Legal and Regulatory Environment: formula sheet

Key formulas

Securities (Section 2(h))

Securities include shares, bonds, debentures, government securities, mutual fund units AND derivatives

A derivative is a security under SCRA, so SCRA and SEBI oversight apply to it.

Derivative (Section 2(ac))

Derivative = security derived from a debt instrument, share, loan, risk instrument or contract for differences | contract deriving value from prices or index of prices of underlying securities | commodity derivative | other instrument notified by the Central Government

Equity futures and options come under the 'value from prices or index of prices of underlying securities' limb.

Legality rule (Section 18A)

Legal and valid = traded on a recognised stock exchange AND settled on that exchange's clearing house, per its rules and byelaws

Both conditions must hold. Trading alone or settlement alone is not enough.

Three objectives of SEBI

Protect investors + Promote market development + Regulate the market

This is the purpose stated in the SEBI Act preamble. Use it to classify any question.

Nature of SEBI

SEBI = statutory body, set up under the SEBI Act, 1992

Before that it was non-statutory (1988). The Act gave it legal powers.

Three types of powers

Quasi-legislative + Quasi-judicial + Executive

Regulations = legislative; hearings and orders = judicial; inspection and registration = executive.

Appeal route

SEBI order → Securities Appellate Tribunal (SAT)

Appeals against SEBI orders go to SAT. Further appeal from SAT lies to the Supreme Court.

Entities SEBI regulates

Exchanges, clearing corporations, depositories, intermediaries, mutual funds, and others

Intermediaries must be registered with SEBI to operate.

Gupta Committee phasing

Index futures → Index options → Stock options → Stock futures

This is the order in which products were introduced. Stock futures came last in actual launch.

Legal basis

SCRA amendment (1999): derivatives included in the definition of 'securities'

This made derivatives legal and regulated under the SCRA. Trading takes place on recognised stock exchanges.

Gupta clearing member net worth

Clearing members need a minimum net worth (recommended by the committee; figure set by SEBI and the exchange)

This was a recommendation. The actual figure is set by SEBI and the exchange, so verify it against the workbook.

Varma margining basis

Initial margin = 99% VaR, one-day horizon

Add daily mark-to-market. A minimum margin applies to short options.

Stock eligibility tests

Eligible stock = meets SEBI tests on market capitalisation and traded value rank, order-size liquidity, market-wide position limit and delivery value

Numeric limits change over time. Know the tests and use the workbook values.

Index eligibility tests

Eligible index = enough constituents, no single stock or few stocks dominating the weight, and constituents mostly F&O-eligible

Numeric limits change over time. Learn the concentration and constituent-count idea.

Trading member

Trading member = right to trade; clearing is done by itself or through a clearing member

A trading member that is not a clearing member must be linked to a clearing member.

Clearing member types

Self-clearing | Trading-cum-clearing | Professional clearing

Professional clearing members clear for others and do not trade.

Clearing corporation role

Novation: CC becomes buyer to every seller and seller to every buyer

This is the basis of the settlement guarantee and counterparty risk protection.

Certification rule

Dealing staff need NISM-Series-VIII; certificate valid 3 years from exam date

Applies to persons who deal in derivatives for the member. Check the workbook for who is covered.

Net worth rule

Clearing member net worth ≥ limit prescribed by exchange or clearing corporation as per SEBI norms

Remember the exact rupee amounts from the current workbook. The clearing member limit is stricter than the trading member limit.

Order of redress

Usual practice: Broker → Exchange investor service cell or SCORES (SEBI) → Arbitration or online dispute resolution for disputes that remain unresolved

This is the usual practice, not a rigid ladder. SCORES is a parallel complaint route and is not a compulsory step before arbitration. Arbitration or online dispute resolution is a separate mechanism for unresolved disputes.

Risk disclosure document

RDD given at registration, acknowledged by client

It warns of risk. It does not guarantee or limit losses.

SCORES

SCORES = SEBI's online complaint redress platform

Complaint goes to the entity concerned, which files an action taken report.

Investor Protection Fund

IPF compensates clients of a defaulting member, within limits

Held by each exchange. Does not cover market losses.

Head of income for F&O

Equity derivatives income on a recognised exchange = non-speculative business income

Not capital gains for a normal trader. Not speculative business income.

STT on futures

STT = rate × traded price × quantity (payable on sale)

Charged on the sell side only. Check the current rate in the workbook.

STT on options

STT on sale = rate × premium × quantity; on exercise = rate × settlement price × quantity

Premium basis applies when the option is sold. Settlement price basis applies on exercise of an option.

Loss treatment

Non-speculative business loss: set off against other income except salary; carry forward 8 years

Carry forward needs the return to be filed on time. Verify against the current workbook.

PMLA duties of a broker

KYC + record keeping + suspicious transaction reporting to FIU-IND

Records kept as prescribed under PMLA rules and SEBI circulars.

Quick revision

• SCRA, 1956 is the Act that governs securities contracts and recognises derivatives as securities.
• The SEBI Act, 1992 set up SEBI as the securities market regulator.
• SEBI's functions include protecting investors, developing the market and regulating intermediaries.
• Derivatives trading takes place only on recognised stock exchanges.
• Eligibility criteria decide which stocks and indices can have derivative contracts.
• Exchanges and clearing corporations must meet SEBI's requirements to operate.
• Members must satisfy the exchange's membership conditions before trading or clearing.
• Investors can first complain to the broker, then use exchange and SEBI complaint channels.
• Disputes can go to arbitration under the exchange's rules.
• Check the NISM workbook for current tax treatment before the exam, as rates can change.
• Read each option fully; one changed word often makes a rule wrong.
• Remember: negative marking is 25% of the marks of the question.

Common mistakes

• Thinking a derivative is not a security Fix: Remember Section 2(h) lists derivative within securities. SCRA treats it as a security.
• Applying only one condition of Section 18A Fix: Always state both: recognised exchange trading and settlement on its clearing house per rules and byelaws.
• Thinking SEBI was created only in 1992. Fix: Remember SEBI was set up in 1988 as a non-statutory body and got statutory status through the 1992 Act.
• Believing SEBI guarantees investor returns or prevents all losses. Fix: Protection means fair rules, disclosure and redressal. SEBI does not guarantee profits or protect against market risk.
• Attributing VaR-based margining to the L.C. Gupta Committee. Fix: Link Gupta with the regulatory framework and Varma with risk containment. Recall VaR as Varma's 'V'.
• Saying stock futures were introduced first. Fix: Remember the order: index futures, index options, stock options, stock futures.
• Treating trading member and clearing member as the same thing Fix: Remember the right: trading member trades, clearing member clears. One firm can hold both rights as a trading-cum-clearing member.
• Saying the exchange guarantees settlement Fix: The clearing corporation guarantees settlement through novation. The exchange provides the trading platform and rules.
• Thinking the risk disclosure document limits the client's loss. Fix: Remember it only informs and warns. It does not cap or cover losses.
• Believing the Investor Protection Fund covers losses from price falls. Fix: It compensates for member default or expulsion, within limits. Market losses are never covered.

Exam tips

• Learn the Section 18A wording as two linked conditions. Questions often drop one of them in a wrong option.
• Remember only two section numbers firmly: 2(h) for securities, 2(ac) for derivative, plus 18A for legality. Do not guess others.
• NISM-Series-VIII has negative marking of 25% of the marks of a question, so skip an option you cannot justify against the rule, rather than guess blindly.
• Watch the words 'only', 'any' and 'not'. A trap option may be nearly right but add or remove a condition.
• The pass mark for Series VIII is 60%, so these easy definition questions are marks you should secure.
• Learn the three objectives word for word. Many questions are direct recall of these.
• Expect questions that ask which entity needs SEBI approval or registration. The usual answer is yes.
• Read negative-marked options carefully. A wrong answer costs 25% of the marks for that question, so skip only if you cannot eliminate any option.