Nepal eyes derivatives market, Experts warn investors and infrastructure are not ready

KATHMANDU: The government’s plan to gradually introduce derivatives trading in Nepal’s capital market has reignited debate over whether the country’s investors, regulatory framework, and market infrastructure are prepared for one of the most complex financial instruments used in global stock markets.

While Nepal’s stock market currently operates primarily through conventional share trading—buying shares at lower prices and selling them at higher prices—recent policy discussions have expanded to include advanced market instruments such as intraday trading, short selling, and derivatives.

In the budget for fiscal year 2083/84 BS, Finance Minister Dr. Swarnim Wagle announced plans to restructure the stock market and gradually introduce intraday trading, short selling, and derivatives. However, market experts argue that derivatives represent a far more sophisticated and riskier financial product than other proposed reforms.

Unlike traditional stock investments, derivatives do not involve direct ownership of shares. Instead, investors trade contracts whose value is linked to the future price movement of an underlying asset such as stocks, indices, commodities, currencies, or other financial instruments.

Under the proposed amendments to Nepal’s Securities Act, derivatives are defined as contractual financial instruments—including forwards, futures, options, and swaps—based on listed securities or market indices, with transactions settled at least 30 days after the agreement is made.

In practical terms, investors in a derivatives market would not necessarily purchase shares of a company. Rather, they would buy the right to purchase or sell shares at a predetermined price in the future, effectively betting on whether the asset’s value will rise or fall over a specified period.

Capital market analysts caution that such products require significant investor education, sophisticated trading systems, strong risk management frameworks, and robust regulatory oversight.

“Talking about launching a derivatives market in Nepal’s current environment is more of a populist slogan than a practical policy initiative,” one market expert told to Fiscal Nepal. “Previous finance ministers have also announced ambitious plans for capital market modernization, but implementation has remained elusive.”

According to analysts, Nepal’s capital market is still in the early stages of development, with many retail investors lacking the technical knowledge required to understand and manage the risks associated with derivatives trading.

They argue that before introducing derivatives, regulators should first focus on strengthening market infrastructure, improving investor awareness, enhancing surveillance systems, and implementing other basic reforms such as intraday and short-selling mechanisms.

Policy Momentum Building

Despite concerns, derivatives trading has increasingly appeared in government reform agendas.

The High-Level Economic Reform Recommendation Commission led by economist Dr. Rameshore Khanal recommended developing the infrastructure necessary for a derivatives market. Similarly, the government’s Economic Reform Implementation Action Plan 2082 includes provisions for creating the foundations of derivatives trading.

Nepal’s Financial Sector Development Strategy (2082/83–2086/87) also identifies the absence of diversified investment products such as derivatives and index funds as a key limitation in the country’s capital market development.

The strategy argues that advanced financial products can help investors manage risk according to their investment capacity while contributing to greater market stability and diversification.

India’s Experience Offers Lessons

India launched its modern derivatives market in June 2000 following recommendations by the L.C. Gupta Committee and regulatory approval from the Securities and Exchange Board of India (SEBI).

The market initially permitted futures trading on major stock indices before expanding to options and futures contracts on individual stocks.

Today, India’s derivatives market is among the largest globally. However, participation is subject to strict regulations. Only highly liquid and large-cap stocks meeting specific trading and public shareholding criteria are eligible for derivatives trading.

Investors are also required to maintain margin deposits, while exchanges operate automated risk-management systems that can immediately close positions if account balances fall below required levels.

In recent years, Indian regulators have tightened rules further after studies showed significant losses among retail traders. Brokers are now required to display prominent risk warnings, and investor suitability assessments have become increasingly important.

High-Risk, High-Complexity Market

Financial experts note that derivatives can serve useful functions such as hedging risks and improving market efficiency. However, they can also amplify losses when used for speculation.

A derivatives contract derives its value from an underlying asset. These contracts allow investors to gain exposure to price movements without owning the actual asset, creating opportunities for both profit and substantial loss.

The concept is already partially familiar to Nepal through commodity futures trading, where contracts are linked to assets such as gold, silver, agricultural products, and other commodities.

Nevertheless, specialists emphasize that derivatives markets are best suited for investors, institutions, and market participants with advanced financial knowledge and strong risk-management capabilities.

As Nepal moves forward with plans to modernize its capital market, the debate is increasingly centered on whether the country should prioritize building investor capacity and market infrastructure before introducing one of the world’s most sophisticated financial trading mechanisms.