Indian investors can now trade in foreign index derivatives

India has become an integral part of the global capital markets, forming a key part of the emerging markets portfolio for large investors. Domestic investors have benefited as the incoming tide of foreign capital flows has swelled investor wealth, over a longer period of time. While foreign investors can hedge their bets across the world, it was not as easy for domestic investors to do so. Increasingly, domestic investors will feel the need to hedge against an unfavourable movement in domestic markets. They could invest in overseas stocks directly but investing in foreign indices is a more convenient form of hedging.

The Securities and Exchange Board of India has allowed Indian investors to trade in derivatives based on foreign indices. This will allow investors to conveniently hedge against exposure to the Indian market or speculate on global market movements. Indian investors are allowed to buy and sell stocks in overseas markets, again under rules and limits fixed by Sebi and the Reserve Bank of India.

Sebi has issued a circular giving stock exchanges permission to introduce derivative contracts, on foreign stock indices, from January 11.

  • The market regulator has specified criteria for inclusion. Though not explicit, it appears that all three criteria need to be met to make a foreign index eligible for derivative trading.

A. The underlying index should be available on approved stock exchanges (list given at end of the article)

B. Trading volumes (number of contracts) in derivatives on the index should rank among top 15 index derivatives globally OR the index should have a market capitalisation of $100 billion

C. The index should be broad-based, further defined as: it should have at least 10 constituents and no single constituent should have more than a 25% weight in the index, on a free-float basis.

  • If an index, on which derivatives are introduced, fails to meet any of these criteria for three consecutive months, no new contracts will be issued.
  • The contract will be issued and settled in rupees. Therefore, there will be an element of foreign exchange risk involved in this contract.
  • The trading position limits and disclosure requirements for clients will be similar to those in the domestic market.
  • The stock exchanges will have to ensure that information on the key constituents of an index is made available to local investors. Perhaps, the stock exchange will tie up with the relevant stock exchanges, to stream regulatory announcements here or with a news agency.
  • Only resident Indians (which excludes foreigners and even non-resident Indians) will be allowed to trade in these derivatives.
  • The wording of the Sebi circular appears to indicate that trading in derivatives will be restricted to stock indices. Some of the exchanges listed below are well known for their commodity indices, but these are unlikely to be available through the stock exchanges. That will be the domain of the commodity exchanges.

List of Approved Exchanges:

2. Chicago Board Options Exchange (CBOE)
3. CME Group
4. ICE Futures U.S.
5. International Securities Exchange (ISE)
6. MexDer
7. Montréal Exchange

Asia Pacific
1. Australian Securities Exchange
2. Bursa Malaysia
3. Hong Kong Exchanges
4. Korea Exchange
5. Osaka Securities Exchange
6. Singapore Exchange
8. Tokyo Stock Exchange Group

Europe, Africa, Middle East
1. Borsa Italiana
2. Eurex
3. Johannesburg SE
5. NASDAQ OMX Nordic Exchange
6. NYSE Liffe (European markets)
7. Oslo Børs
8. Tel Aviv SE

(source: Sebi circular)

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