Sebi order on extending derivative trading: Key takeaways and challenges

In a move aimed at attracting investors dealing in Indian products on foreign exchanges in Singapore and Dubai, the Securities and Exchange Board of India (Sebi) on Friday allowed domestic stock exchanges to extend equity derivatives trading until 11.55 pm. The new timings will also allow a better alignment with commodity markets amid implementation of universal exchanges, which function until 11:55 pm. In this Business Standard special piece, Deven Choksey, managing director of KR Choksey Investment Managers, looks at the Sebi order and explains the key takeaways.

The first good thing about that the entire development is that it brings the equity derivative market in line with the commodity derivative market. Both markets will now have similar trading hours, which will reduce systemic risk in the markets. 

The second aspect, the extension of trading hours will result in providing a hedging facility to portfolio investors. Today, this facility is denied particularly at a time when global news drives markets. Indian markets are well connected to global developments. Investors across the globe can take advantage if the Indian derivative markets are open for business at a time when the global markets, too, are open.

The third noteworthy thing is, while the underlying equity market will work for stipulated hours, investors can hedge even after the cash market closes for business. In typical situations when the equity and derivative markets work in tandem for equal number of hours, they speculate and arbitrage with relatively less use of hedging. The extended hours for derivative markets will provide investors with this opportunity.

The fourth aspect where I find merit is that innovative structural products would emerge, paving the way for hedging. Currently, investors are trading the core equity products or the indices and are not using enough structured products for trading through the derivative market.

The purpose of the derivatives market is to build such structured products that can help hedge the underlying portfolio systematically. That said, these products will emerge as the markets mature going ahead, and with this the trades in the markets will be focussed on generating returns and not merely speculation. The mind-set of the traders and investors will also undergo a sea change and will get tilted towards generating returns rather than speculate. This, however, will happen over the long term. 

The fifth aspect is that the market volatility will eventually come down or get rationalised. Now, the time gap between the last day’s close and the next day’s opening is quite long. Any global event that happens post the Indian markets are closed for trade leads to wild swings or higher volatility and we see a gap-up / gap-down open. If the markets start working extended hours through the derivative segment, then the price discovery part will not have to wait for a long time. The cash markets will already know the derivative position as the price discovery would have already happened at night.

THE CHALLENGES

The safety and surveillance mechanisms, however, remain a challenge. While on one side there are positives for the investors, on the other hand, the complete trading ecosystem will have to undergo a major change. Currently, the exchanges can definitely extend the number of hours. For them, it is the easiest thing to do.

The biggest challenge would be the backend systems. As of now, the trading members and the clearing members are the same in most of the cases in our markets. Internationally, both these members are different. The backend will have to get connected with the clearing corporation, custodians and the banks. Currently the banks operate till 3:30pm (Indian Standard Time) and the clearing corporations do the backend processes thereafter.

I think the situation will change. All the members / parties involved will have to come in a regulated format. Fortunately, the technology will help. I believe most of the financial intermediaries, including the custodians, stock exchanges and financers / banks are working on blockchain technology. This will help complete the backend processes simultaneously. With the technology at hand, the members involved will be able to complete making the backend processes faster.

While there are challenges, it is not that all this will happen from October 01, 2018 onwards. Building the framework on blockchain technology will take time, but from the regulatory side, the stock exchanges have been given the green signal and they can now start preparing themselves for building the entire ecosystem.

On the whole, it is a very mature decision that the regulator has taken.

(As told to Puneet Wadhwa)