On the 28th of September 2015, India witnessed the first ever merger of two financial market regulators. The epic amalgamation between the 60+-year-old Forward Markets Commission (FMC), until then the commodities regulatory body, and SEBI, popularly known as the capital markets watchdog, was formalized by no less than the Finance Minister, Arun Jaitley.
The merger between SEBI and the FMC was proposed over 4 years ago, in the Union Budget 2014-15. It was perceived that the FMC lacked the power to tame the commodities market, which intermittently witnessed wild fluctuations and alleged irregularities. SEBI, on the other hand, although much younger than the FMC, has been equipped with fully independent powers as a result of its autonomous body status, since 1992. The equity market regulator has earned the reputation of having superior surveillance, risk-monitoring and enforcement mechanism.
Post the merger, SEBI will now oversee price discovery of commodities, which has been a major issue in commodities trading. As a result, market players feel that commodity markets will now be better regulated, with more stringent processes — and will thus evoke greater confidence.
On a more tangible note, SEBI has executed a series of upgrades within the commodity market universe. It began by enabling stock brokers dealing in securities, other than commodity derivatives, to deal in commodity derivatives, instantly facilitating ease of doing business.
Alongside allowing common broking businesses for equities and commodities, SEBI has permitted the two leading stock exchanges, NSE and BSE, to bring commodity derivatives onto their trading platform, adding an interesting dimension to the market. Now both NSE and BSE participate in commodities alongside leading national-level commodity exchanges, viz., MCX & NCDEX. Further, SEBI has already introduced option contracts (call and put options) in commodities trading, thereby providing better hedging tools to investors.
SEBI has also now permitted FPIs to participate in commodity derivatives contracts traded in stock exchanges in International Financial Services Centre (IFSC) subject to certain stipulations.
In September, the markets regulator allowed Foreign Institutional Investors, who have an actual exposure to physical Indian commodity markets, to participate in the domestic commodity derivatives segment (barring some ‘sensitive commodities’) of recognized stock exchanges to hedge their exposure. Such entities would be classified as “Eligible Foreign Entities” (EFEs).
Taking into account the demands of commodity market participants through the BSE, the regulator has also extended trading hours in the commodity derivatives segment to encourage hedgers, corporate, institutions and foreign investors to use exchange-traded commodity derivatives as preferred hedging platform.
Playing its part, BSE seeks to support the systematic development of the market through product innovation, awareness and technology. This will also contribute to deepening and widening the overall market. It has also waived transaction charges on commodity trading on the BSE for one year.
Based on the recommendations of the Commodity Derivatives Advisory Committee(CDAC) and market feedback SEBI has decided to allow the hedge funds Category – III Alternative Investment Funds(AIFs) to participate in the commodity derivatives market, subject to certain conditions.
Exciting times ahead
Beyond these changes, SEBI envisages further evolution in the commodities space. A leading SEBI official opined that despite the presence of about 40-plus contracts, the country’s commodities derivatives segment is still at a very nascent stage. Out of the total exchange-traded derivatives across the globe, the size of commodity derivatives is only 22%, out of which India has a negligible share of 5-6%. The regulator looks forward to launching new products such as Index derivatives and is even considering other derivatives like weather and freight derivatives. It also envisages making delivery compulsory in base metals and expects the eco-system such as warehousing, assaying and logistics systems to evolve. Following the Commodity Derivatives Advisory Committee’s proposals (as part of the second phase) it is likely to allow banks, insurers and pension funds in the commodity derivatives market. It also plans to allow mutual funds and portfolio management service providers to participate in the commodity exchange.
All these measures will move the Indian commodity derivative markets towards becoming more broad-based, vibrant, deep and efficient. They will also add to the liquidity in the far-month contracts. By allowing a variety of investor categories to participate, SEBI’s vision for the long run appears to be to pave the way for Indian markets to become price-setters for at least some global commodities.