Corporate Law Newsletter – Risk Disclosure for Trading in Derivatives: May 2023

While the Indian stock market continues to evolve, there is a notable growth in maturity that has been witnessed amongst retail investors. In the past few years, retail investors have brought a balancing element to the Indian stock market that used to be predominantly dependent on the directions of foreign portfolio investors. This is evident from the fact that retail investor participation was not impacted despite significant corrections in the market and huge FPI outflows in 2022. In fact, retail investor participation in NSE-listed securities reached an all-time high of 7.18% in June 2022. There has been a considerable change in terms of the savings behaviour of Indian retain investors with increased savings in financial assets including equities. 

Amidst the rising retail investor participation, the concerns attached to amateur investors (also known as ‘Robinhood’ investors) inevitably arise and are important to be addressed. These investors are generally seen to lack a fundamental understanding of investments and financial markets. The urge to invest money in financial markets is seen to arise in these investors for reasons such as fear of missing out (popularly known as FOMO), hearsay and false perceptions owing to misleading information. The funds that they infuse in financial markets are typically aimed at making quick money as opposed to parking funds for gradual long-term value growth. Resultantly, stock trading and trading in derivatives such as equity futures and options seem more attractive to them. They end up playing risky bets which often result in significant losses that may be beyond their risk appetite. In this context, it is imperative that investors are provided with correct and accurate information and disclosures at the right time so that they can take informed decisions.

In its recent move, the Securities and Exchange Board of India (“SEBI”), vide circular dated May 19, 2023 (“Circular”), has highlighted the need to provide investors with detailed information to empower them to make investment decisions, despite the fact that investors are expected to make investment decisions based on their own due diligence and risk appetite. Thus, through the Circular, SEBI has decided to introduce ‘risk disclosures’ with respect to trading in equity futures and options (F&O) segment.

Risk Disclosure Directions

The directions in respect of such risk disclosures are as follows:

1. All stockbrokers are mandated to display a risk disclosure notice provided as an annexure to the Circular. This notice contains key statistics regarding the probability of incurrence of net loss by investors trading in the F&O segment, the amount of average net trading loss incurred by such investors, and transaction costs involved in such trades.

2. Upon login into trading accounts, clients shall be prompted to read ‘risk disclosures’ that may appear as a pop-up window and shall be allowed to proceed only after acknowledging the same.

3. The ‘risk disclosure’ shall be displayed prominently, covering at least 50% (fifty percent) area of the screen.

4. All qualified stockbrokers are required to maintain the profit and loss account data of their clients on a continuous basis as per the prescribed format and such data shall be retained for at least 5 (five) years.

5. All stock exchanges and depositories have been directed to bring the provisions of the notice to their members/participants and disseminate the same on their websites.

6. All stock exchanges and depositories are further directed to display the ‘risk disclosure’ on their respective websites with a link to the study conducted by SEBI which is provided in the annexure to the Circular.

As per the study conducted by SEBI for analysis of profit and loss of individual traders in the F&O segment, only about 11% (eleven percent) of the total individual traders made a profit during the financial year 2021-2022 with an average profit of INR 1.5 lakhs. The study provides other important insights into the P&L of individual investors who invested in the F&O segment during the period between FY19 to FY22, all of which indicated a need for the regulator to step in and introduce corrective measures. While the actual impact of these measures remains to be seen, it is definitely a step in the right direction.