The Reserve Bank of India (RBI) first announced its intention to allow cross-currency derivatives last September. Not many paid attention, except perhaps the exchanges and some intermediaries. While everyone thought it would take a year or more to operationalise, RBI and the Securities and Exchange Board of India (Sebi) moved with speed and are set to launch cross-currency derivatives trading in three of the most liquid pairs in the world-US dollar versus euro, British pound and Japanese yen. To facilitate trading, the cross-currency derivatives markets will be open from 9 am to 7:30 pm, so as to cover Japanese and European market timings and the first hour of the US markets.
Significantly, a lot of the technology is already in place. With ready infrastructure and a close association between the RBI and Sebi, it is inevitable that more such steps are on the anvil; we have already seen the move to allow foreign direct investment (FDI) in commodity broking.
Is it also an allied effort to finally free-float and internationalise the rupee? Perhaps inspiration has also been taken from China, which has determinedly focused on internationalising the yuan, which has seen its active trading turnover increase four-fold. But this will require a two-way endeavour. Not only will we have to promote cross-currency trading in India to attract global traders, we will also have to head to the world’s largest currency trading playground—London—and work our way into that circuit so that the rupee is actively traded. It also means stocking up our foreign exchange reserves, which we have been doing.
There could be immediate benefits to the domestic trade. Intermediaries stand to benefit from the new product as it will strengthen currency futures and options (F&O) as a revenue line. It also uses the existing dealing set-up and the employees are already familiar with the products. Only brokers’ research teams will have to master the global currency pairs and put out trading recommendations. Not a big task, yet something to work on as trading multiple assets can get complex. Specialist currency research analysts will be required to decipher global and country-specific business cycles and factors.
How other assets like commodities are faring will also affect this as much as exchange rates affect commodity prices. In case of commodities, the impact of release of economic data from several countries can have tremendous impact on a range of currencies. Witness the continuous changes in the strength of the US dollar as ever)7 move by the central banks of the US, the UK, Europe and Japan is analysed. There are many such determinants; as I said earlier, it gets complex. And so there is money to be made.
For clients, it is a new trading opportunity. It also allows full price linkage between asset classes. For example, the price of gold in US dollars primarily depends on the strength of the currency versus the euro. It also reduces one leg of the transaction for traders who, till now, had to synthesise two currency pairs to create the dollar-euro pair. With abundant real-time information available online in these pairs, and market timings designed to capture overseas news flows, this is an ideal product for traders in pursuit of profit.
To ensure that end-users also utilise the markets and it does not become a ‘punters only’ segment, one important bridge still remains to be crossed. Since this market is not deliverable, unlike a position in a bank, the enterprise will have to ultimately convert its forex position back to the bank where there will be a rate differential from the futures or options prices. This will make hedging a challenge. The second test will be liquidity in contracts beyond the immediate months; something that still has to be successfully tackled in our existing commodity and currency markets. We will also have to surmount operational challenges. Currency is traded 24 hours every day, starting Monday morning in Japan to Friday evening in New York. Trading continues on holidays as well. If there is a holiday in, say, the US, trading will still take place in the rest of the world.
Read in conjunction with the recently announced benefits to Gujarat International Finance Tec-City Co. Ltd, also known as GIFT City, Sebi’s growing responsibilities, FDI in commodities broking, and trying to get interest rate futures off the ground (which is a necessity before the rupee becomes fully convertible), the big picture is clear. There are many it’s and buts, yet allowing cross-currency derivatives is a brave move with far-reaching consequences for the vibrant financial services industry in India.
Source The Economic Times
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