The Budget has mooted the idea of allowing over the counter derivatives. Relevant amendments to the Securities Contract Regulation Act would be made to facilitate this.
In India OTC derivatives are not permitted under the SCRA though OTC transactions are permitted on a spot basis. Overseas, OTC derivatives are permitted but there are a whole lot of checks and balances to deal with it, since unlike the exchange traded contracts these do not have the advantage of transparency.
The finance minister also said in his speech that at present there were certain legal issues related to the validity of OTC derivatives.
"We are planning to initiate measures to clear the legal validity for such transactions," he said.
At present, in the debt market, the Overnight Interest Swap market essentially works as an over-the-counter market, but these mostly have to do with fixed deposits and the call money market that cannot be strictly be defined as securities under the SCRA.
Informed market sources said the government might be prompted by giving some benefits to government owned institutions such as banks. "Such OTC derivatives may come of use to banks who lend against shares," said an economist.
When banks lend against shares they have certain margin requirements. They can hedge their exposures outside the market.
Such hedging techniques might require OTC derivatives since if the exposure is huge it might not be accommodated in the market or might cause a temporary instability in the market.
"In such cases it is best if such transactions are done off-market or over the counter between two parties.
However market sources cautioned that unlike spot deals, which are done over-the-counter, such transactions in derivatives -- which are linked to an underlying which is traded on an exchange -- might pose huge risks for the equity markets.
The US Securities Exchange Commission, for instance has commented, "OTC derivatives transactions play a valuable role in the marketplace by, among other things, helping users to manage risk, but OTC derivatives also involve risks for market intermediaries, end-users, and the marketplace."
