Regulatory Updates #32: SEBI introduces options in commodity trading, increases check and balances for brokers, & more

Varun Marwah

Bar & Bench will bring you the latest regulatory and policy updates from different ministries and regulatory authorities. In the this edition of the Bar & Bench Regulatory Updates, we analyse the latest circulars by the Securities and Exchange Board of India (SEBI).

SEBI introduced options contracts in commodity trading

Ushering in a new era in commodity trading, SEBI has allowed commodity derivate exchanges to launch options contracts for trading, a move which will deepen the commodity derivatives market and attract more investors.

This move comes precisely one year after the Forward Markets Commission was merged with SEBI.

Until now, only futures contracts based on individual commodities are traded on commodity exchanges. However, exchanges will need prior approval from SEBI for launching options trading for which detailed norms will be released later.

SEBI tightens warehousing norms

SEBI has sought to rectify the faulty warehousing norms which contributed to the infamous NSEL scam.

In a circular issued last week, SEBI has significantly tightened the warehousing norms. The final norms have been put in place after taking into consideration views of all stakeholders.

SEBI has directed commodity exchanges to follow a stronger and transparent process for accreditation of warehouse service providers (WSPs)

Under the new framework, a WSP can be accredited, but not shared, with more than one exchange. A WSP’s license is valid for three years after which it has to be renewed on the basis of its performance, quality of services and number of client complaints, the regulator said.

Further, every accredited WSP will need to have a paid up capital of at least Rs. 10 crore if it deals in a single commodity and a capital of at least Rs. 25 crore if it deals in multiple commodities. For existing accredited WSPs who are not in compliance with these norms, SEBI has set a deadline of 31 March, 2018.

SEBI issues norms on ‘algorithmic’ trade for commodity exchanges

As defined by SEBI- “Any order that is generated using automated execution logic shall be known as algorithmic trading.

Algorithmic trading or ‘algo’ in market parlance refers to orders generated at a super-fast speed by use of advanced mathematical models that involve automated execution of trade, and it is mostly used by large institutional investors.

SEBI’s circular, inter alia, states that:

  • the capacity of the trading system of the exchange should be at least four times the peak order load encountered and the exchange system should be upgraded on a regular basis;
  • commodity exchanges will be able to process 20 orders per second from a user, irrespective of the order size;
  • in case the order-to-trade ratio of a member reaches 500 during a trading day, the member will not be allowed to place any order for the first 15 minutes on the next trading day as a cooling off action;
  • exchanges will have to ensure that immediate or cancel orders are not placed through the algorithmic trade route;
  • exchanges would have appropriate multi-layer risk control mechanism to address the risk emanating from algorithmic orders and trades.

SEBI enhances supervisory framework for stock brokers

Based on recommendations made by an expert committee on “Enhanced Supervision of Stock Brokers”, SEBI has introduced a slew of checks and balances on stock brokers, aimed at monitoring their financial strength as well as detecting any misutilisation of clients’ funds.

These reforms are also believed to be a part of reforms prompted by the NSEL scam which highlighted several irregularities.

Stock brokers will now, inter alia, be required to:

  • follow a uniform nomenclature for “naming/tagging of bank and demat accounts”;
  • report such accounts to stock exchanges and depositories;
  • monitor clients funds lying with the stock broker by the stock exchanges, through a sophisticated alerting and reconciliation mechanism, to detect any misutilisation of clients fund;
  • follow enhanced procedures with respect to reporting, appointment of internal auditors;
  • conduct “monitoring of financial strength of stockbrokers so as to detect any signs of deteriorating financial health of stockbrokers and serve as an early warning system to take pre-emptive and remedial measures”;
  • put in place “sophisticated alerting and reconciliation mechanism” to detect any mis-utilisation of clients’ funds lying with stockbrokers.
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