The Reserve Bank of India (RBI) issued a discussion paper that proposes to establish a spot currency trading platform.
The scheme for setting up the platform is riddled with few problems.
What is a currency trading platform?
Banks often decide the buying and selling rates for foreign exchange at the opening of business hours and retain the same rate through the day.
Most banks do not transparently disclose their charges for currency dealings.
Direct access to an exchange-like platform for currency tradingmeans when one goes to buy or sell foreign exchange from or to a bank, the buyer or seller dictates the price.
The bank will place the order on the exchange platform for execution.
It places more control in the hands of the consumer and will bring down the costs associated with the forex service.
What are the problems with draft on trading platforms?
Bifurcation - The discussion paper proposes a segment the trading platforms for retail consumers and banks, which are the institutional participants in a currency market.
Bifurcating an exchange into retail and institutional segments dilutes the principle underlying an exchange platform, which is to aggregate, buy and sell orders of all sizes and kinds.
This gives buyers and sellers of assets the benefits of liquidity and efficient price discovery.
It is difficult to envisage a financial market where retail market participants would be deprived of the liquidity provided by institutional participants.
Biased to one player - The discussion paper proposes to allow only one player, namely, the Clearing Corporation of India Limited (CCIL), to offer the spot currency trading platform.
Other vendors will be allowed to offer similar platforms in due course.
The proposal to monopolise the platform through CCIL in the beginning will deprive other players from the first mover’s advantage, which is critical as the value of the service directly depends on the number of users.
To migrate users from one exchange to another at a later stage is costly and difficult.
How to regulate these spot currency exchanges?
The proposal must be revisited in favour of a single platform that pools all orders, retail and institutional.
In a Capital account economy, the rules governing inflows and outflows are laid down in the regulatory framework that imposes capital controls.
The regulator’s job is to ensure people buy foreign currency and repatriate it abroad in compliance with these rules.
In India this is done through authorised dealer bankswhich report the inflows and outflows of foreign exchange in the accounts held with them under the provisions of the Foreign Exchange Management Act, 1999.
Systemic risk issues arising out of default in honouring matched trades can be taken care of through appropriately designed margining systems, as are applied for the membership of every central counterparty clearing platform.
Risk of market abuse, that is price manipulation, which can similarly be dealt with by an appropriate market abuse regime.
Consumer protection issues involved in the sale and advisory of foreign exchange needs regulatory oversight akin to any other financial product that is sold or bought in India.
