Volumes in India’s derivatives trading segment could be adversely affected by the decision of the Singapore Exchange (SGX) to offer single-stock futures (SSF) on Indian stocks. The Dubai Gold and Commodities Exchange (DGCX) is also considering expanding its portfolio of Indian SSF. These new offshore options will highlight the lacunae and frictions in India’s trading environment. Unlike the National Stock Exchange (NSE) and the BSE, the SGX and the DGCX are open 24x7 and these are hard-currency environments. There are no transaction taxes akin to India’s securities transaction tax (STT). The local regulators also place no restrictions on foreign portfolio investors (FPIs), unlike the Securities and Exchange Board of India (Sebi), which has banned derivatives trading via participatory notes (P-Notes).
Given that the SGX and the DGCX offer comfortable regulatory environments, a lot of the derivatives trading volume will likely shift to these offshore centres. India will lose out on tax revenue and brokerage income, while Indian traders will face wider spreads and also the disadvantage of being unable to respond immediately to events that occur when Indian exchanges are shut. Ideally, India should develop offshore exchanges, perhaps in the Gujarat International Finance Tec-City, or in some other state, to offer similar services. However, while this possibility has been on the table for years, there has been no concrete movement towards setting up such an exchange.
The SGX already offers a popular derivatives contract on the NSE’s Nifty50 index futures. It also intends to offer SSF on the 50 companies represented in the Nifty. The DGCX already offers SSF contracts on 10 Indian stocks and futures on dollarised-versions of the BSE Sensex and the MSCI India indices. Both exchanges carry huge volumes of rupee-dollar trades but the proximate trigger for the SGX to expand its India coverage was Sebi’s move to disallow derivatives trading via P-Notes. On July 8, Sebi banned trading in derivatives via P-Notes and demanded direct registration of FPIs carrying out derivatives trades. The regulator said derivatives trading via P-Notes would be allowed only to hedge underlying cash positions. At the time of the ban, P-Note holders had open positions of over Rs 40,000 crore in the futures and options segment of the NSE. Most were closed out. The paperwork for direct registration is complex and Sebi’s definition of hedging is rigid. A further barrier for US-based funds is that they cannot take direct exposure to derivatives offered by Indian exchanges, which are not approved by America’s Commodity Futures Trading Commission (CFTC). Many used P-Notes to bypass that requirement. Both SGX and DGCX are CFTC-approved. Indian exchanges are not, although the NSE is seeking CFTC approvals.
Another source of friction for FPIs is the STT, which is a significant cost for high-volume traders. In 2016-17, STT collections on all equity and derivative transactions amounted to Rs 7,398 crore. Traders complain about this additional burden but the tax is convenient to collect as it is deducted at source. Equity investors are compensated to an extent for the STT because there is zero tax on long-term capital gains for positions held for over a year. But by definition, most derivative contracts are short-term. Offshore exchanges offering similar facilities could bypass the STT and avoid the P-Note issue. But, of course, this will require a review of multiple regulations. Even otherwise, Indian exchanges will have to go 24x7 and Sebi should push the case for CFTC approval in response to the competition.