The Hindu Business Line : Investigate, regulate

WITH FOCUSSED AND professional approach, futures exchanges trading multiple commodities online have, in the last couple of years, brought about a major transformation in the once staid commodity market. Using technology effectively to reach investors nationwide and to drive trading volumes, they clocked an impressive turnover of around Rs 15 lakh crore last fiscal — over three times that of the previous year. A couple of Indian exchanges now rank alongside the world's best commodity bourses. They are constantly endeavouring to strengthen the cash market, improve trading environment, build infrastructure and gain investor confidence.

Yet, not all is well with these impressive edifices of modern India. Despite the fact that contracts for over 60 commodities have been launched, only a handful is actively traded on these exchanges. Currently, the bulk of the activity is at best in half-a-dozen items, a trading environment loaded with attendant risks. The cash market for some of these commodities is shallow, and participation of genuine hedgers rather limited. Speculation is so rampant in some commodities that the market is unconscionably volatile and futures prices seldom bear a logical relation with physical market conditions. Speculator-driven unrealistic futures prices are known to throw export prospects of physical goods into disarray. There is also the risk of transactions suddenly drying up, should a situation not favourable to speculators arise. It may be necessary to segregate hedge and speculative contracts (like commercial and non-commercial transactions of CFTC in the US) and give differential treatment in terms of margin and so on.

From time to time, protests from market participants are heard; but there is no institutional mechanism to address genuine grievances. The latest, of course, is the charge that norms for arriving at the settlement price of some pulses contracts due for maturity on January 20 were changed unilaterally. The regulator — the Forward Markets Commission (FMC), under the administrative control of the Ministry of Consumer Affairs — is expected to take a view on the incident and initiate suitable action, should the situation warrant. This is an opportunity for the regulator to iron out kinks in the marketplace so as to maintain market integrity.

For a start, in addition to whatever action is deemed fit in the instant case, the FMC can order a thorough audit of internal control systems in all the commodity futures exchanges. The full-scale systems audit should examine whether internal controls and procedures of the exchanges are commensurate with the growing size of their operations. Because the regulators may not have the requisite expertise to carry out such an audit, it may have to be conducted by a competent third party. Too much is at stake in the commodity derivatives business, not only for investors but also for promoters of exchanges. Some of the promoters are high-profile entities with their long arm of influence extending to New Delhi. High stakes usually translate into high risk of manipulative tendencies creeping in. The regulator has the unenviable task of harmonising and protecting the interests of all stakeholders without disrupting the market.