Home / Market / Stock-market-news /  Efforts to build exchange-traded currency derivatives market miss the mark

Attempts to build an exchange-traded currency derivatives market in India as a way to give small and medium enterprises easier access to currency hedging tools have yielded little, with most of the volumes in this segment coming from those looking to profit from trading in derivatives rather than those looking to hedge their risks.

Brokerages are the biggest contributor to the volumes in the exchange-traded currency derivatives segment and account for more than half of the turnover through proprietary trading, data from regulators shows. Corporate entities account for a far lower share indicating that genuine end users still prefer to go to over-the-counter (OTC) market due to lower margins and customised deals.

On the National Stock Exchange of India Ltd (NSE), proprietary trading accounted for 57.15% of the total turnover in the currency derivatives segment between January and April, show data from the Securities and Exchange Board of India (Sebi). On BSE Ltd and the Metropolitan Stock Exchange of India Ltd (MSEI), the share of proprietary trading was 50.89% and 45.21% respectively over the same period.

Proprietary trading refers to brokers trading with their own money as opposed to clients’ money to make a profit for themselves.

“It is observed... that the proprietary trading accounts for major contribution in turnover in currency derivatives segment. The contribution of FPIs (foreign portfolio investment) in turnover in currency derivatives segment in all the exchanges was less than 1% during the period January 2015 to April 2015," says the Sebi paper.

The paper placed before the regulator’s board at its 23 June meeting shows that corporate entities account for around 33% turnover on BSE and MSEI. Their share of NSE’s currency derivative segment is pegged at only 17%.

A.V. Rajwade, an independent foreign exchange expert, says that genuine clients do not come to the exchange platform for the simple reason that they find the OTC market more convenient and liquid.

“Corporates can directly buy a forward contract from banks in the OTC market. Depending on their relationship with the bank, they can trade on negligible margins as well. On the exchange platform, initial margin, along with mark to market margins, is required," he says.

This is the first time that the capital market regulator has released the data related to the participation in the currency derivatives segment, which was first launched by NSE in August 2008. Thereafter, MSEI, which was earlier known as MCX Stock Exchange Ltd (MCX-SX) started offering currency derivatives trading in October 2008. BSE launched its currency segment in November 2013.

Currency derivative contracts allow investors to hedge against changes in foreign exchange rates between a pair of currencies. Exchanges in India offer futures and options contracts based on rupee-dollar, rupee-euro, rupee-pound and rupee-yen currency pairs.

Over a period of time, turnover in the exchange traded market has become comparable with the OTC market. In July, the combined average daily turnover on the three exchanges is 19,400 crore. The daily average turnover in the OTC segment is over $3 billion as per market estimates, although no precise data is available from regulators.

Trading, however, is concentrated in rupee-dollar contracts on the exchange. Of the total rupee-dollar turnover, futures and options were 60.8% and 39.2%, respectively between January and April, as per Sebi data.

Suresh Nair, director, Admisi Forex India Pvt. Ltd, says while proprietary trading is key for any market segment, there must be a balance between such trading and real client-based trading.

“When the segment was launched, it was not really meant for large corporate houses that have access to inter-bank market but for SMEs. But the data shows that it has not developed that way. We need to have more client-based business and corporates with actual exposure to currency rather than just proprietary. The product needs to be enhanced in a manner that gets more genuine users on the platform," he says.

Such proprietary trading by brokerages is not limited to the currency segment. As per Sebi data, proprietary trading accounted for 51% of the total turnover in the equity derivatives segment on NSE between January and April. On BSE, proprietary trading accounted for 92% of the total turnover.

According to Manis Thanawala, director, Greenback Forex, a currency risk advisory firm, the reason for limited participation from firms in the currency derivatives segment ranges from inadequate liquidity to limited flexibility in duration of contracts.

“There are restrictions on corporates in terms of size of trade along with margins. The longer term contracts on the exchange have no liquidity, which is limited only on the shorter duration contracts. Along with the margin requirements, these factors impact the participation of genuine users," says Thanawala.

Banks, the major players in the OTC market, accounted for 12-13% of the turnover on NSE and MSEI, while on BSE, their share is less than 3% between January and April.

Foreign entities active in the cash market and to a limited extent in the equity derivatives segment do not play a major role in the currency market. There are only 44 foreign entities that have registered with Sebi to participate in the currency derivatives segment and their share in turnover was less than 1% between January and April.

FPIs were allowed to participate in exchange-traded currency segment in June 2014.

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