This is the whole section of the SEBI document in concern.
4.4 Taking into account trading of individual investors in derivatives
especially options, is there a need to introduce a product suitability
framework in our market.
Feedback
4.4.1 Total 66 responses have been received out of which 40 responses
were received from institutional investors, including stock brokers.
Remaining responses have been received from non-institutional
investors.
4.4.2 Around half of the respondents, including institutions and noninstitutions,
are of the view that product suitability may not be
required in light of the existing Risk disclosure documents that is
mandated while on-boarding clients in F&O segment and
requirement under SEBI (Stock-Brokers and Sub-Brokers)
Regulations, 1992. The remaining respondents felt that there is need
to have product suitability framework for derivatives.
Our Comments
4.4.3 Comparative analysis of the various jurisdictions indicate that certain
jurisdictions have specific provisions for retail investors to qualify
them for trading in derivatives. For instance, South Korea has
“Qualified Retail Investor” Scheme. To prevent retail investors from
making reckless investments and incurring huge losses in derivatives
markets, South Korea has allowed only “qualified” retail investors to
enter derivative market by establishing two stages of entry barriers’
First stage - Retail investors who have completed prior education
program and mock trading; and deposit at least KRW 30 million
(i.e. Rs. 17.1 lakh approx.) as initial margin are allowed to trade
simply-structured futures such as KOSPI200 futures or individual
stock futures.
Second stage - Retail investors with more than one-year trading
experience allowed under the 1st stage and KRW 50 million of
minimum margin (i.e. Rs 28.5 lakh approx.) will be allowed to
trade complicatedly structured-futures and options such as VKOSPI200
futures.
4.4.4 It is noted that internationally the product suitability framework has
evolved taking into consideration the following:
Minimum Income level/Net worth,
Minimum educational qualification,
Minimum experience in dealing in the market,
Due diligence by stock brokers while dealing with clients in
derivative market.
4.4.5 Current framework in India: Risk Disclosure Document:
At the time of on-boarding of a client by a broker, it is mandatory
that a broker executes a Risk Disclosure Document (RDD) and
the same is included in the documentation related to client
registration. The RDD has a separate detailed paragraph, which
contains information about the risks involved in trading in the
derivatives segment. Some of the statements which are given in
the document are as follows:
o The amount of margin is small relative to the value of the
derivatives contract so the transactions are “leveraged” or
“geared”.
o Trading in derivatives can be conducted with a relatively small
amount of margin and there is a possibility of great profit or
loss in comparison with the margin amount.
o Transactions in derivatives carry a high degree of risk.
o The losses may exceed the original margin amount.
o Risk of Option holders: An option holder runs the risk of
losing the entire amount paid for the option in a relatively short
period of time. This risk reflects the nature of an option as a
wasting asset which becomes worthless when it expires. An
option holder who neither sells his option in the secondary
market nor exercises it prior to its expiration will necessarily
lose his entire investment in the option. If the price of the
underlying does not change in the anticipated direction before
the option expires, to an extent sufficient to cover the cost of
the option, the investor may lose all or a significant part of his
investment in the option.
o Risks of Option Writers: If the price movement of the
underlying is not in the anticipated direction, the option writer
runs the risks of losing substantial amount. A spread position
is not necessarily less risky than a simple ‘long’ or ‘short’
position. Combination transactions, such as option spreads,
are more complex than buying or writing a single option. And
it should be further noted that, as in any area of investing, a
complexity not well understood is, in itself, a risk factor.
Trading preferences: It is mandatory for the clients to provide
their trading preference in terms of the exchanges and segments
they want to trade (CIR/MIRSD/16/2011 dated August 22, 2011).
Financial Details: It is mandatory for clients who opt to trade in
derivatives segment to give their financial details i.e. their income
and the proof of income at the time of account opening.
(CIR/MIRSD/16/2011 dated August 22, 2011).
All dealers who operate in derivatives market have to pass
relevant NISM examination or are required to undergo CPE
training prescribed by NISM.
4.4.6 The regulatory framework in India has mainly evolved on the premise
of disclosures. Such disclosures are required to be given at the time
of on boarding of a client by a broker in terms of ‘Rights and
Obligations’ document(s) and ‘Risk Disclosure Document’. A client
needs to confirm having read and understood the contents of the
documents executed with the Stock Broker. In addition, SEBI (StockBrokers
and Sub-Brokers) Regulations, 1992 also specify the code of
conduct for stock brokers while dealing with clients.
4.4.7 Further, in the F&O segment of our market, it is mandatory for
members to collect initial margins from respective clients on an
upfront basis.
4.4.8 At the same time, however, a large proportion of individual investors
trade in derivatives including writing of Options. Contribution of
individual investors to the total turnover in the equity derivative
segment was 25.67% during the FY 2016-17. Some of these
individual investors may not be conversant with the risks associated
with derivatives, even though they have been on boarded based on
signing of the risk disclosure documents.
Proposal:
4.4.9 Considering that different jurisdictions have mandated specific
product suitability norms for individual investors and it is important to
maintain a balance with regard to providing opportunities and
freedom to individual investors to express their views vis a vis risk
associated with derivatives market, it is proposed that;
4.4.9.1 Individual investors may freely take exposure in the market
(cash and derivatives) upto a computed exposure based on
his disclosed income as per his ITR over a period of time.
For any exposure beyond the computed exposure, the
intermediary would be required to undertake rigorous due
diligence and take appropriate documentation to satisfy the
credit/exposure suitability of the individual investor.
4.4.9.2 Determination of the computed exposure and details of due
diligence documents required shall be formulated in
consultation with market participants.