SEBI Lays Framework To Make Physical Settlement Mandatory

The market regulator paved the way for physical settlement of stock derivatives starting April 2019.

All stock derivatives which are currently cash-settled will move to physical settlement, the Securities and Exchange Board of India said in a circular posted on its website today.

The regulator will move to physical settlement of the stocks of companies in descending order, according to the circular. This means that the first 50 companies with the least market capitalisation will move to physical settlement in April contract. The next 50 stocks with least market value will follow in July followed by the similar next 50 stocks in October.

All stocks that will be introduced henceforth in the derivatives segment will be physically settled.

In April this year the National Stock Exchange Ltd released a list of 46 stock futures that will be settled physically post Securities and Exchange Board of India’s decision to move to physical settlement in the derivatives segment in a phased manner. There are currently 200 stocks in the NSE derivatives segment.

The move may to lead to migration of volumes from the Indian shores to Singapore which continues to settle in cash. Singapore Exchange launched stock futures in high volume 50 stock futures in early this year which led to escalation of tensions between the two partners ultimately leading to NSE pulling out its Indices from the Singapore Exchanges. The NSE and SGX are currently under discussion for an amicable solution after the case went into arbitration. Stock futures continue to trade in the SGX albeit with low volumes. The move will ensure that foreign investors who prefer to cash settle in the derivative market will have the option to migrate to Singapore.

Investors taking physical delivery of securities to settle derivative contracts will also have to pay a tenfold higher transaction tax than those who settle in cash after the taxman clarified to the Bombay High Court in August that the same securities transaction tax rate will apply to physical settlement in derivatives and equity segments. For taking delivery of shares, investors will have to pay Rs 10,000 for every Rs 1 crore of transaction value, compared with Rs 1,000 earlier in cash based settlement paid by seller in futures segment.

While physical settlement will require a vibrant Securities Lending and Borrowing Mechanism, the SLB mechanism is yet to pick up despite several attempts by the regulator to kick start this institutional mechanism.