Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Bag of goodies for markets regulated by Sebi

The finance minister lowered the securities transaction tax on equity futures by about 41%.

The finance minister gave a pat on the back to the Securities and Exchange Board of India (Sebi) in his Budget speech and then handed it a bag of goodies for the markets it regulates. This included clarifications to ease the registration process for foreign institutional investors (FIIs), allowing FIIs to participate in the exchange-traded currency derivatives market, giving the green signal for a dedicated debt segment on stock exchanges, as well as permitting insurance companies, provident funds and pension funds to participate in this segment.

In addition, the finance minister lowered the securities transaction tax on equity futures by about 41% and introduced a transaction tax on non-agricultural commodity futures trading. This will create a level-playing field and correct the large shift in trading to the commodity market in recent years.

Incidentally, the currency derivatives market is now the only one in the exchange-traded space which doesn’t attract any transaction tax, and will stand out with significantly lower trading costs. As past history shows, some shift in trading can be expected, as a number of large traders are completely agnostic to the underlying asset and are influenced by trading costs. In this backdrop, it’s good to note that FIIs have also been allowed to participate in this segment to the extent of their rupee exposure in the Indian market. To some extent, this will address the rapid growth of the non-deliverable forward market for the rupee overseas.

Also, the experience from the equity derivatives market shows that FIIs take positions for longer durations, apply a range of trading strategies and add depth to the market on the whole. Some banks are already active in this market, and the addition of FIIs will make the markets much healthier, especially given their natural need to hedge their exposure to the domestic currency. The deepening of this market will help in shifting volumes from the over-the-counter market to the transparent electronic trading screens of exchanges.

On the same lines, it’s interesting to note that the government and Sebi are working towards the development of exchange-traded debt markets. The finance minister has done well to allow insurance companies, provident funds and pension funds to participate when the market gets functioning. Without these important institutional investors, who together hold large amounts of debt securities, all the effort of the launch would have come to naught. It’s important to note here that the above-mentioned sets of investors are not regulated by Sebi and unless the finance ministry intervened, it would have been a while before they could participate in a market governed by Sebi. By addressing the issue in his Budget speech, the finance minister has nipped this issue in the bud.

Sebi has already issued a circular to stock exchanges saying they can choose to provide a separate debt segment, which will trade all debt instruments including corporate bonds and government securities (subject to the Reserve Bank of India’s approval). Late last year, the central bank had issued a circular to banks saying they can become members of stock exchanges and undertake proprietary transactions in the corporate bond market.

Already, Sebi has a proposal from ICAP India Pvt. Ltd, an interdealer broker in the over-the-counter debt market, to set an exchange-based platform for debt trading, starting with corporate bonds. ICAP has envisaged a purely institutional market and interestingly Sebi’s circular provides for such a market. The broker already manages a successful electronic trading platform for interest rate swaps, and over time this can move to the exchange platform.

In developed markets, one of the latest developments is the “futurization of swaps", whereby over-the-counter swaps contracts are getting standardized and trading on futures exchanges. This is driven by new regulations such as the Dodd-Frank Act and European Market Infrastructure Regulation, which require swaps to be centrally cleared, among other things. Given the definite trend of more and more products moving to the exchange-space, it makes sense for the Indian markets also to embrace this model for trading debt instruments. In this backdrop, it’s heartening to note the coordinated work of the finance ministry, Sebi and even the central bank, to some extent.

It was also good to hear the finance minister say that the Financial Sector Legislative Reforms Commission’s recommendations will be acted upon quickly and decisively. However, given that the commission will recommend sweeping changes to financial sector laws, it seems unlikely that the government will be able to pass these laws in the remainder of its tenor. The plan to constitute a Standing Council of Experts in the ministry of finance “to analyse the international competitiveness of the Indian financial sector, periodically examine the transaction costs of doing business in the Indian market, and provide inputs to government for necessary action" also sounds good. The key, of course, is whether the government will eventually take action on the suggestions that come from the council.

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