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Aug 3: The modifications in the Revised Carry-Forward System RCF suggested in the Varma Committee Report would provide to all investors a...

Aug 3: The modifications in the Revised Carry-Forward System RCF suggested in the Varma Committee Report would provide to all investors an effective platform for taking long-term view of the economy, industry and a company in the market. This would enhance liquidity, expand breadth and reduce price volatility of the market.

The carry-forward system is three systems rolled into one: market position transfer, stock lending and financing mechanism. As market players can transfer their position from one settlement to another the carry-forward system allows for position transfer. The system facilitates stock lending to short-sellers. Short-sellers provide liquidity to genuine investors, while stock lenders make additional income. The system also provides funds for buyers who wish to transfer their position to later settlements.

The carry-forward system also provides hedging of risk. An investor holding securities can hedge against a likely fall in prices by selling in a carry-forward market. If prices decline, the losses in the holdings would be offset by the gains in the carry-forward market. Similarly, any investor anticipating future cash flow can hedge against a likely rise in prices by buying in the carry-forward market. If prices rise, the gains in the carry-forward market would offset the additional costs he would have to pay due to the rise in prices in the cash market.

The carry-forward system is a vehicle for controlled speculation. The economic purpose of speculation lies in price formation in a free market by operators who buy or sell on the basis of their view on the direction of the price movement. These people provide liquidity on the opposite side of investors who want to buy or sell for delivery.

The present form of the RCF has many impediments in the smooth running of the system. The exchange has run the system over the last one and a half year. Based on our experience we suggested to SEBI to review the system in the light of many structural changes which have been introduced by the Exchange since January 1996. Briefly these changes are as follows.

Apart from computerised trading system, shorter settlement cycle and trades settled through the Clearing House there is strict adherence to the settlement schedule and the market, at present is much more safer than it ever was in the past. The set-up of Trade Guarantee Fund has ensured that market integrity is maintained. Strict surveillance system is in place to nip in the bud any price manipulation and keep a check on individual member8217;s exposure in the market. Financial safety concepts developed for banking system and derivative markets are used for risk management at the Exchange.

Keeping the above changes in mind, the Varma Committee has recommended to remove many impediments from the present RCF system. We are sure that the Modified Carry Forward System as suggested by the Varma Committee would go a long way in smooth running of the system and making the carry-forward instrument as a vehicle to impart vibrancy to the market.

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One way to boost investor confidence would be to remove impediments from the carry-forward system which have strangulated this instrument and which has been well understood by investors. This would bring liquidity in the market across the specified scrips initially which would spread to whole market.

The author is the President of the Bombay Stock Exchange.