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International Trade And Finance

Project Title:

Comparison Of Derivatives Market In India

And USA

Submitted By:
Nikhil Chainani (13171)
Priya Sharma (13206)
Priyanka Bansal (13208)
Priyanka Goyal ( 13209)
BMS 2D

INDEX

Introduction
Participants
Functions
Types
Instruments in India
Futures
Options
Derivatives market in India
Comparison in Indian and global market
Trading volumes
Regulatory framework
Settlement
Types of derivatives allowed in India and USA
Conclusion

Need for the study

Risk is a characteristic feature of most commodity and capital markets.


Variations in the prices of agricultural and non-agricultural commodities are
induced, over time, by demand -supply dynamics. The last two decades have
witnessed many-fold increase in the volume of international trade and business
due to the wave of globalization and liberalization sweeping across the world.
This has led to rapid and unpredictable variations in financial assets prices,
interest rates and exchange rates, and subsequently, to exposing the corporate
world to an unwieldy financial risk. In the present highly uncertain business
scenario, the importance of risk management is much greater than ever before.
The emergence of derivatives market is an ingenious feat of financial
engineering that provides an effective and less costly solution to the problem of
risk that is embedded in the price unpredictability of the underlying asset.
In India, the emergence and growth of derivatives market is relatively a
recent phenomenon. Since its inception in June 2000, derivatives market has
exhibited exponential growth both in terms of volume and number of traded
contracts. The market turn-over has grown from Rs.2365 crore in 2000-2001 to
Rs. 11010482.20 crore in 2008-2009. Within a short span of eight years,
derivatives trading in India has surpassed cash segment in terms of turnover and
number of traded contracts.
The present study encompasses in its scope an analysis of historical roots
of derivative trading, types of derivative products, regulation and policy
developments, trend and growth, future prospects and challenges of derivative
market in India. Some space is devoted also to a brief discussion of the status of
global derivatives markets especially the USA vis-avis the Indian derivatives
market.

OBJECTIVES OF STUDY

Understanding the role types and functions of derivatives .


To study different types of derivatives forwards , futures, options , swaps,etc.
Comparing the derivatives in india and usa based on the following
1. Volumes
2. Regulatory framework
3. Settlement
4. Types of derivatives allowed in india and usa.

DERIVATIVES
MEANING:
The emergence of the market for derivative products, most notably forwards,
futures and options, can be traced back to the willingness of risk-averse economic
agents to guard themselves against uncertainties arising out of fluctuations in asset
prices. By their very nature, the financial markets are marked very high degree of
volatility. Through the use of derivative products, it is possible to partially or fully transfer
price risks by locking-in asset prices. As instruments of risk management, these
generally do not influence the fluctuations in the underlying asset prices. However, by
locking-in asset prices, derivative products minimize the impact of fluctuations in asset
prices on the profitability and cash flow situation of risk-averse investors.
Derivatives are risk management instruments, which derive their value from an
underlying asset. The underlying asset can be bullion, index, share, bonds, currency,
interest etc. Annual turnover of the derivatives is increasing each year from 1986
onwards,
Year

Annual turnover

1986

146 millions

1992

453 millions

1998
2002 & 2003

1329 millions
it has reached to equivalent stage of cash market

Derivatives are used by banks, securities firms, companies and investors to hedge
risks, to gain access to cheaper money and to make profits Derivatives are likely to grow
even at a faster rate in future they are first of all cheaper to world have met the
increasing volume of products tailored to the needs of particular customers, trading in
derivatives has increased even in the over the counter markets.
In Britain unit trusts allowed to invest in futures & options .The capital adequacy
norms for banks in the European Economic Community demand less capital to hedge or
speculate through derivatives than to carry underlying assets. Derivatives are weighted

lightly than other assets that appear on bank balance sheets. The size of these offbalance sheet assets that include derivatives is more than seven times as large as
balance sheet items at some American banks causing concern to regulators
DEFINITION
Derivative is a product whose value is derived from the value of one or more basic
variables, called bases (underlying asset, index, or reference rate), in a contractual
manner. The underlying asset can be equity, forex, commodity or any other asset.
In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A)
defines derivative to include1. A security derived from a debt instrument, share, and loan whether secured or
unsecured, risk instrument or contract for differences or any other form of security.
2. A contract, which derives its value from the prices, or index of prices, of underlying
securities.
Derivatives are the securities under the SC(R)A and hence the trading of
derivatives is governed by the regulatory framework under the SC(R)A.

PARTICIPANTS IN THE DERIVATIVES MARKET


The following three broad categories of participants who trade in the derivatives
market:
1. Hedgers
2. Speculators and
3. Arbitrageurs
Hedgers:
Hedgers face risk associated with the price of an asset. They use futures or
options markets to reduce or eliminate this risk.
Speculators:

Speculators wish to bet on future movements in the price of an asset.


Futures and Options contracts can give them an extra leverage; that is, they can
increase both the potential gains and potential losses in a speculative venture.
Arbitrageurs:
Arbitrageurs are in business to take advantage of a discrepancy between
prices in two different markets.
For example, they see the futures price of an asset getting out of line with the cash
price; they will take offsetting positions in the two markets to lock in a profit.
FUNCTIONS OF THE DERIVATIVES MARKET

The derivatives market performs a number of economic functions. They are:


1. Prices in an organized derivatives market reflect the perception of market participants
about the future and lead the prices of underlying to the perceived future level.
2. Derivatives, due to their inherent nature, are linked to the underlying cash markets.
With the introduction of derivatives, the underlying market witnesses higher trading
volumes because of participation by more players who would not otherwise
participate for lack of an arrangement to transfer risk.
3. Speculative trades shift to a more controlled environment of derivatives market. In
the absence of an organized derivatives market, speculators trade in the underlying
cash markets.
4. An important incidental benefit that flows from derivatives trading is that it acts as a
catalyst for new entrepreneurial activity.
5. Derivatives markets help increase savings and investment in the long run. Transfer of
risk enables market participants to expand their volume of activity.

TYPES OF DERIVATIVES

Commo
dity

Financia
l

Basic
Instrum
ent

Complex
Instrum
ents

Exotic, Swaptions and


LEAPS etc.
Forward

Futures

Options

Swa
ps

The most commonly used derivatives contracts are forwards, futures and options. Here
various derivatives contracts that have come to be used are given briefly:

1. Forwards
2. Futures
3. Options
4. Warrants
5. LEAPS
6. Baskets
7. Swaps
8. Swaptions
1. Forwards:
A forward contract is customized contract between two entities, where
settlement takes place on a specific date in the future at todays pre-agreed price

2. Futures:
A futures contract is an agreement between two parties to buy or sell an
asset at a certain time in the future at a certain price. Futures contracts are special
types of forward contracts in the sense that the former are standardized exchangetraded contracts.
3. Options:
Options are of two types calls and puts

Calls give the buyer the right but not the obligation to buy a given quantity
of the
underlying asset, at a given price on or before.a given future date.
Puts give the buyer the right, but not the obligation to sell a given quantity
of the
underlying asset at a given price on or before a given date.

4. Warrants:
Options generally have two lives of up to one year, the majority of options
traded on options exchanges having a minimum maturity of nine months. Longerdated options are called warrants and are generally traded over-the-counter.
5. Leaps:
The acronym LEAPS means Long-term Equity Anticipation Securities. These
are options having a maturity of up to three years.
6. Baskets:
Basket options are options on portfolios of underlying assets. The underlying
asset is usually a moving average of a basket of assets. Equity index options are a
form of basket options.
7. Swaps:
Swaps are private agreements between two parties to exchange cash flows
in the future according to a prearranged formula. They can be regarded as portfolios
of forward contracts. The two commonly used swaps are:

Interest rate swaps: These entail swapping only the interest related cash
flows between the parties in the same currency.

Currency swaps: These entail swapping both principal and interest between
the parties, with the cash flows in one direction being in a different currency
than those in the opposite direction.

8. Swaptions:
Swaptions are options to buy or sell that will become operative at the
expiry of the options. Thus a swaption is an option on a forward swap. Rather than
have calls and puts, the swaptions markets has receiver swaptions and payer
swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer
swaption is an option to pay fixed and receive floating.

1.3.6 DERIVATIVES INSTRUMENTS IN INDIA


The first derivative product to be introduced in the Indian securities market is going to
be "INDEX FUTURES". In the world, first index futures were traded in U.S. on Kansas City
Board of Trade (KCBT) on Value Line Arithmetic Index (VLAI) in 1982.
Organized exchanges began trading options on equities in 1973, where as exchange
traded debt options did not appear until 1982, on the other hand fixed income futures
began trading in 1975, but equity related futures did not begin until 1982.

DERIVATIVES SEGMENT IN BSE & NSE


On June 9,2000 BSE & NSE became the first exchanges in India to introduce trading
in exchange traded derivative product with the launch of index futures on sense and
Nifty futures respectively.
Index futures was follows by launch of index options in June 2001, stock options in
July 2001 and stock futures in Nov 2001.Presently stock futures and options available on
41 well-capitalized and actively traded scripts mandated by SEBI.
Nifty is the underlying asset of the Index Futures at the Futures & Options segment of
NSE with a market lot of 200 and the BSE 30 Sensex is the underlying stock index with
the market lot of 50. This difference of market lot arises due to a minimum specification

of a contract value of Rs. 2 lakhs by Securities Exchange Board of India. A contract value
is contracting Index laid by its market lot. For e.g. If Sensex is 4730 then the contract
value of a futures Index having Sensex as underlying asset will Be 50 x 4730 = Rs.
2,36,500. Similarly if Nifty is 1462.7, its futures contract value will be 200 x 1462.7 =
Rs.2, 92,540/-.
Every transaction shall be in multiple of market lot. Thus, Index futures at NSE shall
be traded in multiples of 200 and at BSE in multiples of 50

CONTRACT PERIODS
At any point of time there will always be available near three months contract periods.
For e.g. in the month of June 2009 one can enter into either June Futures contract or July
Futures contract or August Futures Contract. The last Thursday of the month specified in
the contract shall be the final settlement date for that contract at both NSE as well BSE.
Thus June 29, July 27 and August 31 shall be the last trading day or the final settlement
date for June Futures contract, July Futures Contract and August Futures Contract
respectively.
When one futures contract gets expired, a new futures contract will get introduced
automatically. For instance, on 30th June, June futures contract becomes invalidated and
a September Futures Contract gets activated.

SETTLEMENT

Settlement of all Derivatives trades is in cash mode. There is Daily as well as Final
Settlement. Outstanding positions of a contract can remain open till the last Thursday of
that month. As long as the position is open, the same will be marked to Market at the
Daily Settlement Price, the difference will be credited or debited accordingly and the
position shall be brought forward to the next day at the daily settlement price. Any
position which remains open at the end of the final settlement day (i.e., last Thursday)
shall be closed out by the Exchange at the Final Settlement Price which will be the
closing spot value of the underlying (Nifty or Sensex, or respective stocks as the case
may be).

Regulation for Derivatives Trading


SEBI set up a 24-member committee under Chairmanship of Dr.L.C. Gupta to develop the
appropriate regulatory framework for derivatives trading in India. The committee
submitted its report in March 1998. On May 11, 1998 SEBI accepted the
recommendations of the committee and approved the phased introduction of derivatives
trading in India beginning with stock index futures. SEBI also approved the suggestive
bye-laws recommended by the committee for regulation and control of trading and
settlement of derivatives contracts.
The provisions in the SC(R) A and the regulatory framework developed there
under govern trading in securities. The amendment of the SC(R) A to include derivatives
within the ambit of securities in the SC(R) A made trading in derivatives possible within
the framework of the Act.
1. Any exchange fulfilling the eligibility criteria as prescribed in the L C Gupta committee
report may apply to SEBI for grant of recognition under Section 4 of the SC(R) a, 1956
to start trading derivatives. The derivatives exchange/segment should have a
separate governing council and representation of trading / clearing members shall be
limited to maximum of 40% of the total members of the governing council. The
exchange shall regulate the sales practices of its members and will obtain approval of
SEBI before start of trading in any derivative contract
2. The exchange shall have minimum 50 members.
3. The members of an existing segment of the exchange will not automatically become
the members of derivative segment. The members of the derivative segment need to
fulfill the eligibility conditions as laid down by the L C Gupta committee.
4. The clearing and settlement of derivatives trades shall be through a SEBI approved
clearing corporation / house. Clearing corporation / houses complying with the
eligibility conditions as laid down by the committee have to apply to SEBI for grant of
approval.
5. Derivative brokers/dealers and clearing members are required to seek registration
from SEBI.
6. The minimum contract value shall not be less than Rs. 2 Lakh. Exchanges should also
submit details of the futures contract they propose to introduce.

7. The trading members are required to have qualified approved user and sales person
who have passed a certification programme approved by SEBI.

While from the purely regulatory angle, a separate exchange for trading would be a
better arrangement. Considering the constraints in infrastructure facilities, the existing
stock (cash) exchanges may also be permitted to trade derivatives subject to the
following conditions.
I. Trading should take place through an on-line screen based trading system.
II. An independent clearing corporation should do the clearing of the derivative market.
III. The exchange must have an online surveillance capability, which monitors positions,
price and volumes in real time so as to deter market manipulation price and position
limits should be used for improving market quality.
IV. Information about trades quantities, and quotes should be disseminated by the
exchange in the real time over at least two information-vending networks, which are
accessible to investors in the country.
V. The exchange should have at least 50 members to start derivatives trading.
VI. The derivatives trading should be done in a separate segment with separate
membership; That is, all members of the cash market would not automatically
become members of the derivatives market.
VII. The derivatives market should have a separate governing council which should not
have representation of trading by clearing members beyond whatever percentage
SEBI may prescribe after reviewing the working of the present governance system of
exchanges.
VIII. The chairman of the governing council of the derivative division / exchange should
be a member of the governing council. If the chairman is broker / dealer, then he
should not carry on any broking or dealing on any exchange during his tenure.
IX. No trading/clearing member should be allowed simultaneously to be on the
governing council both derivatives market and cash market.

FUTURES

FUTURES
Futures contract is a firm legal commitment between a buyer & seller in
which they agree to exchange something at a specified price at the end of a designated
period of time. The buyer agrees to take delivery of something and the seller agrees to
make delivery.
STOCK INDEX FUTURES
Stock Index futures are the most popular financial futures, which
have been used to hedge or manage the systematic risk by the investors of Stock
Market. They are called hedgers who own portfolio of securities and are exposed to the
systematic risk. Stock Index is the apt hedging asset since the rise or fall due to
systematic risk is accurately shown in the Stock Index. Stock index futures contract is an
agreement to buy or sell a specified amount of an underlying stock index traded on a
regulated futures exchange for a specified price for settlement at a specified time future.
Stock index futures will require lower capital adequacy and margin
requirements as compared to margins on carry forward of individual scrips. The
brokerage costs on index futures will be much lower.
Savings in cost is possible through reduced bid-ask spreads where stocks
are traded in packaged forms. The impact cost will be much lower in case of stock index
futures as opposed to dealing in individual scrips. The market is conditioned to think in
terms of the index and therefore would prefer to trade in stock index futures. Further, the
chances of manipulation are much lesser.
The Stock index futures are expected to be extremely liquid given the
speculative nature of our markets and the overwhelming retail participation expected to
be fairly high. In the near future, stock index futures will definitely see incredible
volumes in India. It will be a blockbuster product and is pitched to become the most
liquid contract in the world in terms of number of contracts traded if not in terms of
notional value. The advantage to the equity or cash market is in the fact that they would
become less volatile as most of the speculative activity would shift to stock index
futures. The stock index futures market should ideally have more depth, volumes and act
as a stabilizing factor for the cash market. However, it is too early to base any
conclusions on the volume or to form any firm trend.

The difference between stock index futures and most other financial
futures contracts is that settlement is made at the value of the index at maturity of the
contract.
FUTURES TERMINOLOGY

Contract Size
The value of the contract at a specific level of Index. It is
Index level * Multiplier.

Multiplier
It is a pre-determined value, used to arrive at the contract size. It

is the price per index point.

Tick Size
It is the minimum price difference between two quotes
of similar nature.

Contract Month
The month in which the contract will expire.

Expiry Day
The last day on which the contract is available for trading.

Open interest
Total outstanding long or short positions in the market at any specific
point in time. As total long positions for market would be equal to total short
positions, for calculation of open Interest, only one side of the contracts is
counted.

Volume
No. Of contracts traded during a specific period of time. During a day,

during a week or during a month.

Long position
Outstanding/unsettled purchase position at any point of time.

Short position
Outstanding/ unsettled sales position at any point of time.

Open position
Outstanding/unsettled long or short position at any point of time.

Physical delivery
Open position at the expiry of the contract is settled through delivery of

the underlying. In futures market, delivery is low.

Cash settlement
Open position at the expiry of the contract is settled in cash. These

contracts Alternative Delivery Procedure (ADP) - Open position at the expiry of the
contract is settled by two parties - one buyer and one seller, at the terms other than
defined by the exchange. World wide a significant portion of the energy and energy
related contracts (crude oil, heating and gasoline oil) are settled through Alternative
Delivery Procedure.
Pay off for futures:
A Pay off is the likely profit/loss that would accrue to a market participant with
change in the price of the underlying asset. Futures contracts have linear payoffs. In
simple words, it means that the losses as well as profits, for the buyer and the seller of
futures contracts, are unlimited.

Pay off for Buyer of futures: (Long futures)


The pay offs for a person who buys a futures contract is similar to the pay

off for a person who holds an asset. He has potentially unlimited upside as well as
downside. Take the case of a speculator who buys a two-month Nifty index futures
contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty
portfolio. When the index moves up, the long futures position starts making profits
and when the index moves down it starts making losses

Pay off for seller of futures: (short futures)

The pay offs for a person who sells a futures contract is similar to the pay
off for a person who shorts an asset. He has potentially unlimited upside as well as
downside. Take the case of a speculator who sells a two-month Nifty index futures
contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty
portfolio. When the index moves down, the short futures position starts making profits
and when the index moves up it starts making losses.
OPTIONS

An option agreement is a contract in which the writer of the option grants the
buyer of the option the right to purchase from or sell to the writer a designated
instrument at a specific price within a specified period of time.
Certain options are shorterm in nature and are issued by investors another group
of options are long-term in nature and are issued by companies.

OPTIONS TERMINOLOGY:

Call option:
A call is an option contract giving the buyer the right to purchase the
stock.

Put option:
A put is an option contract giving the buyer the right to sell the stock.

Expiration date:
It is the date on which the option contract expires.

Strike price:
It is the price at which the buyer of a option contract can purchase or sell

the stock during the life of the option

Premium:
Is the price the buyer pays the writer for an option contract.

Writer:

The term writer is synonymous to the seller of the option contract.

Holder:
The term holder is synonymous to the buyer of the option contract.

Straddle:
A straddle is combination of put and calls giving the buyer the right to
either buy or sell stock at the exercise price.

Strip:
A strip is two puts and one call at the same period.

Strap:
A strap is two calls and one put at the same strike price for the same
period.

Spread:
A spread consists of a put and a call option on the same security for the
same time period at different exercise prices.
The option holder will exercise his option when doing so provides him a benefit

over buying or selling the underlying asset from the market at the prevailing price. These
are three possibilities.
1. In the money: An option is said to be in the money when it is
advantageous to exercise it.
2. Out of the money: The option is out of money if it not advantageous to exercise it.
3. At the money: IF the option holder does not lose or gain whether he exercises his
option or buys or sells the asset from the market, the option is said to be at the money.
The exchanges initially created three expiration cycles for all listed options and each
issue was assigned to one of these three cycles.
January, April, July, October.
February, March, August, November.
March, June, September, and December.

In India, all the F and O contracts whether on indices or individual stocks are
available for one or two or three months series and they expire on the Thursday of the
concerned month.

CALL OPTION:
An option that grants the buyer the right to purchase a designated
instrument is called a call option. A call option is a contract that gives its owner the right,
but not the obligation, to buy a specified price on or before a specified date.
An American call option can be exercised on or before the specified date only.
European options can be exercised on the specified date only.
PUT OPTION:
An option contract giving the owner the right, but not the obligation, to sell a
specified amount of an underlying security at a specified price within a specified time.
This is the opposite of a call option, which gives the holder the right to buy shares.
A put becomes more valuable as the price of the underlying stock
depreciates relative to the strike price. For example, if you have one Mar 09 Taser 10 put,
you have the right to sell 100 shares of Taser at $10 until March 2008 (usually the third
Friday of the month). If shares of Taser fall to $5 and you exercise the option, you can
purchase 100 shares of Taser for $5 in the market and sell the shares to the
option's writer for $10 each, which means you make $500 (100 x ($10-$5)) on the put
option. Note that the maximum amount of potential proft in this example ignores
the premium paid to obtain the put option.
FACTORS DETERMINIG OPTION VALUE:

Stock price

Strike price

Time to expiration

Volatility

Risk free interest rate

Dividend

DIFFERENCE BETWEEN FUTURES & OPTION:

FUTURES

OPTIONS

1) Both the parties are obligated to perform.

1) Only the seller (writer) is obligated to

2) With futures premium is paid by either


party.
3) The parties to futures contracts must
perform at the settlement date only.
They are not obligated to perform before
that date.
4) The holder of the contract is exposed to
the entire spectrum of downside risk and
had the

potential for all upside return.

5) In futures margins to be paid. They are

perform.
2) With options, the buyer pays the seller a
premium.
3) The buyer of an options contract can
exercise any time prior to expiration date.
4) The buyer limits the downside risk to the
option premium but retain the upside
potential.
5) In options premiums to be paid. But they
are very less as compared to the margins.

approximate 15-20% on the current


stock price.

Advantages of option trading

Risk management: put option allow investors holding shares to hedge against a
possible fall in their value. This can be considered similar to taking out insurance
against a fall in the share price.

Time to decide: By taking a call option the purchase price for the shares is locked
in. This gives the call option holder until the Expiry day to decide whether or
exercised the option and buys the shares. Likewise the taker of a put option has
time to decide whether

or not to sell the shares.

Speculations: The ease of trading in and out of option position makes it possible
to trade options with no intention of ever exercising them. If investor expects the
market to rise, they may decide to buy call options. If expecting a fall, they may
decide to buy put options. Either way the holder can sell the option prior to expiry
to take a profit or limit a loss. Trading options has a lower cost than shares, as
there is no stamp duty payable unless and until options are exercised.

Leverage: Leverage provides the potential to make a higher return from a smaller
initial outlay than investing directly however leverage usually involves more risks
than a direct investment in the underlying share. Trading in options can allow
investors to benefit from a change in the price of the share without having to pay
of the share.

Summary of options
Call option buyer

Call option writer (seller)

Pays premium

Receives premium

Right to exercise and buy the

Obligation to sell shares if exercised

share

Profits from falling prices or remaining

Profits from rising prices

Limited losses, potentially

neutral

unlimited gain
Put option buyer

Potentially unlimited losses, limited

gain
Put option writer (seller)

Pays premium

Receives premium

Right to exercise and sell shares

Obligation to buy shares if exercised

Profits from falling prices

Profits from rising prices or remaining

Limited losses, potentially


unlimited gain

neutral

Potentially unlimited losses, limited


gain

Derivatives Market India

Derivatives trading commenced in Indian market in 2000 with the introduction of Index
futures at BSE, and subsequently, on National Stock Exchange (NSE). Since then,
derivatives market in India has witnessed tremendous growth in terms of trading value
and number of traded contracts. Here we may discuss the performance of derivatives
products in India markets as follows.
Derivatives Products Traded in Derivatives Segment of BSE
The BSE created history on June 9, 2000 when it launched trading in Sensex based
futures contract for the first time. It was followed by trading in index options on June 1,
2001; in stock options and single stock futures (31 stocks) on July 9, 2001 and
November 9, 2002, respectively. Currently, the number of stocks under single futures
and options is 1096. BSE achieved another milestone on September 13, 2004 when it
launched Weekly Options, a unique product unparalleled worldwide in the derivatives
markets. It permitted trading in the stocks of four leading companies namely; Satyam,
State Bank of India, Reliance Industries and TISCO (renamed now Tata Steel). Chhota
(mini) SENSEX 7 was launched on January 1, 2008. With a small or 'mini' market lot of 5,
it allows for comparatively lower capital outlay, lower trading costs, more precise
hedging and flexible trading. Currency futures were introduced on October 1, 2008 to
enable participants to hedge their currency risks through trading in the U.S. dollar-rupee
future platforms. Table summarily specifies the derivative products and their date of
introduction on the BSE
Products Traded in Derivatives Segment of the BSE
S.no
1
2
3

Product Traded with underlying asset


Index Futures- Sensex
Index Options- Sensex
Stock Option on 109 Stocks

Stock futures on 109 Stocks

Weekly Option on 4 Stocks

Chhota (mini) SENSEX


Futures & Options on Sectoral indices namely BSE TECK, BSE
FMCG, BSE Metal, BSE

Introduction
Date
June 9,2000
June 1,2001
July 9, 2001
November
9,2002
September
13,2004
January 1,
2008
N.A.

Bankex and BSE Oil & Gas.


8
Currency Futures on US Dollar Rupee
Source: Complied from BSE website

October
1,2008

Derivatives Products Traded in Derivatives Segment of NSE


NSE started trading in index futures, based on popular S&P CNX Index, on June 12, 2000
as its first derivatives product. Trading on index options was introduced on June 4, 2001.
Futures on individual securities started on November 9, 2001. The futures contracts are
available on 2338 securities stipulated by the Securities & Exchange Board of India
(SEBI) . Trading in options on individual securities commenced from July 2, 2001. The
options contracts are American style and cash settled and are available on 233
securities. Trading in interest rate futures was introduced on 24 June 2003 but it was
closed subsequently due to pricing problem. The NSE achieved another landmark in

product introduction by launching Mini Index Futures & Options with a minimum
contract size of Rs 1 lac. NSE crated history by launching currency futures contract on
US Dollar-Rupee on August 29, 2008 in Indian Derivatives market. Table 3 presents a
description of the types of products traded at F& O segment of NSE.
Products Traded in F&O Segment of NSE
S.n
o
Product Traded with underlying asset
1
Index Futures- S&P CNX Nifty
2
Index Options- S&P CNX Nifty
3
Stock Option on 233 Stocks
4
Stock futures on 233 Stocks
5
Interest Rate Futures- T Bills and 10 Years Bond
6
CNX IT Futures & Options
7
Bank Nifty Futures & Options
8
CNX Nifty Junior Futures & Options
9
CNX 100 Futures & Options
10
Nifty Midcap 50 Futures & Options
11
Mini index Futures & Options - S&P CNX Nifty index
12
long Term Option contracts on S&P CNX Nifty Index
13
Currency Futures on US Dollar Rupee
14
S& P CNX Defty Futures & Options
Source: Complied from NSE website

Introduction
Date
June 12,2000
June 4,2001
July 2, 2001
November 9,2001
June 23,2003
August 29,2003
June 13,2005
June 1,2007
June 1,2007
October 5,2007
January 1, 2008
March 3,2008
August 29,2008
December 10,
2008

Growth of Derivatives Market in India


Equity derivatives market in India has registered an "explosive growth" (see Fig. 2) and
is expected to continue the same in the years to come. Introduced in 2000, financial
derivatives market in India has shown a remarkable growth both in terms of volumes
and numbers of traded contracts. NSE alone accounts for 99 percent of the derivatives
trading in Indian markets. The introduction of derivatives has been well received by
stock market players. Trading in derivatives gained popularity soon after its
introduction. In due course, the turnover of the NSE derivatives market exceeded the
turnover of the NSE cash market. For example, in 2008, the value of the NSE derivatives
markets was Rs. 130, 90,477.75 Cr. whereas the value of the NSE cash markets was
only Rs. 3,551,038 Cr. If we compare the trading figures of NSE and BSE, performance of
BSE is not encouraging both in terms of volumes and numbers of contracts traded in all
product categories.
Among all the products traded on NSE in F& O segment, single stock futures also
known as equity futures, are most popular in terms of volumes and number of contract
traded, followed by index futures with turnover shares of 52 percent and 31 percent,
respectively . In case of BSE, index futures outperform stock futures.
Business Growth of Derivatives at NSE from 2000-2009

Source: NSE fact book 2008 issue


Product wise Turnover of F&O at NSE from 2000-2008

Source: Authors calculation based on data complied from NSE

NSE Derivatives Segment Turnover

Year

Index
Futures

Stock
Futures

Index
Options

Stock
Options

Intere
st
Rate
Future

Average
Total

Daily
Turnove

2583617.9 2558863.5 2358916.9


2008-09 2
5
0
3820667.2 7548563.2 1362110.8
2007-08 7
3
8
2006-07 2539574
3830967
791906
2005-06 1513755
2791697
338469
2004-05 772147
1484056
121943
2003-04 554446
1305939
52816
2002-03 43952
286533
9246
2001-02 21483
51515
3765
2000-01 2365
Source: Complied from NSE website

r
7650896.8 46938.0
0
2
13090477. 52153.3
75
0
7356242 29543
4824174 19220
2546982 10107
2130610 8388
439862
1752
101926
410
2365
11

149498.40 0.00
359136.55 0.00
193795
0
180253
0
168836
0
217207
202
100131
25163
-

NSE Cash & Derivatives Segment Turnover


Year
Cash Segment
2007-08
3,551,038
2006-07
1,945,285
2005-06
1,569,556
2004-05
1,140,071
2003-04
1,099,535
2002-03
617,989
2001-02
513,167
2000-01
1,339,510
Source: Complied from
NSE website
Table
Number of contract Traded at NSE
6:
Derivatives Segment
Yea
r

2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02

Index
Futures

Stock
Futures

Index
Options

1364767
47
1565985
79
814874
24
585378
86
216354
49
171916
68
212676
3
102558
8

14915999
7
116790708
20358795 55366038
2
10495540 25157438
1
80905493 12935116
47043066 3293558
32368842 1732414
10676843 442241
1957856
175900

Derivatives
Segment
13090477.75
7356242
4824174
2546982
2130610
439862
101926
2365

Stock
Optio
ns
78262
31
94606
31
52833
10
52407
76
50451
12
55830
71
35230
62
10375
29

(Rs. in
Cr.)

Interest
Rate
Futures
0
0
0
0
0
10781
-

Total
410253
683
425013
200
216883
573
157619
271
7701718
5
5688677
6
1676890
9
419687
3

2000-01
90580
Source:
from NSE
complied
website
Average Daily Transaction at NSE in Derivatives
and Cash Segment

Derivatives
Year
Segment
200708
52153.30
200629543
07
200519220
06
200405
10107
2003838
04
8
2002175
03
2
200102
410
200011
01
Source: Complied from NSE website and NSE
fact book 2008
Table 8:BSE Derivatives Segment
Turnover
Year

Index
Futures

Stock
Futures

Cash
Segment
14,148
7,812
6,253
4,506
4,328
2,462
2,078
5,337

Index
Options
Call
Put

200708
234660
7609
31
8
200607
55491
3515
0
0
20055
1
3
0
06
200405
13600
213
1471
827
20036572
5171
0
0
04
20021811
644
1
0
03
200102
1276
452
39
45
20001673
01
Source: Complied from BSE website & various issues of

90580

Stock
Options
Call
Put

Total

242309

0
0

0
0

59006
9

2
174

0
157

16112
12452

21

2478

79
-

35
-

1922
1673

SEBI bulletins

Number of Contract Traded at BSE Derivatives


Segment
Year

Index

Stock

Index

Stock

Total

Futures

Futures

200708
7157078
295117
200607
1638779
142433
200506
89
12
200405
449630
6725
200304
246443
128193
200203
111324
25842
200102
79552
17951
200001
77743
Source: Complied from BSE website &
SEBI bulletin

Options
Call
Put

Options
Call
Put

951

210

7453371

1545169

100
4806
5

03

27210

72

17

531719

4391 3230

382258

41

783

138037

1139

1276

3605 1500

105527

77743

19

(Rs. in
Cr.)

BSE Cash & Derivatives Segment Turnover


Cash
Year
Segment
200708
1578857
200695618
07
5
200581607
06
4
200451871
05
5
200350305
04
3
200231407
03
3
200130729
02
2
200001
1000032
Source: Complied from BSE website & SEBI bulletin

Derivatives
Segment
2423
09
5900
6
9
1611
2
1245
2
2478
1922
1673

Despite of encouraging growth and developments, industry analyst feels that the
derivatives market has not yet, realized its full potential in terms of growth & trading.
Analysts points out that the equity derivative markets on the BSE and NSE has been
limited to only four products- index futures, index options and individual stock futures
and options, which in turn, are limited to certain select stocks only. Although recently
NSE and BSE has added more products in their derivatives segment (Weekly Options,
Currency futures, Mini Index etc.) but still it is far less than the depth and variety of
products prevailing across many developed capital markets.

Status of Indian Derivatives Market vis-a vis Global Derivatives Market


The derivatives segment has expanded in the recent years in a substantial way both
globally as well as in the Indian capital market. The figures revealed by Futures Industry
Association (FIA)9 Annual Volume Survey bring out the fact that more than 15 billion
futures and options contracts were traded during 2007 on the 54 important exchanges
that report to the FIA, reflecting a remarkable increase of 28% from the previous year.
Looking back at the last four years, it can be worked out that these figures reflect that
the growth rate was 29 % in 2006, 19% in 2006, 12% in 2005, and 9% in 2004. From the
same table it also follows that of the total volume traded globally over the period 200007, the US exchanges alone constituted as much as 35 percent share. Fig. 6 presents
the break down of
derivatives volume by region and it is clearly evident that after North America with a
share of about 40 percent, Asia-Pacific occupies the second slot with a share of 28
percent and Europe falls at the third place with its contribution of 24 percent.

Futures Industry Association (FIA) is an association of futures commission


merchants, banks and trading advisers operating in the United States, European
and Asian futures markets. FIA provides information and education on futures
markets and trading. It also represents the interest of its members by lobbying
If we compare the turnover-wise performance of the derivatives segments
over the last five years, it may be noticed from an inspection of the relevant
tables that the Indian segment has expanded phenomenally as compared to the
global segment. The turnover of the NSE derivatives segment in 2003-04 stood
at Rs. 2130610 crores. It grew to an astonishing level of Rs.13090477 crores
during the year 2007-08, displaying a more than six-time increase over the fiveyear period. In marked contrast, at the global level the increase was less than
even two-fold: the turnover was $ 8163 million in 2003 and $ 15187 million in
2007.
Global Trend in Turnover of Derivatives Trading

Non- US
Year
US Exchanges
Exchanges
2000
1313.65
1675.80
2001
1578.62
2768.70
2002
1844.90
4372.38
2003
2172.52
5990.22
2004
2795.21
6069.50
2005
3525.00
6448.67
2006
4616.73
7245.48
2007
6137.20
9049.47
2000-07 23983 (35.48)
43620 (64.52)
Source: FI Futures Industry, March/April 2008

(in
millions
)
Global
2989.45
4347.32
6217.28
8162.54
8864.71
9973.67
11862.21
15186.67
67604 (100)

Figure 6: Derivatives Volume by Region Jan-Dec 2008

Latin
America

Other 39.74%

4.84%
Europe
Asia
Pacific
28.18
%

23.61%

North America
39.63%

Source: Newedge
Difference on the following parameters volume , settlement ,
regulatory framework and types of derivatives allowed and not allowed.
1. Types of derivatives allowed and not allowed
Types of derivatives allowed in inida vs rest of the world
countries
Index
Futures
Options
Stock
Futures
Options
currency
Futures
Options

Australi
a

China

Hong
kong

india

japan

korea

Usa

yes
yes

no
no

yes
yes

yes
yes

yes
yes

yes
yes

yes
yes

yes
yes

no
no

yes
yes

yes
yes

no
yes

no
yes

yes
no

yes
no

no
no

no
no

yes
no

yes
no

yes
yes

no
no

Interest
rate
Future
Options
Bonds
Futures
Options
Commoditit
ies
Futures
options

yes
yes

no
no

yes
no

yes
no

yes
yes

yes
no

yes
yes

yes
yes

yes
no

yes
no

no
no

yes
yes

yes
yes

yes
yes

yes
yes

yes
no

no
no

yes
no

yes
no

yes
no

yes
no

2. volume
Trading Volumes
After recording a staggering year-on-year growth of 60.43 percent in trading
volumn in 20092010, the NSEs derivatives market continued its momentum in
20102011 by clocking a growth of 65.58 percent (Table 6-5). The NSE further
strengthened its dominance in the derivatives segment in 20102011 with a
share of 99.99 percent of the total turnover in this segment. The share of the BSE
in the total derivatives market turnover fell from 0.0013 percent in 20092010 to
0.0005 percent in 20102011. The total turnover of the derivatives segment
jumped by 26.56 percent during the first half of 20112012 compared to the
turnover in the corresponding period in the previous fiscal year.

The index options segment was the clear leader in the product-wise turnover of
the futures and options segment in the NSE in 20102011 (Table 6-6 and Chart 61). The turnover in the index options category was 62.79 percent of the total
turnover in the F&O segment of the NSE, followed by the stock futures and index
futures that saw a year-on-year growth of 18.79 percent and 14.90 percent,
respectively. This trend continued in the first half of 20112012, with index
options constituting around 72.89 percent of the total turnover in this segment.

The turnover of index optionszoomed by 59.93 percent during the first half of
20112012, compared to the turnover in the corresponding period in the previous
fiscal year.

FIA Volume Report: Global Futures and Options Volume Rose 2.1% to 21.64 Billion
in 2013
FIA released its annual report on global trends in the trading of futures and
options. According to statistics gathered by FIA from 84 exchanges worldwide,
21.64 billion futures and options contracts were traded in 2013, an increase of
2.1% from the previous year, but still well below the number of contracts traded
in 2011 and 2010.
Futures trading accounted for 12.22 billion contracts, just over 56% of total
industry volume. Trading of options accounted for the other 44%. By category,
contracts based on equity indices and individual stocks accounted for 11.77
billion, 54% of total volume. Interest rate futures and options accounted for 3.33
billion, 15% of total volume.
The trends in North America and Asia-Pacific moved in opposite directions.
Exchanges in North America reported 7.9 billion contracts traded in 2013, up
9.9% from the previous year. Exchanges in Asia-Pacific reported 7.29 billion
contracts, down 3.1% from the previous year.

CME Group continued to rank as the worlds largest derivatives exchange by


volume, with 3.16 billion contracts traded in 2013, up 9.2% from the previous
year. IntercontinentalExchange jumped to the second position following its
acquisition of NYSE Euronext and its subsidiary exchanges in Europe and the U.S.
On a combined basis, ICEs volume reached 2.81 billion futures and options, up
14.7% from the previous year.
This years report includes tables showing the top 30 derivatives exchanges
ranked by volume, the top 20 contracts across six categories, and breakdowns of
global volume by region and by category. This years report also includes a special
feature showing the futures and options that have had the greatest increase in
volume over the last five years. FIA collects volume and open interest statistics
from 84 exchanges on a monthly basis. The statistics are provided by the
exchanges on a voluntary basis and are subject to revision by the exchanges. FIA
does not audit the exchanges and does not guarantee that the statistics are
accurate. Volume is measured by the number of contracts traded on a round-trip
basis to avoid double-counting. Some exchanges provide facilities for processing
and clearing offexchange transactions. FIA statistics include these types of
transactions were reported by the exchanges.

Settlement of futures contracts on index and individual securities

National Securities Clearing Corporation Limited (NSCCL) is the clearing and


settlement agency for all deals executed on the Derivatives (Futures & Options)
segment. NSCCL acts as legal counter-party to all deals on NSEs F&O segment
and guarantees settlement.
A Clearing Member (CM) of NSCCL has the responsibility of clearing and
settlement of all deals executed by Trading Members (TM) on NSE, who clear and
settle such deals through them.
Daily Mark-to-Market Settlement
The positions in the futures contracts for each member is marked-to-market to
the daily settlement price of the futures contracts at the end of each trade day.
The profits/ losses are computed as the difference between the trade price or the
previous day's settlement price, as the case may be, and the current day's
settlement price. The CMs who have suffered a loss are required to pay the markto-market loss amount to NSCCL which is passed on to the members who have
made a profit. This is known as daily mark-to-market settlement.
Theoretical daily settlement price for unexpired futures contracts, which are not
traded during the last half an hour on a day, is currently the price computed as
per the formula detailed below:
F =S * e rt
where :
F = theoretical futures price
S = value of the underlying index
r = rate of interest (MIBOR)
t = time to expiration
Rate of interest may be the relevant MIBOR rate or such other rate as may be
specified.
After daily settlement, all the open positions are reset to the daily settlement
price.
CMs are responsible to collect and settle the daily mark to market profits / losses
incurred by the TMs and their clients clearing and settling through them. The payin and pay-out of the mark-to-market settlement is on T+1 days (T = Trade day).
The mark to market losses or profits are directly debited or credited to the
CMs clearing bank account.

Option to settle Daily MTM on T+0 day


Clearing members may opt to pay daily mark to market settlement on a T+0
basis. The option can be exercised once in a quarter (Jan-March, Apr-June, Jul-Sep
& Oct-Dec). The option once exercised shall remain irrevocable during that
quarter. Clearing members who wish to opt to pay daily mark to market
settlement on T+0 basis shall intimate the Clearing Corporation as per the format
specified in specified format.
Clearing members who opt for payment of daily MTM settlement amount on a
T+0 basis shall not be levied the scaled up margins.
The pay-out of MTM settlement shall continue to be done on T+1 day basis.

Final Settlement
On the expiry of the futures contracts, NSCCL marks all positions of a CM to
the final settlement price and the resulting profit / loss is settled in cash.
The final settlement of the futures contracts is similar to the daily settlement
process except for the method of computation of final settlement price. The final
settlement profit / loss is computed as the difference between trade price or the
previous day's settlement price, as the case may be, and the final settlement
price of the relevant futures contract.
Final settlement loss/ profit amount is debited/ credited to the relevant
CMs clearing bank account on T+1 day (T= expiry day).
Open positions in futures contracts cease to exist after their expiration day
Settlement Procedure
Daily MTM settlement on T+0 day
Clearing members who opt to pay the Daily MTM settlement on a T+0 basis would
compute such settlement amounts on a daily basis and make the amount of funds
available in their clearing account before the end of day on T+0 day. Failure to do
so would tantamount to non payment of daily MTM settlement on a T+0 basis.
Further, partial payment of daily MTM settlement would also be considered as non
payment of daily MTM settlement on a T+0 basis. These would be construed as
non compliance and penalties applicable for fund shortages from time to time
would be levied.
A penalty of 0.07 % of the margin amount at end of day on T+0 would be levied
on the clearing members. Further, the benefit of scaled down margins shall not be
available in case of non payment

of daily MTM settlement on a T+0 basis from the day of such default to the end of
the relevant quarter.
Settlement of options contracts on index and individual securities

Daily Premium Settlement


Premium settlement is cash settled and settlement style is premium style. The
premium payable position and premium receivable positions are netted across all
option contracts for each CM at the client level to determine the net premium
payable or receivable amount, at the end of each day.
The CMs who have a premium payable position are required to pay the premium
amount to NSCCL which is in turn passed on to the members who have a
premium receivable position. This is known as daily premium settlement.
CMs are responsible to collect and settle for the premium amounts from the TMs
and their clients clearing and settling through them.
The pay-in and pay-out of the premium settlement is on T+1 day (T = Trade day).
The premium payable amount and premium receivable amount are directly
debited or credited to the CMs clearing bank account.

Final Exercise Settlement


Final Exercise settlement is effected for option positions at in-the-money strike
prices existing at the close of trading hours, on the expiration day of an option
contract. Long positions at in-the money strike prices are automatically assigned
to short positions in option contracts with the same series, on a random basis.
For index options contracts and options contracts on individual securities,
exercise style is European style. Final Exercise is Automatic on expiry of the
option contracts.
Option contracts, which have been exercised, shall be assigned and allocated to
Clearing Members at the client level.
Exercise settlement is cash settled by debiting/ crediting of the clearing
accounts of the relevant Clearing Members with the respective Clearing Bank.
Final settlement loss/ profit amount for option contracts on Index is debited/
credited to the relevant CMs clearing bank account on T+1 day (T = expiry day).
Final settlement loss/ profit amount for option contracts on Individual Securities is
debited/ credited to the relevant CMs clearing bank account on T+1 day (T =
expiry day).
Open positions, in option contracts, cease to exist after their expiration day.
The pay-in / pay-out of funds for a CM on a day is the net amount across
settlements and all TMs/ clients, in F&O Segment.

There are four entities in the trading system of a derivative market:


1. Trading members: Trading members can trade either on their own account or
on
behalf of their clients including participants. They are registered as members with

NSE and are assigned an exclusive trading member ID


2. Clearing members: Clearing members are members of NSCCL. They carry out
confirmation/inquiry of trades and the risk management activities through the
trading
system. These clearing members are also trading members and clear trade for
themselves or/and other.
3. Professional clearing members: A clearing member who is not a trading
member is known as
a professional clearing member (PCM). Typically, banks and custodian become
PCMs and
clear and settle for their trading members.
4. Participants: A participant is a client of trading members like financial
institutions. These
clients may trade through multiple trading members, but settle their trades
through a single
clearing member only.
The terminals of trading of futures & options segment are available in 298 cities
at the end of March
2006. Besides trading terminals, it can also be accessed through the internet by
investors from
anywhere.

Settlement Schedule
Product

Settlement

Futures Contracts on Index & Daily Mark-toIndividual Securities


Market Settlement

Schedule

Pay-in : T+1 working day at


or after 11.30 a.m.
Payout : T+1 working day
at or after 12.00 p.m.

(T is trade day)
Futures Contracts on Index
&
Individual Securities

Final Settlement

Pay-in : T+1 working day at


or after 11.30 a.m.
Payout : T+1 working day
at or after 12.00 p.m.
(T is expiration day of
contract)

Interest Rate Futures


Contracts

Daily Mark-toMarket Settlement

Pay-in : T+1 working day on


or after 11.30 a.m.
Payout : T+1 working day
on or after 12.00 p.m.
(T is trading day)

Interest Rate Futures


Contracts

Final Settlement

Pay-in : T+1 working day on


or after 11.30 a.m.
Payout : T+1 working day
on or after 12.00 p.m.
(T is expiration day)

Options Contracts on Index


&
Individual Securities

Premium Settlement Pay-in : T+1 working day at


or after 11.30 a.m.
Payout : T+1 working day
at or after 12.00 p.m.
(T is trade day)

Options Contracts on Index

Exercise & Final


Settlement

Pay-in : T+1 working day at


or after 11.30 a.m.
Payout : T+1 working day
at or after 12.00 p.m.
(T is expiration day of
contract)

Options Contract on
Individual
Securities

Interim Exercise
Settlement

Pay-in : T+2 working day at


or after 11.30 a.m.
Payout : T+2 working day
at or after 12.00 p.m.
(T is exercise day)

Options Contract on
Individual
Securities

Exercise & Final


Settlement

Pay-in : T+2 working day at


or after 11.30 a.m.
Payout : T+2 working day
at or after 12.00 p.m.
(T is expiration day)

Settlement Price
Product

Settlement

Settlement Price

Futures Contracts
on Index or
Individual Security

Daily
Settlement

Closing price of the futures contracts on the


trading day. (The closing price is the last half
hour weighted average price of the
contract).

Un-expired illiquid
futures contracts

Daily
Settlement

Theoretical Price computed as per formula


F=S * e rt

Futures Contracts
on Index or
Individual
Securities

Final
Settlement

Closing price of the relevant underlying


index / security in the Capital Market
segment of NSE, on the last trading day of
the futures contracts.
(The closing price of the underlying index /
security is its last half an hour weighted
average value / price in the Capital Market

segment of NSE).

Options Contracts
on Individual
Securities

Interim
Exercise
Settlement

Closing price of such underlying security on


the day of exercise of the options contract.
(The closing price of the underlying security
is its last half an hour weighted average
price in the Capital Market Segment of NSE).

Options Contracts
on Index and
Individual
Securities

Final
Exercise
Settlement

Closing price of such underlying security (or


index) on the last trading day of the options
contract.
(The closing price of the underlying security
(or index) is its last half an hour weighted
average price in the Capital Market Segment
of NSE).

Major Payment, Clearing, and Settlement Systems in the United States


The Federal Reserve and the private sector operate the systems that constitute
the infrastructure
for the processing and completion of financial transactions in the United States.
Listed below are
some of the major systems currently operating in the United States. Some
privately-operated
systems have been designated by FSOC as systemically important under Title VIII.
Additional
information regarding selected systems, including recent transaction volume
levels, is set forth in

an Appendix to this report. In the future, new and evolving types of financial
products,
transactions and instruments could lead to new payment, clearing, and
settlement systems and
activities.
FMUs Designated by the FSOC
On July 18, 2012, FSOC voted unanimously to designate eight FMUs as
systemically important.
Each was assigned a supervisory agency on the basis of the types of activities
that they perform.
The eight systemically important FMUs are:
The Clearing House Payments Company, on the basis of its role as operator of
the Clearing House Interbank Payments System (CHIPS).8

(Supervisory AgencyThe Federal Reserve)


CLS Bank (foreign exchange)
(Supervisory AgencyThe Federal Reserve)
Chicago Mercantile Exchange (CME) Clearing (credit default and interest rate
swaps)
(Supervisory AgencyCommodity Futures Trading Commission)
Depository Trust Company (DTC)
(Supervisory AgencySecurities and Exchange Commission)
Fixed Income Clearing Corporation operating the Government Securities
Division (GSD) and the Mortgage-Backed Securities Division (MBSD)
(Supervisory AgencySecurities and Exchange Commission)

ICE Trust (credit default swaps)


(Supervisory AgencyCommodity Futures Trading Commission)
National Securities Clearing Corporation (NSCC)
(Supervisory AgencySecurities and Exchange Commission
8

The Electronic Payments Network and other subsidiaries are deemed


systemically important by default for being
component parts of the parent company The Clearing House Payments Company,
which was designated systemically
important. Supervision of U.S. Payment, Clearing, and Settlement Systems

Congressional Research Service 4


The Options Clearing Corporation (equity derivatives)
(Supervisory AgencySecurities and Exchange Commission)
The Clearing House operates an interbank funds transfer system known as CHIPS
and an ACH
system known as EPN. DTCC operates the Depository Trust Company (DTC), the
major U.S.
depository, and clearing corporations for government, mortgage-backed, and
corporate and
municipal securities. These entities provide the primary infrastructure for the
clearance,
settlement, and custody of the vast majority of transactions in the United States
involving
equities, corporate debt, municipal bonds, money market instruments, and
government securities.9

In the future, FSOC may add or remove PCS systems from the designated list, as
conditions
warrant.

Regulatory framework
Regulatory objectives

The regulation should be designed to achieve specific, well-defined goals. It is


inclined towards positive regulation designed to encourage healthy activity and
behavior .Of course, the ultimate objective of regulation of financial markets has
to be to promote more efficient functioning of markets on the "real" side of the
economy, i.e. economic efficiency.
It has been guided by the following objectives:
a. Investor Protection: Attention needs to be given to the following four
aspects:
i.

Fairness and Transparency: The trading rules should ensure that


trading is conducted in a fair and transparent manner. Experience in
other countries shows that in many cases, derivatives brokers/dealers
failed to disclose potential risk to the clients.

ii.

Safeguard for clients' moneys: Moneys and securities deposited


by clients with the trading members should not only be kept in a
separate clients' account but should also not be attachable for
meeting the broker's own debts. It should be ensured that trading by
dealers on own account is totally segregated from that for clients.

iii.

Competent and honest service: The eligibility criteria for trading


members should be designed to encourage competent and qualified
personnel so that investors/clients are served well. This makes it
necessary to prescribe qualification for derivatives brokers/dealers
and the sales persons appointed by them in terms of a knowledge
base.

iv.

Market integrity: The trading system should ensure that the


market's integrity is safeguarded by minimising the possibility of
defaults. This requires framing appropriate rules about capital
adequacy, margins, clearing corporation, etc.

b. Quality of markets: The concept of "Quality of Markets" goes well beyond


market integrity and aims at enhancing important market qualities, such as
cost-efficiency, price-continuity, and price-discovery. This is a much broader
objective than market integrity.
c. Innovation: While curbing any undesirable tendencies, the regulatory
framework should not stifle innovation which is the source of all economic
progress, more so because financial derivatives represent a new rapidly
developing area, aided by advancements in information technology.

India

Present system of regulation in commodity forward/future trading

At present, there are three tiers of regulations of forward/futures trading system


exists in India, namely, Government of India, Forward Markets Commission and
Commodity Exchanges.
The FC(R) Act, 1952 prohibits options in commodities. For the purpose of forward
contracts in certain commodities can be regulated by notifying those commodities
u/s 15 of the Act; forward trading in certain other commodities can be prohibited
by notifying these commodities u/s 17 of the Act.

Need for regulating futures market

The need for regulation arises on account of the fact that the benefits of futures
markets accrue in competitive conditions. The regulation is needed to create
competitive conditions. In the absence of regulation, unscrupulous participants
could use these leveraged contracts for manipulating prices. This could have
undesirable influence on the spot prices, thereby affecting interests of society at
large.. Regulation is also needed to ensure that the market has appropriate risk
management system. In the absence of such a system, a major default could
create a chain reaction. The resultant financial crisis in a futures market could
create systematic risk. Regulation is also needed to ensure fairness and
transparency in trading, clearing, settlement and management of the exchange
so as to protect and promote the interest of various stakeholders, particularly
non-member users of the market.

Forward Markets Commission

Forward Markets Commission is a regulatory body for commodity futures/ forward


trade in India. This was set up under the Forward Contracts (Regulation) Act of
1952. It is responsible for regulating and promoting futures/ forward trade in
commodities. The Forward Markets Commissions Head Quarter is located at
Mumbai and Regional Office at Kolkata. Web-site:-www.fmc.gov.in

Functions of the Forward Markets Commission

(a) FMC advises Central Government in respect of grant of recognition or


withdrawal of recognition of any association.
(b) It keeps forward markets under observation and takes such action in relation
to them as it may consider necessary, in exercise of powers assign to it.
(c) It collects and publishes information relating to trading conditions in respect of
goods including information relating to demand, supply and prices and submit to
the Government periodical reports on the operations of the Act and working of
forward markets in commodities.
(d) It makes recommendations for improving the organization and working of
forward markets.
(e) It undertakes inspection of books of accounts and other documents of
recognized/registered associations.

Powers of the Commission?

The Commission has powers of deemed civil court for (a) Summoning and
enforcing the attendance of any person and examining him on oath; (b) Requiring
the discovery and production of any document; (c) Receiving evidence on
affidavits, and (d) Requisitioning any public record or copy thereof from any office.
The following powers are vested in the Central Government, most of which are
delegated to the Commission:
The powers of approving memorandum and articles of association and Bye-laws;
powers to direct to make or to make articles (Rules) or Byelaws; powers to
suspend governing body of recognised association, and, powers to suspend
business of recognised association.

Regulatory measures prescribed by Forward Markets Commission

Forward Markets Commission provides regulatory oversight in order to ensure


financial integrity (i.e. to prevent systematic risk of default by one major operator
or group of operators), market integrity (i.e. to ensure that futures prices are truly
aligned with the prospective demand and supply conditions) and to protect &
promote interest of customers /non-members.
The Forward Markets Commission prescribes following regulatory measures:
(a) Limit on net open position as on the close of an individual operator and at
Member level to prevent excessive speculation
(b) Circuit-filters or limit on price fluctuations to allow cooling of market in the
event of abrupt upswing or downswing in prices.
(c) Imposition of margins to prevent defaults by Members/clients
(d) Physical delivery of contracts and penalty for default/delivery obligations
(e) Daily mark to marketing of the contracts

Legal and regulatory provisions for customer protection

The F.C(R) Act provides that clients position cannot be appropriated by the
member of the Exchange, except a written consent is taken within three days
time. Forward Markets Commission is persuading increasing number of Exchanges
to switch over to electronic trading, clearing and settlement, which is more
customer-friendly. Commission has also prescribed simultaneous reporting system
for the Exchanges following open out-cry system. These steps facilitate audit trail
and make it difficult for the members to indulge in malpractices like, trading
ahead of clients, etc. The Commission has also mandated all the Exchanges
following open outcry system to display at a prominent place in Exchange
premises, the name, address, telephone number of the officer of the Commission
who can be contacted for any grievance. The website of the Commission also has
a provision for the customers to make complaint, send comments and
suggestions to the Commission.

Current status on OTC derivative products:

Product/G
-20
requirem
ents

Trade
Standardis
Repositor
ation
y (for
both
interbank
and
client
trades)

Interest
IRS
Rate
Derivative
s

Available
for both
interbank
and client
trade

Credit
CDS
Derivative

Available Standardise Not


for both
d.
available.
interbank
and client
trades.

Forex OTC Forex Available


Derivative forwar for both
s
d
interbank
and client
trades
(FCY -INR
& FCYFCY).

Forex

Available

PartialMIBOR
standardised
.

Central Electronic
Clearing
trading
(CCP)
platform

NonNot
No margin
guaranteed available. requirement
central
Electronic
clearing in trading
place.
platform
CCP based under
clearing
considerati
under
on.
considerati
on.

Not
Guarantee
available as d Central
majority of clearing
interbank
available.
trades
RBI has not
driven by
mandated
customized it.
client trades.

Not

Higher
capital
/Margin
requiremen
ts for noncentrally
clearing
OTC
derivative
trades

Not
available

Margin
requirement
in place

No
exclusive
platform
available.
Can be
traded on
FX- SWAP.

No
regulatory
requirement.

Guarantee Can be

No

Swap

for both
interbank
and client
trades
(FCY -INR
& FCYFCY).

Forex Available
option for both
interbank
and client
trades
(FCY -INR
& FCYFCY).

available as
majority of
interbank
trades
driven by
customized
client
trades..

d Central
clearing
available.
RBI has not
mandated
it.

Not
Central
available as clearing
majority of not
interbank
available.
trades
driven by
customized
client trades.

traded on regulatory
CCIL and
requirement.
Reuters
trading
platform.
Majority of
trades
done
through
brokers.

Not
available.

No
regulatory
requirement.

Curren Available Not


cy
for both
available.
Swap interbank
and client
trades
(FCY -INR
& FCYFCY).

Not
available.

Not
available.

No
regulatory
requirement.

IRS in
FCY

Available Not
for both
available.
interbank
and client
trades.

Not
available.

Not
available.

No
regulatory
requirement.

IRS
Not
Not
option available available.
in FCY due to
negligible
trading
volume.

Not
available.

Not
available.

No
regulatory
requirement.

Source: http://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?
UrlPage=&ID=762

United States
In the United States, the Securities and Exchange Commission
(SEC),Commodity Futures Trading Commission (CFTC), and the Federal
Reserve System (Fed), among others, are responsible for financial regulation.
The SEC regulates the securities industry (stocks, bonds, and security-based
derivatives) and enforces its laws. The CFTC regulates the trading of
agricultural commodities and futures, but as of recently, since most futures
are now based on securities, the distinction between the organizations has been
blurring, especially with regards to derivatives regulation.The Commodity
Exchange Act (CEA) regulates the trading of commodity futures in the United
States. Passed in 1936, it has been amended several times since then. The CEA
establishes the statutory framework under which the CFTC operates. The DoddFrank Wall Street Reform and Consumer Protection Act brings comprehensive
reform to the regulation of swaps
Analysis
Major issues concerning regulatory framework
There are several important issues in connection with derivatives trading, some of
which have a direct bearing on the design of the regulatory framework. They are
listed below:
a. Should a derivatives exchange be organised as independent and
separate from an existing stock exchange?
b. What exactly should be the division of regulatory responsibility,
including both framing and enforcing the regulations, between SEBI
and the derivatives exchange?

c. How should we ensure that the derivatives exchange will effectively


fulfill its regulatory responsibility.
d. What criteria should SEBI adopt for granting permission for
derivatives trading to an exchange?

e. What conditions should the clearing mechanism for derivatives


trading satisfy in view of high leverage involved?
f. What new regulations or changes in existing regulations will have to
be introduced by SEBI for derivatives trading?
Should derivatives trading be conducted in a separate exchange?
1. A major issue raised before the Committee for its decision was
whether regulations should mandate the creation of a separate
exchange for derivatives trading, or allow an existing stock exchange
to conduct such trading. The Committee has examined various
aspects of the problem. It has also reviewed the position prevailing in
other countries. Exchange-traded financial derivatives originated in
USA and were subsequently introduced in many other countries.
Organisational and regulatory arrangements are not the same in all
countries. Interestingly, in U.S.A., for reasons of history and
regulatory structure, futures trading in financial instruments,
including currency, bonds and equities, was started in early
1970s, under the auspices of commodity futures markets
rather than under securities exchanges where the underlying
bonds and equities were being traded. This may have
happened partly because currency futures, which had nothing
to do with securities markets, were the first to emerge among
financial derivatives in U.S.A. and partly because derivatives
were not "securities" under U.S. laws. Cash trading in
securities and options on securities were under the Securities
and Exchange Commission (SEC) while futures trading was
under the Commodities Futures Trading Commission (CFTC).
In other countries, the arrangements have varied.
2. The Committee examined the relative merits of allowing derivatives
trading to be conducted by an existing stock exchange vis-a-vis a
separate exchange for derivatives. The arguments for each are
summarised below.
Arguments for allowing existing stock exchanges to start futures
trading:
a. The most weighty argument in this regard is the advantage of
synergies arising from the pooling of costs of expensive information
technology networks and the sharing of expertise required for running
a modern exchange. Setting-up a separate derivatives exchange will
involve high costs and require more time.
b. The recent trend in other countries seems to be towards bringing
futures and cash trading under coordinated supervision. The lack of
coordination was recognised as an important problem in U.S.A. in the
aftermath of the October 1987 market crash. Exchange-level

supervisory coordination between futures and cash markets is greatly


facilitated if both are parts of the same exchange.

Arguments for setting-up separate futures exchange:


a. The trading rules and entry requirements for futures trading would
have to be different from those for cash trading.
b. The possibility of collusion among traders for market manipulation
seems to be greater if cash and futures trading are conducted in the
same exchange.
c. A separate exchange will start with a clean slate and would not have
to restrict the entry to the existing members only but the entry will be
thrown open to all potential eligible players.
Recommendation

From the purely regulatory angle, a separate exchange for futures trading
seems to be a neater arrangement. However, considering the constraints in
infrastructure facilities, the existing stock exchanges having cash trading may
also be permitted to trade derivatives provided they meet the minimum
eligibility conditions as indicated below :
1. The trading should take place through an online screen-based trading
system, which also has a disaster recovery site. The per-half-hour capacity
of the computers and the network should be at least 4 to 5 times of
the anticipated peak load in any half hour, or of the actual peak load seen
in any half-hour during the preceding six months. This shall be reviewed
from time to time on the basis of experience.
2. The clearing of the derivatives market should be done by an independent
clearing corporation, which satisfies the conditions listed in a later chapter
of this report.
3. The exchange must have an online surveillance capability which monitors
positions, prices and volumes in realtime so as to deter market
manipulation. Price and position limits should be used for improving market
quality.
4. Information about trades, quantities, and quotes should be disseminated by
the exchange in realtime over at least two information vending networks
which are accessible to investors in the country.

5. The Exchange should have at least 50 members to start derivatives


trading.
6. If derivatives trading is to take place at an existing cash market, it should
be done in a separate segment with a separate membership; i.e., all
members of the existing cash market would not automatically become
members of the derivatives market.
7. The derivatives market should have a separate governing council which
shall not have representation of trading/clearing members of the derivatives
Exchange beyond whatever percentage SEBI may prescribe after reviewing
the working of the present governance system of exchanges.
8. The Chairman of the Governing Council of the Derivative Division/Exchange
shall be a member of the Governing Council. If the Chairman is a
Broker/Dealer, then, he shall not carry on any Broking or Dealing Business
on any Exchange during his tenure as Chairman.
9. The exchange should have arbitration and investor grievances redressal
mechanism operative from all the four areas/regions of the country.

10.

The exchange should have an adequate inspection capability.

11.
No trading/clearing member should be allowed simultaneously to be
on the governing council of both the derivatives market and the cash
market.
12.
If already existing, the Exchange should have a satisfactory record of
monitoring its members, handling investor complaints and preventing
irregularities in trading

Summary and Concluding Remarks


Innovation of derivatives have redefined and revolutionised the landscape of
financial industry across the world and derivatives have earned a well deserved
and extremely significant place among all the financial products. Derivatives are
risk management tool that help in effective management of risk by various
stakeholders. Derivatives provide an opportunity to transfer risk, from the one who
wish to avoid it; to one, who wish to accept it. Indias experience with the launch of
equity derivatives market has been extremely encouraging and successful. The
derivatives turnover on the NSE has surpassed the equity market turnover.
Significantly, its growth in the recent years has surpassed the growth of its
counterpart globally.
The turnover of derivatives on the NSE increased from Rs. 23,654 million (US
$ 207 million) in 2000-01 to Rs. 130,904,779 million (US $ 3,275,076 million) in
2007-08. India is one of the most successful developing countries in terms of a
vibrant market for exchange-traded derivatives. This reiterates the strengths of the
modern development of Indias securities markets, which are based on nationwide
market access, anonymous safe and secure electronic trading, and a
predominantly retail market. There is an increasing sense that the equity
derivatives market is playing a major role in shaping price discovery. Factors like
increased volatility in financial asset prices; growing integration of national
financial markets with international markets; development of more sophisticated
risk management tools; wider choices of risk management strategies to economic
agents and innovations in financial engineering, have been driving the growth of
financial derivatives worldwide and have also fuelled the growth of derivatives
here, in India. There is no better way to highlight the significance and contribution
of derivatives but the comments of the longest serving Governor of Federal
Reserve, Alan Greenspan: Although the benefits and costs of derivatives remain
the subject of spirited debate, the performance of the economy and the financial
system in recent years suggests that those benefits have materially exceeded the
costs."

Bibliography
Official sites of RBI , FMC , NASDAQ
www.cmegroup.com
Sm_ed_begn.pdf

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