India’s Financial Regulators to Address Rising Derivatives Risks

India’s financial landscape is poised for an examination as the country’s top financial regulators plan to establish a committee aimed at assessing potential stability risks emanating from the rapid expansion in the derivatives markets. This move comes in the wake of a notable surge in options trading, primarily propelled by a robust influx of participation from retail investors.

Surge in Options Trading

According to the National Stock Exchange (NSE), the notional value of index options traded escalated dramatically in the fiscal year 2023-24, soaring to an impressive $907.09 trillion. This represents a more than twofold increase from $447.69 trillion recorded in the previous year. This surge highlights a significant trend towards derivatives trading within the Indian market, raising concerns among regulatory bodies regarding the sustainability and risks associated with such a rapid expansion.

Formation of the Committee

Sources familiar with the plans have indicated that the Financial Stability Development Council, which comprises key figures including the Finance Minister, the Governor of the Reserve Bank of India, and the Chairperson of the Securities and Exchange Board of India (SEBI), will spearhead the committee’s formation. While the specific members of the committee and its reporting timeline are yet to be finalized, this initiative is anticipated to be a direct response to the changing dynamics within the financial sector.

Objectives of the Committee

The newly formed panel will be tasked with examining potential systemic risks associated with the growing derivatives trading sector. Among its objectives, the committee will evaluate the necessity for enhanced investor protection measures and increased regulatory oversight. Additionally, the committee will investigate the potential correlation between the rise in small, unsecured loans and options trading activity.

One of the sources reported that the committee would conduct thorough checks on the end-use of funds lent by non-banking finance companies (NBFCs) that engage in broking activities, particularly to determine whether these funds have contributed to increased exposure in the capital markets.

Growth in Personal Loans

Recent data from the Reserve Bank of India indicates that personal loans—whose utilization is often not extensively monitored—have been witnessing a significant growth trend, expanding at over 20% annually. This rapid growth raises further questions about financial stability and the interconnectedness of personal borrowing and trading in derivatives.

Current Market Realities

A report from Axis Mutual Fund released in October 2023 underscores the stark reality of India’s derivatives market, revealing that the notional value of derivatives traded is an astounding 422 times greater than that of traditional cash trading—a significant outlier on the global stage where derivatives typically account for just 5 to 15 times cash market volumes. Furthermore, it highlights that India’s premium turnover to cash ratio is also higher than most global economies, signifying a unique and robust derivatives trading environment.

Conclusion

As the committee prepares for its formation and subsequent assessments, stakeholders within the financial sector will be keenly observing its developments. With the increasing complexity of India’s financial markets, the regulators’ proactive approach in addressing emerging risks reflects an essential commitment to maintaining stability and protecting investors in a rapidly evolving landscape. As more information becomes available regarding the committee’s specific actions and recommendations, the implications for both retail investors and the broader financial community will be significant.