In many senses, this is the best framework for the product, and, hopefully, over time will lead to RBI ceding more and more of its control over markets, so it can focus more completely on monetary policy. |
Turning to specifics, though, the guidelines need considerable fine-tuning to increase the likelihood of success. The most important factor determining which success or failure of a futures contract is liquidity; importantly, too, most contracts get only one shot at success. Thus, it is critical, when designing a futures contract or the regulatory regime determining the contract, to keep a single-minded focus on creating liquidity.
This is all the more important in currency futures, which are, in general, not particularly liquid, certainly when compared to commodity or interest rate futures. Globally, currency futures (and options) trade only around $ 90-100 billion a day (in all currency pairs), as compared with $6-7 trillion a day in interest rate futures and options (on all exchanges). This is because banks use interest rate futures very actively to trade and also to hedge their balance sheets and structured product exposures. However, banks do not use currency futures very actively, since they can readily hedge their risks in the OTC forex market, which, at $3 trillion a day, is the most liquid market in the world.
Hedgers "" entities with underlying risk "" can also provide liquidity in futures markets. In commodity markets, these are sometimes the key players. However, and again, because of the depth and liquidity of the OTC forex market, few corporates with underlying forex risk depend on futures markets for hedging. Thus, the bulk of the liquidity in global currency futures markets comes from speculators and arbitrageurs.
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In our attempt to create domestic currency futures, we need to recognise these realities, and build regulation and products to reflect them. Indeed, given the substantial propensity to speculation in Indian markets "" witness the speed with which both equity and commodity derivatives have taken off "" it would seem likely that domestic currency futures may enjoy higher volumes (relative to the OTC market) than the global case. Given that globally, currency futures are about 3 per cent of the OTC volumes, and that the domestic OTC volume is in the range of $50 billion a day, we could define success as a rupee futures contract that trades about $2.5 billion a day "" about 5 per cent of OTC. This is about 40-50 per cent of daily equity volumes, and, as such, offers an excellent business opportunity.
Let's look at likely players in the INR futures contracts. First of all, we do not anticipate significant hedging volume from the corporate sector. Large companies who have strong treasuries are able to access the OTC market as effectively as banks, and so have no need to take their hedging to the futures markets, building in margin and other costs. Small and mid-sized companies, who have limited and/or expensive access to OTC markets, may be attracted at first, but will likely find the cost (margin, brokerage, etc.), the basis (difference between the transaction date and rate with the futures settlement), and transaction settlement issues will limit the effectiveness of futures contracts in hedging.
Banks, as we said before, do not, in general, use currency futures to lay off their risk, and, in any case, the maximum position limit (for clearing members) of $25 million would render the contract of limited value if a large player wanted to, say, hedge some options it had sold.
There would, however, be significant interest from traders and arbitrageurs, many of whom would cut across the above categories. There are many companies, big and small, who trade USD/INR, and these "" certainly the smaller ones "" may find the futures market useful. Equity market players would doubtless be attracted to one more moving number to punt on. And, most importantly, commodity market players "" particularly those arbitraging between domestic and global exchanges in bullion, fuel oil, and other commodities "" would be hugely attracted to this market.
However, again, I feel that the permitted client position limit of $5 million is too small. I recognise that the regulators want to move cautiously, which is not unreasonable, but the truth is that in a speculative market, most of the liquidity so critical for success of the contract comes from short-term traders who go in and out for a few pips.
Again, it will be necessary for the exchanges and brokers to very carefully design their offerings in terms of margins, brokerage and fees, given that the average intra-day movement in USD/INR was just 0.4 per cent, as compared to much higher intra-day movements in currencies like EUR (0.7 per cent), GBP (0.7 per cent) and JPY (1.0 per cent), where there is active and successful futures trading.