ll companies face various market risks: price, interest rate and currency. Ideally, the exhortation is to hedge the risk through various derivatives markets. Price risk hedging is almost axiomatic for companies as it is two sided — buy and sell; and with proxies available on comexes can be seamlessly done by benchmarking at a premium or discount.
Further, as money is always borrowed and interest rates tend to fluctuate, there is the option of hedging through the IRF market where the 10-years GSec offers a proxy. Last, the forex risk follows companies as there are always risks in terms of import, export or external borrowing. The question is how often are these markets accessed?
The derivatives market involving futures became important in the stock market where participants are normally those who trade in stocks while some treasury desks could get involved to book profits or offset their equity exposures. The next step was the commodity derivatives market, resurrected in 2003 and offered various contracts in commodities. Subsequently, IRFs were introduced in various forms with the market now stabilising. Currency futures became important as it was aimed to shift players from the forward market to an online platform.
Typically the volatility in the market should drive the level of activity for both the hedger and speculator. The formerrequires cover and is drawn to the fold, while the latter can profit from such price movements and hence leverage uncertainty. The progress of these markets has been uneven for the first half of FY18 with variable linkages to volatility.
The table shows that while stock futures dominate and are much higher than all the other markets put together, it is driven partly by volatility and also the investor/speculative element which is less emphasised in other markets. The agro market has been volatile with the second highest value. Yet, trading is subdued and is the second lowest. This can be attributed more to the restricted list of commodities available for trading as well as strict regulation on position limits and margins. While this has brought in discipline, the investing community has been deterred with the clause of delivery of open positions adding to apprehension.
The other commodities have fared better with lower volatility as can be seen in the volumes registered in energy and bullion on MCX. Here with fewer controls being in place as price discovery is a global phenomenon, the investor and speculative elements are prominent.
Currency futures on the other side have made rapid progress as this market opened much after the commodity segment but has made smart strides to touch Rs 11.5 lakh crore, which is the second highest segment in this space. Considering that the forwards market is buoyant, the progress here is even more remarkable. Volatility has been low, but given that the rupee has been moving in both directions due to various factors, activity has been robust.
The IRF market continues to underperform. Volatility is low and borrowers would typically be covered by new base rates and MCLR when RBI lowered the repo rate. This makes hedging quite unnecessary and also irrelevant for those affected by rates. In case of speculators, the low volatility does not offer enticing rewards.
The major challenge for these markets is to get in hedgers and speculators in all segments. With bilateral contracts or forward purchases being the order in commodities, moving over to the futures market is going to be difficult. In case of forex, dealing with ADs has become a habit and hence it would take a lot of effort to migrate such players. Companies buying dollars would go through banks as the currency futures market is settled in rupees. The cost becomes an issue given that the interest rate differential can higher than the possible cost of rupee depreciation. This holds for commodities, too.
Until these anomalies are corrected, the derivatives markets would be dominated by stocks and the others would play at best a peripheral role.
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