Derivative’s

What are these derivatives?

 'Derivatives are time bombs and financial weapons of mass
destruction' said Warren Buffett, one of the world's greatest
investors, who overtook Microsoft Maestro in 2008 to become
the richest man in the world and who is known as the 'Sage of
Omaha or Oracle of Omaha'.
 Derivatives, according to him, can push companies on to a spiral
that can lead to a corporate melt down. He compared derivatives
business to hell, easy to enter and almost impossible to exit. In
response to a query as to whether a nuclear war would be the
worst case scenario, a famous daily web log commented that
'the economic collapse triggered by the popping of the
derivatives bubble' presented the worst case scenario.

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Contd…
 True to the above criticism, the world of finance and investments,
was swept by many a tsunami in the past decade and a half.
Some of the 'derivatives disasters' which plunged several
institutions and millions of investors into severe crisis (and even
led to the homicide by a 46 year old former IITian of his entire
family followed by his suicide in US) are as follows:
 (i) The bankruptcy of Orange County, CA in 1994, the largest
municipal bankruptcy in U.S. history. On December 6, 1994,
Orange County declared Chapter 9 bankruptcy, after losing about
$1.6 billion through derivatives known as "reverse floaters" whose
values move inversely with market interest rates.
 (ii) The collapse of the 233 year old Barings Bank when Nick
Leeson, a trader at Barings Bank, made poor and unauthorized
investments in index futures. Through a combination of poor
judgement, lack of foresight, a naive regulatory environment and
unfortunate outside events like the Kobe earthquake, Leeson
incurred a huge loss that bankrupted the centuries-old financial
institution. The loss suffered by the Bank was estimated at $ 27
billion.

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Contd.
 iii) The crumbling of the heavy-into-hedges trading firm known as 'Long
Term Capital Management' under the weight of derivatives worth $ 1.4
trillion, in 1998. But it was bailed out by the joint efforts of the US
Federal Reserve and a few Banks in order to minimise public outcry.
 (iv) The hedge fund fiasco of Amaranth Advisors in September 2006, to
the extent of about $ 6 Billion, due to miscalculation of the price of
natural gas futures.
 (v) The collapse of the largest investment Bank Lehman Brothers and
the leading American insurer AIG, due to extensive exposure to Credit
Default Swaps (CDS) threatening a potential collapse of the United
States financial system in 2008, leading to a $ 700 Billion Bail out plan
whereby the U.S. Treasury agreed to buy out the underlying defaulted
and endangered debt instruments from banks, brokerages and other
financial institutions in an attempt to keep the country's credit market
from shutting down and creating a global economic crisis.

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HISTORY OF EVOLUTION OF
DERIVATIVES
 They had their origin, perhaps in "speculative trading in
commodities" several centuries ago and later underwent a
metamorphosis to become "futures trading" and "forward
trading" a couple of centuries back. Some trace their
history to 600 B.C., when a Greek purchsed an option to
work on olive presses. Others trace it to the period of
Wiliam and Mary in the 17th century. Their history has to
be traced from 3 different perspectives namely
 (1) Forwards/Futures Trading in commodities
 (2) forwards/futures trading in stocks and securities and
 (3) forwards/futures trading in currencies.
 .

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FUTURES TRADING IN COMMODITIESs

 Futures trading in commodities, through recognised Exchanges, got

entrenched firmly in India more than a century ago. Organized futures
market evolved in India with the setting up of "Bombay Cotton Trade
Association Ltd." in 1875. But, following widespread discontent
amongst leading cotton mill owners and merchants over the functioning
of the Association, a separate association by the name "Bombay
Cotton Exchange Ltd." was constituted in 1893. Futures trading
in oilseeds was organized in India for the first time with the setting up of
Gujarati Vyapari Mandali in 1900. Futures trading in Raw Jute and Jute
Goods began in Calcutta with the establishment of the Calcutta
Hessian Exchange Ltd., in 1919. Later East Indian Jute Association Ltd.,
was set up in 1927 for organizing futures trading in Raw Jute. These two
associations amalgamated in 1945 to form the East India Jute &
Hessian Ltd., to conduct organized trading in both Raw Jute and Jute
goods. In case of wheat, futures markets were in existence at several
centres at Punjab and U.P. The most notable amongst them was the
Chamber of Commerce at Hapur, which was established in 1913.
Futures market in Bullion began in Mumbai in 1920 and later similar
markets came up in other places. In due course several other exchanges
were also created in the country to trade in such diverse commodities as
pepper, turmeric, potato, sugar and gur (jaggory).

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FUTURES TRADING IN STOCKS/SECURITIES AND CURRENCIES

 While Forward contracts in commodities other than

securities and currencies were regulated under the
Forward Contracts (Regulation) Act, 1952, the futures
market in stocks and securities were regulated by the
Securities Contracts (Regulation) Act, 1956. Similarly, the
finance market was regulated by (i) the Reserve Bank of
India Act, 1934, (ii) the Banking Regulation Act, 1949 and
(iii) the Foreign Exchange Management Act, 1999(FEMA
1999). While Securities Exchange Bureau of India (SEBI)
became the regulator of the market in stocks and
securities, RBI became the regulator of the finance market,
just as the Forward Markets Commission was made the
regulator of futures trading in commodities

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Meaning of Derivatives (International)
 In simple terms, derivatives are financial instruments whose values
depend on the value of other underlying financial instruments. The
International Accounting Standard (IAS) 39, defines "derivatives" as
follows:
 A derivative is a financial instrument:
 (a) whose value changes in response to the change in a specified
interest rate, security price, commodity price, foreign exchange rate,
index of prices or rates, a credit rating or credit index, or similar
variable (sometimes called the 'underlying');
 (b) that requires no initial net investment or little initial net
investment relative to other types of contracts that have a similar
response to changes in market conditions; and
 (c) that is settled at a future date.
 Actually, derivatives are assets, whose values are derived from
values of underlying assets. These underlying assets can be
commodities, metals, energy resources, and financial assets such as
shares, bonds, and foreign currencies.

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In India
 Section 18A reads as follows:
 18A.Contracts in derivative: Notwithstanding anything contained in
any other law for the time being in force, contracts in derivatives shall
be legal and valid if such contracts are -
 (a) traded on a recognised stock exchange;
 (b) settled on the clearing house of the recognised stock exchange, in
accordance with the rules and bye laws of such stock exchange.
 The definition of the word "derivative" was also incorporated in
Section 2(ac) of the Securities Contracts (Regulation) Act, 1956, by
the aforesaid amendment.
 The definition in Section 2(ac) is as follows:

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Definition (SCR Act)
 2(ac) "derivatives" includes -
 (A) a security derived from a debt instrument, share, loan
whether secured or unsecured, risk instrument or contract for
differences or any other form of security;
 (B) a contract which derives its value from the prices, or
index of prices, of underlying securities;
 As is obvious, the above definition is only inclusive and hence
the natural meaning of the word "DERIVATIVE" was
not lost.

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Illustration
 Derivatives can be used as insurance cover against certain types
of business risks such as fluctuations in the rate of foreign
exchange, fluctuations in the rate of interest on borrowings,
fluctuations in the value of specified assets etc. To take an
example, it is common knowledge that the price of gold keeps
fluctuating. If a manufacturer of gold jewellery anticipates that
he would require a particular quantity of gold at a specified
distance of time, he may enter into a contract with the seller of
gold bars for the supply of the same at a future date, at the rate
specified in the contract. This contract reduces the risk for the
buyer, against a possible steep rise in the price of gold. It
equally reduces the risk of the seller against a steep fall in the
price. Thus the contract acts as an insurance cover. When the
transaction goes through without any dispute, the contract is
fulfilled. But when the transaction fails and the motive behind
the transaction is not necessarily the sale and supply of gold,
but the receipt or payment of the difference in the price
(difference between the prevailing price and the price fixed in
the contract), many eyebrows are raised and many questions are
asked. This is the point where the transaction takes a detour
from a simple contract of insurance.
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Types of Derivatives
 There are four types of Derivatives in practice
1. Forwards: A contract between two parties. One party
agrees to buy a commodity or financial asset on a date in
the future at a fixed price, while the other agrees to deliver
that commodity or asset at the predetermined price. These
are not traded on exchanges because they are negotiated
directly between two parties.
 (2) Futures: A contract essentially the same as a forward
contract, except that the deal is struck via an organized
and regulated exchange. There are three key differences
between forwards and futures. (i) Futures contract is
guaranteed against default (ii) They are standardized and
(iii) They are settled on a daily basis.

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Contd.
 (3) Swaps: A swap is an agreement made between two parties to exchange
payments on regular future dates. Swaps are OTC (Over the counter) products.
Swaps are used to manage or hedge risk associated with volatile interest rates,
currency exchange rates, commodity prices and share prices. Swaps can be
considered as series of forward contracts.

 (4) Options: An 'option' gives the holder the right to buy or sell an underlying asset
at a future date at a predetermined price. A 'call option' is the right to buy. The
buyer of a "call option" has the right, but not the obligation to buy an agreed
quantity of a particular commodity or financial instrument (underlying instrument),
from the seller (or writer) at a certain time (the expiration date) for a certain price
(strike price). The buyer pays a premium for this right. In contrast, a 'put option' is
the right to sell. The buyer of a "put option" has the right, but not the obligation to
sell an agreed quantity of a particular commodity or financial instrument
(underlying instrument), to the seller (or writer) at a certain time (the expiration
date) for a certain price (strike price). We have a variety of options such as
American and European options, depending upon the time of exercise of the right.
Both call option and put option can be combined to achieve "zero cost option.

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Trading
 Trading in these markets are regulated internationally by
Commodity Futures Trading Commission (CFTC) and
International Swaps and Derivatives Association (ISDA) and
the National Futures Association (NFA).
 Experts in the field of economics, finance and investment feel
that derivatives are valuable because they provide efficient
ways to manage and transfer risk. A business owner who is
exposed to changes in market prices can enter into an
appropriate derivatives contract and the risk can be assumed
by a trader or speculator who is prepared to live with
uncertainty in return for the prospect of achieving an
attractive return.
 . Nobel Laureate Kenneth Arrow predicted that this would
increase economic prosperity since people would be more
prepared to engage in risk-taking activities. It could also
serve to improve the quality of prediction of future events in
the world of finance and investments. Derivatives provide a
global network for intelligent assessment, management, and
distribution of risk on a large scale.
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What are Index Futures and Index Option Contracts?

 Futures contract based on an index i.e. the underlying asset

is the index, are known as Index Futures Contracts. For
example, futures contract on NIFTY Index and BSE-30 Index.
These contracts derive their value from the value of the
underlying index.
 Similarly, the options contracts, which are based on some
index, are known as Index options contract. However, unlike
Index Futures, the buyer of Index Option Contracts has only
the right but not the obligation to buy / sell the underlying
index on expiry. Index Option Contracts are generally
European Style options i.e. they can be exercised / assigned
only on the expiry date.
 An index, in turn derives its value from the prices of
securities that constitute the index and is created to
represent the sentiments of the market as a whole or of a
particular sector of the economy. Indices that represent the
whole market are broad based indices and those that
represent a particular sector are sectoral indices.

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 In the beginning futures and options were permitted only on
S&P Nifty and BSE Sensex. Subsequently, sectoral indices
were also permitted for derivatives trading subject to
fulfilling the eligibility criteria. Derivative contracts may be
permitted on an index if 80% of the index constituents are
individually eligible for derivatives trading. However, no single
ineligible stock in the index shall have a weightage of more
than 5% in the index. The index is required to fulfill the
eligibility criteria even after derivatives trading on the index
has begun. If the index does not fulfill the criteria for 3
consecutive months, then derivative contracts on such index
would be discontinued.
 By its very nature, index cannot be
delivered on maturity of the Index
futures or Index option contracts
therefore, these contracts are
essentially cash settled on Expiry.
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Regulatory framework of Derivatives markets in India

Dr. L.C Gupta Committee

 constituted by SEBI had laid
down the regulatory framework
for derivative trading in India. SEBI
has also framed suggestive bye-law for
Derivative Exchanges/Segments and their
Clearing Corporation/House which lay's
down the provisions for trading and
settlement of derivative contracts.

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What are various products available for trading in Futures and Options
segment at NSE?

 Futures and options contracts are traded on Indices and on

Single stocks.
 The derivatives trading at NSE commenced with futures on
the Nifty 50 in June 2000. Subsequently, various other
products were introduced and 4 presently futures and options
contracts on the following products are available at NSE:
 1. Indices : Nifty 50 CNX IT Index, Bank Nifty Index, CNX Nifty
 Junior, CNX 100 , Nifty Midcap 50, Mini Nifty and Long dated
 Options contracts on Nfity 50.
 2. Single stocks - 228

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Why Should I trade in derivatives?
 Futures trading will be of interest to those who wish to:
 1) Invest - take a view on the market and buy or sell accordingly.
 2) Price Risk Transfer- Hedging - Hedging is buying and selling futures
contracts to offset the risks of changing underlying market prices.
 Thus it helps in reducing the risk associated with exposures in
 underlying market by taking a counter- positions in the futures market.
 For example, an investor who has purchased a portfolio of stocks may have a
fear of adverse market conditions in future which may reduce the value of his
portfolio. He can hedge against this risk by shorting the index which is
correlated with his portfolio, say the Nifty 50. In case the markets fall, he
would make a profit by squaring off his short Nifty 50 position. This profit
would compensate for the loss he suffers in his portfolio as a result of the fall
in the markets.
 3) Leverage- Since the investor is required to pay a small fraction of the value
of the total contract as margins, trading in Futures is a leveraged activity
since the investor is able to control the total value of the contract with a
relatively small amount of margin. Thus the Leverage enables the traders to
make a larger profit (or loss) with a comparatively small amount of capital.

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What are the benefits of trading in Index Futures compared to
any other security?

 An investor can trade the 'entire stock market' by buying

index futures instead of buying individual securities with the
efficiency of a mutual fund.
 The advantages of trading in Index Futures are:
 • The contracts are highly liquid
 • Index Futures provide higher leverage than any other stocks
 • It requires low initial capital requirement
 • It has lower risk than buying and holding stocks
 • It is just as easy to trade the short side as the long side
 • Only have to study one index instead of 100s of stocks

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How do I start trading in the derivatives
market at NSE?

 Futures/ Options contracts in both index as well as stocks

can be bought and sold through the trading members of NSE.
Some of the trading members also provide the internet
facility to trade in the futures and options market. You are
required to open an account with one of the trading members
and complete the related formalities which include signing of
member-constituent agreement, Know Your Client (KYC)
form and risk disclosure document. The trading member will
allot to you an unique client identification number. To begin
trading, you must deposit 6 cash and/or other collaterals with
your trading member as may be stipulated by him.

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 Example A.
 On 01 March an investor feels the market will rise
 – Buys 1 contract of March ABC Ltd. Futures at Rs.
260
 (market lot : 300)
 09 March
 – ABC Ltd. Futures price has risen to Rs. 280
 – Sells off the position at Rs. 280. Makes a profit of
 Rs.6000 (300*20)

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Example B.

 On 01 March an investor feels the market will fall

 – Sells 1 contract of March ABC Ltd. Futures at Rs.
260
 (market lot : 300)
 09 March
 – ABC Ltd. Futures price has fallen to Rs. 240
 – Squares off the position at Rs. 240
 – Makes a profit of Rs.6000 (300*20)

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Example C.
Assumption: Bullish on the market over the short

 term Possible Action by you: Buy Nifty calls

 Example:
 Current Nifty is 3880. You buy one contract (lot size 50) of
 Nifty near month calls for Rs.20 each. The strike price is 3900.
 The premium paid by you : (Rs.20 * 50) Rs.1000. Given these,
 your break-even Nifty level is 3920 (3900+20). If at expiration
 Nifty advances to 3974, then
 Nifty expiration level 3974
 Less Strike Price 3900
 Option value 74.00 (3974-3900)
 Less Purchase price 20.00
 Profit per Nifty 54.00
 Profit on the contract Rs. 2,700 (Rs. 54* 50)

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Note:
 1) If Nifty is at or below 3900 at expiration, the call holder would not
find it profitable to exercise the option and would loose the premium,
i.e. Rs.1000. If at expiration, Nifty is between 3900 (the strike price)
and 3920 (breakeven), the holder could exercise the calls and receive
the amount by which the index level exceeds the strike price. This
would offset some of the cost (premium).
 2) The holder, depending on the market condition and his perception,
may sell the call even before expiry.

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 Future risks
 Example 1.
 An investor purchased 100 Nifty Futures @ Rs. 4200 on
 June 10. Expiry date is June 26.
 Total Investment : Rs. 4,20,000. Initial Margin paid : Rs.42,000
 On June 26, suppose, Nifty index closes at 3,800.
 Loss to the investor (4200 – 3780) X 100 = Rs. 42,000
 The entire initial investment (i.e. Rs. 42,000) is lost by the investor.
 Example 2.
 An investor purchased 100 ABC Ltd. Futures @ Rs. 2500 on June 10. Expiry date is June 26.
 Total Investment : Rs. 2,50,000. Initial Margin paid : Rs.37,500
 On June 26, suppose, ABC Ltd. shares close at Rs. 2000.
 Loss to the investor (2500 – 2000) X 100 = Rs. 50,000

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Contd.
 The Clearing Corporation/House shall have the capacity to monitor the overall position of Members
across both derivatives market and the underlying securities market for those Members who are
participating in both.
The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the
position. The concept of value-at-risk shall be used in calculating required level of initial margins.
The initial margins should be large enough to cover the one-day loss that can be encountered on the
position on 99% of the days.
The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for
swift movement of margin payments.
In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House shall
transfer client positions and assets to another solvent Member or close-out all open positions.
The Clearing Corporation/House should have capabilities to segregate initial margins deposited by
Clearing Members for trades on their own account and on account of his client. The Clearing
Corporation/House shall hold the clients’ margin money in trust for the client purposes only and
should not allow its diversion for any other purpose.
The Clearing Corporation/House shall have a separate Trade Guarantee Fund for the trades
executed on Derivative Exchange / Segment.
Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE and the F&O
Segment of NSE.
As in the case of futures contracts, option contracts can be also be settled by delivery of the
underlying asset or cash. However, unlike futures cash settlement in option contract entails paying/
receiving the difference between the strike price/exercise price and the price of the underlying
asset either at the time of expiry of the contract or at the time of exercise / assignment of the option
contract.

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 What are requirements for a Member with regard to the
conduct of his business?

 The derivatives member is required to adhere to the code of

conduct specified under the SEBI Broker Sub-Broker regulations.
The following conditions stipulations have been laid by SEBI on
the regulation of sales practices:
◦ Sales Personnel: The derivatives exchange recognizes the persons
recommended by the Trading Member and only such persons are
authorized to act as sales personnel of the TM. These persons who
represent the TM are known as Authorised Persons.
◦ Know-your-client: The member is required to get the Know-your-client
form filled by every one of client.
◦ Risk disclosure document: The derivatives member must educate his
client on the risks of derivatives by providing a copy of the Risk
disclosure document to the client.
◦ Member-client agreement: The Member is also required to enter into
the Member-client agreement with all his clients.

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Distinct groups of derivatives contracts

 , which are distinguished by the way they are traded in the

market:
 (i) Over-The-Counter (OTC) derivatives, which are contracts that
are traded (and privately negotiated) directly between two
parties, without going through an exchange or other intermediary.
Products such as swaps, forward rate agreements and exotic
options are almost always traded in this way.
 (ii) Exchange-traded derivatives (ETD) are those products that
are traded via specialized derivatives exchanges or other
exchanges. A derivatives exchange acts as an intermediary to all
related transactions, and takes a margin from both sides of the
trade to act as a guarantee. According to BIS, the combined
turnover in the world's derivatives exchanges totalled to USD 344
trillion during Q4 2005.

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Foreign Exchange Management (Foreign Exchange Derivative Contracts)
Regulations, 2000

 'Foreign exchange derivative contract' means a financial transaction

or an arrangement in whatever form and by whatever name called,
whose value is derived from price movement in one or more
underlying assets, and includes,
 (a) a transaction which involves at least one foreign currency other
than currency of Nepal or Bhutan, or
 (b) a transaction which involves at least one interest rate applicable
to a foreign currency not being a currency of Nepal or Bhutan, or
 (c) a forward contract,
 but does not include foreign exchange transaction for Cash or Tom or
Spot deliveries;

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 Schedule-I of the Regulations contained provisions governing
the Foreign Exchange Derivative Contracts permissible for a
person resident in India; Schedule-II of the Regulations
contained provisions governing the Foreign Exchange
Derivative Contracts permissible for a person resident
outside India; Schedule-III prescribed the procedure for
approval of hedging of commodity price risk.

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Contd.
 They are (i) Cross Currency Options to
hedge exposures arising out of trade
(ii) Foreign Currency Interest Rate
Swap / Forward Rate Agreements /
Interest Rate Options / Swaptions/
Caps to hedge interest rate and
currency mismatches and (iii)
Commodity Futures/Options to cover
commodity exposures from overseas
exchanges.
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Currency futures
 Latest segment started in BSE recently.
 Currency futures are contracts to buy or sell a specific
underlying currency at a specific time in the future, for a
specific price. Currency futures are exchange-traded
contracts and they are standardized in terms of delivery
date, amount and contract terms.
 Currency future contracts allow investors to hedge against
foreign exchange risk. Since these contracts are marked-
to-market daily, investors can--by closing out their position-
-exit from their obligation to buy or sell the currency prior
to the contract's delivery date.

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cases
 Rajshree Sugars and Chemicals Limited rep. by its Director and Chief
Operating Officer Mr. R. Varadaraj
Vs.
Respondent: AXIS Bank Limited, formerly known UTI Bank Limited rep. by its
Assistant Vice-President, (Treasury Markets Group), Mr. Malmarughan
Vaikuntam and AXIS Bank Limited rep. by its Senior Manager MANU/
TN/0893/2008

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 FACTS OF THE CASE:
 The plaintiff is a listed company, engaged in the manufacture and export of
sugar to foreign countries. It has External Commercial Borrowings (ECB) from
foreign Banks. As an exporter, the company has receivables in foreign
currencies and as a borrower it has payables in foreign currencies. Since the
rate of exchange of foreign currencies keep fluctuating, the plaintiff decided
to hedge the risk against such fluctuations. Therefore, on 14.5.2004, the
plaintiff herein entered into a I.S.D.A. (International Swaps and Derivatives
Association) Master Agreement with UTI Bank Limited. The Master
Agreement is in an internationally standardised format developed by the
association and the normal practice in the trade is to keep the Master
Agreement as the reservoir, from out of which several deals would flow. There
is a Schedule attached to the Master Agreement, which is flexible and which
gives a leverage for the parties to reduce the terms and conditions between
the parties into specifics.
 On the basis of above facts, one of the major issue of the case is that i.
whether derivate contracts are wager contracts in idnia. And ii) whether these
contracts are against public policy.
 MANU/TN/0893/2008
  
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 After detailed discussion, Madras High Court held that Derivate Contracts in India are not
Wager contracts and also not against public policy of state. The court also laid down
reasons for this are.
 As per the decision of the Privy Council in BhagwandasParasram v.
BurjoriRuttonjiBomanji and followed by the Supreme Court in Firm of PratapchandNopaji
v. Firm of KotrikeVenkataSetty& Sons and Ors., every speculation will not fall under the
category of wager. There must be a common intention to wager. In this case, there was
certainly no intention much less a common intention to wager. The plaintiff attempts to
project the transaction as a wager by contending that OPT 727 was not in respect of a
specific underlying contract of import or export and that therefore it was only speculative
in nature. But the plaintiff cannot be heard to raise such a contention in view of the
covenant (or declaration) made by the plaintiff to the defendant in OPT 727 that there
was an underlying exposure and that the transaction was not for the purpose of
speculation. Even assuming for the sake of argument that there was an intention on the
part of the plaintiff to speculate, no such intention on the part of the Bank to speculate, is
made out by the plaintiff in the plaint. Thus, there was certainly no common intention to
wager, even if it is accepted for the sake of argument that there was an intention on the
part of the Officer of the plaintiff to speculate. In such circumstances, the transaction in
question cannot certainly be termed as a wagering contract. Therefore the plaintiff
cannot avoid the contract on the ground that it was a wager.

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 Multi Commodity Exchange Vs.Central ElectricityRegulatory Commission
 On 19th March, 2005, MCX applied to the FMC seeking approval for launching
electricity futures contracts. The FMC granted its approval on January 07,
2009 to the Petitioner to commence trading in electricity futures at its
exchange. MCX accordingly launched forward trading in electricity with effect
from 8th January, 2009. The third Respondent, Power Exchange of India
Limited (PXIL) challenged the electricity futures contracts formulated by the
Petitioner by its application dated 18th December, 2008, before the CERC on
the ground that (i) the CERC has the exclusive jurisdiction over regularising
electricity including all forward contracts, futures, etc. (ii) after the enactment
of the Electricity Act, 2003, the MCX and the FMC have been denuded of
jurisdiction over electricity and (iii) the MCX had commenced launch of
trading in electricity futures contracts without any approval of CERC and mere
approval FMC had no efficacy in the eyes of law. MCX has raised an objection
about the maintainability of such an application on the ground that CERC has
no jurisdiction to entertain such application as the FMC is a statutory
regulatory authority functioning under the Forward Market Act and the same
is not subjected to the jurisdiction of CERC.
 2011(113)BomLR531, 2011ELR(BOM)1
 2011(113)BomLR531, 2011ELR(BOM)1
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  
 One of the main issue before the Bombay High court was that, whether
electricity derivate’s are regulated by which regulating body either Electricity
commission or MCX. The court held that.
 (a) The Central Electricity Regulatory Commission (Power Market)
Regulations, 2010 are declared inoperative hereinafter, so far as the futures/
forward contracts in electricity is concerned;
 (b) It is further declared that the Petitioner-FMC and authority/commission
under it have no sole and exclusive jurisdiction to regulate and control
forward trading/futures contract in electricity and also CERC and authorities/
commission under it.
 It was further held that the disputes among departments in government are to
be resolved amicably among department through appointment of co-
ordination committees.
  

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 FORWARD CONTRACTS AND REGULATORY BODIES:
 Forward Contracts are regulated by Forward Market commission as per Forward
Contract(Regulation) Act,1952.It is a complete code providing for setting up of FMC
which advises the Central Government in the matter of forward trading in commodities,
registers every Association which organises forward trading and approves Rules and
Byelaws of Associations organizing forward trading. As per the provisions of FCRA,
contracts/agreements are classified into two categories i.e. Ready delivery contract and
forward contract. Ready delivery contract is one which deals with delivery of goods and
full payment of price thereof is made, either immediately or within a period of eleven days
after the date of the contract. Forward contract as per the definition under Section 2(c)
is a contract of delivery of goods and which is not a ready delivery contract. Considering
the provisions of the FCRA, it can be said that a forward contract is one in which it is a
contract for delivery of goods which can be realised either wholly or partly by payment of
any offsetting contract.
 The FMC is a Regulatory authority under the Ministry of Consumer Affairs, Food and
Public Distribution, Govt. of India and has been set up in 1953 under the provisions of the
FCRA. Forward trading in electricity comes under the purview of FCRA and this does not
take away the jurisdiction of CERC in respect of regulating spot trading in electricity. That
the provisions of FCRA were analyzed in great detail by the Supreme Court in the case of
Raghubir Dayal Jai Prakash and Ors. v. Union of India and Anr .
 1962) 3 SCR 547

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 The status of the FMC as an expert body to ensure the proper regulation of forward
contracts in the best interest of the society has been reiterated by the Supreme Court in
the various cases.
 On a conjoint reading of the provisions of FCRA and the Electricity Act, it is axiomatic
that the Electricity Act and the authorities established there under have been empowered
to govern the various aspects of electricity including generation, transmission,
distribution and trading. It is also clear that the FMC established under the provisions of
FCRA is empowered to govern all futures and forward contracts including electricity
futures contracts (being a notified good under FCRA).
 The Mahabir Beopar Mandal Ltd. v. The Forward Markets Commission  MANU/
SC/0047/1977 : AIR 1977 SC 1562.
  

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 It is no doubt true that electricity is a special legislation provided for a specific purpose
wherein the interest of consumer is also required to be taken into consideration.. If any
futures contract in case of a notified commodity under the FMC is concerned, it can be
done only through the machinery provided under the FMC. Looking to the special nature
of the electricity commodity and even considering the controlling of prices, etc. in our
view, the futures contract in electricity cannot be exclusively dealt with by FMC. Similarly,
the CERC has no jurisdiction to frame any Regulation in connection with the futures
contract in electricity. With a view to harmonise the provisions of both the Acts, in Court
view, the futures contract no doubt is within the domain of FMC. Even if futures contract
is to be taken into consideration in the matter of electricity, the same can be done only in
consultation with the CERC. Each domain is exclusive under the respective statutes. One
cannot transgress into another domain. In our view, CERC cannot be totally taken out of
consideration as the physical delivery of the electricity and electricity derivative products
also form part of various aspects of the electricity market structure under the Electricity
Act.
 The Electricity Act deals with in every respect including trading in electricity. The trading
of electricity falls within the concept of commodity trading. Therefore, it may or may not
physically available all the time, unless generated on the day and/or the date of delivery.
Electricity as a goods from other commodities as contemplated under the FCR Act, which
at present deals exclusively with all aspect of futures/ forward contracts.

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Cases contd.
 Others
 Issues
 Validity of contract:
 Legal aspects
 Accounting
 Ethical
 Jurisdictional issues
 Application of law
 Investment laws

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Thank u

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