The Hindu Business Line : Caution on futures

The Securities and Exchange Board of India (SEBI) has surely made out a persuasive case for doubting the genuineness of a set of transactions in the Futures and Options market put through by a section of the broking community. It has based its case on three aspects unique to the offending transactions. One, the derivative contracts in the underlying assets were not the most prominent ones in the market. Two, the transactions were closed within seconds of their being created. Third, the same set of investors, often clients of the same broker, was involved in the reverse transaction. It is one thing to claim that the transactions were artificial, bereft of any legitimate purpose — hedging against the risk of price variation in one's investment portfolio or taking a speculative view on the future direction of an asset price — but quite another to establish beyond a shadow of doubt that the parties had engaged in market manipulation. It is in recognition of this difficulty that SEBI chose to let the brokers off with a `cease and desist' order hoping that if the market players mend their ways then nothing more need be done.

The episode nevertheless underscores an important lesson for the public policy-makers. When they seek to differentiate between groups of people subject to their regulatory oversight (no doubt, with the best of intentions) it must inevitably result in the creation of an arbitrage opportunity for someone whom the policy favours. Thus, those with income below the taxable limit can offer, for a fee, to shelter a portion of the income of another who needs to pay tax. Similarly investment policies that seek to drive a wedge between overseas and domestic investors often end up making the former look for an Indian address to give investments the local colour. Predictably enough, questions are raised as to the true source of money that is labelled domestic capital.

This has happened in the civil aviation sector, as also in telecom. Indeed, the list is endless. In the case that SEBI has highlighted, the transactions were driven more by a quest for tax arbitrage than any innate desire to distort the market process in derivative instruments in the country's stock exchanges. This is not to say that the SEBI exercise in highlighting artificial transactions in derivative instruments is pointless. Only that, there is perhaps something in it for the taxman to ponder.

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