India’s market regulator has proposed stricter norms for sectoral and thematic indices used in derivatives trade, mandating each index to be broad-based to ensure that no single stock dominates it. This would eliminate concentration risks, making equity derivatives safer for investors.
On 29 May, the Securities and Exchange Board of India (Sebi) unveiled norms that stated that each index must have at least 14 stocks to make it broad-based and that no single stock could be more than 20% of the index. Additionally, the weight of the top three stocks on the index was capped at 45%, with the remaining constituents following a descending weight order.
According to a consultation paper issued on Monday on implementation of eligibility criteria for derivatives on non-benchmark indices based on the 29 May circular, market participants informed Sebi that using existing non-benchmark indices for derivatives over prescribing new indices for them would be beneficial to extend benefits of diversification of a derivatives index to exchange traded fund (ETF) or index funds, to preserve liquidity and market-making ecosystems built around these indices and to avoid disruption in derivative contracts linked to these indices.
Accordingly, two alternatives were arrived at. The first one includes launching of new indices that meet the norms and list derivatives on them, while keeping old indices live. The second option includes reworking existing indices by changing constituents and/or weights to meet the new norms.
BSE Ltd concluded that only the BANKEX index (10 constituents) is affected as no ETFs/index funds track it. It preferred the latter alternative in a single shot for convenience.
The National Stock Exchange (NSE) also chose the latter alternative after concluding that two of its indices would be impacted—the Nifty Bank index (12 constituents; ETF assets under management of about ₹34,251 crore as of June 30) and Nifty Financial Services (20 constituents; ETF AUM aod nearly ₹511 crore).
The market regulator has asked whether Nifty Financial Services, which has a smaller ETF AUM of about ₹511 crore, can be brought into compliance in a single tranche. For Nifty Bank, which has a much larger ETF AUM of about ₹34,251 crore, the paper proposes a phased transition over four monthly tranches to keep flows staggered and adjustments orderly.
Under the phased plan, any new constituents would be added in the first tranche.
The top three constituents would be guided to target weights by the fourth tranche; at each step, only the excess over the caps would be pared and reductions would be spread equally across the remaining tranches, with monthly recalibration for price moves.
Any weight trimmed from the top names would be redistributed across the other constituents, while maintaining the prescribed concentration limits and descending-weight structure.
Sebi has sought for comments till 8 September on whether exchanges should opt for adjusting existing indices (second option) rather than launching new ones to meet the norms. If so, whether Nifty Financial Services should transition in a single tranche given its relatively small ETF AUM.
The Sebi has also invited views on whether Nifty Bank should follow a four-tranche, four-month glide path with iterative recalibration each month.
