Risk Disclosure Document
Also written RDD · Risk Disclosure Document (RDD) · Model Risk Disclosure Document
The document a broker must give a derivatives client, and have signed, at registration — setting out the risks of trading on exchanges and the rights and obligations of broker and client.
In plain language
Before a client trades futures and options, the broker has to put the risks in writing and get the client to sign for them. That document is the Risk Disclosure Document.
The workbook describes it as highlighting the risk involved in trading on stock exchanges, and the rights and obligations of the broker and their clients. Chapter 1 calls the standard version the Model Risk Disclosure Document, issued by members of exchanges and covering trading in the equities and F&O segments; it says every prospective participant should read it before trading.
The reason it exists is stated bluntly in Chapter 10: the risk of trading (as opposed to hedging) with derivatives is not widely understood, and in complex products there is a real danger of unethical sales practices — clients being induced to buy unsuitable contracts at unfair prices without understanding the risks.
How it works
When. At the time of client registration / on-boarding. The broker must obtain a copy duly signed by the client. Chapter 8 traces this requirement to the L. C. Gupta Committee report, alongside strict enforcement of Know Your Customer.
What it covers (Chapter 10, section 10.2):
| Risk | Meaning |
|---|---|
| Market risk | Price moves against the investor |
| Liquidity risk | Inability to close a loss-making position — volumes in stock F&O typically fall near expiry |
| Counterparty risk | Default by the other side — generally not applicable to exchange-traded equity derivatives |
All three are heightened by leverage. It then sets out product-specific risks: futures clients face daily MTM calls and possible liquidation if they do not pay; option buyers hold a wasting asset and can lose the whole premium; option sellers face unlimited loss. Chapter 10 also notes the disclosure covers mechanics, transaction costs, margin requirements and tax consequences.
The 2023 addition. Brokers must now also show Risk Disclosure facts as a pop-up at every login, which the client must acknowledge before proceeding. They come from a SEBI study published in January 2023 of individual traders' F&O results for FY 2021-22.
A worked example
The four Risk Disclosure facts, and what they mean for one trader.
| Fact (FY 2021-22) | Figure |
|---|---|
| Individual F&O traders who incurred net losses | 9 out of 10 |
| Average net trading loss of loss makers | close to Rs 50,000 |
| Transaction costs of loss makers, over and above that loss | 28% of net trading losses |
| Transaction costs of profit makers | 15% to 50% of net trading profits |
Illustrative application of those percentages (the trader is hypothetical):
Rohan is a typical loss maker with a net trading loss of Rs 50,000.
Extra transaction costs = 28% × 50,000 = Rs 14,000
Total damage = 50,000 + 14,000 = Rs 64,000
His friend Meera made a net trading profit of Rs 40,000. Her transaction costs were somewhere between:
15% × 40,000 = Rs 6,000 and 50% × 40,000 = Rs 20,000
That is the message the pop-up is designed to deliver before either of them places the next trade. Brokers must keep individual clients' P&L data (including HUFs and NRIs, excluding proprietary traders, institutions and partnership firms) for at least five years, and exchanges and depositories must display the facts with a link to the SEBI study.
Why NISM asks about it
Chapter 1, section 1.7, introduces the Model Risk Disclosure Document. Chapter 8 makes the signed copy a regulatory requirement under the L. C. Gupta Committee framework. Chapter 10, section 10.2, is the main treatment: the three risks, the product-specific risks, and the four SEBI study figures. Those four numbers are prime exam material.
Common exam traps
- Signed by the client, at registration. Not at the first trade, not annually.
- "9 out of 10" incurred net losses — not 9 out of 10 lost money on every trade.
- 28% is the extra cost for loss makers as a share of their losses; 15% to 50% is for profit makers as a share of their profits. Questions swap the bases.
- The study year is FY 2021-22; the study was published in January 2023.
- Counterparty risk is listed but said to be generally not applicable to exchange-traded equity derivatives, because of the clearing corporation's guarantee.
- The pop-up supplements the Risk Disclosure Document; it does not replace it.
Where this is taught
- Series V-D · Chapter 19: Interest Rate Derivativesintroduced here
- Series XXIII · Chapter 3: Registration and Listing on Social Stock Exchangesintroduced here
- Series IV · Chapter 2: Interest Rate Derivativesintroduced here
- Series XVI · Chapter 10: Codes of Conduct and Investor Protection Measuresintroduced here
- Series I · Chapter 10: Codes of Conduct and Investor Protection Measuresintroduced here
- Series VIII · Chapter 8: Legal and Regulatory Environmentintroduced here
- Series IV · Chapter 10: Code of Conduct and Investor Protection Measures
- Series VIII · Chapter 10: Sales Practices and Investor Protection Measures
Related terms
- Liquidity riskThe risk of being unable to get out of a position at or near the quoted price — because the contract is bilateral, because the order book is thin, or because volumes dry up near expiry.
- ChurningUnnecessary and excessive trading in a client's account by a securities professional, done for the sole purpose of generating commissions rather than for the client's benefit.
- LeverageControl of a large contract value for a small upfront outlay — premium for an option buyer, margin for a futures position — which multiplies percentage gains and percentage losses by the same factor.
- Wasting assetAn option, whose time value shrinks towards zero every day it is held and is worth nothing at expiry — so an option buyer loses money simply from the passage of time.
- Counterparty riskThe risk of an economic loss because the other party to a contract fails to fulfil its obligation — acute in forwards, and removed for exchange-traded derivatives by the clearing corporation's guarantee.
- Unsuitable recommendationAdvising or selling an investment that does not fit the investor's objectives and risk profile — the workbook's example is a broker putting a low-risk-tolerance senior citizen into futures or penny stocks.
- Code of conductThe conduct obligations a broker accepts as a condition of registration — integrity, due skill and care, no manipulation, and a specific list of duties owed to the client and to other brokers.
- Officially valid documentsThe alternatives to Aadhaar accepted as identity evidence for KYC — driving licence, passport, voter ID and the NREGA job card — all of which the client supplies voluntarily.
- L. C. Gupta CommitteeThe 24-member SEBI committee under Dr. L. C. Gupta, set up in November 1996, that designed India's regulatory framework for derivatives and recommended they be declared securities.
- Approved userAn individual, certified under a SEBI-approved programme, whom a trading member appoints to operate its derivatives trading terminal — the only person actually allowed to key in orders on it.