Rapid Increase in Derivatives Trading Raises Concerns for Investors: RBI Report

The Reserve Bank of India (RBI) has highlighted potential challenges due to the rapid increase in Futures and Options (F&O) trade volumes. Retail investors, who may not follow proper risk management practices, could be adversely affected by sudden market movements, according to a recent report.

Representative image

The equity derivatives segment has seen a significant rise in retail investor participation. The number of participants increased by 42.8% from 65 lakh in 2022-23 to 95.7 lakh in 2023-24. This growth underscores the increasing interest among retail investors in the derivatives market.

Impact on Market Liquidity and Price Discovery

According to the RBI's bi-annual Financial Stability Report (FSR), trading volumes in the derivatives segment have grown exponentially in notional terms. However, when measured by premium turnover, the growth has been more linear. The ratio of premium turnover to the cash market has remained stable over the past three years.

The FSR noted that while the equity derivatives market can enhance price discovery and improve liquidity in underlying cash markets, it also comes with higher risks. "Since derivatives are more complex than the underlying, investor protection is a key regulatory imperative," stated the report.

Risks and Regulatory Measures

A study by the Securities and Exchange Board of India (SEBI) published in January 2023 revealed that 89% of individual participants in F&O lost money during fiscal years 2018-19 and 2021-22. This statistic highlights the financial risks retail investors face in this segment.

The RBI report also mentioned that the surge in F&O volumes could lead to several challenges. Retail investors might be impacted by sudden market movements without proper risk management, which could have knock-on effects on the cash market. Additionally, the popularity of shorter-duration options in indices with few stocks and high volatility could amplify leverage.

SEBI's Initiatives for Investor Protection

To address these concerns, SEBI has formed an expert working group under its Secondary Markets Advisory Committee. This group will review F&O markets from both investor protection and systemic risk management perspectives.

SEBI is also reviewing the corpus of the Settlement Guarantee Fund (SGF). This includes stress testing methodologies and scenarios for computing core SGF to create a more resilient settlement system capable of handling contingencies arising from any member's failure to meet obligations on a stock exchange.

These measures aim to build a robust framework that safeguards retail investors while ensuring overall market stability. The focus remains on enhancing investor protection and managing systemic risks effectively.