In March 2020, amid the pandemic and an unsettling choppiness in the stock market, the Securities & Exchange Board of India (Sebi) had taken a slew of measures to minimise volatility. One of the steps was capping the naked or unhedged exposure that offshore and local mutual funds could take on equity index derivatives.
On at least 10 instances, some of the FPIs took large short or long positions at various points in 2021 and 2022, said two persons familiar with the matter.
The new rule, which came into effect from March 23, 2020, continues even today though the extent of penalty has been reduced.
Till then, the exposure limit was ₹500 crore or 15% of the open interest – the outstanding or unsettled derivative contracts like futures or options. This limit was lowered to ₹500 crore. A fund overshooting the limit was penalised with its margin chargeable on the excess position getting locked in by the stock exchange and clearing corporation for a period of three months.
The rule was renewed every month in 2020 when volatility was abnormally high, and in November 2020 the lock-in period for the margin was lowered to one month. The November 2020 press release by Sebi also mentioned that these measures were to continue until further directions are issued by Sebi.
However, there was some confusion among the funds as operational guidelines, which were updated by the regulator post 2020, continued to state the original position limits (including the reference to 15% open interest) aspect.
“While the press release was issued as a ‘measure’ to address a specific market volatility emerging out of the pandemic, the conflict between the operational guidelines (and now the Master Circular) on the one hand, and the November 2020 Press Release on the other hand, has led to a situation where market participants seem to increasingly rely on confirmations from the surveillance division of the exchanges,” said Richi Sancheti, founder partner of the law firm Richi Sancheti Associates. According to him, unless FPIs operate with a dynamic ‘compliance manual’ that takes into account the frequent updates from the regulator and the exchanges as well as views emanating from the surveillance divisions, it is evidently tough to avoid breaches in exposure.
A Sebi spokesman did not respond to ET’s queries on the subject while exchange officials did not elaborate on the breaches by the funds. “Without the index derivative exposure cap, the market would have probably witnessed greater bouts of volatility. With the pandemic under control and the market far less volatile than it was two years ago, some of the FPIs have told their custodian banks the need for Sebi to restore the limit to its earlier level of 15% open interest. But the regulator may not be currently reviewing the limit,” said an official with a custodian bank.
As against a net inflow of ₹2.18 lakh crore from FPIs between April and December 2020, foreign funds net sold ₹29,800 crore and a record ₹1.17 lakh crore in 2021 and 2022, respectively.
