SEBI's Consultation: Updating Eligibility Criteria for Stock Derivatives

SEBI’s Consultation Paper on Reviewing Eligibility Criteria for Stock Derivatives

The Securities and Exchange Board of India (SEBI) has issued a consultation paper focused on reviewing the eligibility criteria for stock derivatives. This review acknowledges the significant changes in the market since 2018. SEBI emphasizes the importance of maintaining market integrity and protecting investors by proposing necessary adjustments to criteria such as Median Quarter-Sigma Order Size (MQSOS), Market Wide Position Limit (MWPL), and Average Daily Delivery Value (ADDV). Aimed at ensuring adequate liquidity and trading interest, the paper suggests introducing a Product Success Framework (PSF) for stock derivatives similar to that used for index derivatives. Public feedback on these proposals is encouraged, with comments accepted until June 19, 2024.

Objective

1.1 Importance of Derivative Markets

Derivative markets play a crucial role in enhancing price discovery and market liquidity. However, insufficient depth in the underlying cash market and inadequate position limits can lead to increased risks of market manipulation, heightened volatility, and compromised investor protection. To mitigate these risks while fostering market development, SEBI established a framework for stock eligibility in derivatives trading in 2018. Given the market's evolution, this consultation paper seeks stakeholder input on updating these selection criteria.

Background

2.1 Current Eligibility Criteria

Stocks can be traded under recognized stock exchanges in derivative contracts only if they meet specific objective criteria, which were last updated in 2018. The criteria outlined in Chapter 5 of SEBI's Master Circular on Stock Exchanges and Clearing Corporations include:

Stock Selection: From the top 500 stocks based on Average Daily Market Capitalization and Average Daily Traded Value (ADTV).
MQSOS Requirement: A Median Quarter-Sigma Order Size of at least ₹25 lakh over the past six months.
MWPL Requirement: A Market Wide Position Limit of no less than ₹500 crore.
ADDV Requirement: An Average Daily Delivery Value of at least ₹10 crore in the cash market, noting that single stock derivatives are physically settled at expiry, in contrast to cash-settled index derivatives.

These criteria must be continuously met for six months, considering any surveillance or administrative concerns.

2.2 Exit Criteria

If a stock fails to meet these criteria for three consecutive months, it will exit the derivatives segment, prohibiting the issuance of new contracts. Existing contracts may continue trading until expiration, with new strike prices introduced if applicable.

2.3 Purpose of Current Criteria

The established criteria are designed to ensure that only stocks with sufficient size and liquidity qualify for derivatives contracts, addressing risks associated with low delivery-based activity in the cash market.

Need for Review

3.1 Historical Data on Stocks in Derivative Segment

Data from the past decade, presented below, highlights significant trends in the number of stocks in the derivative segment, indicating fluctuations following the 2018 review.

3.2 Market Growth Indicators

Since the last review of eligibility criteria, market parameters such as market capitalization and turnover have increased significantly:

Index Values:
- Nifty 50: Increased from 10,736.15 in May 2018 to 22,530.70 in May 2024 (110% increase).
- SENSEX: Increased from 35,322.38 to 73,961.31 (109% increase).
Market Capitalization:
- From ₹1,46,93,260 crore to ₹4,08,80,530 crore (178% increase).
Cash Market Daily Average Turnover:
- Increased from ₹31,819 crore to ₹1,12,179 crore (253% increase).
Average Daily Delivery Value:
- From ₹9,635 crore (207 securities) to ₹29,677 crore (182 securities) (208% increase).

This significant growth suggests the need for updated criteria to match the evolving market.

3.9 Investor Protection and Quality Assurance

One of SEBI's primary responsibilities is to safeguard investor interests while developing the securities market. To reduce risks associated with low delivery activity in the cash market and ensure that only high-quality stocks are included in the derivatives segment, it is essential to readjust current eligibility parameters to reflect new market conditions.

Review of Parameters for Eligibility

4.1 Introduction of Product Success Framework (PSF)

The proposed introduction of the PSF for stock derivatives includes:

Ensuring derivative contracts possess adequate liquidity and attract diverse market participants.
Currently applicable only to index derivatives, the PSF mandates that derivatives should meet specified turnover, open interest, and participation criteria. If these criteria are not met, no new contracts will be issued.

4.2 Proposed Eligibility Criteria for Entry/Exit

In light of evolving market dynamics, the following eligibility criteria adjustments are proposed:

S. No.	Criteria	Existing	Proposed Range	Rationale for Change
1.	Average Daily Market Capitalization and ADTV	Top 500 stocks	Top 500 stocks	No change
2.	MQSOS	₹25 lakhs	₹75 to ₹100 lakhs	Increased turnover necessitates higher MQSOS.
3.	MWPL	₹500 crores	₹1,250 to ₹1,750 crores	Market capitalization is now significantly higher.
4.	ADDV	₹10 crores	₹30 to ₹40 crores	ADDV has increased significantly.
5.	PSF Criteria	Not applicable	Specific new requirements for stock derivatives	Ensures sufficient activity and diverse participation.

Conclusion

SEBI's review of stock derivatives eligibility criteria is essential for maintaining market integrity and protecting investor interests. By seeking public input, SEBI aims to make informed decisions that reflect current market dynamics.