Settlement of Cash Segment and F & O Segment upon Expiry of Stock: SEBI

Nikhil Mogha

22 Dec, 2022

The Future & options are a type of derivative products in the securities market. Under the Future segment, two parties entered into a derivative contract with each other wherein they agreed to buy or sell the underlying asset at a fixed date. The fixing of future dates aids in hedging the market risks by locking the value of the asset for a future date. Whereas the options contract provided the investor with a right but not the obligation to buy or sell the assets at a specific price on a specific date. The cash segment or cash trading means that the transaction for all the investments will take place with the help of funds in the investor’s DEMAT account^[1]. It means the buying and selling will take place with money instead of borrowed or margin capital. To provide better alignment of cash & stock derivatives, the SEBI issued the circular “Net Settlement of cash segment and F & O segment upon expiry of stock derivatives” on 30^th November 2022.

What Is The Reason For Issuing A Circular On The Settlement Of The Cash Segment And F & O Segment?

It was reviewed by the SEBI under circular “Review of Framework for Stocks in Derivatives Segment” dated 11^th April 2018 that the stock deviates shall be physically stalled at their expiry in a phased manner. Moreover, there shall be a risk management framework, settlement mechanism and other procedures for the cash segment, which shall be applicable when a stock derivative is transferred into the physical settlement.

Therefore, in order to provide better alignment between the cash and F & O segment, price risk mitigation and bring merged efficiency for the market participant in the cash segment and F & O segment, it is decided by the SEBI in consultation with the SMAC (Secondary Market Advisory Committee) to introduce a mechanism for net settlement of cash segment and F & O segment upon the expiry of stock derivatives.

What Is The Mechanism For Net Settlement Of The Cash Segment And F & O Segment Upon Expiry Of The Stock Derivative?

 As per the circulars on settlement of the cash segment and F & O segment, the following point are deduced by SEBI:

1. The obligations arising out of the settlement of the cash segment and F & O segment shall be settled on a net basis as against the current approach to settling it separately.
2. The benefit of merged settlements shall apply to those investors whose trading member clears trades in cash and F & O segment through the same clearing member. However, the investors whose trading member clear trades through different clearing member or clearing corporation will not be able to avail the benefit of merged settlements.
3. The benefit of merged settlements shall only be available to institutional investors, including some categories of foreign portfolio Investors because the regulatory framework provides that all transactions by institutional investors in the cash market should be backed by the delivery.
4. The benefit of merged settlement should be available for non-institutional custodial participants (CPs)  that are cleared through the same entity, which is registered both as a custodian in the cash market and a clearing member in the Future & Options segment. Provided the benefit shall not be available to those investors or clients or participants that have mandatorily been directed to enter only delivery-backed transactions, such as portfolio managers.
5. The benefit of merged delivery obligations shall be only for the purpose of settlement. Henceforth, Security Transaction Tax and Stamp Duty shall be continued to be levied, computed and reported on a segment-wise level.
6. The clearing corporations should continue to settle obligations on a net-basis clearing member level.
7. The clearing corporation should continue to maintain net segment–wise default waterfalls, irrespective of a single settlement across segments.
8. The loss that occurred in case of default of the clearing member of the clearing corporation should be computed on a pro-rata basis and it shall be calculated on the segment-wise obligation of the clearing member to the clearing corporation.

What Is The Effective Date Of The Circular? 

The circular on settlement of the cash segment and F & O segment shall be effective from March 2023 and the expiry of F & O contracts.

What Are The Directions For Stock Exchanges And Clearing Corporations?

The framework for the settlement of the cash segment and F & O segment is directed to:

1. Put the necessary system in place for the implementation of the circular
2. Bring the provision of the guidelines to the notice of their members.
3. Publish the circular on the website.
4. Communicate to SEBI about the implementation of the provisions for the circular.

Conclusion

The SEBI, in order to bring efficiency by combing the cash and stock derivate, has provided an option to the investors by providing a mechanism for settlement of the cash and F & O segment by meeting both transactions. Now any obligations arising from the settlement of the cash segment and F & O segment shall be settled on a net basis. Furthermore, the benefit of merged settlement of the cash and F & O segment shall be made available only to those investors whose cash and stock derivative is cleared by the trading member.

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