Assessing Liquidity Rebates in India

• Cognizant 20-20 Insights

Assessing Liquidity Enhancement Schemes

Executive Summary

The Indian equity derivatives market has grown to approximately five times the volume of the cash market in the last decade. This growth has not been consistent for all derivatives products or exchanges. Product-specific index futures and options (F&O) accounted for nearly 70% of the total volume of the equity derivatives market in the last four years, with liquidity largely present in near-month contracts only. In the first half of 2010-11, the National Stock Exchange’s (NSE) index F&O rose to nearly 82%. Stock-specific trading accounted for just 18% of overall futures and options trading. On the Bombay Stock Exchange (BSE), stock-specific trading barely exists. The NSE and BSE logged an average monthly F&O turnover of 1.17 lakh crore and 4 crore, respectively, over the past year. As of August 2011, there were 1,599 listed companies in the NSE and 5,085 in the BSE. Only 221 securities (of which 134 were added in July 2011) and 236 securities are traded in the F&O segment of the BSE and NSE, respectively. In its circular in June 2011 (see Figure 1, next page), the Securities and Exchange Board of India (SEBI) provided a big push to Indian stock exchange operators to identify, formulate and implement various liquidity enhancement schemes (LES) to boost the illiquid equity derivatives segment. The goal is to trigger changes in the existing market structure and provide challenges and opportunities for exchange operators and participants. This white paper identifies and evaluates steps that can be taken to take advantage of this regulatory change.

Proposed Liquidity Schemes

In its circular, SEBI suggested a few ways to create liquidity in the equity derivatives segment. Taking the board’s suggestions, and based on our experience with other exchange operators and participants, we have identified several ways to achieve this in the Indian trading context (see Figure 2, next...