India Tightens Margin and Disclosure Rules to Secure Equity Derivatives Market

India is implementing stricter margin and disclosure rules in its equity derivatives market to make stock trading more secure and less like gambling. This initiative aims to protect small-time traders and prevent a market collapse, although it could reduce profits for trading firms like Jane Street and newer discount brokers.

The move comes in response to the exponential growth in the market, which has become the world’s largest by trade volume.

The COVID-19 pandemic led to a surge in retail trading, driving Indian index options turnover to $135 billion in March, a sixfold increase from four years prior.

The number of active derivative traders also grew significantly, from less than half a million in 2019 to four million, as reported by Axis Bank’s mutual fund. This dramatic rise has made India’s market highly active despite its trade value still lagging behind that of more developed markets like the United States.

However, the rapid expansion has come at a cost. A study by the Securities and Exchange Board of India (SEBI) found that nine out of ten individuals trading in futures and options incurred losses in the year ending March 2022.

This situation has led to unusual scenarios where trading tips are commonly exchanged among commuters in Mumbai, and young people in rural areas view trading as a quick path to wealth. Consequently, India’s stock exchanges have proposed a written test for individuals looking to trade derivatives.

Regulatory measures have partly fueled this trading boom. SEBI’s 2020 tightening of margin norms for cash equity trading drove traders toward options. Additionally, the rise of discount brokers like Zerodha and Angel One, which charge significantly lower fees than traditional brokers, has made trading more accessible.

Both companies reported substantial profit growth in the year ending March 2023, while more traditional brokers like ICICI Bank saw earnings decline.

Higher margins on derivatives could potentially curb retail investor activity and impact local brokers and large funds that rely on high trade volumes. However, this regulatory tightening could also introduce new risks similar to those seen with the 2020 rules.

SEBI remains undeterred by these potential issues, as financial busts can rapidly spread throughout India’s financial system, as evidenced by the 2018 default of a large shadow bank. Therefore, making derivatives trading less speculative is considered crucial to maintaining market stability.