The L C Gupta panel set up by the Securities and Exchange Board of India (Sebi) has enquired into sales practice regulations relating to derivatives in US in order to learn from the experiences of the authorities there.
The regulators in US have recognised that derivatives based on options trading strategies could be a highly complex affair. Hence there is a special regulatory regime for options there.
This is instructive for Indian authorities. In order to give a concrete idea about what the regulation of sales practice, particularly for complex types of derivatives, may involve, some special features found in the US are enumerated below:
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nThe option trading rules of a derivative requires heightened suitability standards. Such rules prohibit brokers from recommending to any clients any option transaction unless they have reasonable grounds to believe that the entire recommended transaction is suitable for the customer on the basis of the information published after reasonable enquiry concerning customers investment objectives.
n In addition, rules prohibit brokers from recommending opening options transactions unless they have a reasonable basis for believing that the customer has such knowledge and financial experience that he or she can be expected to be capable of evaluating and financially able to bear the risk of the transaction.
nThe broker must seek to obtain and verify specific categories of information about its options customers including, but not limited to, the net worth, annual income and investment experience.
A separate approval may also be required for trading in particular types of options, strategies and types of option contracts such as foreign currencies.
nIn addition, the approval of account opening must be in writing and can be made only by a senior option supervisor who must ensure that investors are offered an explanation oft he special characteristic and the risk applicable to trading of options.
nThe derivatives exchange also requires that all supervisory and sales personnel pass a general securities examination that includes options materials.
People selling or supervising the sale of options on debt securities or foreign currencies also must pass a separate interest rate options or foreign currency examination.
nThe exchange also requires the broker to keep a current customer complaint log for option related complaints which includes all trade details.
nThe disclosure document about options should contain information describing the mechanics and risk of options trading transaction cost, margin requirement and tax consequences of margin trading.
The broker must provide a copy of this document till the time customers account is approved for standardised options trading.
nThere are also special trading rules applicable to the options market. These include, separate surveillance procedures, front running prohibitions and positions.