NISM Series VIII: Equity Derivatives | Chapter 8: Legal & Regulatory Environment | Full Study Notes

CHAPTER 8: LEGAL AND REGULATORY ENVIRONMENT

8.1 INTRODUCTION TO THE ACTS

The regulatory framework for derivatives in India is governed by two primary acts:

Securities Contracts (Regulation) Act (SCRA), 1956

  • Objective: Aims to prevent undesirable transactions and governs securities trading in India.

  • Definition of 'Securities': Includes shares, bonds, derivatives, units from collective investment schemes and mutual funds, and government securities.

  • Derivatives Validity: Legally valid only if traded and settled on a recognized stock exchange according to its rules and bylaws.

SEBI Act, 1992

  • Establishment: Establishes SEBI with statutory powers to protect investor interests and regulate the market.

  • Key Functions:

    • Protect investor interests and combat fraudulent practices.

    • Oversee corporate issuance and transfer of securities.

    • Conduct inspections, audits, and regulate stock exchanges.

8.2 EVOLUTION OF DERIVATIVES REGULATION

  • L.C. Gupta Committee: Established by SEBI to develop the regulatory framework for derivatives.

  • Phased Introduction: On May 11, 1998, SEBI approved the phased introduction, starting with stock index futures.

  • SCRA Amendment: The SCRA was amended to include derivatives under the definition of 'securities'.

8.3 ELIGIBILITY AND GOVERNANCE

Exchange Requirements

  • Must have a separate governing council with a maximum of 40% representation from trading/clearing members.

  • Requires a minimum of 50 members.

  • Must obtain prior SEBI approval before starting any derivatives contract trading.

Membership and Net Worth

  • Derivative Brokers/Dealers: Must register with SEBI separately from their cash market registration.

  • Clearing Member Net Worth: Must be Rs. 300 Lakhs.

    • Formula: Net Worth = Capital + Free Reserves - Non-Allowable Assets.

    • Non-Allowable Assets: Fixed assets, pledged securities, bad debts, and unlisted securities.

Contract and Margin Requirements

  • Minimum Contract Value: Must be at least Rs. 5,00,000.

  • KYC & Risk Disclosure: Clients must sign a Risk Disclosure Document to be informed of potential risks before trading.

8.4 RISK MANAGEMENT REGULATIONS

  • Margins: Clearing members must pay initial margins upfront (Cash, Bank Guarantees, or approved securities).

  • Liquid Assets: CMs must maintain adequate liquid assets; at least 50% must be in the form of cash.

  • Trade Guarantee Fund (TGF): Funded by exchange members to protect investors and guarantee settlement.

  • Inspection: Member brokers must be inspected by the exchange at least once a year.

  • Position Limits: Maximum exposure levels set by SEBI. If reached, a member can only square-off existing positions.

8.5 ELIGIBILITY FOR MEMBERSHIP

  • Balance Sheet Net Worth:

    • Clearing Members: Rs. 3 Crore.

    • Self-Clearing Members: Rs. 1 Crore.

  • Liquid Net Worth: Must maintain at least Rs. 50 Lakh with the exchange/clearing corporation.

  • Certification: Members and at least two approved users must pass a SEBI-approved certification program (e.g., NISM Series VIII).

8.6 SOP FOR DEFAULT BY TM OR CM

SEBI mandated a Standard Operating Procedure (SOP) to protect non-defaulting clients:

  1. Interim Measures: Settle credit balances of small investors (< Rs. 25 Lakh) using available deposits.

  2. Pro-rata Payments: Investors with balances > Rs. 25 Lakh are paid proportionately from remaining funds.

8.7 SOP FOR STOCK EXCHANGE OUTAGE

Procedures for technical glitches and extending trading hours:

ScenarioExtension of Trading Hours
Normal trading resumes at least 1 hour before market closure.

No change required.

Trading does not resume within 1 hour of scheduled closure.

All exchanges extend trading hours by 1.5 hours.

Outage happens in the last hour (up to 15 mins before closure).

All exchanges extend trading hours by 1.5 hours.

Dhaval Visariya

AMFI Registered Distributor (ARN-327925) | Software Developer & Finance Enthusiast

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Disclaimer: I am an AMFI Registered Mutual Fund Distributor. Views expressed here are for educational purposes. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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