This section, constituting the core of the report, reviews each element of the RCFS and recommends modifications thereto. For convenience, the items are discussed in the order in which they appear in paragraph 149 of the GSPC report. The carry forward system as it emerges from these modifications is referred to in this report as the Modified Carry Forward System (MCFS) wherever it is important to distinguish it sharply from the RCFS.

1. Shares eligible for carry forward (specified shares)

   
   The Group is of the view that though the actual choice of scrips for carry forward is a decision to be left to the exchange, it is essential for market integrity that the scrips have a sufficient floating stock and high liquidity. Essentially, the RCFS is a futures contract on individual stocks; since it is neither cash settled nor affords multiple delivery options as in many other future contracts, the RCFS would be prone to market manipulation unless the stocks are liquid, large cap stocks. The Group therefore endorses the GSPC recommendation that the stocks included in the RCFS must be those that do not lend themselves to price manipulation or cornering of shares.
   
   

2. Common list of specified shares

   
   The GSPC recommendation that the specified shares in various exchanges should be chosen from a common pool of eligible stocks has not been of much relevance so far as only the BSE has adopted the RCFS, but this situation may not continue under the MCFS. The Group does not wish to impose excessive uniformity on the various stock exchanges, nor does it favour the involvement of SEBI in the choice of specified shares. It does however concur with the GSPC that the stocks eligible for RCFS in any stock exchange should be drawn from a list of stocks which satisfy the basic criteria discussed in item 1 above.
   
   

3. Stock exchanges eligible for RCFS

   
   The GSPC drew a distinction between the major stock exchanges like those at Bombay, Calcutta, Delhi, Ahmedabad and Madras on the one hand and any other exchange which might wish to start carry forward trading. The Group is of the view that it is not proper to discriminate between different exchanges on the lines recommended by the GSPC. The Group prefers a uniform set of pre-conditions for any stock exchange which wants to adopt the MCFS. Apart from screen based trading which is now becoming standard in all exchanges, the Group places great emphasis on the efficacy of the margining systems.
   
   Any exchange which intends to adopt the MCFS must demonstrate that it has a well designed software for margin computation and well established governance structures and administrative infrastructure for monitoring and enforcing the margining system. To this end, the Group recommends that prior to granting permission to an exchange to adopt the MCFS, SEBI should carry out an inspection of the exchange to satisfy itself about the adequacy of its margining system. A further inspection of the exchange should be carried out six months after adoption of MCFS to verify that the margining system works properly under actual trading conditions.
   
   

4. Ninety day limit for carry forward

   
   The GSPC asserted that there was no sanctity for the ninety day limit on the length of time for which a transaction can be carried forward. While introducing the RCFS in July 1995, SEBI enforced the ninety day limit, but in October, it relaxed the requirement of an audit certificate and replaced it with self certification by the broker.

   The Group is of the view that, with self certification, the 90 day requirement does not pose serious administrative problems. But, the Group agreed with the GSPC that the 90 day limit had no sanctity at all. It is also easily evaded in practice by shifting positions across exchanges or members. The Group is of the view that with strict mark to market, the time for which a position has been carried forward is totally irrelevant. The whole idea of mark to market is that the position starts from a clean slate just as if it were a new transaction. For this reason, the Group is of the view that the 90 day requirement should be scrapped entirely.
   
   

5. Screen based trading

   
   The Group agrees that screen based trading is desirable, and notes with satisfaction that quite apart from the adoption of the RCFS, screen based trading is now becoming standard in all exchanges.
   
   

6. Four track/ Twin Track/ Single Track Trading

   
   The GSPC recommended a four track trading system which was subsequently implemented as a twin track trading system in which transactions for delivery were separated from those for carried forward. The Group deliberated on this issue at length. The majority view is that twin track system should be discarded. In the past when margining systems were extremely weak, there might have been some merit in the idea of segregating carry forward transactions (which were perceived as speculative in nature) and imposing stringent margins at least on these transactions. Today however, systems have evolved to the point where daily mark to market margins are being collected regularly in the major exchanges on all transactions.
   
   In this situation, there is no justification whatsoever for segregating carry forward transactions. When daily mark to market margins are levied properly, the risk to the trading system from all transactions is the same, namely that of adverse price movements during one day. As such the majority view of the Group is that having regard to their identical risk characteristic, the carry forward transactions and the delivery transactions should be treated alike for margining purposes. Once margins are unified, twin track trading ceases to be an operational idea; with no preferential margins for delivery transactions, brokers would prefer to classify all transactions as carry forward transactions.
   
   The majority view is also that from a pricing point of view, there is no distinction between the two types of transactions. Carry forward is conceptually identical to a closing out of the current week transaction and simultaneous initiation of the next week transaction. Thus carry forward transactions are also closed out on the same settlement date as delivery transactions. Since all transactions for the settlement date are priced identically, there is no pricing difference between the two types of transactions. If the settlement is by carry over instead of delivery, the spot- futures basis is reflected in the form of a contango or backwardation charge at the time of carry over, but there is no pricing difference at the time of initiation of the transaction. Thus single track trading would not vitiate price discovery in any way.
   
   Dr. R. H. Patil is however of the view that separation of the cash market and the carry forward market is necessary in the interests of greater transparency and also to facilitate price discovery.
   
   

7. Squaring of carry forward transactions
   

   The GSPC recommended that under the twin track system, delivery transactions should not be allowed to be squared, while carry forward transactions can be squared at any time. While introducing the RCFS in July 1995, SEBI stipulated that carry forward transactions could not be squared off after 75 days; this was done to facilitate enforcement of the 90 day limit (see item 4 above). With the abolition of twin track trading and the scrapping of the 90 day limit in the MCFS, all these provisions become redundant and the Group is of the view that they should be scrapped.
   
   

8. Common trading

   
   The Group endorses the recommendation of the GSPC that there should be common trading for delivery and carry forward.
   
   

9. Vyaj badla

   
   The Group discussed the implications of the current system under which shares given as collateral to the vyaj badla financier are deposited with the clearing house and are not allowed to be withdrawn by the financier. The Group considered proposals that the financier be allowed to withdraw the shares as well as proposals that the shares should be deposited with a depository instead of a clearing house. The discussion focused on the risks, costs, and administrative problems entailed by different approaches to vyaj badla transactions.
   
   At the outset, the Group agreed that when a substantial degree of dematerialization of shares has taken place, vyaj badla becomes a very simple matter of recording a pledge of the shares in the electronic records of the depository. The real problems arise only in the system of paper based settlement.
   
   In the paper based system, the Group recommends that shares received by vyaj badla financiers should continue to be deposited with the clearing house as at present. In addition to other risk containment measures, the clearing house should at all points of time have an insurance policy covering the aggregate value of shares lying in the clearing house.
   
   

10. Proper records of sources of vyaj badla finance

    
    The majority view is that the vyaj badla financier is a client of the broker like any other buyer or seller and that the broker should (as at present) be required to maintain the same records in respect of the financiers as he is required to maintain of other clients (for example, under the Know Your Client scheme). Dr. R. H. Patil is of the view that vyaj badla financiers must become members of the clearing house just as custodians do currently.
    
    This would prevent any money obtained from illegal sources from flowing into the market as vyaj badla finance. The majority view is that few vyaj badla financiers would satisfy the stringent net worth and other entry norms that clearing houses rightly impose while admitting non members of the exchange as participants in the clearing house. The integrity of the clearing house must be jealously safeguarded.
    
    

11. Contango charges

    
    The Group endorses the recommendation of the GSPC that payment of contango charges to short sellers should be permitted as it is an essential ingredient of the carry forward system.
    
    

12. Settlement and clearing process and reporting

    
    The majority view to abolish twin track trading would simplify the daily reporting in as much as delivery and carry forward transactions would no longer be distinguished. (See item 6 above).
    
    

13. Duration of carry forward session

    
    The Group is of the view that with electronic trading the recommendation of the GSPC to extend the carry forward session from half an hour to one hour is no longer relevant.
    
    

14. Daily margin

    
    In the context of daily mark to market margins and the reduction of the settlement period the Group considered the possibility of reducing the margin. The Group noted that halving of the settlement period from two weeks to one week would not halve the margin requirement because the scaling of volatility is in proportion to the square root of the time scale.
    
    Similarly, if daily mark to market reduces the time scale from ten trading days to one, the reduction in price fluctuations is not by a factor of ten but only by a factor of approximately three (the square root of ten). It must also be considered whether the 15% margin proposed by the GSPC for a two week settlement period was too low to begin with. Taking all factors into account, a reduction of the margin to 10% could be considered.
    
    Under item 6 above, the Group has explained its recommendation for the abolition of twin track trading and the unification of margins on carry forward trades and delivery trades. Unification of margins would imply that margins on delivery trades would also be subject to a minimum of 10%. This could imply an increase in the margins from the current level in some cases. As we have emphasised, with daily mark to market, the key issue is the maximum price change within a single day; and it does not matter whether the transaction is for delivery or carry forward. The only exception to the uniform margining system would be for sale transactions where the seller deposits the shares for delivery.
    
    The 10% margin is a minimum margin and exchanges would be free to levy higher margins. Moreover, during periods of excessive volatility as in mid January 1997 or end March 1997, there may be a need to step up the margins temporarily. The Group reiterates that margins must be levied on gross positions as is mandated at present.
    
    The Group would also emphasise the value dating of margin payments by the brokers. Where a broker deposits margins by cheque these must be value dated the same day. Otherwise, the exchange would be effectively exposed to the broker for more than a single day's price fluctuation. Same day value dating could be accomplished by accepting cheques only on the clearing house's own bank branch or by more rapid "high value clearing", "window clearing" or other similar processes. Over a period of time, exchanges must move towards realization of all margin payments before the next day's trading begins. In the long run, real time funds transfer would be imperative.
    
    Dr. R. H. Patil is of the view that margins must be collected up- front (on both delivery and carry forward transactions) to reduce risks even further. The majority view is that this would not be practical in the absence of electronic funds transfer facilities.
    
    

15. Carry over margin and impounding of profits

    
    The Group is of the view that daily mark to market has rendered the distinction between daily margin and carry over margin redundant, and there is only one comprehensive margining system. The Group is also of the view that the GSPC's proposal to impound 25% of the profits (which has never been implemented) does not serve any useful purpose.
    
    

16. Ad hoc margin

    
    The Group endorses the recommendation of the GSPC to allow exchanges to levy ad hoc margins on members who have unduly large positions or are considered financially weak.
    
    

17. Computerized margin calculations and strict enforcement

    
    The Group endorses the recommendations of the GSPC on margin enforcement. In fact, the Group has gone further in making it a precondition for the adoption of the MCFS (see item 3 above).
    
    

18. Mark to market

    
    The GSPC recommended weekly mark to market (in the context of a two week settlement cycle). The Group is of the view that that this is totally inadequate and that daily mark to market is imperative.
    
    

19. Limits and sub limits

    
    The GSPC recommended various limits on the carry forward position with scripwise sub limits. The Group is of the view that these limits and sub limits should be scrapped. Exposures should be linked to capital and there should be no rupee value limits. The Group is of the view that the GSPC's recommendation regarding limits on aggregate (market wide) outstanding position is redundant in view of item 1, item 16 and item 27.
    
    

20. Vyaj badla limit

    
    The Group is of the view that with mark to market of vyaj badla financiers (see item 9 above), the limit of Rs 10 crore on vyaj badla recommended by the GSPC should be scrapped.
    
    

21. Institutional badla finance

    
    While agreeing with the GSPC's recommendation to encourage institutional vyaj badla financing, the Group is of the view that the initiative for this lies elsewhere.
    
    

22. Overall limit on speculative position

    
    The Group is of the view that these limits recommended by the GSPC (which were incidentally never brought into force) are unnecessary for the same reason as in item 19 and

23. Capital adequacy

    The Group considered and rejected proposals to mandate higher net worth or capital adequacy norms for brokers engaged in carry forward transactions. The Group however reiterates the importance of maintaining capital adequacy ratios at such levels as SEBI may mandate from time to time, and of conforming to various prudential guidelines of SEBI like segregation of broker and client accounts both for money and for shares.
    
    

24. Interim base capital requirement

    
    The GSPC recommended increases in base capital pending introduction of capital adequacy norms. With the introduction of capital adequacy norms, this recommendation is now irrelevant.
    
    

25. Uniform settlement period

    
    The Group is of the view that the GSPC's suggestion on a uniform settlement period is not connected with the RCFS at all. It may or may not be desirable by itself, but the RCFS does not make it any more or any less desirable.
    
    

26. Making up price

    
    The GSPC recommended that in case of a suspicion that the closing price in any settlement period has been rigged or manipulated, the making up price should be based on an average of the last three days' closing prices. The Group is of the view that price rigging is a very serious matter and that an adjustment in the making up price is a very feeble response to this menace.
    
    The Group notes with satisfaction that in recent months, SEBI has taken firm measures to check price rigging and to compel price manipulators to disgorge their profits. The Group is of the view that while the campaign against price rigging must be carried out relentlessly, the sanctity of market prices must not be vitiated by discretionary adjustments to the making up prices.
    
    

27. Suspension of carry forward facility

    
    The Group endorses the recommendation of the GSPC to allow exchanges to suspend carry forward trading in any scrip when aggregate outstanding position in any security exceeds pre- announced limits.
    
    

28. Other regulatory powers of stock exchange

    
    The Group endorses the recommendation of the GSPC that exchanges should be allowed to use the entire armoury of regulatory powers vested in them to regulate the market. The Group does not however go into the merits or otherwise of the specific powers mentioned by the GSPC.
    
    

29. Governance and Administration

    
    In items 29- 38 of para 149, the GSPC made sweeping recommendations on many matters concerned with the governance and administration of the stock exchanges whether or not the RCFS is in operation in the exchange. Some of these may be quite desirable, but they are desirable whether or not RCFS is permitted in any form. The Group refrains from commenting upon them. The Group however reiterates its view (see item 3 above) that an essential precondition for the introduction of the MCFS in any exchange is a well established governance structure and administrative infrastructure for monitoring and enforcing the margining system.