Mumbai: The National Stock Exchange, or NSE, will start currency futures trading on Friday. The launch is likely to see proprietary trading by public sector banks, and client trading will take some time to pick up, foreign exchange dealers say.
A currency future is a contract to exchange one currency for another at a specified date in the future for a specific price. To start with, the trading on NSE will be confined to the dollar with a lot size of $1,000.
The lot size is insignificant compared with global standards, but traders expect it to be increased and many more currencies to be traded after futures trading catches on. The Chicago Mercantile Exchange offers lot sizes of 12.5 million Japanese yen or Australian $100,000 for a single contract.
The contract will be settled in rupee on the last business day of the month, based on the Reserve Bank of India (RBI) rupee-dollar reference rate. The trading limits for an individual is $5 million and for a trading member—a bank or a broker—is $25 million.
According to RBI norms, only Indian entities can participate in the market. This means foreign institutional investors are left out of the currency futures trading, but foreign exchange dealers expect this norm also to change after the market matures.
Globally, the currency market is the biggest of all markets with a daily trading volume of more than $3 trillion. Also, 334 million exchange-traded contracts get executed annually, and most them are in dollars.
Although currency futures is not going to help existing currency market participants such as big banks, it will help small and medium enterprises, or SMEs, that do not have sufficient financial muscle to participate on the over-the-counter, or OTC, market.
The average daily volume of the OTC market is about $34 billion, much higher than what traders expect the volume to be on the currency futures market at the initial stage.
The futures market is seen as a hedging tool for SMEs. This will also help in introducing finer price points than the existing ones where the so-called bid and ask rates of various banks vary, says the treasury head of a private sector bank who asked not to be named.
In an OTC market, the pricing is two-way in nature with bid and ask prices clearly defined. Banks quote different price points to their customers in an OTC market, but this will not be possible in the futures market as both banks and their customers will be on the same platform.
In an OTC market, typically, a bank can quote different rates to different customers and all of them accept these rates as market rates.
With some banks putting up screens at their clients’ offices where daily prices are quoted, the OTC market is gradually becoming transparent. However, in the futures market, the rates will be on the screen and will be uniform.
There are other differences too between the two markets.
A forward contract in an OTC market can be terminated at any time but in a futures contract, even if it is terminated in the middle of a month, the settlement will take place only at the end of the month.
According to dealers, the futures market can also be used for speculative purpose and is a step towards fuller convertibility of the local currency.
Trading in the OTC market is possible only when a client has an underlying transaction, such as an export or import contract. However, in the futures market, there is no need for such underlying securities.
“If you have a view (on the rupee), you should be able to trade. Currency futures give people that opportunity. Futures is complementary to OTC and is not a competitor,” said the head of foreign exchange dealing at a foreign bank, who also did not wish to be named.
“This market will help retail investors in taking currency bets who were solely dependent on surrogate mediums as tech stocks for betting on currency fluctuations,” said Harihar Krishnamurthy, treasury head at Development Credit Bank Ltd.
The introduction of currency futures in India comes after Dubai Gold and Commodities Exchange introduced the world’s first exchange-traded futures contracts in the rupee last year. According to dealers, the daily volume in Dubai is not significant yet.
Currency futures were first introduced in 1972 by a group of brokers on the Chicago Mercantile Exchange who wanted to trade on currencies, but felt the rates at the OTC markets were not transparent.
Saikat Chatterjee and Swati Bhat of Reuters contributed to this story.