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Two decades after it first introduced equity derivatives in India, market regulator SEBI has embarked upon its biggest reform push: taming the futures and options (F&O) market to curb excessive market speculation. SEBI is looking at introducing physical, or delivery-based, settlement in the equity derivatives segment, a move that many say will curtail price manipulation in F&O and boost government taxes by encouraging cash market trade.
Under physical settlement, a buyer or seller of F&O contracts has the choice to seek delivery of shares if the speculator tries to artificially increase or suppress derivative prices. Currently, stock markets follow cash settlement, wherein the F&O contract is settled by paying the difference between strike price and the value of underlying security, which is prone to manipulation.
On July 24, BusinessLine had reported that SEBI was working on measures to curb excessive speculation and boost cash market volumes, in the process preventing huge revenue loss for the government.
“Bringing in delivery-based settlement shows SEBI’s seriousness in protecting the interest of small investors and curtailing speculation,” said Deven Choksey, promoter, KR Choksey Investment Managers. “It is the need of the hour. Both cash and delivery settlement options should be give to traders to balance the markets.”
The buyer of a cash settlement index or stock futures is not buying an underlying stock but merely an option to buy at a future date, which he seldom exercises. Hence, the ‘cash settled’ futures transaction implies no ownership obligation.
Choksey says once delivery settlement comes into play, speculators will be careful and the cash market will get more depth as stock lending and borrowing will pick up.
Stock lending and borrowing, which was introduced by SEBI after the 2008 financial crisis, has been a non-starter as few felt the need to borrow shares. Hence liquidity in the cash segment dried up as speculators shifted to derivatives.
India’s emergence as the second-most speculative equity market globally — due to derivative trading — after South Korea, has rattled both government and SEBI. A recent study showed that ratio of equity derivative turnover to cash segment turnover stood at 15.2:1. That is, more than 15 trades in derivatives were being conducted for every cash market trade.
Sources say the fact that derivative trading was way higher than cash was causing heartburn in the government as it stood to loose on taxes.
Tax collection trends suggest that any surge in cash volumes could see a manifold push in securities transaction tax (STT) collection. For instance, data shows that 67 per cent of the ₹7,350-crore STT collected during financial year 2015-16 came from the cash segment. The trend has been similar for many previous years. The cash segment has an average contribution of over 60 per cent in the government’s STT collection despite accounting for less than 10 per cent of overall equity trading.
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