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India to unveil new rules for forex futures
May, 23rd 2008
India is expected to unveil rules for exchange-traded futures for currencies and interest rates in coming weeks and bankers say authorities will want tight controls on their use after recent losses on derivatives at local firms.

India already has over-the-counter derivatives, directly negotiated between two parties, and now wants exchange-traded instruments to boost the volume of trade and price discovery for companies looking for a hedging instrument.

It also wants to prevent more business shifting offshore after the Dubai Gold and Commodities Exchange (DGCX) started a rupee futures contract last year.

If there is a deeper market in India, price discovery and output will definitely improve, Harihar Krishnamoorthy, treasury head at Development Credit Bank, said.

India already has interest rate swaps and over-the-counter forwards and options for currency trading but needs more hedging tools as the country integrates more with the global economy and because it has moved to more market-driven interest rates.

The Reserve Bank of India (RBI) expects the broad framework for currency futures trading to be finalised by the end of May and senior dealers say trading could start within the year.

The final framework for rate futures is also expected in the next couple of months.

But after several firms began legal action this year against their banks following derivative losses, market participants expect the central bank to keep the rules tight.

The RBI will put in place the checks and balances so that the facility will be used more for hedging than speculation, U Venkataraman, head of treasury at IDBI Bank, said.

Dealers said a futures platform would reduce default risk and draw more pension funds, insurers and overseas investors to deepen trade.

Volumes will definitely grow, Agam Gupta, head of forex trading at Standard Chartered, said.

The central bank has said rupee futures contracts with a notional value of $1,000 could be introduced, with maturities up to 12 months.

The rupee is still only partially convertible although India is moving towards opening its capital account further. Dealers expect futures will eventually guide the spot market.

Any arbitrage between spot and future markets will improve flows into the forex market, J Moses Harding, executive vice president, IndusInd Bank said.

A central bank panel has recommended regulators scrutinise price and position limits on currency futures, although margins will be worked out by settlement agencies.

Typically, on the current reckoning, the volatility tolerance could be much lower when compared to other exchange traded products such as stocks or commodities, it said.

It also wants exchanges to monitor if currency futures prices move consistently with demand and supply towards their expiry and if traders with large positions have the capacity to affect rates in the OTC market.

India first launched rate futures on exchanges in 2003 but they were based on a model with a zero coupon bond, which does not give a market-driven yield, making pricing the future hard.

In 2004, the stock exchange watchdog proposed futures based on yield-to-maturity. Yield-to-maturity bonds have regular coupons and the principal is repaid at maturity.

Another panel recommended letting banks trade as well as hedge in rate futures to manage balance sheet risk. It also said foreign institutional investors could take long positions, a move bankers say will help liquidity.

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