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Introduction: Evolution in India

A derivative is a financial contract whose value depends on a risk factor(s) of a single or a combination of assets, such as Price of a bond, commodity, currency, share, a yield or interest rate, etc., and allows the organization to break financial risk into smaller components to best meet specific risk objectives.

The global economy, in particular the financial markets across the globe, showed signs of complexity and volatility. The emerging inclination towards risk management in financial markets paved the way for introduction of derivatives. In India, derivates first emerged as hedging devices to hedge market and operations risks. Traded over the counter, these instruments were mainly used by Hedgers to reduce or eliminate the risk associated with Price of an asset or commodity like cotton, along with Speculators to get extra leverage in betting on future movements in the price of an asset and Arbitrageurs who take advantage of a discrepancy between prices in two different markets.

Thereafter, the gradual liberalization of Indian economy in the 1990s, substantial inflow of foreign capital, dismantling of trade barriers, and integration of domestic economy with world economy led to the need for re-introduction of derivatives in the Indian market. The Securities Laws (Amendment) Ordinance, promulgated on January 25, 1995, withdrew the prohibitions by repealing Section 20 of the SCRA.

In Nov. 1996, government led L. C. Gupta Committee helped develop regulatory framework for derivatives trading in India by recommending derivatives to be declared as 'securities'. This helped catalyze entrepreneurial activity and transfer risks from risk-averse people to risk-oriented people. Again the J. R. Verma Committee recommendations to develop settlement and risk management systems for derivatives including upfront margins, daily settlement, online surveillance and position monitoring and risk management marked a new development.

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* Contributed by -
Nidhi Sethi,
Batch of 2006,
IMT Ghaziabad.