Part 7: NISM Series I – Chapters 8, 9 & 10: Accounting, Taxation, Regulatory Framework and Investor Protection

NISM Series I Currency Derivatives – Chapters 8, 9 & 10: Accounting, Regulatory Framework and Investor Protection

Welcome to the final post in our NISM Series I Currency Derivatives short notes series on PassNISM.in. This chapter covers three critical areas that are heavily examined: accounting treatment for currency futures, the regulatory framework (SEBI, RBI, SC(R)A, FEMA), and the code of conduct and investor protection measures that govern all currency derivatives market participants.

Missed Part 6? Read it here: Chapter 6 & 7 – Clearing, Settlement, Risk Management and Currency Options.

Chapter 8: Accounting and Taxation for Currency Futures Separate Accounting Heads Required

Every client who trades in currency futures must maintain two separate, dedicated accounting heads:

Initial Margin – Currency Futures
Mark-to-Market – Currency Futures

These must be kept distinct from other accounts and from each other.

Accounting Entries for Live (Open) Positions For Pay-Out (Cash Going Out)

Any cash payment — whether for initial margin or for daily mark-to-market losses — is recorded as follows:

Debit: "Initial Margin – Currency Futures" account OR "Mark-to-Market – Currency Futures" account (whichever applies)
Credit: Bank Account

For Pay-In (Cash Coming In)

When daily MTM settlement results in a gain (cash coming in), the entry is:

Debit: Bank Account
Credit: "Mark-to-Market – Currency Futures" account

Accounting Entries for Expired or Cancelled Positions

When a series of currency futures contracts expires or is closed out, the accounting treatment is:

Calculate the overall profit or loss as the difference between the final settlement price and the original contract price for all contracts in that series
This profit or loss is passed through the Profit & Loss Statement of the client
If a provision for anticipated loss had been created earlier and a balance exists in that provision account, any loss on final settlement is first charged against the provision account. Only the remaining balance goes to the P&L account

Accounting Entries in Case of Client Default

When a client fails to pay their daily MTM settlement, the contract is forcibly closed out (squared off). The unpaid amount is adjusted against the client's initial margin. In the client's books:

Debit: "Mark-to-Market – Currency Futures" account (for the defaulted amount)
Credit: "Initial Margin – Currency Futures" account

This effectively reduces the initial margin by the amount the client failed to pay, and records the loss in the MTM account.

Disclosure Requirements

At year-end, if initial margin has been paid using a bank guarantee or by lodging of securities (rather than cash), the following must be disclosed:

The amount of bank guarantee
The book value of securities lodged
The market value of securities lodged

This disclosure applies to all contracts that have open positions at the year-end reporting date.

Chapter 9: Regulatory Framework for Currency Derivatives Securities Contracts (Regulation) Act, 1956 [SC(R)A]

The SC(R)A is the foundational law governing securities trading in India. Its primary aim is to prevent undesirable transactions in securities. The definition of "securities" — which includes derivatives — is provided in Section 2(h) of the Act. Any exchange trading in currency derivatives must comply with the SC(R)A framework.

RBI-SEBI Standing Technical Committee

The journey toward exchange-traded currency derivatives in India involved both regulators working together:

On April 20, 2007, RBI issued comprehensive guidelines on the use of forex forwards, swaps, and options in the OTC market
RBI simultaneously constituted an Internal Working Group to study the feasibility of exchange-traded currency futures
The Internal Working Group submitted its report in April 2008, recommending introduction of exchange-traded currency futures
In a joint meeting on February 28, 2008, RBI and SEBI agreed to constitute an RBI-SEBI Standing Technical Committee on Exchange Traded Currency and Interest Rate Derivatives
This committee laid the groundwork for the launch of currency futures trading on Indian exchanges

Foreign Exchange Management Act (FEMA), 1999

FEMA governs all foreign exchange transactions in India. Specifically for currency derivatives, FEMA 25/RB-2000 (Foreign Exchange Derivative Contracts Regulations, 2000) was amended to formally define currency futures:

Definition under FEMA: "Currency Futures means a standardized foreign exchange derivative contract traded on a recognized stock exchange to buy or sell one currency against another on a specified future date, at a price specified on the date of contract, but does not include a forward contract."

This definition is critical — it distinguishes currency futures from forward contracts and establishes that futures must be traded on a recognized exchange.

Regulatory Framework for Exchanges

To be permitted to offer a currency futures segment, a recognized stock exchange must meet the following eligibility conditions set by SEBI:

Trading must be conducted through an online screen-based trading system
Clearing must be handled by an independent Clearing Corporation (not the exchange itself)
The exchange must have real-time online surveillance to monitor positions, prices, and volumes — to deter market manipulation
The exchange's balance sheet net worth must be at least ₹100 crore
Trade data (quotes, quantities, prices) must be disseminated in real time to at least two information vending networks accessible to investors nationwide
Computer and network capacity must be at least 4 to 5 times the anticipated or actual peak half-hour load
The currency derivatives segment must have at least 50 members to commence trading
The exchange must have an arbitration and investor grievances redressal mechanism operational in all four major regions of the country
The exchange must have adequate inspection capability and a good record of monitoring members, handling complaints, and preventing trading irregularities

Regulatory Framework for the Clearing Corporation

The Clearing Corporation operating in the currency derivatives space must:

Ensure that all trades are settled by matching buyers and sellers
Enforce the stipulated margin requirements, mark-to-market settlement, and electronic fund transfers
Maintain a separate Settlement Guarantee Fund specifically for the currency futures segment — to meet any settlement obligations that arise
Maintain a separate Investor Protection Fund for the currency futures segment

Chapter 10: Codes of Conduct and Investor Protection SEBI Code of Conduct for Brokers — General Principles

The SEBI code of conduct for brokers covers five main areas:

Integrity: Brokers must conduct themselves with honesty and integrity in all dealings
Due Skill and Care: Brokers must exercise proper professional care and diligence in all activities
No Manipulation: Brokers must not engage in manipulative, fraudulent, or deceptive transactions or spread rumors to distort market equilibrium or make personal gains at others' expense
No Malpractices: Brokers must not create a false market (either alone or in concert with others) or engage in any act that harms investor interests or disrupts fair and orderly market functioning
Compliance with Statutory Requirements: Brokers must fully comply with all applicable laws, rules, regulations, and exchange requirements

SEBI Code of Conduct — Duties to Clients

Execution of Orders: Brokers must execute client orders promptly and in a fair manner
Issue of Contract Note: A contract note must be issued to clients for every transaction
No Breach of Trust: Client information and positions must be kept confidential and not misused
No Churning: A broker must not encourage unnecessary buying and selling of securities just to generate brokerage or commission ("churning")
No Business with Defaulting Clients: Brokers must not knowingly deal with clients who have defaulted on their obligations to other brokers
Fairness to Client: All clients must be treated fairly and equitably
Investment Advice: Any advice given to clients must be appropriate, unbiased, and in the client's best interest

Inter-broker obligations: A broker must extend full cooperation to other brokers in protecting their clients' interests, and must honor all obligations arising from transactions with other brokers.

Note: The code of conduct for sub-brokers is substantially similar to that for brokers. Code of Conduct Specific to Currency Derivatives Segment General Principles

Adequate Disclosures: All material information must be disclosed to clients
No Guarantee Against Loss: No Trading Member may guarantee or promise a client against losses on derivatives positions
Professionalism: High standards of professional conduct must be maintained
Adherence to Trading Practices: All trading must be conducted in accordance with exchange rules and SEBI guidelines
Honesty and Fairness: All dealings must be conducted with honesty and in a fair manner
Capabilities: Members must only undertake activities for which they have the required knowledge, expertise, and resources

Trading Principles

Trading Members and Participants must ensure that all fiduciary obligations are fulfilled by themselves and their staff
A Trading Member is fully responsible for all trades and actions that originate through them, whether entered by staff or routed through their platform
No Trading Member or person associated with them may make improper use of a client's securities, futures positions, or funds
When entering or arranging any transaction, Trading Members must not misrepresent the nature or terms of the transaction in any way

General Guidelines Prohibitions

Shielding or assisting parties who violate market rules
Trading in suspended derivative contracts
Conducting misleading transactions intended to create artificial volumes or prices
Using information obtained in a fiduciary capacity (from clients) for personal gain

SEBI Complaints Redress System (SCORES)

SEBI launched SCORES — a centralized, web-based investor complaints redressal system. Here is what investors and market participants need to know:

Investors can lodge, follow up, and track the status of their complaints online from anywhere, at any time
Market intermediaries and listed companies receive complaints, redress them, and report the resolution through SCORES
Every step — from lodging to final disposal by SEBI — is online and in an automated environment
The current status of every complaint can be viewed online at any time
Investors not familiar with SCORES or without internet access can lodge complaints in physical form; these are scanned and uploaded to SCORES
SCORES is available online 24×7, providing easy retrieval and tracking at any time

Arbitration of Disputes

SEBI has directed all exchanges to establish arbitration committees to resolve disputes between trading members and investors efficiently. Key facts about the arbitration process:

Arbitration is also governed by Exchange Bye-laws
It is a quasi-judicial process that handles disputes between Trading Members, Investors, Sub-Brokers, Clearing Members, and between Investors and Issuers (listed companies)
Applications for arbitration must be filed at Arbitration Centers established by the exchange
Both parties to the dispute must select their arbitrator from the panel provided by the exchange
The arbitrator conducts proceedings and normally passes an award within four months from the date of initial hearing

Combination Option Strategies (Quick Reference)

The NISM exam also tests awareness of combination strategies used in the currency options market. These use multiple option positions simultaneously:

Moderately Bullish or Bearish View on USDINR

Bull Call Spread
Bull Put Spread
Bear Put Spread
Bear Call Spread

Range-Bound View (Low Volatility Expected)

Short Strangle
Short Straddle
Long Butterfly

Breakout View (High Volatility Expected)

Long Straddle
Short Butterfly

Strategies Complementing Existing Futures Positions

Covered Call (long futures + short call)
Covered Put (short futures + short put)
Protective Call (short futures + long call)
Protective Put (long futures + long put)

Exam Tip: For detailed payoff diagrams and strategy mechanics, refer to the official NISM workbook. The exam may test which strategy suits a given market view. Complete Quick Revision: Must-Know Points for the Exam

Two accounting heads required: "Initial Margin – Currency Futures" and "Mark-to-Market – Currency Futures"
Pay-out (cash out): Debit the relevant margin account; Credit Bank
Pay-in (cash in): Debit Bank; Credit MTM account
P&L on expired contracts = Final settlement price – Contract price
On default: Debit MTM account; Credit Initial Margin account
SC(R)A 1956: Defines derivatives; governs securities trading in India; Section 2(h) defines "securities"
RBI-SEBI joint committee on exchange-traded currency derivatives formed Feb 28, 2008
FEMA 1999: Currency futures defined as standardized FX derivative on a recognized exchange; excludes forward contracts
Exchange eligibility: online trading, independent clearing, real-time surveillance, ≥₹100 crore net worth, ≥50 members, 4–5× capacity, 2 information networks, arbitration in 4 regions
Clearing Corporation: must settle all trades, enforce margins, maintain separate Settlement Guarantee Fund
SEBI Broker Code: Integrity, Skill/Care, No Manipulation, No Malpractice, Statutory Compliance
Duty to clients: Execute orders, issue contract notes, no churning, fairness, no breach of trust
Currency derivatives code: No guaranteed returns, adequate disclosure, no misrepresentation, no use of fiduciary information
SCORES: online 24×7 complaint system; physical complaints also accepted and uploaded; full lifecycle online
Arbitration: quasi-judicial; arbitrator from exchange panel; award in 4 months from first hearing
Combination strategies: Spreads for directional views; Straddle/Strangle for volatility views; Butterfly for range-bound

Internal Links

Final Note: Your Complete NISM Series I Revision Checklist

You have now completed all seven chapters of the NISM Series I Currency Derivatives syllabus through our short notes series. Here is your final preparation checklist before you take the exam:

✅ Chapter 1: Currency market history, currency pairs, OTC market, IBR, RBI Reference Rate, spot/forward, cross rates, economic indicators
✅ Chapter 2: Derivative types (forwards, futures, options, swaps), market participants (hedgers, speculators, arbitrageurs), SC(R)A definition
✅ Chapter 3: Futures terminology (spot price, contract cycle, expiry date, MTM, lot size), IRP, 7 currency pairs on Indian exchanges
✅ Chapter 4: Hedging strategies (long/short futures based on exposure), speculation, arbitrage, triangular arbitrage, spreads
✅ Chapter 5: Trading entities (TM, CM, TCM, PCM, Participant), order types (Day, IOC, Market, Limit, Stop Loss, Pro, Cli), circuit filters (±3%/±5%)
✅ Chapter 6 (Clearing/Settlement): MTM computation, final settlement = RBI Reference Rate on T+2, margin types (SPAN, Initial, Extreme Loss, Calendar Spread), ₹50 lakh minimum liquid net worth
✅ Chapter 7 (Options): Call/Put, buyer/seller rights, European vs. American (India = European only), ITM/ATM/OTM, intrinsic + time value, Greeks (Delta, Vega, Theta, Rho), Black-Scholes vs. Binomial
✅ Chapter 8 (Accounting): Two margin accounting heads, pay-in/pay-out entries, expired contracts to P&L, default handling, disclosure requirements
✅ Chapter 9 (Regulatory): SC(R)A 1956, RBI-SEBI committee (Feb 28, 2008), FEMA definition of currency futures, exchange eligibility (₹100 crore net worth, 50 members), Clearing Corporation obligations
✅ Chapter 10 (Investor Protection): SEBI broker code (5 general principles, 7 client duties), currency derivatives code, SCORES (24×7, online, physical also accepted), Arbitration (4 months, exchange panel)

All the best for your NISM Series I Currency Derivatives Certification Exam! Visit PassNISM.in for free mock tests, chapter-wise practice questions, and the latest exam updates.