Some eight years ago, a high-powered executive committee of the Ministry of Finance chaired by Percy Mistry submitted a report on making Mumbai an international financial centre. The report talked of the missing BCD (bonds, currencies and derivatives) nexus, and emphasised that “…A series of measures are needed to achieve market integration and convergence, and thus enable economies of scale and scope, greater competition and enhanced International Financial Service export capability…”. The Financial Sector Legislative Reforms Commission (FSLRC) that submitted its report in 2013 felt that regulatory convergence is one of ways for markets to move in sync, and extract economies of scale and scope. The 2015 Budget announced the merger of the commodities markets regulator, Forward Markets Commission (FMC), with Securities and Exchange Board of India (SEBI).

The merger will require several legislative changes, including amendments to SEBI Act and the Securities Contracts (Regulation) Act. More importantly, this also opens up avenues for various types of products that were not allowed to be traded under the outmoded Forward Contracts Regulation Act 1952, governing the commodity derivatives market. These include especially options and index based products. Now, there are many risk management products or to be specific, insurance products that lie at the interface of being commodity and securities.

Index-based derivatives

As I have argued in one of my previous articles in these columns last year, as also in a paper in Commodity Vision journal, India needs to have trading in water futures and options. I have argued in the detailed paper that water futures index can reduce the scarcity value of water, thereby helping in water conflict resolution. Such derivatives products cannot be delivery-based, but should be index-based.

Delivery is a costly affair, and completely defeats the purpose for which such a product is conceived. Many of these sustainability-related products such as weather derivatives, which can also be linked to crop insurance products floated by banks in the markets are index-based, are non-deliverable.

In the previous regulatory regime governed by the FCRA 1952, such products were not allowed to be traded, as the statute governing commodity markets mandates every derivative product to be delivery-based. Carbon credit derivatives that were floated in India also failed, and there were two reasons for that: the improper timing of product launch as carbon markets were moving down from 2009 onwards, and it proved unattractive for speculators due to the delivery clause.

Risk products for agri

In the face of climate change and with increasing frequency of extreme events, there are various risk management products that are needed for the country's agriculture. Worldwide, there are various risk management instruments such as crop-yield insurance (linked to the productivity), crop-hail insurance (covers against hailstorm in US), multi-peril crop insurance (covers against multiple extreme events like floods, droughts, hail, etc), crop-revenue insurance, etc. Further even, weather derivatives products such as heating degree day and cooling degree days are also in vogue. While insurance companies or banking institutions worldwide have conceived of such products, globally these institutions access futures or derivatives markets for their own risk management.

However, the statute does not allow access to the commodity derivatives market in India. Even the Banking Act 1948 prohibits institutional access to commodity markets, though banks can access stock markets. One of the reasons often cited is that commodity markets regulator was not autonomous and did not have enough teeth to regulate such products and institutions.

Avenue for innovation

With the new statutes in place, all such restrictions will be gone. There will be more ideas to be implemented, as the relevance of the FCRA will cease to exist. Despite contending claims, let us recognise that so far the financial market in India has failed to play any role in the context of sustainability. There have only been proposals to trade on sustainability indices of listed companies in the stock exchanges, which might have some implications for implementation of sustainable development goals, but it hardly has anything to do with ground level risk management, and creation of social security.

The FMC-SEBI merger opens up the avenue for innovative products to bridge that gap. It will also open up avenues for Foreign Institutional Investors (FIIs) and other foreign players to access the markets, thereby enhancing liquidity. Hence, this might create the opportunity for many derivative products based on “global commons” (like CO2 emission) to succeed, which otherwise failed in India due to lack of foreign participation. The new face of regulatory architecture will indeed usher in an age of innovation, thereby helping link the financial markets with sustainability!

The writer is Senior Fellow (Professor) at Observer Research Foundation, Kolkata Chapter, and Senior Advisor – Environmental Economics, World Wide Fund for Nature, India. Views are personal.

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