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The recent actions of SEBI to regulate India's derivatives market with respect to foreign portfolio investors (FPIs) have brought about significant changes. The intention is to enhance the market liquidity, improve trading conditions in the market, and make sure that only the institutional clients engage themselves in such contracts. This intervention will bring stability and participation to the Indian capital market.
But at the same time, there are some challenges that need to be navigated by the investors.
Larger Lot Sizes: SEBI's new regulation increases lot sizes for index derivatives like Nifty and Bank Nifty from ₹5 lakh to ₹20 lakh. This aims to control speculation and encourage long-term investment by requiring FPIs to commit more capital per contract. The benefits for the larger institutions are obtained, while the capital requirements will cause liquidity pressure on the smaller FPIs. It changes the mode of participation by FPIs in the Indian equity derivatives market, thereby strengthening the market. On the other hand, this would seem like an opportunity for market power consolidation for big institutions.
Single Weekly Index F&O Expiry on Each Exchange: The other changes introduced by SEBI are weekly expiry for certain derivatives. While such a move may be accommodating for traders who want a short-term hedging facility, it also requires an increased level of active surveillance on positions. Weekly expiry could introduce some volatility and make risk management somewhat trickier, so execution would have to be even more precise. This is highly impactful for foreign investors who have been accustomed to the system of quarterly expiry. The weekly expiry forces investors to make decisions much more quickly, and in some cases, might even trigger a need for more sophisticated strategies and tools.
FPIs Future Outlook: For FPIs, this could be a shift in strategy as they now have to commit larger amounts of capital to meet the new margin requirements for trading index futures and options. India's economy has seen very strong demand, with a 150% ratio of NSE market cap to GDP in September 2024, which was the highest in over 20 years. Despite losses to individual investors in the F&O market, FPIs booked profits of ₹28,000 crores in FY24, which is likely to position them well to thrive and further strengthen India's emerging F&O market.
Overall, SEBI’s order is well-intentioned to rationalize market operations and institutional depth; FPIs will be required to alter their trading strategies. The integration of weekly expiry and greater lot sizes will probably induce a more complex and intense form of risk management among FPIs, in which both short-term as well as long-term factors become pertinent when participating in Indian derivatives markets.
Thank you.
Regards,
Kautilya, IBS Mumbai.
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