Institutional framework of derivatives market

1. Exchange

Exchange provides buyers and sellers of futures and option contract necessary infrastructure to trade. In outcry system, exchange has trading pit where members and their representatives assemble during a fixed trading period and execute transactions. In online trading system, exchange provide access to members and make available real time information online and also allow them to execute their orders. For derivative market to be successful exchange plays a very important role, there may be separate exchange for financial instruments and commodities or common exchange for both commodities and financial assets.

2. Clearing House

A clearing house performs clearing of transactions executed in futures and option exchanges. Clearing house may be a separate company or it can be a division of exchange. It guarantees the performance of the contracts and for this purpose clearing house becomes counter party to each contract. Transactions are between members and clearing house. Clearing house ensures solvency of the members by putting various limits on him. Further, clearing house devises a good managing system to ensure performance of contract even in volatile market. This provides confidence of people in futures and option exchange. Therefore, it is an important institution for futures and option market.

3. Custodian / Ware House

Futures and options contracts do not generally result into delivery but there has to be smooth and standard delivery mechanism to ensure proper functioning of market. In stock index futures and options which are cash settled contracts, the issue of delivery may not arise, but it would be there in stock futures or options, commodity futures and options and interest rates futures. In the absence of proper custodian or warehouse mechanism, delivery of financial assets and commodities will be a cumbersome task and futures prices will not reflect the equilibrium price for convergence of cash price and futures price on maturity, custodian and warehouse are very relevant.

4. Bank for fund movements

Futures and options contracts are daily settled for which large fund movement from members to clearing house and back is necessary. This can be smoothly handled if a bank works in association with a clearing house. Bank can make daily accounting entries in the accounts of members and facilitate daily settlement a routine affair. This also reduces a possibility of any fraud or misappropriation of fund by any market intermediary.

5. Regulatory Framework

A regulator creates confidence in the market besides providing Level playing field to all concerned, for foreign exchange and money market, RBI is the regulatory authority so it can take initiative in starting futures and options trade in currency and interest rates. For capital market, SEBI is playing a lead role, along with physical market in stocks, it will also regulate the stock index futures to be started very soon in India. The approach and outlook of regulator directly affects the strength and volume in the market. For commodities, Forward Market Commission is working for settling up national National Commodity Exchange.

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