Retail investors turned surprisingly active in India's tepid exchange-traded commodity derivatives (ETCD) segment during the West Asia conflict, in the backdrop of regulatory curbs on rupee speculation that took effect two years ago.
Market observers said wartime volatility prompted more retail investors to hedge their underlying exposure, in line with a Reserve Bank of India (RBI) circular dated 5 January 2024. The circular had said that users could trade up to $100 million across currency pairs like dollar/euro/British pound and yen versus rupee across all stock exchanges—but only if they could establish the existence of unhedged underlying obligations to buy or sell forex if required.
The recent jump in retail participation as a percentage of turnover is interesting, as a failure to disclose underlying exposure—if asked—can invite stringent penalties or even arrest under the Foreign Exchange Management Act (Fema) of 1999 during audits of broker books by the Securities and Exchange Board of India (Sebi), which regulates the ETCD segment along with RBI.
The National Stock Exchange (NSE), which holds 100% market share in the ETCD segment, defines retail investors as individuals, non-resident Indians (NRIs), Hindu Undivided Families (HUFs) and proprietorships.
Unhedged exposure
"NRIs, HNIs (high networth investors) and super HNIs and proprietorships are mostly active on the currency futures segment of exchanges," said a Delhi-based broker, requesting anonymity as he can't speak on clients. "Their trades are backed by unhedged spot market exposure, which entails selling dollar or buying the same at a later date ."
NRIs generally need to convert their dollars to rupees when they buy Indian shares, and to buy dollars when they repatriate their funds after selling the shares.
Proprietorships which run businesses in their names and high- or ultra-high-net worth investors sell or buy dollars or euros for travel, children's education, and overseas medical expenses, among others. They can also take a hedge on ETCD. Derivatives hedging is a risk management tool to offset anticipated losses due to adverse price movements in spot markets.
Such users face risks of extreme currency volatility, especially during events like the US-Iran war, which disrupted global crude supplies and drove the rupee to a record low against the dollar.
"We allow participants to trade only against documents supporting underlying exposure and a CA (chartered account) certificate," said Naveen Mathur, director (currencies & commodities), Anand Rathi Group. Mathur said he believed that other brokers too allow retail or corporate clients to trade in ETCD only after exercising adequate due diligence.
Daily turnover
The average daily turnover of ETCD futures—largely dollar versus rupee—jumped to ₹5,535.58 crore through 25 June in the current fiscal, up 65% from ₹3,360 crore during the same period of the previous fiscal year, NSE data showed. This is also just a third below the ₹7,344.64 crore in the corresponding period of FY25, when the RBI cracked down on the ETCD space to curb rupee speculation.
The rupee plunged 6.5% from 91.07 to the dollar on 27 February, the day the war broke out in West Asia, to a low of 96.96 on 20 May after crude surged 39% to $101 a barrel over the same period, data from financial portal investing.com showed.
This sharp rupee volatility at first caused retail participation as a share of futures turnover on the NSE to slip to 5.9% in March from 7.8% in February, before rising to 10.2% in April and 11.1% in May, as per NSE data.
The market share of foreign investors, the second-biggest ETCD participants after proprietary traders and ahead of retail participants at the third slot, followed activity similar to retail.
Their share dipped one percentage point from February to 15.7% in March, before rising to 17% in April and 17.3% in May. Prop traders' share ranged from 52.3-62.9% over the same period.
‘Contracted exposure’
The RBI circular of January 2024, which took effect on 5 May that year, said users could trade in ETCD to hedge "contracted exposure." This clause effectively barred users from speculating on ETCD, and caused average daily turnover to plunge 81% to ₹5,520 crore in FY26 from a year ago.
The circular took effect ahead of India's inclusion on the JP Morgan Government Bond Index on 28 June 2024, that would see foreign investors pumping up to $20-25 billion into stipulated government bonds over the next 10 months.
However, the RBI's crackdown elicited criticism from certain quarters.
"Any such contract (ETCD) takes time to mature, deepen and attract liquidity. We must mature as a market and economy, and get rid of the fear that someone is out there to get us," said senior securities lawyer Chirag Shah. "If such arguments (trading only against contracted exposure) are to be accepted, equity markets should be closed down in case of a bear raid or persistent FPI (foreign portfolio investor) selling pressure. Markets are not only gauges; they are a safety valve too."
NSE began offering ETCD in August 2008, soon after the erstwhile MCX Stock Exchange did.