Sebi in February last year had allowed stock exchanges to introduce incentive schemes for brokers and intermediaries to enhance liquidity in illiquid securities in the equity cash and derivative segments.
Under the scheme, brokers and other market intermediaries are given incentives for a specified period of time to bring in liquidity and generate investor interest in securities which have limited trading activity.
In a circular issued on Wednesday, Sebi said the liquidity enhancement schemes enhance would have to be "objective, transparent, non-discretionary and non-discriminatory".
The scheme would not compromise on market integrity or risk management.
Sebi said liquidity enhancement scheme would have the prior approval of the stock exchange's board. Besides, implementation and outcome of the scheme would be monitored by the board at quarterly intervals.
Also, the scheme is required to specify the incentives available to market makers /liquidity providers and such incentives include discount as well as adjustment in fees in other segments, cash payment or issue of shares, including options and warrants.
The effectiveness of the scheme would be reviewed by the exchanges every six months and they would submit half-yearly reports to Sebi.
The regulator said the schemes can be discontinued at any time with an advance notice of 15 days.
It said that outcome of the scheme like incentives granted and volume achieved on the market maker and security wise would be disseminated on a monthly-basis.
Regarding illiquid securities, Sebi said that the stock exchange would formulate its own benchmarks for selecting such securities for liquidity enhancement.
Bourses would introduce liquidity enhancement schemes on any security for a maximum period of three years.
Sebi said that once the scheme is discontinued, it can be re-introduced on the same security provided it is less than the three year period since the introduction of scheme on that security.
"Further, an exchange may introduce liquidity enhancement schemes in securities where liquidity enhancement scheme has been introduced in another exchange. Such schemes cannot be continued beyond the period of liquidity enhancement schemes of the initiating exchange," Sebi noted.
The list of securities eligible for liquidity enhancement would be disseminated to the market.
Sebi said incentives under liquidity enhancement schemes would have to be transparent and measurable.
The regulator said that incentives during a financial year would not exceed 25 per cent of net profits or 25 per cent of free reserves of the stock exchange, whichever is higher, as per the audited financial statements of the preceding financial year.
Sebi also said shares that may accrue on exercise of warrants or options, given as incentives under all liquidity enhancement scheme, during a financial year, would not exceed 25 per cent of the issued and outstanding shares of the bourse on the last day of the preceding fiscal year.
The regulator said that stock exchanges are required to have systems and defined procedures in place to monitor collusion between stock brokers indulging in trades solely for seeking incentives and prevent payment of incentives in such cases.
It also said that incentives would not be given for the trades where the counterparty is self, i.e., same unique client code (UCC) is on both sides of the transaction and any violation of this clause would be viewed most seriously.
Sebi said that all market maker/ liquidity enhancer orders / trades would have to be identifiable by the stock exchange.
"Any conflict of interest framework shall be put in place by the exchange for the liquidity enhancement scheme. Such a framework shall provide for obligation on the part of the market maker/liquidity enhancer to disclose any conflict of interest while participating in the scheme. The same shall be disclosed by the exchange on their website," Sebi said.
The new guidelines would not be applicable to securities listed on the small and medium enterprise (SME) platform.