1. exchanges. Though over 80 commodities are allowed

1.     
 

2.     
Increased
Off-Balance Sheet Exposure of Indian Banks:  The growth of derivatives as off-balance sheet
(OBS) items of Indian Banks has been an area of concern for the RBI. The OBS
exposure/risk has increased significantly in recent years. The notional
principal amount of OBS exposure increased from Rs.8,42,000 crore at the end of
March 2002 (approximately $181 billion at the exchange rate of Rs.46.6 to a US
$) to Rs.149,69,000 crore (approximately $321 billion) at the end of March
2008. (RBI, 2009) The Regulator: As the market activity pick-up and the volumes
rise, the market will definitely need a strong and independent regulator;
similar to the Securities and Exchange Board of India (SEBI) that regulates the
securities markets. Unlike SEBI which is an independent body, the Forwards
Markets Commission (FMC) is under the Department of Consumer Affairs (Ministry
of Consumer Affairs, Food and Public Distribution) and depends on it for funds.
It is imperative that the Government should grant more powers to the FMC to
ensure an orderly development of the commodity markets. The SEBI and FMC also
need to work closely with each other due to the inter-relationship between the
two markets.

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3.     
Competition
of OTC derivatives with the Exchange-traded Derivatives: A general view
emerging after the recent financial crisis is that OTC derivatives trading
should be moved to an exchange platform. The proponents of this view hope that
this would increase liquidity and reduce significantly the opacity of the
market. They argue that exchanges provide transparent and reliable price
formation mechanisms, neutrality, robust and appropriate technology, better
regulation and, above all, centralized clearing and settlement system. These
arguments are based on the assumption that the existing method of trading in
OTC products is all based on telephone trading and there is no clearing system
in place.

 

4.     
Lack
of Economies of Scale: There are too many (3 national level and 21
regional) commodity exchanges. Though over 80 commodities are allowed for
derivatives trading, in practice derivatives are popular for only a few
commodities. Again, most of the trade takes place only on a few exchanges. All
this splits volumes and makes some exchanges unviable. This problem can
possibly be addressed by consolidating some exchanges. Also, the question of
convergence of securities and commodities derivatives markets has been debated
for a long time now. The Government of India has announced its intention to
integrate the two markets. It is felt that convergence of these derivative
markets would bring in economies of scale and scope without having to duplicate
the efforts, thereby giving a boost to the growth of commodity derivatives
market. It would also help in resolving some of the issues concerning regulation
of the derivative markets. However, this would necessitate complete
coordination among various regulating authorities such as Reserve Bank of
India, Forward Markets commission, the Securities and Exchange Board of India,
and the Department of Company affairs etc.

5.     
Strengthening
the Centralized Clearing Parties: CCIL, which started functioning in 2002,
is the only centralized clearing party for trade processing and settlement
services in India. It currently provides a guaranteed settlement facility for government
securities trading, clearing of collateralized borrowing and lending
obligations (CBLO), guaranteed settlement of foreign exchange trading, and
settlement of all Indian Revenue Service (IRS). Though the concentration of
business relating to money, securities and forex markets with the CCIL helps in
pooling risks and reducing the overall transactions costs for the system, the
Certified Financial Services Auditor’s (CFSA) report opined that the
concentration of such a wide spectrum of activities leads to concentration of
risks in one entity. Therefore, there is the need to strengthen more and more
clearing parties.

6.     
Tax
and Legal bottlenecks: In India, at present there are tax restrictions on
the movement of certain goods from one state to another. These need to be
removed so that a truly national market could develop for commodities and
derivatives. Also, regulatory changes are required to bring about uniformity in
octroi and sales taxes etc. VAT has been introduced in the country in 2005, but
has not yet been uniformly implemented by all states.

 

7.     
New
Derivatives Products for Credit Risk Transfer (CRT): Credit risk transfer
(CRT), in a broad sense (including guarantees, loan syndication, and
securitization), has a long history. However, there has been a sustained and
rapid growth of new and innovative forms of CRT associated with credit
derivatives. The most common credit derivatives are credit default swaps (CDS)
on single corporate entity (single-name CDS) and collateralized debt
obligations (CDOs). Since 2005, CRT activity became significant for two
additional underlying asset classes – asset backed securities (ABS) and
leveraged loans. Internationally, banks and financial institutions are able to
protect themselves from credit default risk through the mechanism of credit
derivatives. However, credit derivatives were not allowed in India until
recently. The RBI has made an announcement in its second-quarter monetary
policy 2009-10 that it has considered it appropriate to proceed with caution on
this issue. To start with Ist December 2011, RBI has introduced guidelines for
a basic, over-the-counter, single name CDS for corporate bonds for resident
entities, subject to safeguards.