Sebi prescribes new guidelines to de-risk equity derivatives

Securities and Exchange Board of India (Sebi) has come out with new guidelines for de-risking the equity derivatives segment so as to safeguard investments amidst the changing market dynamics.

The market regulator has introduced new stress tests that include Stressed Value at Risk (VaR), a filtered historic simulation, and a factor model. VaR uses volatility from stress periods and Monte Carlo simulations to calculate price movements, with option volatility shocked by 100 per cent.

It also prescribed an exponentially weighted moving average (EWMA) for simulation by adjusting past data to reflect current volatility. Besides, there is a factor model based on the highest 3-day Nifty movements adjusted by the stock's beta.

The aim is enhance the determination of the Minimum Required Corpus (MRC) for the Core Settlement Guarantee Fund (Core SGF), Sebi said in a circular.

In its previous guidelines, issued in October 2023, Sebi had specified methods for assessing credit risk in clearing corporations (CCs). 

Besides, Sebi has prescribed various other guidelines, which include upfront premium collection, position monitoring and expiry day changes, for ensuring the health of the futures and options market.

Clearing corporations have been tasked with the job of defining, updating, and reviewing stress periods using the 3-day stress test data on a regular basis.

Sebi has also permitted clearing corporations to transfer excess funds from the equity cash segment (ECM) to the equity derivatives segment (EDX) to meet any increase in corpus requirements for equity derivatives, but on specific conditions.

The new Sebi directives are part of the market regulator’s move to rein in the unchecked growth of the equity derivatives segment, whose turnover has surpassed the size of the Indian economy - zooming over 40-fold since 2019 to hit a record $6 trillion in February.

Sebi has always been cautioning small investors about the risk in taking market challenges like better-funded and experienced financial market players.

A Sebi study has found that foreign funds and proprietary trading desks made gains to the tune of Rs58,840 crore ($7 billion) from trading Indian equity derivatives in the year ended 31 March 2024. Bulk of the gains came at the expense of individual traders and others, who lost a combined Rs61,000 crore by investing in stock futures and options.