ISDA PRESS REPORT - MAY 18, 2001

* Proposed Rule Would Ease Transition Of SEC-Registered Firms to CFTC
Oversight - BNA
* Brokers will respond once they smell money - Business Standard
* Tax dues mar brokers foray into derivatives - Business Standard
* New attack on proposal to allow advertising by hedge funds -
Financial Times

Proposed Rule Would Ease Transition Of SEC-Registered Firms to CFTC
Oversight
BNA - May 18, 2001

The Commodity Futures Trading Commission (CFTC) proposed new rules May 14
that would relax the registration requirements of Securities and Exchange
Commission-registered broker-dealers wishing to cross over and trade
security futures products.

In a May 17 Federal Register notice, the futures regulatory agency said it
wants to amend its rules so that such broker dealers can seek CFTC
registration by notice filing (66 Fed. Reg. 27,476, 5/17/01). Currently, all
potential futures commission merchants (FCMs) and introducing brokers, as
traders of commodities and futures are categorized, must file at least two
registration forms with the CFTC.

CEA Revised

When Congress revised the Commodity Exchange Act (CEA) in December, it
allowed single stock futures and futures on certain narrow-based stock
indices for the first time in nearly 20 years. Such instruments--"security
futures"--are expected to be offered by firms that do not typically conduct
transactions in futures products, creating a regulatory dilemma.

The proposed new rule would allow any broker-dealer that limits its futures
activity to security futures products and that is in good standing with the
SEC to become registered with the CFTC "with the submission of notice." In
this case, notice would likely be filed with the National Futures
Association, the CFTC said.

The commission also proposed a rule that would allow such registrants to
avoid the requirement that all FCMs be members of a registered futures
association.

Though it is operating under a voluntary moratorium on new rules requested
by the White House, the CFTC has received permission from the Office of
Management and Budget to propose rules that arose out of Congress's sweeping
reform package, known as the Commodity Futures Modernization Act, which
passed in December. The moratorium, which was extended to all government
entities under interim leadership back in January, is expected to be in
place until someone is named to chair the commission permanently.


Brokers will respond once they smell money
Business Standard - May 18, 2001
By Janaki Krishnan and Tamal Bandopadhyay

Once a staunch supporter of badla, Securities and Exchange Board of India
(Sebi) board member J R Varma has in the recent past been a strong proponent
of replacing the product with derivatives . Two days after the capital
market watchdog rang the death knell for badla and ushered in derivatives
trading in a big way, a relaxed Varma justified his stand to Janaki Krishnan
and Tamal Bandopadhyay. "Carry-forward has lost its historic relevance. If
instead of a complex product that does many things hedging, speculation,
finance, we have products that do different things, but do them better, I
think it is preferable to make the transition." Extracts:

Q. Will the migration from carry forward to the derivatives market be easy?
Will it be painless?

A: No. I would be untruthful to myself if I say that that the transition
will be painless. There will surely be pain as a system migrates from the
familiarity of badla to the complexities of derivatives trading. But at the
end of the day, you have to see whether it is a pain worth taking. To my
mind, this is certainly the case. The Indian equities market has to move up
to better products even if it means some short-term adjustment pains.

Q: Do you think volumes will dry up?

A: Certainly not. It will be fairly liquid and vibrant. There may be a drop
in volumes at the initial stage, but in six to eight months, I expect the
markets to revive to their normal levels of activity.

Q. The Sebi had introduced index futures in June last year. What has been
the experience so far?

A: Ever since index futures were introduced in June last year, there has
been a slow but steady growth. The trading volumes are growing every month.
Last July was better than June and so it continued. In February 2001, the
average daily trading was worth around Rs 50 crore. So it is very clear that
the product (index futures) fills in some perceived need in the market for
such a product. Otherwise, such products die a very quick death. The
increasing volumes also tell us that it is attracting new adherents by the
day, which means those who started early have stayed on and their
experiences are helping new players to come into the market. In that sense,
I am satisfied. But mind you, this is growth on a low base. We still have a
long way to go. It has been the global experience that the derivatives
markets take off slowly. Typically, you have to give it one-and-a-half to
two years to reach critical mass. If the Indian markets do not show signs of
growth in the next six to seven months, after taking into account the one
year in which index futures has been around, then we have a problem.... In
our case the experience is not terribly bad but certainly not as good as one
would have expected.

Q. What is the level of preparedness of the market participants?

A: The stock exchanges are by and large prepared. They have already been
trading in index futures, and hopefully, their software and systems are in
place. Coming to brokers, I think they have to make an effort to set their
back offices and trading strategies in order. But I am very optimistic that
the brokers will respond to the new regime enthusiastically, once they smell
money in terms of trading opportunities. Well, it is a challenge since the
margining system is much more complex, and the methodology of computing
margins is not a straight calculation. In fact, the challenge is in getting
the margins right.

Q: Do you think the ordinary investor will embrace the new system or will he
be marginalised?

A: I pin my highest hopes on the Indian investor who has shown a great
capacity to learn. Everyone is on the learning curve, but once the average
investor realises the benefits of the new system, he is sure to take the
plunge.

Q: The big question remains: earlier you were a badla supporter, why have
you changed your stance?

A: (Laughs) Well yes, I was a strong badla supporter when badla was banned
in 1992. In fact, I was among the few who protested the badla ban then. My
point was simple: how can you take away whatever rudimentary instruments
investors have to hedge themselves against risk? And, if you have a
theoretical problem with badla, you must have a better system to replace it
with. In 1992-93, we didn't have an alternative.

I had written a paper (in 1993-93) where I argued that badla was meeting a
whole lot of requirements in the system. For instance, if you remember that
was the time when all shares were in paper form. So if a guy had sent shares
for transfer which often took two months or more then he couldn't sell in
the interim period. Badla gave him the opportunity to exit by selling first
and postponing delivery till such time as he got the shares to deliver.
Badla was a hedging mechanism that doubled up as a tool for speculation. It
was the only way to have short sales in the system, which is the ultimate
bulwark against the bullish price manipulation of shares. And, it was the
only means of getting finance into the equity markets. So there were three
or four very obvious functions that badla was doing. If you look at the
scenario now, demat has removed the issue of delays in getting shares
transferred...so on, the stock lending scheme has replaced badla as the
preferred option to get shares to make deliveries in case of short sales.
Badla has lost its relevance now.

Q: But do derivatives fill in all the market requirements?

A: Please understand that there are lots of specific products that have been
introduced in the system over the last decade that fulfill each of these
requirements individually. So instead of a complex system, which served all
purposes in a sub-optimal manner, now we have an array of specialised
products that deliver specific services and do it better. In derivatives ,
we have a world class hedging tool now available to Indian investors.

Q: You said that globally, the derivatives markets take two years to develop
fully. How much time do you give yourself for the Indian derivatives market
to reach critical mass?

A: I would give it six to nine months. By early 2002, I expect average daily
volumes of Rs 100 crore.

Q: What will be the role of banks in the new system?

A: Of course, banks will continue to be the fulcrum of the new system, too.
We will need to have clearing banks that settle the cash part of the
transactions. Plus, there will be a whole new vista of opportunities for
banks in the derivatives markets. For instance, banks can do "calendar
spreads" as yet another method of parking their surplus funds and earning
returns.

Calendar spreads are nothing but simple contracts where banks buy an option
for a near period (say June) and sell it for a longer period, (say
September). It is like a forward-to-forward contract in the foreign exchange
markets, and banks can get positive returns. In the long run, this can be a
huge market like the overnight call money market where banks can park their
short-term funds.

Q. Do you think financing will be an issue in the markets when badla
financiers are thrown out of the new system?

A: It is not true that badla financiers will be removed from the system. It
is just their methods of operations will change. They can arbitrage between
the cash market and derivatives markets and even within the derivatives
market. By deploying their funds between different parts of the market, they
will not only impart depth to the markets, but will also make a decent
return on their funds.

Q: The way you put it, is the system going to be a level playing field for
foreign institutional investor, mutual funds and large players? In the badla
system, these players, for instance, were prohibited from short selling.

A: I think it is a level playing field for everyone though I have received
some queries whether FIIs will also be allowed to short sell. We are
negotiating with RBI.

Q: What is the issue with FIIs?

A: There is no issue. It is just that the RBI had mandated that FIIs can
only buy derivative contracts to hedge against an underlying position. So if
an FII had a purchase position in the spot market, it could short sell in
futures, but not a naked short sale. Maybe there is a policy issue
somewhere, but we are in dialogue with the central bank and hope to resolve
the issue.


Tax dues mar brokers foray into derivatives
Business Standard - May 18, 2001
By Aniek Paul

The Securities and Exchange Board of India (Sebi) has decided that the
brokers seeking fresh registration for the derivatives segment, will have to
first clear their turnover tax dues to the market regulator.

Brokers are upset with the decision, and feel that this would deter the
growth of the derivatives market as the tax would mean an additional burden
on them, and substantially reduce the interest in the segment, which needs
to grow fast.

According to rough estimates, the aggregate dues of the broking firms to
Sebi as outstanding tax on turnover is about Rs 800 crore. The amount due
from individual brokers varies from few lakh to several crores.

The brokers had moved court disputing the Sebi's claim, but they lost their
case in the Supreme Court in February this year, after a protracted legal
battle.

In addition to the dues to be cleared, brokers would have to pay the
standard registration fee - which even for a trading member is about Rs 20
lakh - and for the software.

Sebi has also mandated that all broking firms seeking registration for the
derivative segment must have at least two experts in derivatives trading
with a NCFM (NSE Certification for Financial Markets) certificate.

Sebi full time board member Jayanth R Varma said: "It is untenable that the
brokers will be offered registration for a new segment without clearing
their dues. Besides, when the apex court has upheld Sebi's claims, the
brokers cannot get away without paying it."

Speaking on the various nuances of the derivatives segment, Varma said, in
the beginning the derivatives segment would be `cash-settled', implying that
the difference between the strike price and reigning market price would be
paid to the gainer, and securities would not be delivered.

"We will follow the American model in individual stock options, and the
European model in index options," Varma said. In the American model, one can
exercise the option at any point during the entire life of the option, while
in the European model, the right to exercise the option is restricted within
a specific time frame.

Varma also said, it would take the market regulator a couple of meetings to
fine-tune the risk management system for the segment. Varma added, in the
next board meetings, Sebi would discuss whether smaller exchanges like
Calcutta Stock Exchange would be allowed to start their own derivatives
segment.


New attack on proposal to allow advertising by hedge funds
Financial Times - May 18, 2001
By JOHN AUTHERS

The Investment Company Institute, the trade association for the US mutual
fund industry, started its annual meeting in Washington yesterday with a
renewed attack on proposals to allow hedge funds to advertise.

Matthew Fink, the institute's president, said hedge fund advertising could
create "serious and unnecessary risks" to public confidence in the industry.
Hedge funds should accept greater regulation if they wanted to open
themselves to the general public, he said.

"If parallel industries are permitted to develop - one regulated, one
unregulated - the only direction we are destined to move in is a race to the
bottom, as competitive forces pressure all firms to minimise regulatory
costs."

The Managed Funds Association, which represents hedge funds, wants
relaxation of the rules against advertising but says it does not want to
compete for retail investors.

The institute also took the opportunity to respond to the widespread belief
that mutual fund flows make the market more volatile. This followed an
outflow of Dollars 20.6bn from equity mutual funds in March, the highest
monthly outflow on record. This appears to have been followed by a heavy
inflow in April.

Terry Glenn, chairman of Merrill Lynch funds and chairman of the Institute,
denied there was any sign of panic from mutual fund investors during the
early months of this year.

"'Panic' is not a word one would associate with our investors. Shareholders
are not insensitive to stock price movements but their response to market
movements tends to be spread over time."

Mr Glenn added that fund investors have never responded to sharp market
falls by redeeming shares en masse, in any period since the war. "There is
no evidence that this long-established pattern of behaviour will change," he
said.

**End of ISDA Press Report for May 18, 2001.**

THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF, ISDA'S
BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA.  THIS PRESS REPORT IS
NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION), AND ISDA IS
NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE PUT.







Scott Marra
Administrator for Policy & Media Relations
ISDA
600 Fifth Avenue
Rockefeller Center - 27th floor
New York, NY 10020
Phone: (212) 332-2578
Fax: (212) 332-1212
Email: smarra@isda.org