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Tuesday, August 01, 2006

Dabba trading on currencies

The issue of "dabba trading" springs up from time to time in India. The way this works is roughly like this. Suppose there is a pre-existing market like NSE, NYSE, or whatever - let us call this "the main market". The dabba trading shop has screens for the main market. It then acts like a market maker which matches the bid/offer quotes seen on the main market. Customers are then able to buy/sell at these stated bid / offer quotes as seen on the main market.

The house earns the bid/offer spread on a large number of transactions, which can be quite profitable. There has been a great deal of discussion about "quote matching" by people like Bernard L. Madoff in the NYSE context; so I think that "dabba trading" isn't new to India.

What is the incentive in favour of dabba trading? In the domestic case, this involves not posting margin, not paying NSE its charges, not paying MoF the securities transaction tax, and not paying SEBI its transaction tax. To the extent that transaction taxes are bigger, the incentive for dabba trading is bigger. In the international case, dabba trading is a way to bypass either capital controls or local financial repression: the order flow that ought to have gone to a global exchange or to a local exchange ends up at the local dabba trading shop.

Dabba trading involves two-way credit risk. If a client makes a big loss, he can default, and the shop operator has to struggle to recover money. This isn't that different from an ordinary "full fledged" brokerage firm, which also faces such risk: the key difference is that the "full fledged" brokerage firm imposes bigger collateral requirements and thus faces lower credit risk.

On the reverse side, a client faces bigger credit risk because it can happen that a client has made a big profit but the shop is now bankrupt. The "full fledged" brokerage firms are a bit better capitalised, are less likely to suddenly vanish, and the client has recourse to the investor protection fund run by the exchanges.

In my opinion, some of the commodity futures trading taking place in India is much like "dabba trading" in that there really isn't much of local price discovery. This is particularly the case in the "evening session" where local orders are placed with one eye on the bid/offer quotes found on global exchanges. What is taking place is really local participants taking positions on a global price time-series. Capital controls hold back the local participants from placing orders on the global trading venue.

A recent Economic Times has a fascinating story about "dabba trading" taking place on currencies. I found it particularly interesting that they don't trade the INR/USD - since India has a de facto pegged exchange rate, there isn't much vol in the INR/USD. But the INR/GBP, INR/EUR, INR/JPY etc. are floating rates with a great deal of vol.


  1. This phenomenon of "dabba trading on currencies" is certainly not new.

    In Asia, there is always an unofficial or underground market for trading of currencies in countries which impose capital or forex controls.

    Even if there is no capital control in a country, it is not impossible to find commission houses operating in major cities in Asia.

    For example, during the seventies/early eighties in Singapore, commission houses mushroom as regulatory controls were lax and banks/financial insitutions were unable to offer currency trading facilities then. These so called "Bucket Shops" capitalise the greed of small time retail investors by providing them currency trading facilities at "nominal" margin collaterals. These unlicensed/un-regulated bucket shops were finally weed out as MAS tighten the screws and regulated the industry.

    In Indonesia, it is still prevalent to have numerous commission or brokerage shops offering currency trading to small time investors. While some of these shops may have valid licence, there are many that operate without one. According to my friend in Indonesia, an unofficial estimate of such brokerage shops is in excess of 1,000.

  2. I am not sure if you are referring to just unlicensed dabba trading. But I think regular brokerages do bid/ask matching from internal flows all the time. (Is it illegal?) In US, every few years there is a large-scale scandal of brokerages or trading shops front running their clients because of visibility of order flows.

  3. I would make a distinction between a black market for spot transactions as opposed a black market for placing speculative bets.

    On any street in the world, I can convert a Rs.1000 note into a twenty-dollar bill. That's a fairly unremarkable spot market transaction. Where things get interesting, in my opinion, is when a person gets an opportunity to place a leveraged trade. Here, I see a classification scheme that is interesting. There is "a good way" - with a futures exchange, a clearing corporation, a fairly sound securities firm, etc. And there is "a bad way" where customers place orders with a bucket shop which is just a quote matcher.

  4. i know wht about dabbas but i dont have any of the connection. if you have any dabba traders in commodities and currencies pls tell me. any ph nos any party ? i want to hedge my position.


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