From test to income clause: How Sebi can save small investors from F&O risk

Market regulator might introduce income and education criteria to ensure gullible investors stay away from the high-risk derivatives segment

Capital market regulator Securities and Exchange Board of India (Sebi) is concerned over the growing participation of retail investors in the high-risk futures and options (F&O) segment.

In July, Sebi had issued a discussion paper ‘growth and development of the equity derivatives market', where it highlighted the high derivatives-to-cash turnover in the domestic market. It also raised concerns over many small investors dealing only in the derivatives segment, essentially meant for hedging the underlying exposure in the cash segment.

The discussion paper issued by Sebi was open-ended, where it invited market participants to give feedback to some of the issues plaguing the derivatives market. While the regulator had not made any proposals, it had deliberated on a few issues. Based on market feedback, Sebi might introduce income and education criteria to ensure that gullible investors stay away from the high-risk derivatives segment.

A mandatory test?

Sebi plans to make financial market knowledge mandatory for investors wanting to trade in the F&O segment. While it is not clear how this proposal will be implemented, one option could be prescribing a test for such investors – quite like the test that one needs to take while applying for a driving licence. Sebi might set up a course under its education arm National Institute of Securities Markets (NISM) for this purpose. An NISM certificate might be made mandatory for investors dealing in derivatives.

Income check

The derivatives markets are highly risky as the entire capital invested can get wiped out if the trade goes wrong. To ensure financially sound investors enter this space, Sebi may even prescribe a certain income limit for investors entering this space. Currently, an investor has to state the income while signing up with a brokerage. However, there is not income limit on investors wanting to open broking accounts.

Going ahead, while anybody would be allowed to deal in the cash segment, for derivatives trading, Sebi might set an income benchmark of Rs 500,000 or more. This would discourage small investors from trading in the derivatives market. Also, this might encourage investors to opt for mutual funds or exchange-traded funds (ETFs) to participate in the derivatives market.

Tweaks to the derivatives framework

While it has been over eight months since Sebi issued the paper on the derivatives segment, it has still not made any large-scale change to the derivatives framework. Experts say this is a highly sensitive issue as it might impact liquidity and price discovery. Sources say Sebi has collected market feedback on the issue and might soon announce some measures. The regulator, however, would want to tread cautiously to ensure any measure doesn’t have any intended consequences on the market system.