Feb 02

Workshop on Capital Markets by Intelivisto in Ghaziabad, NCR

Intelivisto has launched iMAP (Intelivisto Mentoring And Accelerate Program) to bring the youngest work force of the world (students in India) and industry experts at one forum so that both can play their significant role in the mission of re-emerging India by synchronizing and synergizing their efforts and required skill-sets for financial markets in particular.
Workshop on capital markets was the first in the series of interactive programs under the iMAP program and conducted on Jan. 14th-15th, 2012 at Kaushambi, Ghaziabad based state-of-the-art auditorium of Adroit Financial Services Pvt. Ltd. Final year students of MBA-Finance from various management institutes across NCR and professionals from Adroit Financial Services Pvt. Ltd. attended the workshop and interacted with each other.
Students, those have been selected for this iMAP program, comes from institutes like Bangalore School of Business, Delhi, Delhi Business School, Netaji Subhash Institute of Management Sciences, Birla Institute of Management & Technology, Greater NOIDA & Rukmini Devi Institute of Advanced Studies etc. Some aspiring CA students and traders from Master Trust Ltd. also participated in the program.

Feb 02

Development of Derivative Markets in India

Derivatives markets have been in existence in India in some form or other for a long time. In the area of commodities, the Bombay Cotton Trade Association started futures trading in 1875 and, by the early 1900s India had one of the world’s largest futures industry. In 1952 the government banned cash settlement and options trading and derivatives trading shifted to informal forwards markets. In recent years, government policy has changed, allowing for an increased role for market-based pricing and less suspicion of derivatives trading. The ban on futures trading of many commodities was lifted starting in the early 2000s, and national electronic commodity exchanges were created.
In the equity markets, a system of trading called “badla” involving some elements of forwards trading had been in existence for decades. However, the system led to a number of undesirable practices and it was prohibited off and on till the Securities and Exchange Board of India (SEBI) banned it for good in 2001. A series of reforms of the stock market between 1993 and 1996 paved the way for the development of exchange-traded equity derivatives markets in India. In 1993, the government created the NSE in collaboration with state-owned financial institutions. NSE improved the efficiency and transparency of the stock markets by offering a fully automated screen-based trading system and real-time price dissemination. In 1995, a prohibition on trading options was lifted. In 1996, the NSE sent a proposal to SEBI for listing exchange-traded derivatives. The report of the L. C. Gupta Committee, set up by SEBI, recommended a phased introduction of derivative products, and bi-level regulation (i.e., self-regulation by exchanges with SEBI providing a supervisory and advisory role). Another report, by the J. R. Varma Committee in 1998, worked out various operational details such as the margining systems. In 1999, the Securities Contracts (Regulation) Act of 1956, or SC(R)A, was amended so that derivatives could be declared “securities.” This allowed the regulatory framework for trading securities to be extended to derivatives. The Act considers derivatives to be legal and valid, but only if they are traded on exchanges. Finally, a 30-year ban on forward trading was also lifted in 1999.
The economic liberalization of the early nineties facilitated the introduction of derivatives based on interest rates and foreign exchange. A system of market-determined exchange rates was adopted by India in March 1993. In August 1994, the rupee was made fully convertible on current account. These reforms allowed increased integration between domestic and international markets, and created a need to manage currency risk. The easing of various restrictions on the free movement of interest rates resulted in the need to manage interest rate risk.
Derivatives Instruments Traded in India
In the exchange-traded market, the biggest success story has been derivatives on equity products. Index futures were introduced in June 2000, followed by index options in June 2001, and options and futures on individual securities in July 2001 and November 2001, respectively.
Derivatives on stock indexes and individual stocks have grown rapidly since inception. In particular, single stock futures have become equally popular to the index futures. In fact, NSE has the highest volume (i.e. number of contracts traded) in the single stock futures globally, enabling it to highest rank holder among world exchanges at point of time. While single stock options were less popular than stock futures, they have witnessed a high growth rate since starting of 2011 after they were changed to European style. On the other hand, index options are hugely popular than index futures. Now a days, index options turnover share the 2/3rd of the total F&O turnover. NSE launched interest rate futures in 2009 on 10 Year Notional Coupon-bearing Govt. of India Security & the recently introduced (2011) 91-day Govt. of India T-Bill; but in contrast to equity derivatives, there has been little trading in them. This particular segment is still in its nascent stage.
Regulators permitted the exchanges to launch currency derivatives contracts to start with USDINR currency pair in 2nd half of 2008. Later on three more currency pairs EURINR, GBPINR & JPYINR is allowed in Feb. 2010. Currency options contracts were launched on Oct. 29th 2010 on USDINR only & so far now this is the only option contract available in the segment. Since its launch forex derivatives have seen continuous activity & rising trading volumes than interest rate derivatives and any other segments.
Exchange-traded commodity derivatives have been allowed for trading only since April 2003. The number of commodities eligible for futures trading is 109 by 2011 on 21 recognized exchanges. Of all the commodities, bullion contracts shares 40.75%, most of the total turnover. Among all exchanges, MCX enjoys the biggest share of turnover of more than 82% of the total traded value.

Feb 02

Synopsis of Derivatives

A derivative instrument is a financial contract whose value is derived from the value of something else, such as a stock price, a commodity price, an exchange rate, an interest rate, or even an index of prices.
Rise of Derivatives
The global economic order that emerged after World War II was a system where many under developed countries administered and controlled prices and centrally allocated resources. Even the developed economies operated under the Bretton Woods system of fixed exchange rates for currencies/foreign exchange.
The system of fixed prices came under stress from the 1970s onwards. High inflation and unemployment rates made interest rates more volatile. The Bretton Woods system was dismantled in 1971, freeing exchange rates to fluctuate as per demand and supply. Under developed countries like India began opening up their economies and allowing prices to vary with market conditions in early 90’s with start of economic liberalisation process and RBI started playing little role in controlling the foreign exchange prices.
Price fluctuations make it hard for businesses to estimate their future production costs and revenues. Derivative securities provided them a valuable set of tools for managing this risk.
Uses of Derivatives
Derivatives may be traded for a variety of reasons. A derivatives contract enables a trader to hedge some market risk by taking positions in derivatives markets that offset potential losses in the underlying or spot market.
Another motive for derivatives trading is speculation (i.e. taking positions to profit from anticipated price movements). In practice, it may be difficult to distinguish whether a particular trade was for hedging or speculation, and active markets require the participation of both hedgers and speculators.
A third type of trader, called arbitrageurs, profit from discrepancies or mispricing in the relationship of spot and derivatives prices, and thereby help to keep markets efficient.
Exchange-Traded and Over-the-Counter Derivative Instruments
India is one of the most successful developing countries in terms of a vibrant market for exchange-traded derivatives. This reiterates the strengths of the modern development of India’s securities markets, which are based on nationwide market access, anonymous electronic trading, a predominantly retail market and an active regulatory framework. There is an increasing sense that the equity derivatives market is playing a major role in shaping price discovery.
OTC (over-the-counter) contracts, such as forwards and swaps, are bilaterally negotiated between two parties. The terms of an OTC contract are flexible, and are often customized to fit the specific requirements of the user. OTC contracts have substantial credit risk, which is the risk that the counterparty that owes money defaults on the payment. In India, OTC derivatives are generally prohibited with some exceptions: those that are specifically allowed by the Reserve Bank of India (RBI) or, in the case of commodities (which are regulated by the Forward Markets Commission), those that trade informally in “hawala” or forwards markets.
An exchange-traded contract, such as a futures contract, has a standardized format that specifies the underlying asset to be delivered, the size of the contract, and the logistics of delivery. They trade on organized exchanges with prices determined by the interaction of many buyers and sellers. Contract performance is guaranteed by a clearinghouse, which is a wholly owned subsidiary of the exchanges trading derivatives as per present market structure in India. Margin requirements and daily marking-to-market of futures positions substantially mitigate the credit risk of exchange-traded contracts, relative to OTC contracts.
Derivatives Users in India
The use of derivatives varies by type of institution. Financial institutions, such as banks, have assets and liabilities of different maturities and in different currencies, and are exposed to different risks of default from their borrowers. Thus, they are likely to use derivatives on interest rates and currencies, and derivatives to manage credit risk. Non-financial institutions are regulated differently from financial institutions, and this affects their incentives to use derivatives.
In India, financial institutions have not been heavy users of exchange-traded derivatives so far. However, market insiders feel that this may be changing, as indicated by the growing share of index derivatives (which are used more by institutions than by retail investors). Transactions between banks dominate the market for interest rate derivatives, while state-owned banks remain a small presence. Corporations are active in the currency forwards and swaps markets, buying these instruments from banks.
Why do institutions not participate to a greater extent in derivatives markets? Some institutions such as banks and mutual funds are only allowed to use derivatives to hedge their existing positions in the spot market, or to rebalance their existing portfolios. Since banks have little exposure to equity markets due to banking regulations, they have little incentive to trade equity derivatives.
Foreign investors must register as foreign institutional investors (FII) to trade exchange-traded derivatives, and be subject to position limits as specified by SEBI. In practice, some foreign investors also invest in Indian markets by issuing Participatory Notes to an off-shore investor. FIIs have a significant and increasing presence in the equity derivatives markets. They have no incentive to trade interest rate derivatives since they have little investments in the domestic bond markets.
Retail investors (including small brokerages trading for themselves) are the major participants in equity derivatives. The success of single stock futures in India is unique, as this instrument has generally failed in most other countries. One reason for this success may be retail investors’ prior familiarity with “badla” trades which shared some features of derivatives trading. Another reason may be the small size of the futures contracts, compared to similar contracts in other countries. Retail investors also dominate the markets for commodity derivatives, due in part to their long-standing expertise in trading in the “hawala” or forwards markets.
Summary and Conclusions
In terms of the growth of derivatives markets, and the variety of derivatives users, the Indian market has equalled or exceeded many other regional markets. While the growth is being spearheaded by retail investors, private sector institutions and large corporations, smaller companies and state-owned institutions are gradually getting into the act. Foreign brokers are boosting their presence in India in reaction to the growth in derivatives. The variety of derivatives instruments available for trading is also expanding.
In the past, there were major areas of concern for Indian derivatives users. Large gaps exist in the range of derivatives products that are traded actively. In equity derivatives, NSE figures showed that almost 90% of activity was due to index options, index futures & stock futures, whereas trading in options is limited to a few stocks, partly because stock options were of American style & they are settled in cash and not the underlying stocks. But with the start of 2011 all stock options available for trading were changed to European style. This change has led to the liquidity in stock options not only close to ATM strikes but also across multiple strikes just as in case of index options. This change has encouraged the options writers to go ahead eliminating the assignment risk prior to expiry which will eventually benefit them.
Considering these changes derivatives market in India is poised to grow and mature further to accommodate larger participation across varied asset classes by wide range of participants.