Diamond Derivatives: Lessons

from Indian Markets

June 2007
 Background
 Economic reforms since 1991-92
 Foreign Exchange
 Current account convertibility
 Active derivatives market
 Equity Market Reforms
 Electronic trading platform
 Active derivatives market
 Fixed Income Market
 Limited trading
 Commodities Market
 Active derivatives market

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 Structure of Financial Markets

Equity

Debt F/X

Commodities

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 Equity markets
Regulator Securities & Exchange Board of India (SEBI)

Exchanges NSE/ BSE and other exchanges in India

Presence of electronic dealing platforms

Dematerialized trading for cash markets
Limits on Foreign Institutional Investors relaxed
Features over the period of time
 Futures and Options Market introduced during
1999-00 with daily settlement and margin
requirements

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 Equity market – Cash v/s derivative segments
USD billion
2000
1800
1600
1400
1200
1000
800
600
400
200
2 00 3 -04 20 0 4-0 5 2 0 0 5-06 2 00 6 -0 7
Cas h s e g m e n t 39 2 4 07 5 84 70 9
F&O s e g m e n t 50 9 6 32 11 8 1 1805

More than proportionate increase in annual F&O segment turnover vis a vis
1the Cash
USD segment
= INR 40.75turnover

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 Currency markets
Reserve Bank of India (RBI) through FEMA and
Regulator
Exchange Control guidelines

Currency markets controlled by RBI till

introduction of the Liberalized Exchange Rate
Management System in 1992
Features Introduction of plain vanilla currency options
by RBI in 2000-01
Structured swaps and exotic options
Active Spot/Forward markets in USD/INR

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 Currency market turnover
USD billion
Merchant Spot/ Fwd/ Inter-bank Spot/ Fwd/
Year Swaps Swaps Total
Purchase Sale Purchase Sale

2002-03 165.55 163.67 624.24 631.40 1,584.86

2003-04 259.02 235.75 819.94 825.09 2,139.80

2004-05 354.53 349.99 1,095.82 1,091.75 2,892.09

2005-06 603.68 617.38 1,554.58 1,639.65 4,415.29

Source: Reserve Bank of India

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 Debt markets
Reserve Bank of India (RBI) / FIMMDA
Regulator
guidelines

Sovereign debt volume dependent on borrowing

program of the Government of India (GOI)
Active OTC - INR swap markets
Features Less active non government bonds
Interest rate futures less active

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 GOI securities - volumes
Year No. of trades Trade volumes (USD
billion)
2002-03 191,968 264.24

2003-04 243,623 386.68

2004-05 160,522 278.10

2005-06 125,683 212.43

2006-07 137,123 250.87

Source: CCIL

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 Commodity markets
Regulator Forward Market Commission

Exchanges MCX, NMCE & NCDEX

 Fragmented commodity trading since 1875

 New exchanges since 2004: Currently 3 active
exchanges
Features Over 60 commodities listed, however liquidity in
less than 10 commodities
 Turnover doubles in 2007 to USD 1000 bn

compared to 2006

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 Commodity Futures – Daily Volumes
Commodity Trade Volumes Trade volumes (USD
(Rupees million) million)
Gold 27000~30000 600~720

Silver 22000~25000 520~580

Copper 20000~24000 480~560

Crude oil 12000~16000 300~370

Zinc 4000~6000 100~140

Source: MCX, June 2006

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 Key observations

 Equity and commodity derivatives markets

 Very high volumes and high growth p.a
 Active retail and institutional participation
 Hedgers and traders provide liquidity
 Number of participants very high

 Fixed Income and Foreign Exchange markets

 Largely institutional players
 Reach restricted
 Regulatory influence

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 Key Learning

 High price volatility & liquidity

 In commodities with international linkages and
multiple listings
 Derivative market trading volumes are 15 times the value
of cash markets (Eg: Gold)
 Diamond futures volumes to be around USD
150~200bn annually by this estimate
 Traders & Speculators in Stock & Commodity markets
similar in profile to Indian diamond community

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 Diamond Derivatives: Building Blocks
 Bench mark reference
 Need for active cash market
 Standardised “commodity”
 Market makers
 Low bid offer – high liquidity
 High volumes
 Price discovery
 Hedgers
 Traders
 Speculators
 Investors

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 Diamond Derivatives: Building Blocks

 Transparency & Price discovery

 Pros and cons for Industry
 Governance
 Arms length and insider information
 Exchange trading of commodities
 Elimination of credit risk to participants
 Market information for price volatility
 Dissemination of information to market players

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 Diamond Industry in India

 High importance to Indian Economy

 Contributes over 15% exports (USD 12 billion) & 6%
imports (USD 9 billion)
 India accounts for over 90% volumes & 55% value in
cutting & polishing of diamonds
 Increasing trend in retail appetite for diamond jewellery
 High GDP growth
 Higher net disposable income
 Continued Government support to promote this sector

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 Diamond Derivatives: Discussion
Should Diamonds be listed in India?
 Pros
 Natural linkages with the industry
 Market players to provide liquidity
 Commodity Exchanges and Electronic trading
platforms available
 Provides arbitrage opportunities if listed else where
internationally
 Cons
 Entry restrictions for foreign players
 Initial regulatory interference

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