The Committee has deliberated over many pre-requisites which are required before derivatives can be successfully introduced in India. But, the report is silent over these issues. The following are some of the pre-requisites before the introduction of derivatives in India.

  1. Short sale and Borrow/Loan System :
 There is enough evidence that the facility to sell short increases price efficiency of cash equity markets, this is essential for a derivatives market. Short sale is necessary to ensure that derivatives are properly priced. Without short sale, the link that arbitrageurs provide in ensuring the correct pricing of derivatives would be lost.

 Further, without the participation of the institutional players, the markets would be swallow. It is of paramount importance that legal changes should be brought about so that institutional players are able to sell short.

 Associated with the above is the necessity for proper functioning for proper functioning of stock borrow/loan function. This will ensure that traders who want to go short would have the option of borrowing the securities. Further one should be able to go short in all the scrips listed.

 2.  Depository
 The levels of dematerialisation have to be of a much higher magnitude to ensure that the cost of arbitrage between the index and the underlying cash scrips can be done at a low cost and efficiently.

 3. Funding Requirement

 The report is silent over the financing needs of arbitrageurs and market makers. If the arbitrage function is not performed well there will be mispricing and the entire purpose would be lost.

 4. Creation of an Electronic Fund Transfer facility

 Funds should be able to move from one place to another within 24 hours. A delay would mean that the margin collection would be tardy or the rates of delay would mean that the margin would have to be increased to account for the delay. This would increase transaction costs and make derivatives that much less attractive. According to the Price Waterhouse report, ‘85% of the markets offering options on individual stocks make use of some form of liquidity provider’.

 5. Buoyant debt market

 A liquid debt market is of paramount importance for arbitrageurs to park their funds for short-term which can be used for arbitrage when an opportunity arises. This is even more important in a scenario where the banking sector chokes the supply of funds for these purposes. The banking system has to respond to the changes in the capital markets and provide funds for such legitimate business.