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Sebi grappling with carry-forward issue

India's stock market regulator faces a dilemma -- should it ban a unique carry-forward facility that has served one of Asia's oldest bourses for over a century?

The Securities and Exchange Board of India, under pressure to cleanse the system of unbridled speculation after recent scandals, is expected to a make a decision on May 14.

Carry-forward allows an investor to take on bigger positions than they could otherwise afford. The positions are squared-off later without any requirement to accept delivery of shares.

The facility is a popular among local investors and accounts for nearly 90 percent of trades at India's 23 exchanges.

But it has also been faulted for encouraging excessive speculation that has sporadically caused trouble when investors fail to complete settlements.

Earlier this year, the system was plunged into crisis when 10 brokers at the Calcutta Stock Exchange failed to honour their commitments, leaving the exchange to dip into reserve funds to make up for the shortfall.

That crisis and a blizzard of stock market scandals in March involving share price manipulation sliced the market capitalisation of the Bombay Stock Exchange -- India's biggest bourse and one of Asia's oldest -- by about $47 billion.

At least five suicides, including brokers, were linked to the stocks crash. The tumble also caused an uproar in Parliament with calls for tougher regulations.

A Sebi meeting last Saturday deferred a decision on the future of the facility because some directors were not present.

Stumbling block

The biggest stumbling block against scrapping carry-forward is the potential impact on volumes.

"If they do decide on the ban, it will be significantly negative for volumes," said Bobby Surendranath, a portfolio manager with Zurich India Asset Management.

Volumes have already taken a hit after the regulator imposed curbs on short sales in March to cushion a stocks slide.

Average volumes at the BSE have shrunk to around 70 million shares a day from nearly 200 million before curbs were imposed.

A ban on carry-forward trading will squeeze the volumes drastically in the near-term, especially because there is no alternative hedging facility, traders say.

The market watchdog is keen to launch globally accepted hedging instruments such as options and futures in stocks.

"The new trading system reflects global standards and will therefore mitigate concerns of institutional investors, especially foreign investors, about risks in the existing system," Morgan Stanley said in a recent report.

Fund managers agree the price discovery process would become more transparent but the shift will take time.

"The infrastructure needs to be first put in place, writers have to be licenced, net worth criteria have to be established, depositories will have to be appointed," said Surendranath.

"At the outset the two systems should be allowed to co-exist," he said.

Another fund manager disagreed.

"So long as an old alternative is available, investors will avoid moving to the new system," said Suhas Naik, fund manager at IL&FS Mutual Fund, which manages Rs 3 billion.

Analysts said index futures, introduced a year ago, has not taken off because the carry-forward facility offered greater leverage to investors.

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