RISKY BUSINESS?

SEBI's efforts to protect retail investors from derivatives market risks could inadvertently dampen market volumes

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On 30th July, market regulator the Securities and Exchange Board of India (SEBI) released a consultation paper outlining proposed measures to strengthen the index derivatives framework in India. Based on recommendations from an expert committee, SEBI has suggested seven changes to the futures and options market.

The proposed changes to the index derivatives are intended to enhance investor protection and promote market stability. Given the impressive performance of Indian markets in recent years, with a compound annual growth rate (CAGR) of approximately 15% in USD terms over the last 5 years, there has been a surge in interest from retail investors, both directly and indirectly.

The number of unique mutual fund investors has jumped from 2.2 crore in March ’20 to 4.7 crore in June ’24. Similarly, the number of unique demat holders has increased from 3.6 crore to 9.6 crore during the same period.

The increased participation of domestic investors has significantly outpaced that of foreign investors. From FY15-16 to FY20-21, on average, mutual funds, other domestic institutional investors (DIIs), and individuals collectively invested an average of ₹40,000 crore annually in the Indian equity secondary market. However, since FY21-22, these domestic investors have dramatically increased their investments to an average of ₹3.1 lakh crore per year, a nearly eightfold increase.

The increase in demand for Indian equities has been positive, but it has also raised concerns, particularly regarding the growth of the derivatives market. These concerns centre around four key areas:

1) Cash Vs Derivatives Market: One concern is a potential mismatch between the cash and derivatives markets. While the derivatives market should ideally take cues from the cash market, the increased activity in certain index derivatives segments could lead to the opposite scenario.