When the Securities and Exchange Board of India (Sebi) had haphazardly banned the issuance of equity derivatives-linked participatory notes (PNs) last October, many including this paper had suggested that this would lead to the export of a section of our capital markets.
Back then, National Stock Exchange (NSE) had a market share of well over 90% in the thriving index futures segment both in terms of volumes and open interest. Futures on NSE’s Nifty index are also traded on the Singapore Exchange (SGX), but the exchange had a small 5-7% share before the PN ban came into force.
But after the restrictions on PN issuances, SGX’s share has steadily increased, and now its open interest in value terms is as high as that of NSE. In other words, its market share has risen from 5% to 50% since the PN ban.
In terms of volumes, however, NSE is still way ahead. Last Thursday, when the July contract expired, Nifty futures worth $4.1 billion (Rs17,384 crore) were traded on NSE. Trades on SGX were worth less than a sixth that amount at $640 million.
It makes more sense to look at traded volumes while calculating market share, simply because exchanges earn fees based on turnover, and not the amount of outstanding positions. Still, the chart alongside shows that even volumes have risen sharply, indicating that a part of India’s equity index futures market has been exported to Singapore.
For foreign investors who can’t access the Indian market, SGX is a perfect substitute, since the expiry date and the settlement price of the contracts are the same as on NSE. P-note issuers can now easily hedge their positions on SGX and issue linked-notes to their clients. Such issuances don’t come under the purview of Sebi.
The increase in liquidity could even attract players who are allowed to participate in the Indian market. Foreign investors who are registered with Sebi as foreign institutional investors (FIIs) or sub-accounts of FIIs are free to deal in derivatives on NSE. The restriction is on these investors issuing PNs to other entities.
But since the contract traded on SGX is denominated in US dollars, some foreign investors may prefer it because of the currency protection it offers. Trades done in India, on the other hand, carry the risk of the rupee depreciating. Brokers say that thanks to the increase in liquidity in SGX Nifty futures contract, even some savvy Indian players have started trading there, mainly to take advantage of arbitrage opportunities.
The Singapore market has a history of exploiting restrictions in other markets. In the early 1990s, when margins on Nikkei 225 futures were raised sharply in Japan, the Singapore Exchange responded by reducing margins. Soon enough, trading on Nikkei futures shifted to Singapore and it enjoyed majority share until Japan took remedial action in the late 1990s.
Even in the case of Nifty futures, margins and brokerage fees are higher in the home country. But the difference is not as high as in the case of the Nikkei 225 in the early 90s.
The predominant reason why some traders have shifted to the SGX is the restrictions imposed by the PN ban. Indian regulators need to take remedial action soon, unless they want to cede a 50% market share to SGX even in volume terms.
This is not to say that the damage done by the PN ban is irreparable. Volumes on NSE continue to be strong as domestic retail and high net-worth players are quite active in this market, and they not only prefer trading in the domestic currency but also find it much more convenient. If PN restrictions are lifted, or the registration process is relaxed, one would see a shift back to the home market.
The index futures market is not the only segment that has suffered because of regulatory restrictions.
Securities lending and borrowing, which was introduced in April , has hardly had any trades, owing to over cautious regulations.
The upshot: There is a flourishing parallel market for stock lending carried out by brokers. But thankfully in the case of stock lending, Sebi is looking at taking some remedial action.
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