How Sebi’s serial crackdown crimped F&O volumes and crashed broking-firm stocks

The current contraction, however, is not merely a result of regular market cycles or global economic factors. Instead, it represents the culmination of a series of strategic regulatory measures the Securities and Exchange Board of India (Sebi) has implemented since July 2024.

The fall guys

The most immediate and visible impact of these recent regulatory changes has been on capital-market-oriented companies and exchanges in India. Stock exchanges, brokerages, and other financial intermediaries have seen their revenues decline sharply owing to decreased trading activity in the derivatives market. Many of these companies rely heavily on transaction fees and commissions from derivatives trading. With reduced volumes, their profit margins have shrunk, leading to cost-cutting measures and potential layoffs in some cases.

Shares of these firms have been battered as investors price in the new reality of lower trading volumes and reduced fee income. This downturn has significantly affected their business models and financial performance.

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Motilal Oswal, IIFL Capital, and Angel One have seen their stock prices plummet by 47%, 58%, and 43%, respectively, from their October 2024 highs. Even the exchanges themselves haven’t been spared, with BSE and MCX shares down 28% and 33% from their recent peaks.

The pain is particularly acute for discount brokers such as Angel One, whose business models rely heavily on high-volume, low-margin trades. These firms are now scrambling to diversify their revenue streams and adapt to the new regulatory landscape.

From peak to pique

To truly appreciate the reasons why these stocks have fallen, we must first cast our minds back to August 2024. It was a time of unbridled optimism in the Indian derivatives market, with average daily trading turnover soaring to an unprecedented ₹537 trillion. The market was awash with liquidity, and traders reveled in the opportunities presented by a seemingly limitless array of futures & options contracts.

But as the old adage goes, what goes up must come down. In this case, the descent was orchestrated by none other than India’s markets regulator.

The opening salvo: Broker fee reforms

Sebi’s first move came on 1 July 2024, with a circular that struck at the heart of the discount broking model that had hitherto allowed many brokers to offer zero-commission trading. This seemingly innocuous change had far-reaching consequences.

Discount brokers, who had built their businesses on high-volume, low-margin trades, were forced to pivot. By 1 October, when the circular took effect, brokerages across the board had increased their fees to between ₹5 and ₹10 per trade. For many retail traders accustomed to commission-free trading, this represented a significant increase in transaction costs.

The impact was immediate and profound. Trading volumes, particularly in the derivatives segment, began to decline as the cost-benefit equation shifted for many small-scale traders.

Reining in the wild west of weekly expiries

But Sebi was just getting started. On 1 October, the regulator unveiled its next salvo: a dramatic restructuring of derivatives expiry schedules. The new rules mandated only one weekly expiry per exchange and restricted sectoral indices to monthly expiries only.

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This was aimed squarely at curbing excessive speculation and reducing the frenzied trading that often accompanied multiple weekly expiries. The Nifty Bank index in particular, which had been a favorite playground for day traders due to its high volatility and frequent expiries, saw a significant drop in trading activity.

December 2024 marked the first full month under these new rules, and their impact was stark. The derivatives market, which had already been feeling the pinch from increased brokerage fees, now faced a further contraction in trading opportunities.

Margin requirements and premium collections

As if these changes weren’t enough, Sebi introduced additional measures in December. Higher extreme loss margins (ELM) were implemented, forcing traders to maintain larger cash buffers against potential losses. The regulator also mandated upfront collection of option premiums and removed calendar spread benefits on expiry days.

These changes struck at the core of leveraged trading strategies that had become popular among retail traders. The increased capital requirements and reduced ability to offset risks across different expiries led to a further decline in trading volumes.

Numbers don’t lie

The cumulative effect of these regulatory changes has been significant. By January, the average daily turnover for futures & options had plummeted to ₹298 trillion – a staggering 44% decline from the August 2024 peak. Even a spike in market volatility in January failed to significantly boost derivatives turnover, suggesting that Sebi’s structural changes had fundamentally altered market dynamics.

Meanwhile, the average turnover of the cash market remained relatively stable at ₹1.1 trillion a day for the NSE and BSE combined. This disparity between cash and derivatives transactions underscores the targeted nature of Sebi’s reforms and their outsized impact on speculative trading.

Since August 2024 derivatives turnover has fallen much more sharply than cash.

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More changes on the horizon

But Sebi isn’t done yet. On 26 February the regulator released a consultation paper proposing to redefine the market-wide position limits (MWPL) for all F&O stocks. If implemented, this change is expected to further reduce trading volumes in the derivatives market.

Sebi also plans to introduce intra-day monitoring of positions from 1 April. This is likely to add another layer of complexity and cost for traders, potentially suppressing volumes even further.

Adapting to the new normal

Critics may argue that the new regulations have gone too far, stifling market liquidity and potentially driving trading activity offshore or to unregulated platforms. They contend that a vibrant derivatives market is essential for price discovery and risk management, and that excessive regulation could hamper India’s aspirations to become a global financial hub.

Proponents of the changes, on the other hand, may point to the risks posed by unchecked speculation, particularly for retail investors, who may not fully understand the complexities of derivatives trading. They argue that a more measured approach to derivatives trading will lead to a healthier, more sustainable market in the long run.

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As market participants adjust to this new reality, we’re likely to see a period of consolidation in the broking industry. Firms that can diversify their revenue streams, offer value-added services, and navigate the new regulations will be best positioned to thrive.

For retail investors, the increased costs and reduced trading opportunities may prompt a shift towards more long-term, fundamentals-based investing strategies. This could ultimately lead to a more stable and mature market that’s less prone to the wild swings often associated with speculative derivatives trading.

The coming months will be crucial in determining whether Sebi has struck the right balance with its reforms. Will we see a gradual recovery in trading volumes as market participants adapt to the new rules? Or will the Indian derivatives market continue to contract, potentially ceding ground to international competitors?

For more such analysis, read Profit Pulse.

Dev Chandrasekhar advises businesses on the big picture of markets, technology, strategy, and geopolitics.

Disclosure: The author does not hold shares of the companies discussed, or any derivatives. The views expressed are for informational purposes only and should not be considered investment advice. Readers are encouraged to conduct their own research and consult a financial professional before making any investment decisions.