Description

SEBI mandates constituent and weight adjustments in existing Non-Benchmark Indices (NBIs) to comply with prudential norms for derivatives trading, with phased implementation for BANKNIFTY.

Summary

SEBI has issued implementation guidelines for eligibility criteria on derivatives contracts for existing Non-Benchmark Indices (NBIs). Following public consultation and recommendations from the Secondary Market Advisory Committee, stock exchanges must undertake constituent and weight adjustments in existing NBIs to comply with prudential norms introduced in May 2025. BANKEX and FINNIFTY will implement changes in a single tranche, while BANKNIFTY will undergo phased implementation over four monthly tranches to ensure orderly rebalancing of Assets Under Management tracking the index.

Key Points

  • Stock exchanges must adjust constituents and weights in existing NBIs to comply with prudential norms, rather than creating separate indices
  • BANKEX (BSE) and FINNIFTY (NSE) will implement compliance in a single tranche
  • BANKNIFTY (NSE) will implement compliance through four monthly tranches for orderly rebalancing
  • Minimum 14 constituents required for NBI derivatives
  • Top constituent weight capped at 20%
  • Combined weight of top three constituents capped at 45%
  • Descending weight structure mandatory for all constituents
  • New constituents for BANKNIFTY will be added in tranche 1
  • Top 3 constituents in BANKNIFTY will have target weights achieved by end of tranche 4
  • Excess weight reduction will be distributed equally over remaining tranches

Regulatory Changes

This circular implements the prudential norms previously announced in SEBI circular SEBI/HO/MRD/TPD-1/P/CIR/2025/79 dated May 29, 2025. The key change is the clarification on implementation methodology:

Eligibility Criteria for NBI Derivatives:

  • Minimum 14 constituents in the index
  • Top constituent weight must not exceed 20%
  • Combined weight of top three constituents must not exceed 45%
  • All constituents must follow descending weight structure (lower-weighted constituents cannot have higher weights than higher-weighted constituents)

Implementation Approach:

  • Adjustments to be made in existing indices rather than creating new separate indices
  • Single tranche implementation for BANKEX and FINNIFTY
  • Four-tranche phased implementation for BANKNIFTY with monthly adjustments

BANKNIFTY Phased Adjustment Method:

  • New constituents added in first tranche
  • Weight adjustments for top 3 constituents spread across 4 tranches
  • At each tranche, weights re-evaluated and remaining excess distributed equally over remaining tranches
  • Example: If constituent has 28% weight with 20% target (8% reduction needed), first tranche reduces by 2% (8%/4), subsequent tranches adjust based on re-evaluated weights

Compliance Requirements

Applicable to:

  • All Stock Exchanges (except Commodity Derivatives Exchanges)
  • All Clearing Corporations (except Commodity Derivatives Clearing Corporations)

Actions Required:

  • Stock exchanges must undertake necessary constituent and weight adjustments in existing NBIs having derivatives contracts
  • BSE must adjust BANKEX index constituents/weights in single tranche
  • NSE must adjust FINNIFTY index constituents/weights in single tranche
  • NSE must adjust BANKNIFTY index constituents/weights over four monthly tranches
  • Ensure compliance with all four prudential norms (minimum constituents, top constituent cap, top 3 constituents cap, descending weight structure)
  • Monitor inter-tranche price movements and re-evaluate weights at beginning of each tranche for BANKNIFTY

Important Dates

  • May 29, 2025: Original circular issued with prudential norms and 30-day submission deadline for proposals
  • August 18, 2025: Public consultation conducted on implementation approach
  • October 30, 2025: This implementation circular issued
  • Implementation timeline: Single tranche for BANKEX and FINNIFTY; four monthly tranches for BANKNIFTY (specific dates not mentioned in circular)

Impact Assessment

Market Impact:

  • Significant structural changes to three major banking sector derivative indices traded on BSE and NSE
  • BANKNIFTY, being one of the most actively traded derivative contracts in India, will experience gradual rebalancing over four months
  • Passive funds and ETFs tracking these indices will need to rebalance their portfolios accordingly
  • Phased implementation for BANKNIFTY aims to minimize market disruption and ensure orderly adjustment of substantial AUM tracking the index

Operational Impact:

  • Stock exchanges must recalculate index compositions and weights
  • May require addition of new constituents to meet minimum 14 constituent requirement
  • Top-heavy indices will need to redistribute weights from highly-weighted constituents
  • Single-tranche adjustment for BANKEX and FINNIFTY requires immediate implementation
  • Four-tranche approach for BANKNIFTY requires monthly monitoring and progressive adjustments

Derivatives Market Impact:

  • Existing derivative contracts on these indices will be affected by underlying index changes
  • Derivatives traders and hedgers need to account for changing index composition
  • Liquidity patterns may shift as index constituents and weights change
  • Risk management models based on historical index composition may need recalibration

Investment Impact:

  • Passive investment vehicles tracking these indices must adjust holdings to match new index composition
  • Portfolio turnover costs for index funds and ETFs
  • Potential tracking error during transition period, especially for BANKNIFTY during the four-month phased implementation
  • Investment strategies based on current index composition will need adjustment

Impact Justification

Significant structural changes to major derivative indices (BANKNIFTY, FINNIFTY, BANKEX) affecting passive funds, derivatives contracts, and index composition with mandatory compliance requirements.