The Hindu Business Line : Derivative ideas

The idea of derivative contracts with smaller lots that SEBI has put up for public debate is bound to appeal to a wider section of retail investors. Currently the contract size in each of these derivative instruments is so fixed as to make the value at least Rs 2 lakh. This is in line with the recommendations of the Parliamentary Standing Committee on Finance, which examined this issue before its introduction in the stock exchanges. The Committee perhaps thought that ret ail investors are better off avoiding such instruments, at least in the initial phase. But it is more than seven years since these instruments were launched. Since then, the trading and settlement systems in the securities market have become robust enough to dismiss any lingering doubts that a ‘Barings’ like fiasco may be upon us.

Second, the rise in equity values has anyway made the minimum value of contracts, in most cases, far higher than what the committee felt was prudent. Finally, if such instruments were meant to enable investors hedge their exposure in the equity market, then keeping the minimum contract value high defeats that purpose. Indeed, despite the high entry barrier, retail investors account for the bulk of such contracts. SEBI is, therefore, better off lowering the entry barrier to a level more affordable to a wider section of retail investors. Equally, the decision to offer contracts with a longer tenure should be welcomed as it enables those with longer investment horizons to hedge their exposure conveniently, avoiding the tedium of having to roll short-term contracts several times over.

Of greater significance is the SEBI proposal to permit stock exchanges to offer derivative contracts for foreign exchange. The stock exchanges have in place a versatile online trading platform that has stood the test of time. They should be just as capable of putting through trades in foreign currency as in other financial assets. However, for settlement of derivative contracts in foreign currency there is a need for a vibrant and, more importantly, a transparent ‘spot’ market in foreign currency. The country lacks such a system as banks, the key institutional players in the system, are content to operate in an opaque ‘Over the Counter’ market. This becomes clear from a comparison of trades put through the Clearing Corporation of India’s (CCIL) trading platform and those put through via private trading terminals but reported to the CCIL for settlement; the private deals vastly outstrip those put through the CCIL system. Getting banks and other forex dealers to adopt a transparent platform that is open to the scrutiny of both the regulator and the public is the challenge facing the RBI and SEBI.

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