The Securities and Exchange Board of India (Sebi) is in the process of formulating guidelines that will allow stock exchanges to infuse liquidity into their futures and options (F&O) segments through a liquidity enhancement mechanism. The guidelines, to be issued in a month, would be applicable only for the equity derivative segment of stock exchanges and not cover interest rate derivatives and currency futures, according to a senior Sebi official. The proposal under consideration includes permitting market makers for the derivatives segments and providing cash incentives to traders.
Market making is aimed at infusing liquidity by way of two- way quotes (buy and sell) given by market makers. For market making to succeed there must be traders who are willing to buy or sell securities from such market makers.
?One way to ensure such continuous flow of orders is to provide cash incentives to traders to trade more on the exchange,? the Sebi official said.
Though market making is not banned by the regulator at the moment, exchanges need to seek the regulator?s approval before launching such a scheme if it offers some compensation or incentive structure to the brokers.
?What we are going to issue is a broader regulatory framework governing liquidity enhancement schemes in compliance to which all stock exchanges will be permitted to implement their respective proposals. Market making and cash incentives are one among the several options being considered under the proposed scheme,? said the official.
Sebi has already held two rounds of discussions with senior executives of the National Stock Exchange (NSE), Bombay Stock Exchange (BSE), United Stock Exchange (USE) and MCX Stock Exchange (MCX-SX). After making it operational on the equity derivative segment, Sebi will consider extending the proposed scheme gradually to interest rate derivatives and currency futures segment after holding consultation with the Reserve Bank of India (RBI).
Among the several initiatives proposed by Sebi for the current financial year, laying down the broader principles and defining an incentive structure for market making is one of its top priorities. The major beneficiary of the proposed scheme will be BSE, which has been making persistent attempts to revive its derivative segment and increase market share. Allowing market makers and providing cash incentives is one of the measures being actively considered by the exchange to boost liquidity in its derivative segment. BSE recently shifted to a delivery-based settlement for F&O contracts from a cash-based settlement mechanism to woo traders from its rival exchange.
At present NSE dominates the equity derivatives market with close to 100% market share. The average daily turnover for the last six months on NSE F&O segment stood at R1.36 lakh crore. Experts also reckon that NSE, which is planning to introduce futures contracts based on overseas equity indices like Dow Jones, S&P 500 and FTSE 100, could also benefit from the proposed liquidity enhancement scheme.