Guidelines of SEBI and RBI

With the amendment in the definition of ”securities” under SC(R)A (to include derivative contracts in the definition of securities), derivatives trading takes place under the provisions of the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992. 

Dr. L.C Gupta Committee constituted by SEBI had laid down the regulatory framework for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lays down the provisions for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/House have to be framed in line with the suggestive Bye-laws. SEBI has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/House. The eligibility conditions have been framed to ensure that Derivative Exchange/Segment & Clearing Corporation/House provide a transparent trading environment, safety & integrity and provide facilities for redressal of investor grievances. Some of the important eligibility conditions are :

1. Derivative trading to take place through an online screen based Trading System. 
2. The Derivatives Exchange/Segment shall have online surveillance capability to monitor positions, prices, and volumes on a real time basis to deter market manipulation. 
3. The Derivatives Exchange/ Segment should have arrangements for dissemination of information about trades, quantities and quotes on a real time basis through atleast two information vending networks, which are easily accessible to investors across the country. 
4. The Derivatives Exchange/Segment should have arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country. 
5. The Derivatives Exchange/Segment should have satisfactory system of monitoring investor complaints and preventing irregularities in trading. 
6. The Derivative Segment of the Exchange would have a separate Investor Protection Fund.
7. The Clearing Corporation/House shall perform full novation, i.e. the Clearing Corporation/House shall interpose itself between both legs of every trade, becoming the legal counterparty to both or alternatively should provide an unconditional guarantee for settlement of all trades. 
8. The Clearing Corporation/House shall have the capacity to monitor the overall position of Members across both derivatives market and the underlying securities market for those Members who are participating in both. 
9. The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the position. The concept of value-at-risk shall be used in calculating required level of initial margins. The initial margins should be large enough to cover the one-day loss that can be encountered on the position on 99% of the days.
10. The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for swift movement of margin payments. 
11. In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House shall transfer client positions and assets to another solvent Member or close-out all open positions. 
12. The Clearing Corporation/House should have capabilities to segregate initial margins deposited by Clearing Members for trades on their own account and on account of his client. The Clearing Corporation/House shall hold the clients’ margin money in trust for the client purposes only and should not allow its diversion for any other purpose. 
13. The Clearing Corporation/House shall have a separate Trade Guarantee Fund for the trades executed on Derivative Exchange / Segment.
Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE and the F&O Segment of NSE.

The Reserve Bank of India (hereinafter referred to as ‘RBI’), vide A.P. (DIR Series) Circular No. 11 [RBI/2017-18/88]1 dated November 9, 2017, has notified that the Simplified Hedging Facility for risk management and inter-bank dealings will be effective from January 1, 2018. RBI stated that this facility is being introduced in order to simplify the process of hedging exchange rate risk by reducing documentation requirements.

The purpose and guidelines:

The scheme of Simplified Hedging Facility was announced by the RBI for the first time in August, 2016, and the draft scheme was released on April 12, 2017. Earlier this year, RBI had also released a Statement on Developmental and Regulatory Policies, dated August 2, 2017, wherein it was stated that this scheme is aimed at simplifying the process for hedging exchange rate risk by reducing documentation requirements and avoiding prescriptive stipulations regarding products, purpose and hedging flexibility. RBI also stated that this scheme is expected to encourage a more dynamic and efficient hedging culture.

In furtherance to the same, RBI has notified guidelines through this notification which will govern this facility. Any Over the Counter (OTC) derivative or Exchange Traded Currency Derivative (ETCD) permitted under the Foreign Exchange Management Act, 1999, (hereinafter referred to as ‘ FEMA, 1999’) will be covered under this scheme. The purpose of this facility as per the guidelines is to hedge exchange rate risk on transactions permissible under FEMA, 1999.

The companies under this scheme can take exposure of up to USD 30 million on gross basis. Further, as per the guidelines, if hedging requirement of the user exceeds the limit in course of time, the designated bank may re-assess and, at its discretion, extend the limit up to 150% of the stipulated cap.

Also, in accordance with the guidelines the banks shall have an internal policy regarding the time limit up to which a hedge contract for a given underlying can be rolled-over or rebooked by the user and when the user migrates to other available facilities, the designated bank shall report this information to the Trade Repository and the Trade Repository shall update this information in its records and notify the recognized stock exchanges to stop reporting data for the user concerned.

This facility is expected to avoid unnecessary hurdles and to encourage a more dynamic and efficient hedging culture.

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