The Nifty derivative contracts traded on the Singapore Stock Exchange (SGX) have been the bone of contention between the Indian and Singapore government for many years now. Trading of these contracts had gained traction over the last two decades as foreign portfolio investors’ exposure to Indian markets increased.

With the Singapore offshore financial centre providing easier and low-tax alternative to foreign investors seeking short-term exposure to the fast-growing Indian equity market, hedge funds and other global investors began using the SGX Nifty extensively.

This has however resulted in offshore trading in Nifty futures being higher than in domestic exchanges. As Ajay Tyagi, former SEBI Chairman, remarked in January, around 60 per cent of turnover and around 75 per cent of open interest in Nifty index futures had shifted to SGX by January. It’s not surprising that the Indian government and the regulators were quite piqued about this state of affairs. This unbridled trading of Nifty 50 and other Indian derivative contracts on SGX was resulting in a big loss of revenue for the government, besides making it difficult for regulators to check unwanted speculative activity.

The struggle to move the Nifty derivative contracts onshore has not been easy. The government’s efforts to stop trading of Nifty products on SGX was met with vehement protests from global investors and funds, who called India’s decision arbitrary and high-handed.

But a tentative solution has been found using the SGX-NSE IFSC connect at GIFT City — one that does not result in too much loss of revenue to SGX, while placating the Indian government.

But this will not result in an immediate burst of activity at the GIFT city exchanges. Liquidity is extremely low on these exchanges as of now. Participation of domestic retail investors needs to be facilitated on these exchanges so that liquidity increases and attracts other foreign investors.

The dispute, the resolution

The show-down between the Indian government and SGX began in February 2018 when Indian exchanges stopped providing live data feed to SGX for trading of SGX Nifty futures and options. SGX retaliated by creating copy-cat contracts similar to the Nifty contracts calling them SGX India future, SGX India options, SGX India Bank future etc, using the closing price of the domestic Nifty contracts.

NSE filed a case against SGX in Bombay High Court and the matter went into arbitration. Meanwhile, someone in the Centre came up with the bright idea to route the SGX Nifty trading to the NSE platform in the GIFT city IFSC.

After many months of deliberations, in October 2021, SGX opened an office in the GIFT City and the GIFT data connect went live. This ensured that SGX received live data feed from the trading of Nifty contracts in the NSE IFSC.

In May, another step was taken towards bringing SGX Nifty home, by moving negotiated large trades in Nifty 50 contracts from SGX to the NSE IFSC. Finally, on July 29, the NSE IFSC-SGX Connect went fully live, ready to trade and clear all SGX Nifty equity derivatives.

Battle only half won

But the beginning of the Connect is not going to result in a sudden jump in volumes. The members of SGX who trade Nifty contracts have to be onboarded on the NSE IFSC platforms before these trades get reflected in the NSE at GIFT City. This could take a while. Even once the trades are executed on the GIFT trading platform, the SGX Group’s derivatives clearing company will act as the central counterparty, thus resulting in a large part of revenue going to SGX.

If we look at the turnover on the NSE IFSC platform, value of traded contracts has declined 4 per cent in August after the commencement of the GIFT Connect, implying that the flow of trades from SGX has not commenced yet.

However, the value of contracts have shown more than three-fold jump since May 2022, largely due to the transfer of Negotiable Large Transactions, from the SGX. While the average monthly value traded was $7 billion in 2021-22, it moved above $25 billion since June.

The turnover on NSE IFSC will improve once SGX Connect begins, but there is scarcely any activity on the exchange besides this.

Feeble activity

The trading action on the India INX, the IFSC arm of BSE as well on NSE IFSC is, in fact, very weak. While the exchanges offer a bevy of products including commodity and currency derivatives and global stocks, activity is concentrated in just a few pockets on both exchanges.

India INX mainly trades India50 index and options, which mimic the Nifty50, gold futures and INR-USD futures. Volumes on the exchange are mainly led by stock brokers trading on their proprietary books. The liquidity enhancement scheme wherein market-makers as well as members are incentivised to trade on the exchange has also been instrumental in driving volume on the exchange.

The NSE IFSC has a narrower active product portfolio, with trading predominantly in Nifty 50 futures and options. Almost the entire trading volume on the NSE IFSC in 2021-22 was due to Liquidity Enhancement Scheme, where trading members and market makers participate.

This state of affairs is due to the fact that domestic retail investors can not trade on these exchanges. It is a peculiar logjam created by existing regulations. Domestic investors have to use the money they are allowed to invest overseas under the Liberalised Remittance Scheme limit of $250,000 to trade on GIFT City exchanges.

But the RBI bars the use of LRS funds for “remittance from India for margins or margin calls to overseas exchanges/overseas counterparty”. This implies that remittances under LRS can not be used to trade futures and options. So retail investors can buy bonds or global depository receipts on the IFSC exchanges but they can not trade in the derivatives. With futures and options being the primary products on the GIFT exchanges, domestic investors are unable to participate.

The RBI needs to modify this rule by removing this exemption for using LRS proceeds. Once that is done, Indian investors may look more closely at GIFT IFSC, especially due to the favourable tax treatment on the GIFT IFSC. Going ahead, a route can be devised to allow foreign portfolio investors registered with SEBI to trade on GIFT City exchanges too.