FIIs may get to trade in currency futures

FIIs may get to trade in currency futures
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First Published: Sat, Dec 13 2008. 05 24 PM IST

Updated: Sat, Dec 13 2008. 05 24 PM IST
Mumbai: India’s capital markets regulator, the Securities and Exchange Board of India (Sebi), is all set to allow foreign institutional investors (FIIs)—the main driver of the Indian stock market—to participate in the country’s nascent currency futures market, according to two senior Sebi officials.
The officials spoke on the condition they wouldn’t be identified.
Sebi has already had discussions with the Reserve Bank of India (RBI) on this issue and both regulators have in principle agreed that FIIs will be allowed to enter the currency futures market, an RBI official also confirmed. He can’t be identified as he is not authorized to speak to the media.
The matter could potentially come up for discussion as early as Friday at a scheduled Sebi board meeting in Mumbai.
Also See Rising Volumes (Graphic)
If Sebi formally signs off, FIIs can hedge the forex risk on their investments in Indian equities on the exchange-traded platform.
Currently, these investors are dependent on the larger but relatively less transparent over-the-counter (OTC) market, where banks quote prices on contracts.
FIIs have taken out at least $12.5 billion (Rs62,375 crore) from Indian market in 2008 after investing $17.36 in Indian equities during 2007 and about $12 billion in 2006.
The Bombay Stock Exchange’s (BSE) benchmark index, the Sensex, has lost about 56% since January.
The value of FII investments in Indian stocks has eroded more than that since the Indian rupee has fallen about 20% against the dollar in 2008.
If FIIs are allowed to hedge their position in the currency futures market, they will be able to protect their portfolio from the loss arising out of the erosion in the value of local currency.
Separately, Sebi is also planning to raise the position limits for currency futures significantly. The quantum of hike is still under discussion but one Sebi official said it could be raised to as high as $100 million. On this issue too, both Sebi and RBI have held discussions.
According to the existing guidelines, the position limits for a single client is $5 million or 6% of the open interest, whichever is higher.
On 26 November, the open interest on currency futures at the National Stock Exchange (NSE), the first entity to kick off the currency future trade, stood a tad above 170,000 contracts. Since the lot size of each contract is $1,000, the open interest was $170 million. So, the maximum position allowed for a single client, on Wednesday, was a little above $10 million.
This limit is too low for the hedging needs of most large Indian companies and this has been keeping them away from this market. A hike in position limits will help attract these companies to participate in currency futures.
Apart from the low limit, the so-called margin requirement is also a deterrent for the growth of the currency futures market. Companies are required to deposit 1.75% of the value of the contracts as margin with the exchange to trade in futures but such margins are not required for booking forward contracts through banks where companies pay a flat fee per contract.
Mint couldn’t immediately ascertain whether Sebi will make any change in the margin requirements.
One of the Sebi officials Mint spoke to said that the decision to allow FIIs was taken considering the stability and the rising volumes in the currency futures market. Initially, the limits were set low and FIIs were kept away “to avoid large guys manipulating at low volumes”, the official said.
Daily turnover in the currency futures market was around 560,000 contracts, or $560 million, on 20 November, the highest in recent times.
This is almost a 10-fold jump from around $50 million daily average turnover in this market, when it was kicked off in the last week of August. The average daily volumes at the forwards market in India is about $3.5 billion and that of non-deliverable forwards (NDFs) overseas is about $1 billion. NDFs are contracts that do not require settlement in dollars.
India is the 17th largest foreign exchange and derivatives market in the world. The average daily turnover in the foreign exchange market has almost doubled, from $25.8 billion in 2006-07 to $48.1 billion in 2007-08, reflecting large international trade inflows.
So far, currency futures are offered only in dollars. NSE is planning to introduce futures in other currencies such as the Japanese yen, euro, Chinese yuan and pound sterling to increase volumes on its platform. Apart from NSE, two other exchanges, BSE and the Multi Commodity Exchange of India Ltd’s stock exchange, are allowed to float currency futures products. A fourth exchange, which is being set up by at least 12 banks, led by Kerala-based private lender Federal Bank Ltd and other financial institutions, has applied to Sebi for approval.
Foreign exchange dealers have been saying that unless regulatory restrictions such as the $5 million cap and ban on trades by non-resident Indians, FIIs and mutual funds are relaxed, the market will not be liquid.
They also said the currency futures market may face the same fate the interest rate futures market faced in 2003.
Interest rate futures, introduced in June 2003, failed to take off as market participants were apprehensive of betting on futures in the absence of a reliable spot curve. The pricing benchmark was also not clear and there were only three products in the market—the 91-day treasury bill, 10-year zero coupon bond and 6% 10-year bond.
Sebi and RBI have been talking about the reintroduction of interest rate futures in next few months. Meanwhile, the entry of FIIs will deepen the currency futures market manifold.
Ravi Krishnan contributed to this story.
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First Published: Sat, Dec 13 2008. 05 24 PM IST
More Topics: FIIs | Sebi | RBI | BSE | Currency futures market |