A Finance Ministry-appointed committee has recommended allowing banks and foreign institutional investors in the commodity futures market.

The committee’s recommendations intend mainly to facilitate frictionless arbitrage between the spot and futures market. This is key to fulfilling the objectives of price discovery and hedging and greater hedger participation in the market, the committee said.

The committee was set up after the commodity derivative market and its regulator, Forward Market Commission, were transferred to the Finance Ministry in September 2013 from the Consumer Affairs Ministry in the wake of the ₹5,600-crore NSEL scam.

According to the committee, chaired by Senior Economic Advisor (Finance Ministry) DS Kolamkar, trading cost needs to be reduced.

“One way to reduce the cost of capital for the commodities trader is, to make banks and other financial institutions an integral part of trading in commodity derivatives.” This will require amendment in the Banking Regulation Act.

It also said that foreign financial firms (both intermediaries and end-users) should be permitted to participate in commodity futures trading. The existing system of limits on open interest and risk management provides adequate safeguards against the risk of allowing foreign participation in Indian markets.

The committee was asked to examine whether commodity futures market in India has achieved the objectives of price discovery and risk management, besides identifying constraints and suggest ways to remove these.

There is a view that commodity futures market is mainly for hedging.

On constraints, the committee felt that high warehousing and assaying costs add to the transaction cost of hedgers.

“While use of scientific storage and grading etc. should be encouraged, one way to do so is to provide these services at low price,” it suggested, adding that modernisation and professionalisation of warehousing will reduce the frictions in arbitrage.

The committee has advised the Finance Ministry to engage with the Warehousing Development and Regulatory Authority and the Food Department to pursue a work programme to assist the emergence of high-quality warehouses, negotiability of warehouse receipts, and spot market trading in warehouse receipts.

“A robust and liquid market in warehouse receipts would facilitate and encourage credit market participation in commodities derivatives in the form of loans against warehouse receipts,” it said.

It has also recommended that the Government should exempt arbitrageurs from the restrictions on holding inventory under the Essential Commodities Act, 1955.

In order to assist the development of organisational capability of firms operating in the commodity futures ecosystem, the Government should also stop the suspension of trading in an abrupt and unreasoned manner, it added.

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