SEBI Proposals to Enhance Integrity of Non-Benchmark Indices and Equity Derivatives

SEBI’s Push to Rein in Risk: New Guardrails for Non-Benchmark Indices and Equity Derivatives

In a market where investor participation is broadening and derivative volumes are hitting record highs, the Securities and Exchange Board of India (SEBI) has taken a sharp turn toward tighter regulation. Its latest consultation paper—released on February 24—isn’t just a routine update. It marks a decisive move to clamp down on excessive concentration in thematic indices and to close long-standing risk loopholes in the equity derivatives segment.

Fixing the Fundamentals: What’s Changing with Non-Benchmark Indices?

Thematic funds and sectoral strategies have seen a surge in popularity, but they come with their own set of challenges—chief among them, overexposure to just a handful of heavyweight stocks. SEBI wants to nip this in the bud.

Here’s what the regulator is proposing:

Minimum Constituents: No More Skinny Indices

Every non-benchmark index—regardless of its theme—must include at least 14 unique stocks. The idea is to broaden the base and avoid artificial concentration masquerading as thematic investing.

Capping Concentration: Keeping Big Players in Check

No single stock should carry more than 20% weight.
The top three holdings combined must not exceed 45%.

These measures aim to rein in the dominance of large-cap favourites that often skew the performance and increase the manipulation risk of so-called “diversified” indices.

Derivatives Reform: Risk Monitoring Gets a Much-Needed Overhaul

While derivatives have long been a core driver of market liquidity in India, their rapid expansion—especially around non-benchmark indices—has sparked concern.

Here’s where SEBI’s proposals start getting granular.

Tighter Rules for Index Derivatives

Derivatives on thematic or sectoral indices are attractive—but also riskier, given the smaller stock pool and higher volatility. SEBI now wants to ensure that only adequately diversified indices make the cut for derivative trading.

This isn’t just risk aversion—it’s risk realism.

Position Duplication: Plugging a Regulatory Blind Spot

Some indices allow traders to replicate large, untracked positions, skirting around market-wide limits. SEBI is putting its foot down here. The regulator is looking to eliminate structural blind spots that allow market participants to accumulate risk behind a veil of complexity.

The Real Gamechanger: Rethinking Open Interest Calculations

Perhaps the most sophisticated—and overdue—reform in SEBI’s paper is the proposed change in how open interest (OI) is calculated for equity derivatives.

Currently, OI is measured by netting out long and short positions. But this netting approach can be misleading. SEBI gives a textbook example: imagine a trader holding long at-the-money calls while also shorting out-of-the-money calls. On paper, the position might appear balanced, but in practice, the net delta risk can be substantial.

SEBI’s Solution:

A methodology that captures the real risk—not just the notional offset. The new framework would aim to surface the true exposure hidden behind supposedly “neutral” strategies.

The goal? Prevent hidden leverage, improve transparency, and avoid unjustified trading bans triggered by distorted OI readings.

Market-Wide Risk Controls: Updating the Bigger Picture

Beyond indices and options, SEBI is using this paper to nudge the entire system toward better risk hygiene. Here’s what else is on the docket:

Market-Wide Position Limits (MWPL):

A revised methodology for setting MWPL is being considered. The idea is to prevent market instability by ensuring no single player—or group—gets too large a footprint in the derivatives space.

Exposure Norms for Funds:

Mutual funds and AIFs (Alternative Investment Funds) that dabble in derivatives will face updated exposure calculations. The tweak is aimed at strengthening fund-level risk control and ensuring institutional investors don’t inadvertently add to market fragility.

Why This Matters

Taken together, SEBI’s proposals mark a calibrated tightening of the screws on a market that’s matured rapidly—but not always evenly. The regulator isn’t trying to stifle growth. It’s trying to make that growth sustainable.

By pushing for broader-based indices, refining how we measure risk, and sharpening the tools for oversight, SEBI is saying loud and clear: innovation is welcome, but not at the cost of market integrity.

Final Thoughts

If you’re a market participant—whether a fund house, trader, or index provider—this is the time to sit up and take notice. These reforms, when implemented, won’t just tweak the way you do business. They’ll reshape the architecture of risk-taking in India’s capital markets.

The consultation window is open, but make no mistake—this is the direction SEBI intends to go. And with the stakes as high as they are, few would argue against it