SEBI begins 2019 with screws on cash-based trading in equity, commodity

Nearly two decades after equity derivatives came to India, SEBI has declared it was altering its rules, which many in the market believe may be a game changer.

SEBI has said that the bottom 50 stocks in the derivatives segment will move to delivery settlement every quarter in 2019. This means, within nine months the entire equity market will shift to delivery trading. In January 2018, SEBI first announced bringing 42 stocks in the derivatives segment under compulsory delivery settlement. After finding there were no major hiccups, SEBI has now said that entire derivative trading should move to delivery settlement from the current cash system in a phased manner in 2019. The new system is aimed at discouraging excessive speculation and abrupt market volatility.

‘Further tweaks required’

Deven Choksey, founder promoter, KR Choksey Investment Managers, told BusinessLine that further tweaks may be required to make the system flawless. “Three changes are required as a precursor. Monthly settlement has to be daily as end of day delivery can be demanded. Market lots were for cash settlement and need to go. Funding against stocks should be shifted to exchange platform instead of current off-market deals,” Choksey said.

Under the cash system, derivative contracts are settled by paying the difference in cash and there is no obligation on the buyer to accept delivery of goods or underlying security he traded. This pushed up ‘speculative’ volumes way higher than actual available stocks.

The trigger for SEBI’s change of heart was a study done by the government in 2017 that showed cash market volumes at its nadir in equities while derivatives propelled India as the most speculative market globally after Korea. The ratio of derivative to cash segment turnover stood at 15.2:1 — more than 15 trades in derivatives for every cash market trade. Also, tax collection from derivatives is low compared to the cash segment.

“With delivery-based trading, markets could become more safe as casino-like trading may see curbs,” said DR Mehta, who was SEBI chairman between 1995 and 2002. It was under Mehta that derivatives trading in India was first introduced for equities, and a committee appointed by him then declared that delivery settlement was the way forward.

SEBI recently pushed commodity bourse MCX to change course and shift to delivery settlement, which is expected to cut India’s dependence on foreign exchanges for price discovery in base metals. MCX will start with delivery trading in zinc and nickel. The exchange has been paying hefty fee to the London Metal Exchange and the Chicago Mercantile Exchange for price discovery even as domestic companies that require hedging mostly stay away due to non-availability of local price and speculators dominate, experts say.

Commodity derivatives was launched by MCX in 2013 and the exchange never made any attempt to shift to delivery trades until new entrants in the segment, the NSE and the BSE, were not asked to do so. Domestic price discovery is possible if delivery of goods is involved as it could promote local price pooling. Tata Steel, Vedanta and Hindalco are among top global companies exporting base metals.

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