Financial derivatives have established themselves as a major driving force in the international monetary sphere in the recent past. While derivatives were originally used as an effective monetary instrument to multiply the wealth through ripple effect, of late these instruments are also used by banks and financial institutions to mitigate risk arising from the volatility of the underlying asset. This apart, derivatives along with the new generation monetary instruments such as investment securities in bearer form have already become the backbone of international economy.
Regulation of financial derivatives has a chequered history. There were periods in history when the trading in these instruments was banned. However, like any prohibition, the prohibition of openly trading in financial derivatives only led to the evolution of a clandestine market for these instruments, and innovative players in these markets created new types of instruments to bypass regulatory restraints.
Derivatives regulation in the US as well as in India is essentially a hybrid of ‘institutional’ and ‘functional’ regulation. Some organizations that trade in derivatives are regulated by institutions like Financial Services Authority (FSA), Securities and Exchange Commission, Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) etc., and these institutions have come up with disclosure norms to ensure greater transparency in the trading of derivatives. On the other hand, the functional regulatory regime controls the instruments which are ‘financial instruments’ with a slew of measures to ensure transparency and accountability. On the whole it can be seen that the derivative regulation is more focused on self regulation with an underlying assumption that the trade houses that utilize derivatives, do so prudently, and with self regulation.
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