Introduction
A letter issued by SEBI to BSE has caused ripples. The letter was disclosed by BSE on 26 April 2024. In it, SEBI posed a demand for shortfall in regulatory fees to be paid to by BSE to SEBI. The fee is charged to recognised stock exchange under the SEBI (Regulatory Fee on Stock Exchanges) Regulations 2006, read with Regulation 11 of the Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 ("SECC Regulations"), at the rates defined under Part-A of Schedule III thereto.
The said regulatory fee is paid on a yearly basis, calculated on the basis of the 'annual turnover' of an exchange. The method of calculation of this fee has since become a subject of much debate and conjecture. While SEBI's letter attempts to bring about some clarity, it remains to be seen if it brings with it any quietus.
Background
Of the various transactions undertaken on an exchange, trading of options stands on a peculiar footing. Options are a derivative, which derive their value from an underlying asset, being either an index or equity stock. Its buyer pays (and seller receives) a 'premium' and payment for the 'underlying' takes place during settlement, if and when the option is exercised. This explains premium value of an option.
An option is settled either in cash, as in the case of an index-option, or physically, as in the case of a stock-option, when the option expires 'In The Money' ("ITM"). Options that are 'Out of The Money' ("OTM") expire worthlessly. These are colloquially referred to as 'European Options' and are exercised automatically on the date of expiry when they are ITM. Therefore, not all options result in the trade of an underlying. Where they do result in a trade of the underlying, they can be said to have been traded at notional value, which takes into account both, the value of the premium as well as of the underlying.
Issue
The explanation to Regulation 11(2) of the SECC Regulations defines 'annual turnover', for the purposes of the sub-regulation, to meanthe aggregate value of the transactions, excluding turnover on agricultural commodity derivatives, which took place on the recognised stock exchange during the relevant financial year.
From this explanation, it can be gathered that the annual turnover is to be calculated on the aggregate value of the transaction, i.e., considering the buy-value and sell-value cumulatively. However, there is no mention of the value being calculated on the basis of the "notional value" of a transaction. And yet, SEBI in its letter has insisted that the annual turnover of BSE from options should be calculated on the basis of the "notional value" of the options, seemingly relying solely on the said statutory explanation. Furthermore, the letter creates a deeming fiction with retrospective effect when it states that the annual turnoverwas always deemed to have been computed on the basis of the notional value of options contracts for the purpose of payment of regulatory fee to the Board.This has left many the expert scratching their heads.
Analysis
Besides the apparent lack of statutory basis for SEBI's demand, it seems unjustified that, when calculating annual turnover, the value of all option contracts should be calculated at notional value. This is simply because not all options trades result in the trade of an underlying. More frequently than not, options are traded keeping in mind the premium. Conversely, those who close their positions in the options segment prior to expiry enjoy one degree of separation from the underlying. SEBI's stance to treat these trades at notional value for the purpose of calculating annual turnover on an aggregate basis would not be justified.
Then comes the question of index-options. Commonly referred indices are the NIFTY50 by NSE Indices Ltd., and S&P BSE Sensex by Asia Index Pvt. Ltd. Indices are not equity. Rather, they are a measure of performance for equity. Hence, index-options cannot be physically settled and are cash-settled. That being said, indices are expressed in points, requiring the application of a formula/conversion factor to express them in rupee terms for the purposes of options settlement. This conversion factor is generally the lot size of the option. It must be kept in mind that it is only the difference between the strike price and the spot value of the index which is settled in rupee terms when an index-option is exercised. It would be a far stretch to say that NIFTY50 at, say 20,000 points, translates to INR 20,000. Hence, it would not be justified to impute the points-value of an index to the options contracts and translate the same to rupee terms when calculating notional value of an index option towards annual turnover.
The way Securities Transaction Tax ("STT") is charged on an options contract is also instructive in this regard. As on date, STT is charged on the premium value of an option and on the intrinsic value (being the difference between the settlement/spot price and the strike price) when the option is exercised. This method of calculating STT can be utilized similarly for calculating the annual turnover arising out of options contracts trades.
Conclusion
Besides the obvious implications on BSE's share-price, SEBI's letter has various far-reaching implications on the market, especially its burgeoning F&O segment. BSE has disclosed that the differential SEBI regulatory fees will amount to approximately INR 96.3 Crores exclusive of GST. It will force exchanges to re-look at their commercials and redefine the competitive dynamics. SEBI's demand for arrears in regulatory fee is also likely to pinch the pocket of options traders if the cost is passed down by the exchange in terms of revised fees.
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