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At a time when commodity derivatives market in the country is struggling to attract volumes , scouting for new participants and launch of new products, comes the RBI’s draft directions for hedging of commodity price risk in overseas exchanges.
The provocation for issue of the draft directions is unclear; but the proposal is clearly fraught with undesirable and unintended consequences.
After SEBI became the commodity derivatives market regulator more than a couple of years ago, the market has witnessed a slew of progressive reforms. The intention is to strengthen, deepen and widen the domestic market by encouraging the exchanges to explore new products and new participants.
Direct, indirect exposure
The RBI draft directions talk about direct exposure and indirect exposure to commodity price risk for eligible entities.
An entity will / said to have ‘direct exposure’ if it purchases/sells a commodity in India or abroad whose price is fixed by reference to an international benchmark or the product contains a commodity and the price of the product is linked to the price of the commodity by a defined formula.
The RBI directions go one step further and define ‘indirect exposure’ of an entity to commodity price risk if it purchases/sells a product in India or abroad which contains a commodity and the price of the product is not linked to the price of the commodity by a defined formula. The indirect exposure of an entity to a commodity contained in a product is a nebulous idea.
It would be a complex exercise to ascertain the indirect risk of the user. How and who will decide whether or not there is an indirect exposure could be subject to debate.
Importantly, for small and medium enterprises with exposure to commodities, there are attendant risks in hedging their price risks in overseas exchanges.
Why not Indian bourses?
It is necessary for RBI to explain the rationale for the draft direction. Have a large number of entities approached RBI for the facility?
Did the RBI investigate why these entities want to hedge their price risks in overseas market when domestic exchanges are available? If yes, what are the findings?
What are the shortcomings of Indian exchanges?
Because Indian exchanges are part of market infrastructure and have a social obligation (notwithstanding that they might have been set up with private capital), it is necessary for the RBI to be transparent and open about the justification for issuing the draft guidelines.
Did commercial banks play any part in influencing RBI decision to issue the said directions?
If there is pressure on the RBI from large corporate houses, let the RBI decide on case by case basis. In any case, asking the corporate houses to retain at least a modest part of their price risk management activity within the country by supporting domestic exchanges would make eminent sense.
Instead of seeking to export commodity derivatives trading to overseas exchanges, the attempt by all stakeholders including regulators should be to promote Indian exchanges.
The draft RBI directions seek to do the exact opposite.
Indeed, the decision to allow foreign participants to enter Indian commodity derivatives market is at an advanced stage of finalisation.
Our market must attract overseas players; and not the other way round.
The writer is a global agri-business and commodities market specialist. Views are personal.
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