for identifying the top members to be taken up for 100% inspection, (b) the percentage of remaining members to be inspected on a sampling basis, and (c) mechanism to ensure that active members do not go uninspected for several years in succession.

The exchanges should consider developing a specific stock watch system for derivative markets as the cash market surveillance mechanism may not meet all the requirements of the derivatives market. Unified surveillance of cash and derivatives markets is essential both at the exchange level and at the level of SEBI.

Physical Settlement: Derivatives on individual stocks should shift to physical settlement. It should be such that at no point in time, trades on the derivative segment commingle with the trades in the cash market.

Derivative Cell: The Derivative Cell should be strengthened both quantitatively and qualitatively to shoulder most of the responsibility for operational issues regarding the derivatives market.

Source: NSE News

If you have any queries relating to the futures/options markets and strategies that can be used in these markets, please mail them to Futures & Options, Kasturi & sons, 859-860, Anna Salai, Chennai 600 002 or email them to with a mention of futures/options in the subject line of the mail.

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