A panel of industry veterans helped explain the current state of India’s derivatives markets to attendees of the FIA Asia conference in Singapore on 5 December.
Panel moderator Mohit Batra, executive director at Nuvama Investment Advisors, set the stage for the discussion, noting "India derivatives have become such a big buzzword recently.”
Batra largely chalked up the buzz to India having the single largest index options market in the world by number of contracts, with 500 million traded daily.
At the same time, he offered an important perspective about the size of those 500 million contracts. The contracts come in considerably smaller, at $8,000, than those traded on US and other markets around the globe.
To help offer a better apples-to-apples comparison, Batra suggests exploring premiums traded. Where India does approximately $7 billion in premiums, index options in the US – both listed and over-the-counter – bring $11 billion.
India also brings a wide mix of market participants. And, as reported in a 16 August MarketVoice article, much of the rapid growth in the markets comes from retail investors.
“It's not just machines trading against machines, which is in most index options markets in the world. You've got 30% to 40% of daily trading done by retail,” Batra noted.
Historical perspective
A 28-year veteran of the National Stock Exchange of India, K. Hari, now the founder of OnSpin Consultants, offered a historical perspective to the current growth. “In the last five to six years, the Indian market cap has gone up about 2.5 times to about 5.2 trillion.”
Perhaps more importantly, assets under management from outside the country has increased from approximately $500 billion to about $900 billion in that time.
Hari offered that the growth in the past half-decade owes much to increased trust in the markets. “Regulators have done multiple things over a period of time, which has brought a lot of trust in the market. During the peak of COVID, we had interoperability coming between exchanges. Then we had client collateral segregation. Then regulators said that all the brokers need to upstream the client funds at the end of the day to the Clearing Corporation, so the money is safe. Pledging and repledging of securities got streamlined. And last month, one more circular came out regarding how to stress-test to enhance the core settlement guarantee fund. So, all these measures gave a lot of trust and credibility to the market.”
The government changing the security transaction tax (STT) also served as a significant update. It changed from taxing the notional turnover to premium turnover. Where it previously was about 90% futures volume and 10% options volume, those numbers reversed.
This led to exchanges introducing many new products. NSE introduced the Bank Nifty weekly in 2016. “After it got introduced, the whole game changed. Everybody started trading it,” Hari said.
Sunil Ramrakhiani, chief business officer for equities at BSE, discussed how BSE reached out to market participants in May 2023 to learn what they wanted. That led to BSE launching its flagship product, the Sensex 30, which covers the top 30 listed stocks on the BSE. In 18 months, BSE became the second largest derivatives exchange in the world, in terms of number of contracts traded in a day.
From there, the exchanges continued introducing several more weekly contracts. They set up the expiry to land on each day of the week for the contracts, effectively offering zero-day expiry contracts.
According to Hari, "the number of investors grew from 30 million to 105 million,” he said, with about 40 million investors joining the markets from 2020 to 2023.
This influx of activity and the ease with which retail traders can establish an account (five to seven minutes from signing up to trading) caught the eye of the market regulator.
The new regulatory landscape
In July, the Securities and Exchange Board of India (SEBI) proposed a series of steps to curb retail activity in the index derivatives segment, including raising the minimum contract size of index derivatives, limiting weekly options to a single benchmark of an exchange, collecting options premium upfront and reducing the number of strike prices.
Ramrakhiani explained the reasoning behind some of the regulatory changes.
“Under the new regulatory guidelines, one of the important guardrails has been that each exchange has only one weekly expiration index contract,” he said. “In addition to that, there are other important guardrails, in terms of the volume on expiry. Sixty to 80% of the volume used to happen on the expiry day of that contract. To avoid any skewing in terms of the price spikes, which can happen on those days, the exposure loss margins have been increased on the expiry days.”
In addition to those guardrails, another will take effect in early 2025 related to intraday monitoring of position limits.
Robert Risk, head of business development for Asia-Pacific with Susquehanna, discussed the possible impact on trading volume.
“One of the questions that keeps coming up is: How will this impact volume? Because that's going to impact the whole market, exchanges, brokers and trading firms like ours that provide liquidity. We think there will be a significant change to the volumes. If we look at one change, for example, the removal of these weekly options series. The irony of that situation is that Japan, Australia, Hong Kong, they are all desperately bringing new, short-dated option contracts to the market. They're desperate to see more retail flow come into the market. Where everyone's trying to win this retail flow, ironically, in India, they're trying to push it back a little bit.”
“From a market making and liquidity providing perspective, we see 35% of the volume coming from retail. If a retail trading participant comes into the market and buys an option, and we are that seller, we have a choice at that point. Do we go and hedge that position? If we hedge, we'll go and buy another option in the market. Typically, we will buy off one of our peer firms. So, you get this flow. And then what does that peer firm do? Well, they might have to go and buy another option somewhere else, as well. So that retail flow generates more flow. And that's a really important point to understand when we look at the volumes and what's going to happen down the track,” Risk added.
Manu Dua, managing director for APAC prime services and equities with Citi Global Markets in Singapore, sees opportunity in the wake of the guardrails.
“I see more prospective clients wanting to trade in India. The SEBI guardrails protect the market structure and creates a certain expectation on how the market should work. I think this gives that assurance to investors that there is a regulator who is looking after the market.”
“India is a darling for investors wanting to come in, due to the potential opportunities. There is no lack of client interest because certain guardrails were introduced,” he added. “No investors, I think he have lost interest due to guardrails being introduced. Markets will evolve. There will be opportunities now that all the expiries are lined up for the end of the month. Yes, there will be less trading opportunity during the week. But that has not turned investors away.”
George Harrington, managing director and global head of fixed income and derivatives – index for MSCI, brought a different perspective. MSCI offers one of the largest suites of products for accessing India from offshore, both on the ETF side and the futures side.
Harrington said trading with MSCI’s exchange partners – Eurex, ICE, HKEX – has quadrupled year-over-year, and he estimated open interest topped 15 billion in the third quarter. Importantly, as an offshore trade, it’s very institutional with almost no retail.
Much of the interest comes from investors looking to grow their emerging markets basket of investments. Where participants used to look to China, they now look more broadly, including India, Brazil and Saudi Arabia.
As Harrington put it, “The strong story is that the institutional demand continues unfettered. All the MSCI derivative offerings in India, from a growth standpoint, are one of the strongest, if not the strongest by far. The volume is absolutely there.”
