He discovers that, despite some obstacles ahead,
further growth is likely – proof that sometimes, there
is huge pent-up demand to trade futures.
If the outstanding success story of 2009
in global listed derivatives was the Steel Rebar Futures at
Shanghai Futures Exchange, this year’s wunderkind
has been in India. And there are two of them.
The US dollar/Indian rupee futures at
Multi Commodity Exchange Stock Exchange and the National Stock
Exchange of India have soared to become the two most actively
traded currency derivatives on any exchange in the world, by
number of contracts.
The NSE’s US Dollar Future
traded 68.3m times in June and MCX-SX’s contract
79.4m times. The only listed derivative in the world that was
traded more times was Korea Exchange’s Kospi 200
Option, with 286m bargains made.
The Indian FX contracts’
prominence is exaggerated by their small sizes – each
future is for $1,000. That means MCX-SX’s volume
in June was $79.4bn.
This is not nearly as large as the CME
Group’s EUR/USD Future, which had volume in June
of 7.9m contracts. Each is worth €125,000, giving cash
volume of €988bn. BM&F Bovespa’s US
Dollar Future, which tracks the dollar-Brazilian real exchange
rate, had turnover of $375bn in the same month. But then, CME
has been offering that contract since 1998, while BM&F
launched its in 1987.
And even on a notional cash basis the
Indian contracts still outstrip most other FX futures.
Like China’s success with its
metal futures, India’s dizzying growth in currency
derivatives has been achieved despite substantial barriers to
foreign participation, and other tight regulatory controls.
Ajay Shah, professor at the National
Institute for Public Finance and Policy in New Delhi, and a
former consultant to the finance ministry, explains: "Foreign
institutional investors are banned from trading in
India’s currency futures market, while there is
also a position limit imposed, depending on what institution
and their exchange membership, so big companies find that their
hedging needs can’t be met."
Trading members of exchanges are not
allowed to hold positions exceeding 15% of total open interest
or $50m, whichever is higher. For trading members that are
banks, the cap is the higher of 15% of total open interest or
Client members of exchanges are capped at
6% of open interest or $10m, whichever is higher.
The market began in August 2008 when the
Securities and Exchange Board of India approved the listing of
dollar/rupee futures. All contracts must be financially settled
and for $1,000, it said.
Quick out of the traps was the National
Stock Exchange of India, followed two months later by the then
newly launched MCX Stock Exchange, daughter of Multi Commodity
Exchange of India.
The Bombay Stock Exchange also joined the
fray, but it recently delisted its currency futures, putting
its weight instead behind its new partner, the United Stock
With a slight head start, NSE established
a lead in trading but MCX-SX soon began to chip away at it,
capturing about 30% of market activity as volumes across the
two exchanges amounted to $6bn a month.
This was just the start, however, as
trading continued to grow month-on-month. Just a year after
launch, the market was already turning over about $1bn a
The trend of success continued through the
second half of 2009 and slowly MCX-SX began to eat into the
NSE’s lead. In the first quarter of 2010 MCX-SX
went ahead, with about $62bn of trading in March, to
NSE’s $58bn. Since then, MCX-SX has cemented its
Meeting a need
Despite the restrictions, the
contracts’ introduction has given market
participants who had never been able to use over-the-counter
currency derivatives a way to hedge their currency risk.
"Every Indian is exposed to currency risk
in one way or another," says DK Aggarwal, chairman of SMC
Wealth Management, one of India’s largest brokers.
This need goes far beyond those who export goods or import
dollar-priced commodities. "Suppose I have a child going to
study overseas, I know that I need to hedge," Aggarwal
India’s financial laws
put barriers in the way of over-the-counter hedging. Any Indian
firm, institution or resident that wishes to hedge currency risk
using OTC forwards, swaps or options, must first demonstrate an
exposure to the underlying risk, a requirement not stipulated
for exchange-traded derivatives.
Small wonder that market participants have
rushed to use the futures. According to SEBI’s
latest report on India’s currency derivatives
market, published in August 2009: "The Indian currency futures
market has grown since its commencement in August 2008. The
currency futures turnover as a percentage of OTC currency
forward turnover has increased from 7.19% in November 2008 to
59.60% in August 2009."
Day traders flock to the
While there may a be a significant demand
to hedge currency risk, Jamal Mecklai of Mecklai Financial, an
Indian consulting company that specialises in treasury risk
management, says the currency futures market is dominated by
"India’s currency market is a
highly speculative one," Mecklai says. "There are a number of
people that look at the currency futures market and see that
the leverage is good, costs are low. Currently, about 60% to
70% of the market is day traders. There is very little
corporate hedging and it is hard to see corporate hedging
increase until delivery is permitted."
Aggarwal disagrees on corporate
participation. He says firms have become increasingly drawn to
FX futures. They are often quoted with tighter bid/offer
spreads than OTC instruments, reducing the costs to companies,
which he says are becoming more and more open to exchange
The high level of day trading can be
explained by the low cost of trading. Transaction fees and
margin requirements are low – and crucially, the
government has waived the securities transaction tax for
currency futures. That means it is often cheaper to trade FX
contracts than equities or equity derivatives.
While specialised trading firms are
becoming more active, there is also a growing number of banks
in the market. So far they have stuck mainly to the OTC market,
partly because of the position limits in futures.
But one executive at a bank in Mumbai says
the banks are now spotting an opportunity. Since they can
access both markets, there are arbitrages to be had. He expects
these to proliferate as the listed sector grows.
No love lost
Despite the soaring volumes in FX futures,
the two exchanges do not seem to feel there is room for both of
them in the market. Rivalry between them has been intense since
day one, and each is trying aggressively to win market
MCX-SX was particularly upset when
the NSE waived its fees for FX futures trading. It complained
to the Competition Commission of India, which ordered an
investigation into MCX-SX’s allegation that NSE
was misusing its dominant position by waiving fees, a practice
that MCX-SX said it could not afford to emulate.
MCX-SX said NSE’s pricing was designed to drive
the weaker MCX-SX out of business. NSE is denying the
accusation, telling the Commission that "the fee waiver in the
new currency derivative segment... is in the nature of
introductory pricing with no intention to eliminate
The watchdog has yet to rule, and the
animosity between the two exchanges persists. On July 17,
MCX-SX took an advertisement in Indian newspapers, hitting out
at the delay in being granted approval to offer equities,
equity derivatives and interest rate derivatives.
It also complained about its competitors,
hinting at NSE. "There have been attempts by some elements to
spread misinformation to create doubt among our shareholders
and undermine our reputation and business for their benefit,"
the advertisement read.
While the NSE and MCX-SX are focused on
each other, new competition is set to emerge. The United Stock
Exchange is now just weeks away from introducing its own
dollar/rupee futures contract, though as yet it has not
confirmed a launch date.
The new exchange has 21 Indian banks as
equity backers, including the Bank of India, United Bank of
India and the Central Bank of India. It also has seven Indian
private sector banking shareholders, including HDFC Bank and
"While the USE is entering the currency
futures market later than the two leading exchanges, the
commitment from some of India’s largest banks
– which have previously stayed away from the
exchange-traded market, may be significant," says the bank
source in Mumbai – implying that their backing could
help USE win business.
The tip of the
As India continues its path of market
liberalisation derivatives specialists are particularly
optimistic about the prospects for exchange-traded currency
SEBI has already committed to allowing the
introduction of currency options – some market
participants believe approval may come any day, bringing a new
product that would complement the futures.
One possible roadblock, however, may
be the actions of Indian local governments. On July 12 the
government of New Delhi said
proprietary futures trades would be subject to a stamp duty of
Rp1,000 for every Rp1 crore (Rp10m) in the case of
delivery-based transactions and Rp200 per Rp1 crore for
are tiny – 1 basis point and 0.2bp – but some
market participants still believe they could dampen volume from
traders in New Delhi.
remain excited about the prospects. "I believe the
currency futures market will continue to experience strong
growth," says Mecklai.
Aggarwal, too, is bullish, predicting: "I
believe currency derivatives exchanges will be even bigger than
commodity derivatives exchanges."
(Picture by zadeus)