While India keeps its date with currency futures trading on Thursday, it may be a while before brokers start making money from this business.
The brokerage rates, sources familiar with the developments said, will be 3-4 times higher than that of stock derivatives, but volumes will take time to grow.
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“Brokerage rates may come down once competition emerges and volumes grow,” said senior official with a foreign bank.
The reason why brokers don’t expect volumes to grow in the near-term is because nobody expects retail participation to be high in the initial phase as small investors are yet not familiar with the currency market.
Many individuals have foreign exchange exposures for medical treatment, study, travelling etc. When they approach banks for getting forex, they actually end up paying a higher price compared to the quoted price as banks keep a larger spread.
If say, the dollar is quoted at Rs 43.50, banks will sell the customer at Rs 44.30. If individuals want to sell to banks, they will get a rate of Rs 42.80. This problem can be solved if they buy their requirements from futures as the spread will not be so big.
The problem is currency futures are settled in cash and no delivery will take place. So they can only get rates and not dollars. If their requirements are for a future date, they can hedge it on the exchange and buy futures for the required amount if they perceive a fall in the value of the rupee.
Here they will have to become the clients of a broker and do all the related formalities. They will also have to pay brokers’ fees and other charges while their requirement may be one time or occasional. So futures are not that useful for these potential players.
At present most of currency hedging happens in the OTC market in the form of forwards and options. In India, there is an active OTC market for forwards with an average daily turnover of $34 billion. Internationally also, the OTC market is much bigger than that for currency futures.
“Currency futures are generally 5-10 per cent of OTC markets,” said R H Patil, Chairman of Clearing Corporation of India.
This means currency futures can achieve a daily turnover of Rs12,000 crore to Rs 14,000 crore, or $3-4 billion. This size is also good, but brokers say it will take time to achieve the level.
Another issue that can come in the way is the lower position limit, which is $25 million for members. Client level limits will be further lower. Only small and medium sized companies can do some hedging in currency futures as large companies and exporters have much larger exposures and will have to resort to OTC products.
Many small units can be in the form of a partnership firms and whether partners are allowed to do hedging or enter the derivative market may become an issue for the brokers as he is not equipped to do this due diligence. This job is generally performed by banks.
However, source in Sebi said that eventually the position limit can be raised once the market stabilises and there is need for such revision.”
Brokers also see a lack of clarity on the need for underlying before one enters currency futures. RBI and Sebi guidelines say “Indians can hedge their future currency exposures….”
But hedging requires some underlying exposure and if it is a plain deal, there need not be an underlying. The NSE note on currency futures also says that an underlying is not required, but brokers feel there should be regulatory clarification.
Exposure in the futures market without underlying is generally speculative in nature. Going by the current understanding of the market, only speculation may thrive initially. On the other hand, it is a fact that speculators can provide much needed liquidity.
