Foreign Exchange Markets in India-Futures Versus Forward Trading
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FOREIGN EXCHANGE MARKETS IN INDIA: FUTURES V/S FORWARD TRADING
Tulsi Lingareddy* (August 2009) Foreign exchange market in India has made significant strides in the recent years gaining depth and volumes and introduction of i n c re a s i n g n u m b e r o f d e r i v a t i v e s instruments for hedging against price risk. Further, with the rapid increase in global integration of financial markets and to facilitate the increased cross boarder transfer of funds, the RBI has permitted exchange trade of currency futures in 2008. Consequently, currency futures contracts were introduced for trading on the National Stock Exchange Ltd (NSE) with the effect from Aug 29, 2008. Following this, two more exchanges, Bombay Stock Exchange (BSE) and Multi Commodity Exchange-Stock Exchange (MCX-SX), also started offering currency futures trade in Sept and Oct respectively, in 2008. Soon after their introduction, trading in currency futures picked up momentum rather quickly and the total volumes reached Rs.5.14 lakh crore by the end of May 2009. The main advantage of currency futures over its closest substitute product, viz., forwards which are traded over-the-counter (OTC) lies in price transparency, elimination of counterparty credit risk and greater reach in terms of easy accessibility to all. However, futures’ trading also involves speculators and arbitragers who don’t have any underlying physical exposure but participate in trading with profit motive. As a result, there are apprehensions that the excessive speculation may adversely affect both futures as well as the underlying spot markets. Considering these developments, an attempt is made to study the pattern of trade, comparative economics forex derivatives and the impact of futures on forwards and spot. Trends in forex derivatives market trade Forex forwards (OTC products): The trends in the trade of forex forwards indicated that majority of the trades were concentrated in the tenor of 6 months to one year followed by less than 30days and 3090days tenor. The shares of less than 30days and 30-90 days were almost equal during most of the time though, the trade concentration in the shortest tenor (<30 days) has increased significantly during 200708. On the other hand, the share of 90-180 days tenor has steadily declined through the past 7 years.
* Dr. Tulsi Lingareddy is Deputy Manager, Economic Research & Surveillance Department, The Clearing Corporation of India Ltd.
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Table 1: Tenor-wise trade analysis (%)
< 30 Days 16.1 22.5 20.0 22.8 25.6 31.5 23.6 33.2 20.2 26.8 30 to 90 Days 22.9 24.8 24.1 24.2 25.1 25.8 23.4 19.3 20.1 19.7 90 to 180 Days 22.4 20.2 17.9 15.2 17.2 17.2 18.6 12.4 12.9 12.7 180 to 365 Days 37.2 31.8 36.3 36.2 30.5 24.5 32.0 34.2 45.2 39.6 >1 Year 1.4 0.7 1.8 1.6 1.6 1.0 2.4 0.9 1.7 1.3
2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Apr -09 May-09 Apr-May ‘09
available for trading, the BSE could not gain much volume while the MCX-SX and NSE have been contributing nearly equal share to the total traded volumes of currency futures market. Data & Methodology Data on forward rates for various term structures were collected from traded as well as polled data. Source for traded data was the CCIL while the polled rates were collected from the RBI. The extent of match/mismatch between the polled and traded forward rates were studied for pooled as well as individual categories of major trading members such as foreign banks, nationalized banks and private banks. Further, in order to bring comparability, the traded data were collated into different term structures like 1-month, 3month, 6-month and one-year. Test Statistics:
Source: Rakshitra, May 2009.
Exchange traded futures: Currency futures gained significant volumes soon after their introduction on domestic exchanges and have grown many folds, from about Rs 5 thousand crore in September 2008 to Rs.124 thousand crore in May 2009. Unlike the case of OTC forward market, where trading is well diversified across different tenors and the long tenors are relatively more active, futures volumes have largely been confined to near month contracts accounting for about 90 per cent. Although three trading platforms are
The data were analyzed using simple statistical tools such as correlations and ttests to find out the extent of association Table 2: Trends in trade volumes of currency futures between the data of two sources viz., traded and polled. T-test for paired two sample Total Share (%) Volume means was used in order to test the statistical (Rs. crore) 1M 2M 3M significance of mean differences in the data Sep-08 5174.5 84.3 9 6.7 from the two sources.
Oct-08 16663.1 45776.6 48394.9 63956.3 99461.2 77921.8 124900.7 83.9 87.2 86.7 87.9 86.6 92.1 93.3 8 9 9 9 9 6 5 8.1 3.8 4.3 3.1 4.4 1.9 1.7 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 31083.2 81.1 10 8.9
Comparative economics of forwards and futures Spread: Simultaneous trade of foreign exchange on different platforms as well as in the OTC market provides arbitrage opportunity if there is any significant
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difference in the rates traded across different platforms. Lesser the spread, efficient are the markets. Hence, the spread between the exchange traded futures and OTC forwards was calculated and tested for its statistical significance. In addition, the RBI also fixes daily exchange rates for reference based on the polled information and the exchange traded futures have to be settled based on the RBI’s reference rate. Table 3: Spread among exchange
Spread (paise) Between Sep’08 and Dec ‘08 Futures - Fwd traded Fwd polled - Futures Fwd polled - Fwd traded Between Jan ’09 and Mar ‘09 Futures - Fwd traded Fwd polled - Futures Fwd polled - Fwd traded Between Sep’08 and Mar ‘09 Futures - Fwd traded Fwd polled - Futures 4.99 -2.465 3.09 7.01 10.10 -2.465 2.627 -6.202 6.33 5.05 11.38
by the RBI was found to be the maximum at 11.38 paise.
The daily average spread between futures and polled forward rates during the initial three months of futures trade was the lowest at 5.05 paise. However, the futures rates moved relatively closer to traded forwards, apparently due to the existence of arbitrage activity. The spread between futures and traded forwards narrowed to 3.09 paise, while the spread between the futures and polled rates from forward rates widened to 7.01 paise during t-stat ?value Jan-Mar ‘09 despite the fact that the futures contracts are settled based on the RBI -2.465 0.008 reference rate.
2.627 -6.202 0.005 0.000 0.008 0.005 0.000 0.008
Thus, on average, the daily average spread between the traded exchange rates has narrowed to half within six months of introduction of futures trading, suggesting that the foreign exchange markets in India are becoming efficient over a period.
Volatility: Volatility in the three exchange rates was measured by using the standard Fwd polled - Fwd traded 10.85 -6.202 0.000 deviation and coefficient of variation for three different sources different periods. The results indicated that the volatility was relatively lower, though The results based on paired t-statistic only marginally, in the case of OTC traded indicated that the daily average spreads forwards and futures compared to the polled among all three exchange rates were falling in RBI reference rate in the three periods the range of 5 to 11 paise and was found to be considered for the study. statistically significant. Among the three different exchange rates, the OTC forward Although the increase in volatility during rates were the lowest, followed by the Sep-Dec‘08 coincided with the introduction exchange traded futures and polled rates by of futures, the volatility level in Jan-Mar ’09 the RBI. As a result, the spread between returned to the level that existed prior to the traded forward rate and polled forward rate introduction of futures. Hence, the rise in
5.86 2.627 0.005
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volatility during Sep-Dec ‘08 could possibly be on account of the turmoil in the global markets that transmitted to Indian markets during the same period. Thus, there was no significant change in the volatility of foreign exchange markets after the introduction of trading futures contracts. Table 4: Volatility trends in exchange rate
Standard Deviation OTC Polled RBI traded Futures reference forward rate 1.216 NA 1.246 1.680 1.227 1.776 1.713 1.246 1.791 1.743 1.256 1.815
Table 5: Charges per trade accepted per segment
Trade Value (in USD) Less than 1 million 1 million to less than 3 million 3 million to less than 5 million 5 million to less than 10 million 10 million to less than 20 million 20 million and above Charges Rs 90/Rs 110/Rs 125/Rs 150/Rs 175/Rs 200/
Apr-Aug Sep-Dec Jan-Mar Sep-Mar
Co-efficient of Variation (%) OTC Polled RBI traded Futures reference forward rate 2.880 NA 2.943 3.506 2.462 3.645
Source: www.ccilindia.com
Costs involved in trading Cost of trading becomes another important factor for the participants to choose the platform and product for trading. For the sake of comparability, total costs involved from the entry into the contract till the delivery or settlement of the contract. Forwards: The cost of trading in case of forwards, as they are over the counter contracts, comes into picture only when it enters into the settlement guaranteed clearing system (provided by the CCIL in India). If it is mutually settled out of the guaranteed settlement system then there are no costs in case of OTC contracts (forwards). However, majority of the trades are settled through the guaranteed settlement provided by the CCIL and fees charged by the CCIL becomes cost of trading for forwards. The details of the costs involved in the settlement of forwards through CCIL are specified in Table 5.
Futures: In the case of futures, there are two major costs that involve in 3.569 3.629 2.500 2.515 trading on exchange 3.672 3.718 platform apart from the brokerage; one is in the form of margins and the other is the transaction charges. Margin costs are not paid out costs to the exchange but are held by the exchange till the settlement day, adjusting daily on a mark-to-market basis and settled at the expiry of contracts. Though the exchanges normally charge transaction fee for using the platform to trade, at present, transaction costs for trading in currency futures are nil, plausibly to encourage and promote the participation in futures. Nevertheless, the participants have to pay a nominal fee of Rs 20/- per crore towards SEBI turnover fee and outstanding fee of Rs.10/- per million per month on the outstanding contract, based on its residual maturity. To illustrate, a participant with a position of Rs.10 million in a futures contract that expires after five months will have to pay Rs.500 per month towards outstanding fee. However, the charges are
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levied daily on a pro-rata basis. This may also be a reason for the concentration of trades in near month contract especially in view of the zero transaction costs that facilitate frequent rollover of contracts. In addition, brokerage charges also need to be considered when the trading is done through brokers in both forward and futures trading. Although precise information is not available on the level of brokerage, the brokerage charges of futures trading reported to be considerably lower than that in forward (OTC) trading. Nevertheless, brokerage charges are optional in both markets.
Impact of futures on forward trade There was no perceptible impact of futures trading on forward trade volumes as the trading in both derivatives exhibited a similar growth trend. Trade volumes in forwards declined steadily after Oct ’08 except in Dec ’08, coinciding with the initiation of currency futures trade. But, the period also coincided with the deepening of global financial crisis that led to less activity in financial markets in general. The decline in activity was evident from the similar pattern of fall in spot market volumes during the corresponding period as shown in Chart 1. Further, the trade activity in futures and forwards showed a similar growth trend since the introduction of futures.
Thus, taking into account of various costs involved except the brokerage charges, trading on exchange Growth trends in Foreign Exchange Volumes appears to be relatively 120 costly even when the 100 transaction charges are 80 not yet levied by the 60 exchanges. Further, as 40 e v i d e n t f ro m t h e 20 0 composition of trade in -20 established forex -40 derivatives market -60 (OTC), majority (about FWD Spot Futures 50%) of trades are concentrated in longer Thus, based on the available trends in futures tenors of 6 months to 1-year. If such longand forwards so far, it is not evident that the term hedgers want to use futures platform, futures trading has caused any significant they need to rollover their position to meet shift in OTC forward volumes. In addition, their requirement, as the liquidity is largely considering the nature and concentration of concentrated in the near month contract in trade in both the markets (OTC and futures) futures markets. Once the exchanges start and in view of the similar trends in their charging transaction costs, the rollover in volumes, it appears that at present the currency futures may become expensive.
Growth (%) Aug-08 Jun-08 Apr-08 May-08 Feb-09 Sep-08
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Nov-08
Mar-09
Jul-08
Dec-08
Oct-08
Jan-09
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objective of participation in both markets is different. The OTC market is predominantly used by hedgers with physical exposure, while futures market apparently used mostly for the arbitrage and speculation purposes. Hence, there was no notable shift in volumes from forwards to futures, despite the rapid
Clients higher of 6% of total open interest or USD 10 million
upper limit on the position taken by each participant. The details of the limits fixed by the exchanges are given below. Because of these limitations, the participants cannot take position beyond this limit and to the extent they need and hence it becomes a constraint.
Banks higher of 15% of the total open interest or USD 100 million
Trading Members higher of 15% of the total open interest or USD 50 million
and significant increase in futures volumes. Factors discouraging futures trading Mismatch of Contract size: Since the futures contracts are standardized with a fixed amount of quantity that may not match the actual requirement of the participants many times. As a result, the participants may prefer to take positions in OTC market where the contracts can be customized to their required amount or size. Mismatch in maturity: Another difficulty the hedgers may face in case of futures is the mismatch between the date of requirement and the maturity date of the contract. The hedgers who actually interested to take the delivery will find it difficult when the date of maturity of the contract does not match with the date of their requirement. Position limits: Another important factor that may be discouraging the participation in futures is the position limits. The exchange fixes the
No physical delivery Lack of physical delivery option and only cash settlement in futures trading becomes a problem for hedgers when they have payment obligations in foreign currency. Hence, this may discourage participants, who need physical delivery of foreign currency. Restriction on the participation of FIIs Another important factor that discourages the active trading in futures is the restriction of foreign institutional investors (FIIs) participation. According to guidelines of the Reserve Bank of India, trade participation of FIIs in futures trading is not yet allowed. Factors encourage futures trading Easy entry and exit The facility to easily enter into and exit from the contract encourages participation from those who do not have specifications of physical delivery in the terms of quantity, maturity date and position limits which g e n e r a l l y a re t h e s p e c u l a t o r s a n d arbitrageurs.
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Anonymity and Transparency in dealing Since the deals occur online on the exchange platform, there is transparency in pricing and arriving at the deal. Conclusions The existing trends so far suggest that despite the significant rise in futures volumes, there was no notable shift in volumes from forwards to futures market. The fee structure and near-month liquidity in currency futures
possibly attracted the participation of arbitragers and speculators, while the hedgers continued to prefer OTC forward contracts due to the flexibility and customization particularly in case of long term requirements. Thus, the remarkable growth in futures could not bring any notable changes in forward markets so far since the purpose as well as nature of participation in futures appeared to be different from that of the forwards market.
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FOREIGN EXCHANGE MARKETS IN INDIA: FUTURES V/S FORWARD TRADING
Tulsi Lingareddy* (August 2009) Foreign exchange market in India has made significant strides in the recent years gaining depth and volumes and introduction of i n c re a s i n g n u m b e r o f d e r i v a t i v e s instruments for hedging against price risk. Further, with the rapid increase in global integration of financial markets and to facilitate the increased cross boarder transfer of funds, the RBI has permitted exchange trade of currency futures in 2008. Consequently, currency futures contracts were introduced for trading on the National Stock Exchange Ltd (NSE) with the effect from Aug 29, 2008. Following this, two more exchanges, Bombay Stock Exchange (BSE) and Multi Commodity Exchange-Stock Exchange (MCX-SX), also started offering currency futures trade in Sept and Oct respectively, in 2008. Soon after their introduction, trading in currency futures picked up momentum rather quickly and the total volumes reached Rs.5.14 lakh crore by the end of May 2009. The main advantage of currency futures over its closest substitute product, viz., forwards which are traded over-the-counter (OTC) lies in price transparency, elimination of counterparty credit risk and greater reach in terms of easy accessibility to all. However, futures’ trading also involves speculators and arbitragers who don’t have any underlying physical exposure but participate in trading with profit motive. As a result, there are apprehensions that the excessive speculation may adversely affect both futures as well as the underlying spot markets. Considering these developments, an attempt is made to study the pattern of trade, comparative economics forex derivatives and the impact of futures on forwards and spot. Trends in forex derivatives market trade Forex forwards (OTC products): The trends in the trade of forex forwards indicated that majority of the trades were concentrated in the tenor of 6 months to one year followed by less than 30days and 3090days tenor. The shares of less than 30days and 30-90 days were almost equal during most of the time though, the trade concentration in the shortest tenor (<30 days) has increased significantly during 200708. On the other hand, the share of 90-180 days tenor has steadily declined through the past 7 years.
* Dr. Tulsi Lingareddy is Deputy Manager, Economic Research & Surveillance Department, The Clearing Corporation of India Ltd.
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Table 1: Tenor-wise trade analysis (%)
< 30 Days 16.1 22.5 20.0 22.8 25.6 31.5 23.6 33.2 20.2 26.8 30 to 90 Days 22.9 24.8 24.1 24.2 25.1 25.8 23.4 19.3 20.1 19.7 90 to 180 Days 22.4 20.2 17.9 15.2 17.2 17.2 18.6 12.4 12.9 12.7 180 to 365 Days 37.2 31.8 36.3 36.2 30.5 24.5 32.0 34.2 45.2 39.6 >1 Year 1.4 0.7 1.8 1.6 1.6 1.0 2.4 0.9 1.7 1.3
2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Apr -09 May-09 Apr-May ‘09
available for trading, the BSE could not gain much volume while the MCX-SX and NSE have been contributing nearly equal share to the total traded volumes of currency futures market. Data & Methodology Data on forward rates for various term structures were collected from traded as well as polled data. Source for traded data was the CCIL while the polled rates were collected from the RBI. The extent of match/mismatch between the polled and traded forward rates were studied for pooled as well as individual categories of major trading members such as foreign banks, nationalized banks and private banks. Further, in order to bring comparability, the traded data were collated into different term structures like 1-month, 3month, 6-month and one-year. Test Statistics:
Source: Rakshitra, May 2009.
Exchange traded futures: Currency futures gained significant volumes soon after their introduction on domestic exchanges and have grown many folds, from about Rs 5 thousand crore in September 2008 to Rs.124 thousand crore in May 2009. Unlike the case of OTC forward market, where trading is well diversified across different tenors and the long tenors are relatively more active, futures volumes have largely been confined to near month contracts accounting for about 90 per cent. Although three trading platforms are
The data were analyzed using simple statistical tools such as correlations and ttests to find out the extent of association Table 2: Trends in trade volumes of currency futures between the data of two sources viz., traded and polled. T-test for paired two sample Total Share (%) Volume means was used in order to test the statistical (Rs. crore) 1M 2M 3M significance of mean differences in the data Sep-08 5174.5 84.3 9 6.7 from the two sources.
Oct-08 16663.1 45776.6 48394.9 63956.3 99461.2 77921.8 124900.7 83.9 87.2 86.7 87.9 86.6 92.1 93.3 8 9 9 9 9 6 5 8.1 3.8 4.3 3.1 4.4 1.9 1.7 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 31083.2 81.1 10 8.9
Comparative economics of forwards and futures Spread: Simultaneous trade of foreign exchange on different platforms as well as in the OTC market provides arbitrage opportunity if there is any significant
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difference in the rates traded across different platforms. Lesser the spread, efficient are the markets. Hence, the spread between the exchange traded futures and OTC forwards was calculated and tested for its statistical significance. In addition, the RBI also fixes daily exchange rates for reference based on the polled information and the exchange traded futures have to be settled based on the RBI’s reference rate. Table 3: Spread among exchange
Spread (paise) Between Sep’08 and Dec ‘08 Futures - Fwd traded Fwd polled - Futures Fwd polled - Fwd traded Between Jan ’09 and Mar ‘09 Futures - Fwd traded Fwd polled - Futures Fwd polled - Fwd traded Between Sep’08 and Mar ‘09 Futures - Fwd traded Fwd polled - Futures 4.99 -2.465 3.09 7.01 10.10 -2.465 2.627 -6.202 6.33 5.05 11.38
by the RBI was found to be the maximum at 11.38 paise.
The daily average spread between futures and polled forward rates during the initial three months of futures trade was the lowest at 5.05 paise. However, the futures rates moved relatively closer to traded forwards, apparently due to the existence of arbitrage activity. The spread between futures and traded forwards narrowed to 3.09 paise, while the spread between the futures and polled rates from forward rates widened to 7.01 paise during t-stat ?value Jan-Mar ‘09 despite the fact that the futures contracts are settled based on the RBI -2.465 0.008 reference rate.
2.627 -6.202 0.005 0.000 0.008 0.005 0.000 0.008
Thus, on average, the daily average spread between the traded exchange rates has narrowed to half within six months of introduction of futures trading, suggesting that the foreign exchange markets in India are becoming efficient over a period.
Volatility: Volatility in the three exchange rates was measured by using the standard Fwd polled - Fwd traded 10.85 -6.202 0.000 deviation and coefficient of variation for three different sources different periods. The results indicated that the volatility was relatively lower, though The results based on paired t-statistic only marginally, in the case of OTC traded indicated that the daily average spreads forwards and futures compared to the polled among all three exchange rates were falling in RBI reference rate in the three periods the range of 5 to 11 paise and was found to be considered for the study. statistically significant. Among the three different exchange rates, the OTC forward Although the increase in volatility during rates were the lowest, followed by the Sep-Dec‘08 coincided with the introduction exchange traded futures and polled rates by of futures, the volatility level in Jan-Mar ’09 the RBI. As a result, the spread between returned to the level that existed prior to the traded forward rate and polled forward rate introduction of futures. Hence, the rise in
5.86 2.627 0.005
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volatility during Sep-Dec ‘08 could possibly be on account of the turmoil in the global markets that transmitted to Indian markets during the same period. Thus, there was no significant change in the volatility of foreign exchange markets after the introduction of trading futures contracts. Table 4: Volatility trends in exchange rate
Standard Deviation OTC Polled RBI traded Futures reference forward rate 1.216 NA 1.246 1.680 1.227 1.776 1.713 1.246 1.791 1.743 1.256 1.815
Table 5: Charges per trade accepted per segment
Trade Value (in USD) Less than 1 million 1 million to less than 3 million 3 million to less than 5 million 5 million to less than 10 million 10 million to less than 20 million 20 million and above Charges Rs 90/Rs 110/Rs 125/Rs 150/Rs 175/Rs 200/
Apr-Aug Sep-Dec Jan-Mar Sep-Mar
Co-efficient of Variation (%) OTC Polled RBI traded Futures reference forward rate 2.880 NA 2.943 3.506 2.462 3.645
Source: www.ccilindia.com
Costs involved in trading Cost of trading becomes another important factor for the participants to choose the platform and product for trading. For the sake of comparability, total costs involved from the entry into the contract till the delivery or settlement of the contract. Forwards: The cost of trading in case of forwards, as they are over the counter contracts, comes into picture only when it enters into the settlement guaranteed clearing system (provided by the CCIL in India). If it is mutually settled out of the guaranteed settlement system then there are no costs in case of OTC contracts (forwards). However, majority of the trades are settled through the guaranteed settlement provided by the CCIL and fees charged by the CCIL becomes cost of trading for forwards. The details of the costs involved in the settlement of forwards through CCIL are specified in Table 5.
Futures: In the case of futures, there are two major costs that involve in 3.569 3.629 2.500 2.515 trading on exchange 3.672 3.718 platform apart from the brokerage; one is in the form of margins and the other is the transaction charges. Margin costs are not paid out costs to the exchange but are held by the exchange till the settlement day, adjusting daily on a mark-to-market basis and settled at the expiry of contracts. Though the exchanges normally charge transaction fee for using the platform to trade, at present, transaction costs for trading in currency futures are nil, plausibly to encourage and promote the participation in futures. Nevertheless, the participants have to pay a nominal fee of Rs 20/- per crore towards SEBI turnover fee and outstanding fee of Rs.10/- per million per month on the outstanding contract, based on its residual maturity. To illustrate, a participant with a position of Rs.10 million in a futures contract that expires after five months will have to pay Rs.500 per month towards outstanding fee. However, the charges are
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levied daily on a pro-rata basis. This may also be a reason for the concentration of trades in near month contract especially in view of the zero transaction costs that facilitate frequent rollover of contracts. In addition, brokerage charges also need to be considered when the trading is done through brokers in both forward and futures trading. Although precise information is not available on the level of brokerage, the brokerage charges of futures trading reported to be considerably lower than that in forward (OTC) trading. Nevertheless, brokerage charges are optional in both markets.
Impact of futures on forward trade There was no perceptible impact of futures trading on forward trade volumes as the trading in both derivatives exhibited a similar growth trend. Trade volumes in forwards declined steadily after Oct ’08 except in Dec ’08, coinciding with the initiation of currency futures trade. But, the period also coincided with the deepening of global financial crisis that led to less activity in financial markets in general. The decline in activity was evident from the similar pattern of fall in spot market volumes during the corresponding period as shown in Chart 1. Further, the trade activity in futures and forwards showed a similar growth trend since the introduction of futures.
Thus, taking into account of various costs involved except the brokerage charges, trading on exchange Growth trends in Foreign Exchange Volumes appears to be relatively 120 costly even when the 100 transaction charges are 80 not yet levied by the 60 exchanges. Further, as 40 e v i d e n t f ro m t h e 20 0 composition of trade in -20 established forex -40 derivatives market -60 (OTC), majority (about FWD Spot Futures 50%) of trades are concentrated in longer Thus, based on the available trends in futures tenors of 6 months to 1-year. If such longand forwards so far, it is not evident that the term hedgers want to use futures platform, futures trading has caused any significant they need to rollover their position to meet shift in OTC forward volumes. In addition, their requirement, as the liquidity is largely considering the nature and concentration of concentrated in the near month contract in trade in both the markets (OTC and futures) futures markets. Once the exchanges start and in view of the similar trends in their charging transaction costs, the rollover in volumes, it appears that at present the currency futures may become expensive.
Growth (%) Aug-08 Jun-08 Apr-08 May-08 Feb-09 Sep-08
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Mar-09
Jul-08
Dec-08
Oct-08
Jan-09
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objective of participation in both markets is different. The OTC market is predominantly used by hedgers with physical exposure, while futures market apparently used mostly for the arbitrage and speculation purposes. Hence, there was no notable shift in volumes from forwards to futures, despite the rapid
Clients higher of 6% of total open interest or USD 10 million
upper limit on the position taken by each participant. The details of the limits fixed by the exchanges are given below. Because of these limitations, the participants cannot take position beyond this limit and to the extent they need and hence it becomes a constraint.
Banks higher of 15% of the total open interest or USD 100 million
Trading Members higher of 15% of the total open interest or USD 50 million
and significant increase in futures volumes. Factors discouraging futures trading Mismatch of Contract size: Since the futures contracts are standardized with a fixed amount of quantity that may not match the actual requirement of the participants many times. As a result, the participants may prefer to take positions in OTC market where the contracts can be customized to their required amount or size. Mismatch in maturity: Another difficulty the hedgers may face in case of futures is the mismatch between the date of requirement and the maturity date of the contract. The hedgers who actually interested to take the delivery will find it difficult when the date of maturity of the contract does not match with the date of their requirement. Position limits: Another important factor that may be discouraging the participation in futures is the position limits. The exchange fixes the
No physical delivery Lack of physical delivery option and only cash settlement in futures trading becomes a problem for hedgers when they have payment obligations in foreign currency. Hence, this may discourage participants, who need physical delivery of foreign currency. Restriction on the participation of FIIs Another important factor that discourages the active trading in futures is the restriction of foreign institutional investors (FIIs) participation. According to guidelines of the Reserve Bank of India, trade participation of FIIs in futures trading is not yet allowed. Factors encourage futures trading Easy entry and exit The facility to easily enter into and exit from the contract encourages participation from those who do not have specifications of physical delivery in the terms of quantity, maturity date and position limits which g e n e r a l l y a re t h e s p e c u l a t o r s a n d arbitrageurs.
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Anonymity and Transparency in dealing Since the deals occur online on the exchange platform, there is transparency in pricing and arriving at the deal. Conclusions The existing trends so far suggest that despite the significant rise in futures volumes, there was no notable shift in volumes from forwards to futures market. The fee structure and near-month liquidity in currency futures
possibly attracted the participation of arbitragers and speculators, while the hedgers continued to prefer OTC forward contracts due to the flexibility and customization particularly in case of long term requirements. Thus, the remarkable growth in futures could not bring any notable changes in forward markets so far since the purpose as well as nature of participation in futures appeared to be different from that of the forwards market.
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