The Securities and Exchange Board of India (Sebi) believes that the concentration of weights among the top few index constituents gives rise to “fears or risks of market manipulation and /or excessive market volatility” among market participants. The regulator proposed a set of measures in a consultation paper on Monday, seeking public comments through 17 March.
In terms of popularity on the derivatives segment, the Bank Nifty from NSE and Bankex from BSE, to a lesser extent, are next only to benchmarks like the Nifty and Sensex. NSE is the market leader in cash and equity derivatives trading, with BSE trailing at a distant second.
Any sectoral or thematic index other than benchmarks like Nifty and Sensex on which derivatives are sought to be introduced should comprise a minimum of 14 stocks, the Sebi paper proposed. The top constituent must have a weight of not more than 20%, and the combined weight of top three stocks in the index should not exceed 45%. All other constituents’ individual weights should be lower than those of the higher weighted constituents.
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Impact on sectoral indices
The proposal, if implemented, will need a recast of the Bank Nifty.
At the end of January, the Bank Nifty had 12 constituents, with the top two having over 20% weight each, and the top three well in excess of the proposed 45%.
HDFC Bank, the top stock, has a weight of 27.63%, ICICI Bank 25.05%, and Kotak Mahindra Bank 9.61%, totalling 62.29%.
Apart from having to add at least two more banking stocks, the weights of HDFC Bank and ICICI Bank will also have to be reduced significantly if the provisions are applied to them.
“In my view, this will make the environment healthy and significantly reduce any chance of manipulation,” said Ashish Nanda, president and head of digital business at Kotak Securities.
Terming the proposals “a step in the right direction,” Nanda said it would have to be seen whether indices on banks and financial services that do not adhere to the proposed criteria require a recast or whether the norms would apply prospectively to new sectoral or thematic indices.
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Queries emailed to NSE and BSE went unanswered.
NSE’s average daily equity derivatives turnover stood at ₹1.99 trillion in the month through 25 February, while that of BSE was ₹12,332 crore, exchange data showed. Both the figures are based on the premium turnover of options.
The change, if implemented, will apply to the BSE Bankex too.
The Bankex has 10 constituents, with every stock subject to a maximum weight cap of 22%. However, ICICI Bank, HDFC Bank and SBI have a combined weight above 50%, and this too, like Bank Nifty, would require reconstruction if the Sebi proposal takes effect.
If a high proportion of index weights is attributable to a small set of stocks, participants with deep pockets trying to engineer a sharp rally or fall in the index derivatives can simply buy or sell one or two of its constituents in the cash market, as there is a nexus between the cash and derivatives segments.
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Rajesh Palviya, senior vice-president, head of derivatives and technical research at Axis Securities, said that participants can sell or buy huge quantities of shares of a highly weighted constituent on the index in the cash market to manipulate the index. They can either buy back the stock at lower levels or sell the same once their “ends have been met.”
“It’s a good move to curb excessive speculation,” Palviya stated.
NSE’s indices are developed and maintained by its subsidiary NSE Indices Ltd, while BSE’s indices are developed and maintained by its wholly owned subsidiary Asia Index Pvt. Ltd.
