Derivatives Regulation and Growth

Download as pptx, pdf, or txt
Download as pptx, pdf, or txt
You are on page 1of 15

Derivatives: Regulation

and Growth

By
Nagendra Kumar Maurya
Assistant Professor
Institute of Economics and Finance
Bundelkhand University
Jhansi
Development of derivatives market in
India
 The first step towards introduction of derivatives trading in India was the promulgation of the
Securities Laws(Amendment) Ordinance, 1995, which withdrew the prohibition on options in
securities. The market for derivatives, however, did not take off, as there was no regulatory
framework to govern trading of derivatives. SEBI set up a 24–member committee under the
Chairmanship of Dr.L.C.Gupta on November 18, 1996 to develop appropriate regulatory framework
for derivatives trading in India. The committee submitted its report on March 17, 1998 prescribing
necessary pre–conditions for introduction of derivatives trading in India. The committee
recommended that derivatives should be declared as ‘securities’ so that regulatory framework
applicable to trading of ‘securities’ could also govern trading of securities.
 SEBI also set up a group in June 1998 under the Chairmanship of Prof.J.R.Varma, to recommend
measures for risk containment in derivatives market in India. The report, which was submitted in
October 1998, worked out the operational details of margining system, methodology for charging
initial margins, broker net worth, deposit requirement and real–time monitoring requirements. The
Securities Contract Regulation Act (SCRA) was amended in December 1999 to include derivatives
within the ambit of ‘securities’ and the regulatory framework was developed for governing
derivatives trading. The act also made it clear that derivatives shall be legal and valid only if such
contracts are traded on a recognized stock exchange, thus precluding OTC derivatives. The
government also rescinded in March 2000, the three–decade old notification, which prohibited
forward trading in securities.
Continue……………..
 Derivatives trading commenced in India in June 2000 after SEBI granted the final
approval to this effect in May 2001. SEBI permitted the derivative segments of two
stock exchanges, NSE and BSE, and their clearing house/corporation to commence
trading and settlement in approved derivatives contracts. To begin with, SEBI
approved trading in index futures contracts based on S&P CNX Nifty and BSE–
30(Sensex) index. This was followed by approval for trading in options based on
these two indexes and options on individual securities.
 The trading in BSE Sensex options commenced on June 4, 2001 and the trading in
options on individual securities commenced in July 2001. Futures contracts on
individual stocks were launched in November 2001. The derivatives trading on NSE
commenced with S&P CNX Nifty Index futures on June 12, 2000. The trading in
index options commenced on June 4, 2001 and trading in options on individual
securities commenced on July 2, 2001. Single stock futures were launched on
November 9, 2001. The index futures and options contract on NSE are based on
S&P CNX
Regulation in India
The forward markets in certain commodities existed in India for a long time.
The Forward Market Commission allows the execution of NTSDCs,
TSDCs, and futures contracts in certain commodities. Forward trading
regulated by the Forward Contracts (Regulation) Act, 1952.
Forward trading is allowed in six commodities namely, turmeric, castor
seeds, hessian (jute fiber), potatoes, cotton, and paper.
As far as the financial derivatives are concerned, the only ones which
existed for a long time were non-tradable warrants, convertibles, non-
tradable buy-back options on industrial debentures and units of mutual
funds, and forward exchange contracts or currency forwards.
How ever picture has been changing over the past three years during which
certain new derivative products have been introduced , albeit on small scale.
Continued…………
In January 1995, the SCRA was amended whereby a reference in
the Act to ‘Prohibition of options' has been deleted.
August 1996, the NSE had planned to introduce stock index
futures and options in three stages spread over a period of about a
year, that is by the end of the 1997.
The NSE has launched Futures and Options Exchanged in late
1996, but its three-stage plan has remained largely
unimplemented.
In spite of the above-mentioned efforts and policy changes, the
derivatives markets are almost non-existent in India at present.
The SEBI has appointed the following three committees in the
recent past to study the question of developing a hedging
mechanism in India: the Patel Committee on forward trading, the
Verma Panel on Badla, and the Gupta Committee on derivatives.
Continued…………….
Trading at present done through the existing exchanges
namely BSE, OTCEI and NSE. The clearing
houses/clearing corporation of the respective exchanges
trade and settle derivatives contracts.
Apart from index futures and index options, individual
stock futures and individual stock options were also
introduced on BSE and NSE on Nov. 9, 2001, and they
appear to be more attractive to the traders.
SEBI Guidelines for trading
The principal guidelines given by the SEBI for trading in individual
stock futures and individual stock options are as follows:
Contracts will have to be settled in cash.
The contract would be with a maturity period of one month, two
months, three months, and at a later date 12 months.
There will be margin requirements for continuity risk
The Stock Exchanges will monitor exposure limits. the value of the
gross open position at any point of time in all the stock future
contracts shall not exceed 20 times the available net worth of a
member.
The exchanges will collect mark-to- market margins in cash before
the start of trading next day.
L. C. Gupta Committee
 Based on the report of Dr. L.C. Gupta Committee, the following
recommendations are accepted by SEBI on
Derivatives. These recommendations are placed before the Parliament
 There should be phased introduction of derivative products with the Stock Index
Futures as the starting point for Equity derivatives in India.
 Definition of securities under SCRA be expanded by declaring derivative
contracts based on prices securities and other derivative contracts as securities.
 Existing Stock Exchanges be permitted to trade derivatives provided they meet
the eligibility conditions which should include adequate infrastructural facilities,
on-line trading and surveillance system and minimum of 50 members opting for
derivate trading.
 The derivative market should have a separate Governing council with
representation of trading members of the derivative segment limited to 40
percent. The Chairman of the Government Council shall not carry on any trading
or clearing business on any exchange during his ensure as chairman. Further, no
trading members shall be allowed to simultaneously be on the Governing council
of derivative segment and the underlying securities market.
Continue……….
Initial margin requirements related to the risk of loss on the position and
capital adequacy norms shall be prescribed.
Annual inspection of all members operating in the derivative segment
would be undertaken by the stock exchanges.
The exchanges would disseminate information about trades, quantities
and quotes in real time over at least two information vending networks.
There would be two tier membership that is the trading member and
clearing member and the entry norms for the clearing member would be
comparatively more stringent. The clearing member should have a
minimum net worth of Rs. 3 crore and shall make a deposit of Rs. 50 lakh
with the Exchange/ clearing corporation in the form of liquid assets.
The issue of accounting and disclosure norms for derivatives be taken p
with the Institute of Chartered Accountants of India so that proper
accounting and disclosures are made in the annual reports of the
corporate and others.
Accounting of Derivatives :

The Institute of Chartered Accountants of India


(ICAI) has issued guidance notes on accounting of
index futures contracts from the view point of
parties who enter into such futures contracts as
buyers or sellers. For other parties involved in the
trading process, like brokers, trading members,
clearing members and clearing corporations, a
trade in equity index futures is similar to a trade in,
say shares, and does not pose any peculiar
accounting problems.
Taxation
The income-tax Act does not have any specific provision regarding
taxability from derivatives. The only provisions which have an
indirect bearing on derivative transactions are sections 73(1) and
43(5). Section 73(1) provides that any loss, computed in respect of a
speculative business carried on by the assessee, shall not be set off
except against profits and gains, if any, of speculative business. In
the absence of a specific provision, it is apprehended that the
derivatives contracts, particularly the index futures which are
essentially cash-settled, may be construed as speculative
transactions and therefore the losses, if any, will not be eligible for
set off against other income of the assessee and will be carried
forward and set off against speculative income only up to a
maximum of eight years .As a result an investor’s losses or profits
out of derivatives even though they are of hedging nature in real
sense, are treated as speculative and can be set off only against
speculative income.
Growth of Derivatives
During 2001-02, the total turnover in equity derivatives
on BSE and NSE recently was of the order of Rs.
1,03,849 crore, while the turnover in cash equity
markets in India was Rs. 8,20,459 Crore. Thus the
former was about 16 percent of the total trading
volume in the equity cash market. The former is soon
expected to exceed the latter.
The volume of turnover in derivatives market has
increased from a paltry sum, of Rs. 4038 crore in 2000-
01 to Rs. 4,42,342 crore in 2002-03.
Growth of Derivatives
Thank You
Rho
The rho of a portfolio of options is the rate of change of the
value of the portfolio with respect to the interest rate.
It measures the sensitivity of the value of a portfolio to
interest rates. For a European call option on a non-
dividend-paying stock,
Rho(call)= KT-rTN(d2)
for a European Put option
Rho(put)= KT-rTN(-d2)
These same formulas apply to European call and put options
on stocks and stock indices paying known dividend yields
when d2 changes.

You might also like