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Will SEBI ban on Reliance from derivatives trading impact the market?

Bhavesh Shah | Updated on: 25 March 2017, 16:53 IST
(AFP photo)

Almost 10 years after trades were executed on the National Stock Exchange, the Securities and Exchange Board of India (SEBI) on Friday ruled that India's largest private sector firm, Reliance Industries Limited (RIL), and 12 related entities manipulated the price and unlawfully made profits out of it.

Further, SEBI ruled that with immediate effect RIL and the other entities should be banned – directly and indirectly – from trading in equity derivatives market for one year.

“The market may give a knee-jerk reaction to the order on Monday. However, things will settle as the trading session progresses further. I do not see any major negative reaction on the price of RIL shares beyond a point,” said the head of a foreign institutional desk of a leading brokerage firm.

Terming the transactions as fraudulent, SEBI – with immediate effect – has directed RIL and 12 other entities to stop trading in the derivatives segment of the market.

In simple terms, RIL, as an entity, cannot participate in trading. Shares and other instruments listed in the market will continue to trade. There is no ban on the trading of securities of RIL.

As per the order, RIL has to shell out Rs 447.27 crore (illegal profit due to trading in derivatives) along with an interest of 12% since 29 November, 2007. The total penalty plus interest would be around Rs 1,300 crore.

On its part, RIL has said that it is consulting legal advisors and considering challenging the order in the Securities Appellant Tribunal (SAT). “SEBI appears to have misconstrued the true nature of transactions and imposed unjustifiable sanctions. The trades were genuine and bona fide transactions carried out in the best interest of the company and its shareholders,” company said in a statement.

The case

As part of fund raising, the board of Reliance Petroleum Limited (RPL, which was merged with RIL in 2009) decided to offload 5% of the promoters' stake in the market, but trades were executed in the month of November.

During the investigation, it was found that RIL executed the share sale in the cash segment of the NSE and another dozen entities (hired by RIL) started taking positions in the derivatives market. These dozen entities were connected directly or indirectly with RIL.

As the position in the derivatives contract rose to alarming levels, SEBI launched an investigation in the case, and found that entities hired by RIL had held a large position in the RPL shares ahead of the stake sale by RIL in the cash market.

What is derivatives trading?

The derivatives (or futures and options) segment of the market is used by market participants to hedge their positions in the cash market. Buying or selling futures would be considered as an investment strategy that hedges the risk of a falling or rising market. Put options and call options are used to hedge the risk of gaining profit for falling or rising price of a share.

In theory, when a large quantity of shares are sold in the open market, the price of the security falls. The position taken in put options (an option to sell assets at an agreed price on or before a particular date) is a strategy where the buyer of the put option gets a profit if the price falls to a particular level.

Illegal gains

As per the investigation conducted by SEBI and the notice issued to RIL, just ahead of the stake sale, entities hired for a commission payment booked positions in the derivatives segment to the extent of 9.92 crore shares. Trades in derivatives were ordered by an employee of the group entity of RIL.

When prices started falling for RPL shares, these entities allowed to expire their position to the extent of 7.97 crore shares in the derivatives market. Meanwhile, 1.95 crore shares were sold in the cash segment ahead of the expiry of contracts.

SEBI alleges that RIL earned illegal profit of Rs447 crore due to the trading activity.

SEBI's ruling

“This is not a normal case of price manipulation or volume manipulation. This is a case of a unique strategy of per se not manipulating the price or volume in a single market, but manipulating the settlement price in one market to gain across the volumes accumulated in the other market. The actual manipulation has happened with respect to the convergence price of the spot with the futures,” the SEBI order states.

As per the SEBI order, the very act of appointment of entities by RIL, coupled with the act of assuming separate position limits by these entities in the derivatives segment, was fraudulent. Further, the order states: “RIL was not genuinely hedging the risk, but was aiming at reaping huge speculative profits by cornering futures positions and playing a fraud on the general investors and the market.”.

It added that cornering position in open interest by RIL would amount to a well-planned, fraudulent and manipulative trading scheme.

What next?

The legal battle is almost 10 years old, but is not over yet.

All efforts during the period by RIL, the company with largest number of shareholders in the country, have been shot down by SEBI and SAT. Even a request by RIL for settlement of charges (consent order) in this matter was dismissed in 2014.

Looking at the reactions from RIL, however, the battle looks set to shift again to the SAT or higher courts.

First published: 25 March 2017, 16:25 IST