Derivatives Trading

REGULATORY FRAME WORK

The trading of derivatives is governed by the provisions contained in the SC(R)A, the SEBI Act, the regulations framed the reunder and the rules and bye-laws of stock exchanges.

In this chapter we look at the broad regulatory frame work for derivatives trading and the requirements to become a member and an authorized dealer of the Futures and Options segment and the position limits as they apply to various participants.

REGULATION FOR DERIVATIVES TRADING

SEBI has setup a 24 member committee under the Chairmanship of Dr. L.C. Gupta to develop the appropriate regulatory framework for derivatives trading in India.

On May, 11, 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index futures.

The provisions in the SC(R)A and the regulatory framework developed the rounder govern trading in securities. The amendment of the SC(R)A to include derivatives within the ambit of’securities’ in the SC(R)A made trading in derivatives possible within the framework of that Act.

  1. Any Exchange fulfilling the eligibility criteria as prescribed in the LC. Gupta committee report can apply to SEBI for grant of recognition under section 4 of the SC(R)A, 1956 to start trading derivatives. The derivatives exchange/segment should have a separate governing council and representation of trading/clearing members shall be limited to maximum of 40% of the total members of the governing council. The exchange would have to regulate the sales practices of its members and would have to obtain prior approval of SEBI before starting of trading in any derivative contract.
  2. The Exchange should have minimum 50 members.
  3. The members of an existing segment of the exchange would not automatically become the members of derivative segment. The members of the derivative segment would need to fulfill the eligibility conditions as laid down by the LC Gupta committee.
  4. The clearing and settlement of derivatives trades would be through a SEBI approved clearing corporation/house. Clearing corporations/houses complying with the eligibility conditions as laid down by the committee have to apply to SEBI for grant of approval.
  5. Derivative brokers/dealers and clearing members are required to seek registration from SEBI. This is in addition to their registration as brokers of existing stock exchanges. The minimum net worth for clearing members of the derivatives clearing corporation/house shall be RS.300 lakh. Thenetworth of the member shall be computed as follows.

I.      CAPITAL + FREE RESERVES

II.    LESS NON-ALLOWABLE ASSETS VIZ

a.     Fixed Assets

b.     Pledged securities

c.      Member’s cards

d.     Non-allowable securities, (unlisted securities).

e.     Bad deliveries

f.     doubtful debts and allowances.

g.     prepaid expenses.

h.    Intangible assets

i.      30 % marketable securities.       

1.     The minimum contract value shall not be less than Rupees two lakh. Exchanges have to submit details of the futures contract they propose to introduce.

2.     The initial margin requirement, exposure limits linked to capital adequacy and margin demands related to the risk of loss on the position will be prescribed by SEBI/ Exchange from time to time.

3.     The LC Gupta committee report requires strict enforcement of “Know your customer” rule and requires that every client shall be registered with the derivatives broker. The members of the derivatives segment are also required to make their clients aware of the risks involved in derivatives trading by issuing to the client the Risk Disclosure Document and obtain a copy of the same duly signed by the client.

4.     The trading members are required to have qualified approved user and sales person who have passed a certification programme approved by the SEBI.

 

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