It would be dangerous to open the derivatives market to small investors in the beginning. In fact, former Governor of the RBI, Shri S. Venkitramanan (March 5^th , 1995) is of the opinion :

In the Committee deliberation Dr.Gupta had mentioned that of all the people who lose money in derivatives trading, 70% are small investors. This is corroborated by what was told to me at the Pacific Stock Exchange, San Francisco in October, 1997. We have already observed, in the last two years, that in the cash market after the introduction of computerised trading system, volumes have increased manifold, but only in handful of scrips, due to speculative intra-day/intra-hour trading transactions instead of delivery based transactions. The report acknowledges this section 2.12 (d) (Page 15). The report, however, is silent on how does one deal with ill-effects of such transactions.

It may be recalled that in 1993-94, when the turnover of BSE was around Rs.300 crores with actual delivery of 20-25%, the then Chairman of SEBI, Shri G.V. Ramakrishna, had called it highly speculative and even banned the Carry-Forward System on that count. Today, the turnover is around Rs.3500-4000 crores in the country, deliveries are less than 10% and in some stock exchanges it is even less than 2%.

What has been implications of such high speculation on small investors? It is a myth that retail investors are not in the market. What has actually happened is that retail investor’s money has been and is being lost in speculation/trading transactions. The losses have been and are being met by selling shares held in their investment portfolio. Unfortunately, this matter has not been addressed by anyone so far. It would be desirable for SEBI and government to conduct a serious study on this matter to ascertain impact of such massive speculation and consequential losses incurred by retail investors.

In the light of massive erosion of equity of retail investors, only after the study has been done and after the matter is thoroughly debated with the various stock exchanges and Investors Associations, a decision should be taken for extending the financial futures market to individuals and small investors. It is expected that whilst trading in Index Futures would be pure and simple wagering, it would give further push to volumes in cash market, making market players (small as well as big) more vulnerable. It would be pertinent to point out that wagering is illegal under the Indian Contracts Act.

I am, certainly, worried that if derivatives are introduced without the Indian institutions fully prepared for it, the derivatives market will be dominated by FIIs. This could turn out to be disastrous. It would not be out-of-place to mention that recently in the Wall Street Journal (December 5, 1997) reported that traders from prominent financial institutions have been suspected of, or found to have been manipulating stock indexes in markets from the United Kingdom to Australia. The traders were from institutions such as J.P.Morgan, Credit Suisse, Swedbank and Nomura International. All these traders from these institutions are being investigated for manipulating stock market indexes.

Furthermore, there is bound to be mispricing of derivatives in the beginning and the FIIs are likely to take advantage of it. Moreover, they also have the deep pockets. In addition, the tendency of FIIs in any emerging market to follow a herd instinct might result in a one-sided offer flow and thus making derivatives pricing inefficient. This will increase the ‘noise’ in the India stock markets rather than helping the process of price discovery. The only solution is that the FIIs should be allowed only when the Indian domestic institutions are fully geared to use the futures market as a hedging tool. Alternatively, we can have a cap on the total exposure limit for each broker irrespective of its net worth as we have in the carry-forward system. This can go on for 1 or 2 years before the limits are completely opened up.

 Further, our markets were opened to FIIs to bring in long term portfolio investments. However, over a period of time they have become traders. It is clear that they are setting the trends in our markets and playing havoc with it. The volatility of our markets have increased tremendously since their participation. With the introduction of derivatives they will become speculators with their horizons shortening even further. These risks have not been mentioned in the report. The report has not formulated the broad guidelines for participation of the FIIs - should they be allowed to hedge only ? Under what conditions should they be allowed to speculate ? Further, what would be the limits on speculation ?

 The report has not brought out the highly leveraged nature of derivatives and the possible risks, which Lord Bagri has indicated. The examples given are based on the assumption that one can enter and exit the futures markets without affecting the cash prices much. The cash markets and the futures markets are tightly linked. The regulators and purists who have an obsession of keeping the cash and futures market must realise that the future and the cash markets are tightly linked by the arbitrageurs. It is only in theory that the process of price discovery takes place in the cash market. In fact, in the modern world, trading or taking positions through the futures market has become so convenient that the futures market discount the new information first and the arbitrageurs ensure that the cash markets reflect this in case of any mismatch. It is impossible to say at any given point of time whether the cash market is affecting the futures price or vice versa. Keeping the flow of information unilaterally from the cash market to the futures market is a dream - one cannot separate the cash and the futures market