Uniform Risk Disclosure Documents — What Every Segment-Specific Version Must Cover

SEBI has prescribed uniform Risk Disclosure Documents (RDD) for all segments and exchanges, covering the risks of trading in equities, derivatives, and other instruments. The RDD is a mandatory document that must be provided to every client before trading. This article explains what every segment-specific version must cover, the basic risks, and the additional risks for derivatives trading.

The Regulatory Basis

The Risk Disclosure Document is part of the uniform documentation prescribed by SEBI for trading account opening. It contains important information on trading in Equities/Derivatives Segments of the stock exchanges. All prospective constituents should read this document before trading in Equities/Derivatives Segments of the Exchanges.

Basic Risks (Applicable to All Segments)

1. Risk of Higher Volatility

Volatility refers to the dynamic changes in price that a security/derivatives contract undergoes when trading activity continues on the Stock Exchanges. Generally, higher the volatility of a security/derivatives contract, greater is its price swings. There may be normally greater volatility in thinly traded securities / derivatives contracts than in active securities / derivatives contracts.

2. Risk of Lower Liquidity

Liquidity refers to the ability of market participants to buy and/or sell securities / derivatives contracts expeditiously at a competitive price. There may be a risk of lower liquidity in some securities / derivatives contracts as compared to active securities / derivatives contracts. As a result, your order may only be partially executed, or may be executed with relatively greater price difference or may not be executed at all.

3. Risk of Wider Spreads

Spread refers to the difference in best buy price and best sell price. Lower liquidity and higher volatility may result in wider than normal spreads for less liquid or illiquid securities / derivatives contracts. This in turn will hamper better price formation.

4. Risk-Reducing Orders

The placing of orders (e.g., "stop loss" orders, or "limit" orders) which are intended to limit losses to certain amounts may not be effective many a time because rapid movement in market conditions may make it impossible to execute such orders.

5. Risk of News Announcements

News announcements that may impact the price of stock / derivatives contract may occur during trading, and when combined with lower liquidity and higher volatility, may suddenly cause an unexpected positive or negative movement in the price.

6. Risk of Rumors

Rumors about companies / currencies at times float in the market through word of mouth, newspapers, websites or news agencies, etc. The investors should be wary of and should desist from acting on rumors.

7. System Risk

High volume trading will frequently occur at the market opening and before market close. Such high volumes may also occur at any point in the day. These may cause delays in order execution or confirmation. Under certain market conditions, it may be difficult or impossible to liquidate a position.

8. System/Network Congestion

Trading on exchanges is in electronic mode, based on satellite/leased line based communications, combination of technologies and computer systems to place and route orders. Thus, there exists a possibility of communication failure or system problems or slow or delayed response from system or trading halt.

Additional Risks for Derivatives Trading

1. Effect of "Leverage" or "Gearing"

In the derivatives market, the amount of margin is small relative to the value of the derivatives contract so the transactions are 'leveraged' or 'geared'. Derivatives trading provides the possibility of great profit or loss in comparison with the margin amount. If the prices move against you, you may lose a part of or whole margin amount in a relatively short period of time. The loss may exceed the original margin amount.

2. Futures Trading

Futures trading involve daily settlement of all positions. Every day the open positions are marked to market based on the closing level of the index / derivatives contract. If the contract has moved against you, you will be required to deposit the amount of loss resulting from such movement.

3. Currency-Specific Risks

The profit or loss in transactions in foreign currency-denominated contracts will be affected by fluctuations in currency rates. Currency prices are highly volatile. Price movements for currencies are influenced by changing supply-demand relationships; trade, fiscal, monetary, exchange control programs and policies of governments; foreign political and economic events and policies; changes in national and international interest rates and inflation; currency devaluation; and sentiment of the market place.

4. Risks of Option Holders

An option holder runs the risk of losing the entire amount paid for the option in a relatively short period of time. This risk reflects the nature of an option as a wasting asset which becomes worthless when it expires. An option holder who neither sells his option in the secondary market nor exercises it prior to its expiration will necessarily lose his entire investment.

5. Risks of Option Writers

If the price movement of the underlying is not in the anticipated direction, the option writer runs the risks of losing substantial amount. The risk of being an option writer may be reduced by the purchase of other options, but the risks may still be significant.

Trading Through Wireless Technology/Smart Order Routing

Any additional provisions defining the features, risks, responsibilities, obligations and liabilities associated with securities trading through wireless technology/ smart order routing or any other technology should be brought to the notice of the client by the stock broker.

Client Acknowledgment

The constituent must acknowledge and accept that there can be no guarantee of profits or no exception from losses while executing orders for purchase and/or sale of a derivative contract being traded on Stock exchanges.

How We Help

At Anuj Desai & Associates, we help stock brokers prepare and implement the Risk Disclosure Document, ensure compliance with SEBI's requirements, and update the document as regulations change. If you need assistance with RDD compliance, reach out to our regulatory compliance desk.