From exposure to enforcement: Inside SEBI’s new derivatives discipline
- CCL NLUO
- 17 minutes ago
- 6 min read
Author: Himansh Soni
Second year student at Hidayatullah National Law University, Raipur
I. Background
The Indian F&O markets have experienced an unprecedented bull run since the pandemic, which has simultaneously engendered augmented market exposure and undersecured position stacking. In efforts to mitigate these systemic risks, on 29 May 2025, the Securities and Exchange Board of India (“SEBI”) issued a circular tendering Measures for Enhancing Trading Convenience and Strengthening Risk Monitoring in Equity Derivatives. Preceded by a Consultation Paper issued by SEBI on February 24, 2025, the circular aims to enhance monitoring and disclosures of risks in F&O and reduce spurious F&O bans by ameliorating the oversight mechanism. Consequently, an analysis of the circular is necessary to assess SEBI’s efforts aimed at regulatory reforms and aligning India with global trading standards.
Through this article, the author engages with various facets of the circular in three segments. Firstly, it lays down the major takeaways vis-à-vis their legal backdrop and imperatives. Secondly, it highlights the potential shortcomings of the circular. Lastly, it puts forth the author’s suggestions to mitigate these hurdles, summing up the circular with a way forward.
II. Delta- Deep: Measuring up the SEBI’s reforms in the circular
The SEBI, exercising its statutory power under Section 11 of the SEBI Act of 1992 (hereinafter referred to as “1992 Act”), has introduced a series of regulatory measures aimed at strengthening oversight and risk metrics with the view of investor protection amid the evolving derivative market in recent years, with heightened retail participation and trading volumes in index derivatives on expiry day. The index derivatives, especially the short-dated options on indices, have experienced a surge in activity, which heightens in the expiry days as the traders seek to benefit from rapid time decay and low upfront premiums, resulting in concentrated intraday activity and exaggerated systemic exposure.
This initiative aligns with the Preamble of the 1992 Act, which provides for the protection of the interests of investors as one of the aims of the SEBI. Firstly, the Circular has provided for linking the Market Wide Position Limit (“MWPL”) for single stocks to the cash market and calibrating it to a new formulation of Open Interest (“OI”). This initiative aims to reduce the potential manipulation by linking the risk arising from the speculation of derivatives to the liquidity and capacity of the underlying cash market. It ensures that the speculative positions do not disproportionately exceed the actual liquidity of the underlying derivative, avoiding circumstances where illiquid stocks are allowed high derivative exposure, leading to heightened speculation and price manipulation of the underlying stock. The measure aligns with global standards, such as the European Securities and Markets Authority (“ESMA”), which has developed Regulatory Technical Standards (“RTS”). Article 9 of the Commission Delegated Regulation dated 1 December 2016 of the ESMA provides for a baseline mechanism for calculating position limits based on deliverable supply for a particular commodity derivative, hence gauging the capacity of the market to respond to speculative exposure. Furthermore, it aligns with Regulation 4(2) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating To Securities Market) Regulations, 2003, which prohibits manipulative and fraudulent trade practices.
Secondly, the watchdog has decided to measure the OI of the participants in derivatives at the portfolio level by computing the net Delta-adjusted open positions across F&O at a given point in time. Delta refers to a measure that compares the change in the price of the underlying stock with that of an option. This initiative aims to gauge the real market exposure by avoiding distortions arising from nominal OI measurement. This aligns with international legal principles such as Principle 6 of the International Organization of Securities Commissions Principles (“IOSCO Principles”), which obligates the Regulator to have a process to mitigate and manage systemic risks. Furthermore, this comes as an extension of SEBI’s efforts to specify a framework of dynamic trade-based price checks to prevent uncontrolled trades, as a part of its Pre-trade Risk Controls. This move was necessitated by the F&O frenzy in the earlier half of 2024, which involved a frenetic retail trading, posing a plethora of challenges and potential bans in the market. Thus, to resolve the impediment of the risk of artificial ban periods, the regulator considered transitioning to Delta-based OI, which potentially reduces this possibility by taking into account only the effective exposure of out-of-money positions.
Thirdly, to deal with the fear of manipulation of underlying derivatives associated with large index positions, SEBI has stipulated PAN-level limits for index options as Rs. 1,500 crores to be the Net End of Day Future Equivalent Open Interest (“FutEq OI”) and gross FutEq OI to be Rs. 10,000 crores. The measure stands as a continuation of the PAN-based monitoring of the regulator to prevent the circumvention of position limits via multiple brokers or accounts, however, this time it comes with a tightening for exposure control in the form of the use of net and gross delta-adjusted exposure metrics. This is in line with Regulation 18 of SEBI (Stock Brokers) Regulations, 1992, which calls for a stockbroker to maintain client-wise end-of-day margins and ensure other compliance and risk management processes. The impetus for this measure stems from cases like Karvy Stock Broking v SEBI, where IPO shares reserved for retail applicants were manipulated by fictitious dematerialized demat accounts created by key operators, thereby monopolizing the retail allotment.
Lastly, to ensure positions are backed with adequate risk coverage, SEBI has mandated the monitoring of positions in equity derivatives indices based on the total open interest of the market at the end of the previous day’s trade. If a party holds positions beyond the permissible limit without being backed by sufficient cash or security holdings, then it will be deemed non-compliant and has to reduce its options positions by the end of T+1, as per the delta value of derivatives contracts as of the end of T+1. The case of Archegos Capital's Collapse highlights the ramifications of unbacked leveraged derivative positions, where the entity utilized return swaps to take long positions with insufficient backing, leading to a collapse in the market as the derivative prices fell and the entity failed to meet margin calls.
III. Margins of Error: Key Shortcomings of the Circular
While the circular marks a significant stride towards exposure-based surveillance and systemic risk management, concerns persist over potential hurdles to its effectiveness that warrant closer scrutiny. Firstly, the measure of PAN-level monitoring in derivatives is primarily based on the assumption of a precise and synchronized data integration for the enforcement of respective measures across all the exchanges, brokers, and clearing corporations. However, data synchronization lags and infrastructural gaps persist, especially across foreign institutional participants and brokers operating through diverse systems, which can potentially lead to flawed reporting of exposure. The issue lies in the lack of a centralized mechanism responsible for the aggregation of diverse data sets, leading to impediments in implementation. A pertinent instance highlighting this problem is the Karvy Stock Broking Investigation in 2019, where it was found that the stockbroker was able to hide its misdeed of misusing securities of its clients by not reporting the concerned accounts in its submissions to the NSE.
Hence, to resolve this impediment, SEBI must establish a centralized position aggregation system that operates on uniform data protocols and utilizes real-time API-based updates. The Indian regulator can take inspiration from its global counterparts, such as the US, which, along with FINRA, operates the Consolidated Audit Trail (“CAT”), which captures data on order and trading activity in US equity markets. Such a system can also publish biannual integration scorecards reflecting compliance infrastructure at the intermediary level.
Secondly, the T+1 compliance requirement for monitoring of index positions mandates option positions to be backed either by cash/cash equivalent or securities; however, this mechanism does not specify any relief apparatus when such positions are already fully margined and hedged, which can potentially penalize margin-compliant trades having low exposure. A pertinent incident highlighting this impediment is the Amaranth Advisors Fund Collapse in 2006, where the fund’s large concentrated exposure in natural gas derivatives triggered its collapse, which was exacerbated by regular margin calls and the fund’s failure to meet intraday requirements.
To mitigate this issue, the regulator can incorporate a marginal equivalence relief mechanism, which allows participants to maintain positions above the limit if the margin covers the worst-case exposure as per delta-adjusted metrics suggested in the circular, and the positions are delta-neutral. Further, the risk associated with a shortfall in margin can be monitored with real-time alerts through administration by clearing corporations.
IV. Conclusion
SEBI’s risk monitoring framework is a significant advancement towards addressing the flaws in the existing framework and modernizing it in consonance with global standards. The regulator has responded to the frenetic retail trade and growing complexity of the market by formulating dynamic measures in the form of PAN limits and delta-adjusted position monitoring. However, the efficacy of these reforms can be hindered by implementational and structural issues, which need to be overcome to serve the intended purpose of these reforms.
