SEBI allows Stock Exchanges to launch futures contracts in corporate bond indices

Securities and Exchange Board of India (SEBI) on 10th January,2023 has issues a circular vide notification no. SEBI/HO/MRD/MRD-PoD-3/P/CIR/2023/11 and has approved the Introduction of future contracts on Corporate Bond Indices in exercise of the powers conferred under Section 11 (1) of the Securities and Exchange Board of India Act 1992, to protect the interests of investors in securities and to promote the development of, and to regulate the securities market.

The exchanges, to start with, are permitted to launch futures contracts on corporate bond indices, Market regulatory, the Securities and Exchange Board of India (SEBI) said in a statement.

Key Highlights

1. It has decided to permit stock exchanges to introduce derivative contracts on indices of corporate debt securities rated AA+ and above to enhance liquidity in the bond market.
2. In order to enhance liquidity in the bond market and also to provide opportunity to the investors to hedge their positions, SEBI had constituted a working group of representatives of NSE, BSE and MSEI to make recommendations on the matter of ‘Derivatives on Bond Indices.’
3. It has been decided to permit Stock Exchanges to introduce derivative contracts on indices of corporate debt securities rated AA+ and above. To start with, the Stock Exchanges are permitted to launch future contracts on corporate bond indices.
4. The details regarding index composition, contract specifications, position limits, risk management framework, etc. for introduction of future contracts on corporate bond indices are given in the Circular.
5. The stock exchanges desirous of introducing such contracts shall submit a detailed proposal to SEBI for approval, inter alia, providing details relating to underlying corporate bond index, the index methodology, contract specifications, applicable trading, clearing & settlement mechanism, risk management framework, the safeguards to ensure market integrity, investor protection, surveillance systems, etc.
6. For implementation of the above, Stock Exchanges and Clearing Corporations are advised to:

• take necessary steps and put in place necessary systems.
• make necessary amendments to the relevant bye-laws, rules and regulations.
• bring the provisions of this circular to the notice of their members and also to disseminate the same on their websites.

7. It could be one step towards widening the market by allowing for hedging and arbitrage.
8. There is a robust derivatives market for equities and commodities, there is no such market for the corporate bonds.
9. The corporate bond index should be composed of debt securities and the constituents of the index should have adequate liquidity and diversification at the issuer level.

Let us have a quick review of Product design and risk management framework for Cash Settled (CBIF)

Permitted Corporate Bond Index

The index underlying the derivative contract shall be as per the following:

1. The index shall be composed of corporate debt securities.
2. Constituents of the index should have adequate liquidity and diversification atissuer level, as decided by the stock exchanges.
3. Constituents of the index shall be periodically reviewed (at least on halfyearly basis).
4. Constituents of the index shall be aggregated at issuer level for the purposeofdetermining exposure limits for single issuer, group, sector, etc.
5. Single issuer shall not have more than 15% weight in the index.
6. There shall be at least 8 issuers in the index.
7. The index shall not have more than 25% weight in a particular group ofissuers [excluding securities issued by Public Sector Undertakings(PSUs), Public Financial Institutions (PFIs) and Public Sector Banks(PSBs)].
8. The index shall not have more than 25% weight in a particular sector(excluding securities issued by PSUs, PFIs and PSBs).
9. The duration buckets of the index may be decided by the stock exchanges.
10. The index shall have a track record of at least one year.

Contract Value

The value of the CBIF contracts shall not be less than INR 2 lakhs at the time of introduction. Stock exchanges shall review the contract value or lot size on halfyearly basis and may make revisions, if required, by giving an advance notice to the market.

Trading Hours

The trading hours shall be between 9:00 AM and 5:00 PM on all working days from Monday to Friday. Exchanges shall align the trading hours of CBIF with the tradinghours of the underlying market. Stock exchanges and clearing corporation(s) shall have infrastructure and risk management systems in place which are commensurate to the trading hours.

Tenure of the Contracts

• Tenure: The stock exchanges may introduce contracts of up to a tenure of 3 years.
• Contract Cycle: Weekly, three Serial monthly contracts, one quarterly contract of the cycle March/June/September/December or one half-yearly contract of the cycle June/December.

Contract Expiry

The expiry or last trading day for the contract shall be the last Thursday of the expirycycle. If any expiry day is a trading holiday, then the expiry or last trading day shallbe the previous trading day.

Settlement Mechanism

The contracts would be settled in cash in Indian Rupee (INR).

Settlement Day

Settlement day shall be the next working day of the expiry day.

Price Bands

For every CBIF, stock exchanges shall set an initial price band at 5% of the previous closing price or base price thus preventing acceptance of orders for execution that are placed beyond the set band. Whenever a trade in any contract is executed at the highest or lowest price of the band, stock exchanges may expand the price band for that contract by 0.5% in that direction after 30 minutes after taking into account market trend. However, no more than 2 expansions in the price band shall be allowed within a day.

Risk Management Framework

The clearing corporations shall define appropriate risk management framework(including margining methodology) and the clearing and settlement mechanism etc.for the product, and submit the same to SEBI for approval.

The initial margin requirement shall be based on a worst case loss of a portfolio of an individual client across various scenarios of price changes. The variousscenarios of price changes would be computed to cover a 99.9% VaR over aone day horizon. Further, Extreme Loss Margins and calendar spread marginsshall also be prescribed by the clearing corporations. Margins shall be deductedfrom the liquid assets of the clearing member on real time basis.

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