TRADING MECHANISM IN EXCHANGE TRADED CURRENCY DERIVATIVES .

TRADING MECHANISM IN EXCHANGE TRADED CURRENCY DERIVATIVES

Key Entities in the Trading System

Stock Exchanges: A stock exchange is a platform where buyers and sellers meet to transact in securities. It provides a trading facility for various financial instruments and ensures equal access to investors across the nation.
Clearing Corporations (CC): A Clearing Corporation is responsible for clearing, settlement, and risk management of trades executed on exchanges. It also provides a settlement guarantee for such trades.
Trading Members: A trading member is a member of the stock exchange who can execute trades on their own account as well as on behalf of their clients. They are intermediaries between investors and the exchange.
Authorized Persons: An authorized person is an agent of a trading member who provides access to the trading platform of a stock exchange.
Clearing Members: Clearing members have clearing and settlement rights in a recognized clearing corporation. They help in clearing trades of their clients.
Investors/Clients: Investors/clients trade in exchange-traded currency derivatives through trading members of the currency derivatives segment.

Features of the Exchange Trading System

Screen-based Trading System: The exchange trading system is a fully automated screen-based platform that supports an order-driven market.
Transparent: The system provides complete transparency of trading operations, with quantity and price information related to orders and trades disseminated on a real-time basis.
Anonymous Order Matching: The identity of buyers and sellers is not revealed to the market, with only price and quantity information available on the system.
Higher Speed of Execution: The system can handle multiple orders and trade execution at high speeds.
Connected to Multiple Interfaces: The trading system is connected to the clearing corporation system, surveillance system of the exchanges, and data vendors' systems for dissemination of data.
Risk Management Facility: The system has a risk management facility to avoid errors related to order entry.
Nationwide Reach: Trading members/participants can access the system from any part of the country.

Order Management

Trader Workstation (TWS): The trader workstation is the terminal from which a member accesses the trading system.
Order Placement: Brokers accept orders from clients and send them to the exchange after performing risk management checks. Clients can place orders directly through various channels, such as internet, phone, or direct market access.
Order Types: The system supports various order types, including limit orders, market orders, and stop-loss orders.

Trading Mechanism in Exchange Traded Currency Derivatives

Order Placement: All brokers are required to execute trades of clients only after maintaining evidence of such order placement, which can be in the form of physical records, telephone recordings, emails, log of internet transactions, or any other legally verifiable record.
Telephone Recording: SEBI has instructed that wherever order instructions are received from clients through the telephone, the stock broker must mandatorily use a telephone recording system to record the instructions and maintain telephone recordings as part of its records.
Internet Trading: Internet trading can take place through order routing systems, which route client orders to exchange trading systems for execution. SEBI-registered brokers can introduce internet-based trading after obtaining permission from respective Stock Exchanges.

Direct Market Access (DMA)

Definition: DMA is a facility that allows brokers to offer clients direct access to the exchange trading system through the broker’s infrastructure without manual intervention by the broker.
Advantages: Some of the advantages offered by DMA are direct control of clients over orders, faster execution of client orders, reduced risk of errors associated with manual order entry, greater transparency, increased liquidity, lower impact costs for large orders, better audit trails, and better use of hedging and arbitrage opportunities.
Eligibility: SEBI-registered brokers can introduce DMA facility to their clients after obtaining permission from respective Stock Exchanges. The facility of DMA provided by the stock brokers shall be used by the client or an investment manager of the client.

Algorithmic Trading and High Frequency Trading

Algorithmic Trading: Any order that is generated using automated execution logic shall be known as algorithmic trading. Automated Trading shall mean and include any software or facility by which, upon the fulfillment of certain specified parameters, without the necessity of manual entry of orders, buy/sell orders are automatically generated and pushed into the trading system of the Exchange for the purpose of matching.
High Frequency Trading (HFT): HFT is a type of algorithmic trading that is latency sensitive and is characterized by a high daily portfolio turnover and high order-to-trade ratio (OTR).
Risk Controls: SEBI has advised the stock exchanges to ensure that all algorithmic orders are necessarily routed through broker servers located in India and the stock exchange has appropriate risk controls mechanism to address the risk emanating from algorithmic orders and trades.

Order Routing and Execution

Order Routing: Once the order is entered and confirmed by the client/dealer at his trading terminal and verified by the broker software, the order is routed to the exchange for its execution.
Order Execution: The order execution at the exchange depends upon the type of order. If the order is a market order, it gets executed immediately, subject to availability of counter order. If it is a limit order, it is matched against appropriate counter orders.

Order Book

Definition: The term “order book” refers to an electronic list of buy and sell orders which are available for matching (not yet converted in trade or outstanding order) for a specific security or derivatives contract organized by price level.
Components: An order book lists the number of shares/lot being bid on or offered at each price point, or market depth. It also provides the number of orders at each price level.
Purpose: The order book helps to improve market transparency as it provides information on price, availability, depth of trade.

Spread Order Book

Definition: Exchanges provide a separate spread order book for participants interested in executing calendar spreads. A calendar spread is a contract where you buy/sell a particular month’s contract (Futures or Options) and sell/buy (take an opposite position) of the same contract maturing in a different month.
Components: The spread order book shows the difference in price between the far-month contract and near-month contract. The orders are matched in the spread order book on price-time priority only, where the price is basically the difference between the far-month contract and near-month contract.

Trading Mechanism in Exchange Traded Currency Derivatives

Lot Size: Trading in derivatives is mainly in lot size, where the number of lots is specified.
Buy and Sell Side Spread: A buy side spread involves selling the near-month leg and buying the far-month leg, while a sell side spread involves buying the near-month leg and selling the far-month leg.

Order Matching Rule

Price-Time Priority: Exchanges follow continuous matching based on price-time priority, where the best price orders are matched first.
Partial Matching: An order may match partially with another order, resulting in multiple trades.
Best Buy and Sell Price: The best buy price is the highest buy price amongst all buy orders, and the best sell price is the lowest price of all sell orders.

Order Management

Components of an Order: The main components of an order are price, time, quantity/no. of contracts, security/contract, action (buy/sell), and client identity (UCC) and proprietary/client identifier.
Order Entry: A trading member can enter various types of orders depending on their requirements, and orders are allowed to be entered during market hours only.

Types of Orders

Price Condition:
- Market Order: A market order is where a trader purchases or sells their contracts at the best market price available.
- Limit Order: Limit orders involve setting the entry or exit price and then aiming to buy at or below the market price or sell at or above it.
- Stop Orders: Stop orders allow the trading member to place an order which gets activated only when the market price of the relevant security reaches or crosses a threshold price.
Time-Related Conditions:
- Day Order: A day order is an order that is valid for the current trading day only.
- Good Till Cancelled (GTC) Order: A GTC order is an order that remains valid until it is cancelled by the trading member.
Quantity-Related Conditions:
- All or None (AON) Order: An AON order is an order that must be executed in its entirety, or not at all.
- Fill or Kill (FOK) Order: An FOK order is an order that must be executed immediately and in its entirety, or it will be cancelled.

TRADING MECHANISM IN EXCHANGE TRADED CURRENCY DERIVATIVES

Stop Loss Orders

Definition: A stop loss order is an order to buy or sell a security when it reaches a certain price, known as the stop price or trigger price.
Details: Stop loss orders can be used to limit losses or lock in profits. For example, a trader who buys USDINR futures at Rs.83 can place a stop loss sell order at Rs.82.80 to limit their loss if the price falls.

Types of Stop Loss Orders

Sell Stop Loss Order: A sell stop loss order is placed at a price below the current market price. If the price falls to the trigger price, the order is executed as a sell order.
Buy Stop Loss Order: A buy stop loss order is placed at a price above the current market price. If the price rises to the trigger price, the order is executed as a buy order.

Time Condition

DAY: A day order is an order that is valid for the day on which it is entered. If the order is not matched during the day, it gets cancelled automatically at the end of the trading day.
IOC (Immediate or Cancel): An IOC order allows a trading member to buy or sell a security as soon as the order is released into the market, failing which the order is removed from the market.
GTC (Good Till Cancelled): A GTC order is an order that remains in the system until it is cancelled by the Trading Member.
GTD (Good Till Days/Date): A GTD order allows the trading member to specify the days/date up to which the order should stay in the system.

Quantity Condition

DQ (Disclosed Quantity): An order with a DQ condition allows the Trading Member to disclose only a part of the order quantity/lot to the market.
MF (Minimum Fill): An MF order allows the Trading Member to specify the minimum quantity by which an order should be filled.
AON (All or None): An AON order allows a Trading Member to impose the condition that only the full order should be matched against.

Other Conditions

Pro (Proprietary Trading): Proprietary trading refers to trading on the trading member's own account.
Cli (Client Trading): Client trading refers to trading on behalf of a client.

Order Modification and Cancellation

Order Modification: Orders can be modified till the time they are not fully executed. Order modification is allowed only for certain parameters like price, quantity, etc.
Order Cancellation: Orders can be cancelled during market hours if they have not been fully or partially executed.

Trade Execution

Trade Execution: Execution of trades occurs when a buyer and seller reach an agreement pertaining to the terms and price of a trade and the order to buy or sell a security is completed after the same is matched on the Exchange platform.

Risk Management and Order Routing

Risk Management: An efficient risk management system is integral to an efficient settlement system. The broker system should have an on-line risk management capability for all orders placed on the exchange platform.
Margin: A margin is an amount that clearing corporations levy on the brokers for maintaining positions on the exchange. The amount of margin levied is proportional to the exposure and risk carried by the broker.

Trading Mechanism in Exchange Traded Currency Derivatives

Risk Management System

Definition: A broking firm's risk management system is designed to measure and manage its own and its client's exposure to various risks.
Details: The system should assess the risk of clients as soon as an order is received and have system-based controls on trading limits and exposure.

Risk Management Requirements

Establish Standards and Reports: Brokers must set standards and report to management for review and action.
Impose Position Limits and Rules: Brokers must impose limits to cover exposures and overall position concentrations relative to systematic risks.
Set Investment Guidelines and Strategies: Firms should outline investment guidelines and strategies for risk-taking in the immediate future.

Types of Risk for Members

Operational Risk: The risk of monetary loss resulting from inadequate or failed internal processes, manual and systems errors, or external events.
Market Risk: The possibility of incurring large losses from adverse changes in financial asset prices.
Credit Risk: The risk of default on a debt that may arise from a borrower failing to make required payments.

Pre-Order and Pre-Trade Checks

Pre-order checks:
- Price range check
- Quantity Freeze
- Single order quantity/value limit
- User order value limits
- Cumulative open order value checks
- UCC/PAN check
Pre-trade checks:
- Trade Execution Range
- Self-Trade Check
- Market price protection
- Kill Switch
- Cancel on Logout (COL)

Investor Risk Reduction Access (IRRA) Platform

Introduction: A joint platform developed by exchanges to provide investors with an opportunity to square off/close open positions and/or cancel pending orders in case of disruption of trading services.
Salient Features:
- Supports multiple segments across multiple exchanges
- Enables investors to square off/close open positions and/or cancel pending orders
- Provides access to an Admin Terminal for trading members to monitor and carry out actions

Framework to Address Technical Glitches

Introduction: A framework to address technical glitches in stock brokers' electronic trading systems.
Salient Features:
- Stock brokers must inform exchanges about technical glitches immediately
- Stock brokers must submit a Preliminary Incident Report and a Root Cause Analysis (RCA) Report
- Exchanges must build an API-based Logging and Monitoring Mechanism (LAMA) to monitor technical glitches

Business Continuity for Interoperable Segments

Introduction: A decision by SEBI for the interoperable segments of stock exchanges.
Details: Participants can hedge their open positions by trading on another venue if identical or correlated trading products are available.

TRADING MECHANISM IN EXCHANGE TRADED CURRENCY DERIVATIVES

Business Continuity Plan

Definition: A plan to ensure continuity of trading in case of an outage on one exchange.
Details:
- Exchanges may create reserve contracts for scrips exclusively listed on other exchanges.
- Index derivatives products not having correlated index derivatives products on another exchange may be created.
- The affected exchange should intimate SEBI and the alternative trading venue within 75 minutes of the occurrence of the impact.
- The alternative trading venue would invoke the business continuity plan within 15 minutes from such intimation.

Surveillance

Definition: The ability of exchanges to monitor positions, prices, and volumes in real-time to deter market manipulation.
Details:
- Surveillance systems automatically generate alerts for material aberrations from normal activity.
- The systems monitor open interest, cost of carry, and volatility.
- They capture and process client-level details and develop databases of trading activity.
- Information from member inspections is used for effective surveillance.

Price Limit Circuit Filter

Definition: A mechanism to prevent the acceptance of orders placed beyond the price limits set by the stock exchanges.
Details:
- No daily price bands are applicable for currency futures contracts, but operating ranges are kept at +/-3% of the base price for contracts with tenure up to 6 months and +/- 5% of the base price for contracts with tenure greater than 6 months.
- Dynamic price bands are relaxed in increments of 1% as and when a market-wide trend is observed.

Trading Cost

Definition: The various charges, including brokerage, payable by the client when trading in Exchange Traded Currency Derivatives (ETCD).
Details:
- Statutory levies, such as Goods and Service Tax and Stamp Duty, may be recovered from the client only at actuals paid/payable.
- Regulatory levies/charges, such as SEBI turnover fees and Exchange transaction charges, may be recovered from the client only at actuals paid/payable.
- Brokerage can be charged as may be mutually agreed between the member and the client, subject to the maximum permissible by the exchange.

SEBI Turnover Fees

Definition: A fee paid by stock brokers/clearing members/self-clearing members to SEBI in respect of securities transactions.
Details:
- The fee is currently Rs. 10 per crore of turnover for Currency Derivatives.
- A clearing member/self-clearing member must pay a fee of Rs. 50,000/- per year till the registration is in force.

Stamp Duty

Definition: A duty collected on transactions for both futures and option contracts executed on stock exchanges.
Details:
- The applicable stamp duty rate for Currency Derivatives is 0.0001%.
- Stamp duty is collected on transactions and is valued at the actual traded price for futures trades and at premium for option trades.