07 March 2010

Exchange based derivatives reforms

The SEBI Board decided the following on 5th Mar 2010:

A. Margin Requirement in Public Issues
The Board decided that with effect from 1st May 2010, all types of investors would be required to bring in 100% of the application money as margin along with the application for securities in public issues. This would avoid inflated demand in public issues and provide level playing field to all investors subscribing for securities.

B. Reservation for Employees in Public/Rights Issues
The Board also decided that the reservation for employees in public/rights issues would be available to employees of subsidiaries and material associates of the issuer whose financial statements are consolidated with the issuer’s financial statements.

C. Reforms in Derivatives Market
The Board further decided in principle to allow the Stock Exchanges to introduce:
a. equity derivatives contracts with tenures upto 5 years;
b. derivative contracts on volatility indexes which have suitable track record, and
c. physical settlement of equity derivatives.

C (a) and (b) are very interesting developments and will allow Indian exchange based derivatives to mature. All we need is allowing a borrowing and lending market in securities to prosper, which is still-born because of regulatory restrictions on tenure (still short and a compulsory put and call make it useless) and centralised (people should be allowed to borrow and lend to who they choose, not mandatorily through a centralised mechanism).

Physical settlement of securities in equity derivatives is probably an economic non event as it is unlikely to improve any efficiencies in the pricing.

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