Mint reported late last week that the currency derivatives market shrank nearly 40% in October, after two leading exchanges introduced transaction charges in the segment. This isn’t surprising. Volumes had begun falling soon after the bourses announced the new charges in mid-August. But now that it’s been over two months since transaction charges were imposed, it makes sense to look at the impact on the market in greater detail.
It’s been almost 50 trading sessions since National Stock Exchange (NSE) and Multi Commodity Stock Exchange (MCX-SX) imposed charges in the currency derivatives segment. The average daily volumes during this period stood at $8.2 billion, across the three exchanges—which also includes United Stock Exchange (USE)—that operate in the segment. In just the month before the fees were introduced, average daily volumes were at $15.8 billion. In this comparison, volumes have dropped by 47.5%. The drop has been uniform across the futures and options segments, with slight variations in the performance of the three exchanges.
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As this column pointed out in August, currency traders work on thin spreads and a charge of around Rs 100 for every Rs 1 crore of transactions means that they would flip trades less often. The fact that volumes have nearly halved shows that a large number of short-term traders were present in the market earlier. This community obviously now finds it less lucrative to trade in the segment. But the good news is that despite the sharp fall, average daily volumes are still healthy at $8.3 billion. In the first six months of 2011, average daily volumes across the three exchanges stood at $8.9 billion. These levels of trading still allow genuine hedgers and users of the market to take meaningful positions.
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More importantly, outstanding positions in the market haven’t fallen at the same rate as turnover. In the currency futures segment, the peak open interest position in the October expiry cycle stood at $4.6 billion, 32% lower than the peak open interest position of $6.8 billion in the July expiry cycle. And as the chart alongside shows, open interest and volumes are beginning to converge. Only about a year ago, the market open interest was just 20% of the volumes generated. In other words, most trades were squared-off intra-day. As USE experience has shown recently, a large number of trades could have been artificial as well, to give the impression of liquidity.
There is little doubt that scalpers and short-tern traders add liquidity and should not be driven away from the market. Having said that, markets are clearly better-off without artificial volumes. Transaction fees seem to have taken off the froth away from the currency derivatives market. In the futures segment, open interest has now risen to 68% of volumes and on a market-wide basis, it has risen to 94%.
NSE continues to lead in this area, averaging an open interest to volume ratio of 1.1 in the past month, with MCX-SX at 0.47 and USE at merely 0.22. Before the cut in transaction charges, the open interest to volume ratio at the three exchanges stood at 0.63, 0.32 and 0.12, respectively. Each exchange has seen a reduction in intra-day trades and an improvement in the open interest to volume ratio.
On the face of it, it appears that volumes are settling around 40-50% lower from the peak just before the fees were imposed. These are still healthy levels of trading. The fact that charges were imposed three years after trading began seems to have given currency exchanges adequate time to build interest in the segment.
Of course, transaction charges are an irritant from the point of view of corporate users of the segment, who aren’t used to paying transaction fees in the competing over-the-counter currency derivatives segment. Even so, the fact that the exchange-traded segment is much more transparent, and considering that volumes are still healthy, there are still compelling reasons for hedgers to migrate to this segment.
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PDF by Yogesh Kumar/Mint
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