SEBI's F&O Crackdown: Collateral Damage to UK Market?

The Securities and Exchange Board of India (SEBI) is proposing new regulations for Futures & Options (F&O) trading, and experts warn of potential negative consequences, echoing concerns raised a decade ago in South Korea.

The South Korean regulator's attempt to protect retail investors by increasing minimum deposits and mandating F&O trading education resulted in a significant drop in trading volume. The regulator was later forced to partially roll back these measures.

Industry experts fear a similar outcome in India. They argue that the market relies on diverse participation for optimal function. Increasing barriers to entry could deter retail investors from hedging, potentially leading to decreased activity from market makers and liquidity providers.

"If market makers, who profit from options, reduce their activity, this reduction could extend to the cash market as well," warns Rishi Kohli, CIO of Hedge Fund Strategies at InCred Asset Management. He explains that even small retail investors, who use F&O for hedging purposes, contribute to market activity. Reducing this participation could impact liquidity, leading to higher trading costs and potentially impacting even long-term investors.

The proposed changes could also impact government revenue. India earns a substantial £6 billion annually in taxes from the equity market, with minimal administrative costs. While only a third of this revenue comes from retail investors, any restrictions on F&O trading could reduce this income stream.

Jimeet Modi, founder of SAMCO Securities, highlights the potential impact on market liquidity. "In a highly liquid market like the National Stock Exchange (NSE), impact costs are typically lower due to numerous buyers and sellers. However, in less liquid markets like the Bombay Stock Exchange (BSE), the impact cost is higher because each trade has a greater effect on the price," he explains.

He warns that restricting F&O trading could lead to reduced liquidity, increasing systemic risk.

Atul Parakh of Bigul believes that imposing additional charges on F&O trading is not the solution. "Increasing costs will only lead to losses and will not have a significant impact on market dynamics," he says.

Zerodha's CEO, Nithin Kamath, agrees that the proposed changes, even with an increase in Securities Transaction Tax (STT), are unlikely to impact options volumes significantly. However, he believes that futures volumes will decline. He attributes this to the higher odds of profitability for futures traders compared to options traders.

Kamath suggests that a product suitability framework, which would make it more difficult for casual traders to participate, could be a more effective solution to reduce speculation. He also highlights the importance of addressing the root cause of declining household savings, which he attributes to higher inflation and rising interest rates.

Experts advocate for a more liberal approach to India's financial markets, arguing that excessive regulation could hinder economic growth and development. They highlight the importance of allowing free market forces to operate and advocate for a learning experience from the US markets, which primarily focus on regulation and awareness rather than direct market intervention.

In conclusion, the proposed F&O regulations in India have the potential to significantly impact the market, with implications extending beyond the derivatives segment. Experts express concerns over reduced liquidity, increased trading costs, and potential revenue losses for the government. The discussion raises questions about the effectiveness of the proposed measures and highlights the importance of balancing investor protection with market efficiency and growth.