Incredible India Formidable Futures By Michael Gorham There is a campaign to promote tourism years before the creation of the New Orleans in 1952 the new Forward Contracts in India called Incredible India. This nicely Cotton Exchange. Cotton was hot in that Regulation Act prohibited all commodity alliterative slogan appeals to our quest for the period—cotton futures markets were also set options and cash settlement on all commod- different, for the exotic. There is a lot of the up in Egypt (1861), England (1882) and ity forwards. In the midst of the shortages exotic in India, but are Indian futures really France (1882). But India continued to add caused by both drought and the Indo- all that different than those traded in futures, including oilseeds in 1900, gold in Chinese border clash in the 1960s, farmers Chicago or London? Well to a corn-and- 1920 and a host of others in those early years. defaulted on forward contracts, a few com- bean Midwesterner, or even a jaded New Then, less than 70 years after the cotton mitted suicide, and futures trading was Yorker, guar seeds, chana and urad sound exchange started, there was a reversal in banned for virtually all commodities. The pretty exotic and they just happen to be the government policy. During WW II, options premise was that futures lead to speculation, first, second, and fifth most actively traded on cotton and forwards on oilseeds, food high prices, and shortages. physical commodity products in India. Over grains, spices, and sugar were banned. Then the next few pages we will explore the main features of futures markets in India by con- trasting them with their siblings in the Indian Futures Timeline United States. We do this not to make judg- ments about one being better than the other, G 1875 Cotton futures start but rather to help us to know something new G 1900 Oilseed futures start by comparing it to something already known. G 1920 Gold futures start G 1939 Cotton options prohibited G 1943 Oilseed, food grain, spices, sugar forwards prohibited Birth, Death and Rebirth G 1952 Forward Contracts Regulation Act H Prohibits all commodity options As in the U.S., the history of derivatives H Prohibits cash settlement of forward contracts in India goes back to the period after the G 1960s Forwards in primary and essential commodities prohibited American Civil War. A cotton futures G 2000 BSE and NSE list index futures exchange was started in Bombay in 1875, just G 2001 BSE & NSE list index options, stock options and stock futures a decade after the creation of the Chicago G 2002 NMCE opens as a National Commodity Exchange Board of Trade, five years after the creation of G 2003 MCX & NCDEX open as National Commodity Exchanges the New York Cotton Exchange and five 1 Futures Industry Now there still were futures markets dur- has substantially less than a 1% market share market, which has six exchanges listing 33 ing this period in the desert. They were just (if that’s possible). The BSE was hurt even index futures contracts and seven exchanges illegal and underground and small. It is diffi- worse by the 2001 government-mandated offering 100 index options contracts. Despite cult to stay underground and hidden if you switch from one-week settlement sessions to the apparent competition in the U.S., one get too big. The rebirth started slowly. In the the rolling settlement used in the rest of the exchange, the Chicago Mercantile Ex- e 1970s futures were again allowed on seven world and a ban on its beloved badla trading. change, still accounts for 92% of all index non-essential commodities, though trading Second, futures dominate the scene, futures trading. was still sparse. Finally, between 2000 and accounting for 76% of equity derivatives trad- India tried to establish a broader base. 2002 all restrictions on commodity futures ing, while options play a weak second fiddle The BSE, for example, had listed seven trading were lifted and the framework for a with a 34% share (by value as of July 2006). indexes and the NSE another 17. But only set of national-level commodity exchanges Third, despite their poor performance in one index still hangs on at the BSE with a was put in place. most the rest of the world, and especially the shred of activity and this is its banner SEN- U.S., individual stock futures are wildly pop- SEX index. The SENSEX in India has the Equity Derivatives ular and account for almost half (47%) of all same place in the popular imagination as The story of modern derivatives in India equity derivatives trading. The huge success the Dow in the U.S. And the S&P CNX really starts on the financial side of the of stock index futures is due partly to the fact NIFTY appeals to the professional crowd aisle. In the second half of the 1990s, the that they were launched at about the same just as the S&P 500 does back here. But National Stock Exchange of India (aka time that traders were being deprived of the looking at the volumes, it is clear that India NSEIL or more commonly NSE) got the traditional synthetic futures with the elimi- is really a one-index country, with the S&P notion that the country should have finan- nation of one-week settlement periods and CNX NIFTY accounting for over 99% of all cial futures markets. Its much older, but not badla. Index futures is the second most pop- index futures volume. necessarily wiser, cousin, the Bombay Stock ular instrument, with a 39% share. But this Exchange, disagreed and argued that India 39% share is essentially in one product, the Other Financial Contracts already had a home-grown, tested and true S&P CNX NIFTY, while individual stock The United States has the full array of version of stock futures built on a couple of futures is spread over 123 individual issues. financial derivatives contracts—equity, debt, traditional features of Indian equity mar- So from an individual product point of view, and foreign exchange, but like the rest of the kets. The first feature was a week-long set- the NIFTY rules. Rounding out the product world, debt futures account for just over half tlement period which allowed traders to buy mix is index options with 11% and stock of all futures trading (53% of U.S. trading, and sell all they wanted and deliver or options with only 3%. 54% of rest of the world trading in 2005). receive only their net position as of the end India has futures or options on only four Indian financial futures is all equities all of the settlement period. Add to this a indexes listed at two exchanges. This is good the time. The NSE attempted an interest unique Indian practice referred to as badla, when compared to other emerging markets, rate contract in the summer of 2003, but it which allowed traders to roll a net position but substantially narrower than the U.S. traded for only three months—9,768 con- over to the next settlement period and traders could obtain stock market exposure for days, weeks or even months, without Monthly Derivatives Trading at the NSE ever having to make or take delivery, very June 2000 - June 2006 much like a futures contract. The government did what governments are wont to do; they appointed a commit- tee, known as the LC Gupta Committee, to look into the question. Dr. Gupta is a thoughtful, scholarly man who lives in Delhi, but his Committee went on for a long time and the government took even longer and in June 2000, both the BSE and NSE launched stock index futures. Index and stock options were approved a year later in July 2001, followed by stock futures in November 2001. So the whole portfolio of products was rolled out over a 17-month period ending almost five years ago—long enough to see the dust settle. And what do we see? First, there is only one survivor from the equity derivatives wars—the NSE. The BSE never wanted the products, never had its heart in it, and today Source: National Stock Exchange September/October 2006 2 tracts in June, 963 in July and 50 in August, contracts are physically delivered—corn, Naturally this created uncertainty for the then nothing. The problem, in part, appears wheat, soybeans, cattle, coffee, cocoa, etc. buyer since he didn’t know if he was receiving to be due to poor contract design. And the There are a few exceptions like feeder cattle product or not. In addition, some relatively Reserve Bank of India has not yet given the and hogs at the CME and all of the new thin markets seemed to have problems with green light for foreign exchange futures, nor NYMEX swap contracts. But in every case, false reporting of cash market prices in order have capital controls been adequately liber- the contract is designed so that all partici- to benefit futures positions. The result is that alized. So there is still a lot of growth poten- pants remaining at contract expiration do there seems to be a strong trend toward the tial as contracts are eventually added in the the same thing—participate in a physical U.S. style of mandatory physical delivery. Cur- debt and foreign exchange areas. delivery or get settled in cash at a final settle- rently, of NCDEX’s 61 listed products, only ment price determined in the cash market. eight still have matching of interested buyers Physical Commodity In India, contracts were initially designed and sellers, 26 give the sellers the option, and Contract Design so that the exchange attempted to match 27 have mandatory physical delivery.