Insider trading in IRFs

S. MURLIDHARAN | Updated on March 09, 2011

The government must identify those classes of offcials likely to get price-sensitive information and bar them from trading in interest rate futures

Insider trading is instinctively and innately associated with equity shares. Indeed, it is de rigueur in the share markets all over the world though some countries, notably the US, have registered a modicum of success in reining in the evil. The US law deems any short-swing profit — profit from sale of shares within six months of their purchase - as arising out of insider knowledge in the hands of a 10 per cent shareholder.

A couple of years ago, the Securities and Exchange Board of India under Mr C.B. Bhave sought to emulate the US law, but the move apparently was scuttled down by vested interests. Apart from nailing short-swing profits by significant stakeholders, the US SEC keeps its ears to the ground so much so that it is confident of nailing Mr Rajat Gupta, the Indian consultancy whiz kid, on charges of passing on privileged and price-sensitive information, from companies such as Goldman Sachs of which he was the director, to his associates for them to make a killing in the market apparently for a quid pro quo.

The record of Indian authorities, especially the SEBI, is nothing to write home about. If anything, it is dismal. The advent of foreign institutional investors (FIIs) to be sure has added dispassionate players to the market, but before them the market was for, by and of insiders. The Companies Bill 2009 contains a provision that has been hailed as salutary by the cognoscenti — key managerial personnel of a listed company are prohibited from trading in the futures and options market in respect of the company's own shares.

Options market

It is common knowledge that the options market beckons an insider more than anybody else because he can confidently leverage his small investment and make enormous profits. A director of a company armed with encouraging news about the company may buy 40,000 call options at Rs 5 each to buy the company's share at Rs 1,000 each one month from now. If indeed his confidence is borne out and the share races to Rs 1,200, he would have made Rs 78 lakh (Rs 80 lakh minus Rs 2 lakh). Had he gone to the cash segment with the same information, he would have at best made Rs 40,000 — Rs 200 on 2,000 shares. The options market in shares in the event is tailor-made for insiders and it is just as well that the government is all set to nip the evil in the bud though there is no guarantee that a company's managerial personnel would not get round the bar through surrogates.

Interest rate futures

As pointed out at the outset, insider trading conjures up visions of shares. But one can easily visualise insider trading in interest rate futures (IRFs) also. The buzz is that the IRFs market the world over accounts for more than 25 per cent of trading in derivatives of all products put together. Does this point to a sizeable insider activity taking place in this esoteric product?

In India, the Reserve Bank of India (RBI) takes call on monetary matters though there are people who believe that the RBI is only as independent as the CBI and that it is influenced by the Ministry of Finance. Be that as it may, it is indeed possible for officials of the RBI or the Finance Ministry who are privy to sensitive information on monetary policies to invest in IRFs and make a killing, especially in the run-up to quarterly monetary policy changes. This is not to even remotely make any allegation of actual wrong doing. The point is would it not be wise to bar the RBI and Finance Ministry officials peremptorily from participating in the IRF market.

The derivatives market is dominated by speculators the world over. But it is also the happy hunting ground for insiders. Insider trading is not only innately and instinctively associated with shares but also with company promoters and its managerial personnel. But in a country particularly practicing dirigisme, the officialdom could also be privy to a lot of price-sensitive information. It is for the government to identify those classes of persons who are likely to come into possession of price-sensitive information and bar them straightaway peremptorily from trading. Keeping the monetary policy mandarins from the interest rate futures and options market could be the first step in pre-empting insider trading by government officials.

(The author is a Delhi-based chartered accountant.)

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Published on March 09, 2011
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