The NSEL imbroglio has trained attention on the working of spot exchanges and the risks associated with a lack of strict regulatory oversight. While the futures exchanges are by and large well regulated, the same cannot be said of spot exchanges.

But do we need spot exchanges? Yes, we do. It is well recognised that the sustained development of a futures market for commodities (for price discovery and price risk management) depends on the development of the physical or spot market. So, a need was felt for pan-India commodity spot exchanges on the lines of commodity futures exchanges.

While modern online futures exchanges started to function from 2003, it was only in 2007 that spot exchanges came into operation. It is ironic that policymakers put the cart before the horse by encouraging the setting up of futures exchanges even before reforming the antiquated and opaque cash market.

The influence of World Bank and UNCTAD was evident. It is well recognised that the futures market cannot function efficiently without an efficient underlying physical market. But we created a superstructure of commodity futures exchanges on a shaky, unreformed physical market.

Be that as it may, in order to provide adequate liquidity on the trading platform of spot exchanges, the Government permitted them the facility of offsetting contracts on the day they are entered into.

If, however, the contracts are not offset the same day, it will compulsorily result in a delivery of goods. Since offset contracts are defined as “forward contracts” in the Forward Contracts Regulation Act, 1952, the Ministry of Consumer Affairs, exercising its powers under section 27 of FCRA, exempted all one day forward contracts for the sale and purchase of commodities traded on three spot exchanges — the National Spot Exchange of India Limited (NSEL), NCDEX Spot Exchange Ltd and the National APMC.

The exemption was subject to some conditions such as “no short sales” and compulsory delivery of all outstanding positions at the end of the day.

Regulatory vacuum

Admittedly there has been a regulatory vacuum in the governance of spot exchanges for customer protection and risk management and settlement systems.

The Financial Stability and Development Committee (FSDC) set up for inter-regulatory co-ordination has, time and again, raised this issue with respect to contracts traded on electronic spot exchanges, including e-gold and e-silver traded at NSEL.

At the second meeting of the FSDC sub-committee on May 24, 2011, a senior Reserve Bank of India official had stated that the spot exchange does not fall under the regulatory purview of either the Securities and Exchange Board of India (SEBI) or the Forward Markets Commission (FMC).

At the meeting, the SEBI chairman agreed there was a large regulatory vacuum, important given the growing volumes and increasing retail participation.

Constitutional provisions

The subject “Markets and fairs” is covered in entry 28 of the State List in the VIIth Schedule of the Constitution. The States have enacted Agriculture Produce Marketing Committee Acts under the entry, but these apply only to agricultural markets.

The spot exchanges have accordingly taken licences from the appropriate State governments and have provided a platform for trading in the commodities notified under the Act. However, trading in commodities such as metals, which are outside the purview of the APMC Acts, is also carried out.

While intra-State spot trading is subject to State government regulation, “inter-State trade and commerce” is covered in entry 42 of the Union List and “Stock exchanges and futures markets” is covered in entry 48 of the Union List in the VIIth Schedule VII.

The trading facility provided by the spot exchanges is both intra-State and inter-State; therefore, these exchanges fall within the purview of both State and Union regulations. Presently, there is no legislation to regulate such trade executed on electronic spot exchanges.

Entry 33 in the Concurrent List of the VIIth Schedule covers trade and commerce in the following commodity groups: “Trade and commerce in, and the production, supply and distribution of — (a) The products of any industry where the control of such industry by the Union is declared by Parliament by law to be expedient in the public interest, and imported goods of the same kind as such products; (b) Foodstuffs, including edible oilseeds and oils; (c) Cattle fodder, including oilcakes and other concentrates; (d) raw cotton, whether ginned or unginned, and cottonseed; and, (e) raw jute.”

Thus, Parliament is competent to enact legislation covering spot trade and commerce — inter-State and intra-State — in these commodities.

Legislating regulations

(a) Warehousing Development and Regulatory Authority (WDRA): On October 11, 2010, the WDRA had circulated a draft Bill in which it had sought to regulate trading in electronic warehouse receipts (EWRs). Soon after this was discussed in the WDRA Advisory Committee meeting on August 12, 2011, the FMC in its comments expressed reservations about trading in EWRs being regulated by the WDRA.

Based on the comments received from different agencies, the WDRA revised the draft EWR Regulations in 2012. Again, on November 5, 2012, FMC had conveyed that trading in EWRs effectively means trading in the goods represented by these EWRs.

(b) Department of Agriculture and Cooperation: The Department of Agriculture and Co-operation had prepared the Inter-State Agricultural Produce Trade and Commerce (Development and Regulation) Bill, 2012, to facilitate the seamless trading of agricultural produce.

A committee was constituted by the Ministry of Consumer Affairs to examine the provisions of the Bill vis-à-vis the WDRA Act, the Essential Commodities Act and other related laws.

While forwarding its views on the draft Bill, the FMC had observed that spot commodity exchanges and futures trading in commodities should be regulated by a single regulator, the FMC.

The definition of inter-State trade and commerce proposed in the draft Bill should be specific to exclude “forward trade” and “forward markets” from the purview of the proposed Act so that no regulatory overlap is created subsequently through an incorrect interpretation of the terms used in the draft Bill.

Role of FMC

It is clear that from 2012, the FMC has maintained a consistent stand on the issue of spot market regulation or trading in EWRs.

As for spot exchanges, the role of the FMC is limited by the condition imposed by the Ministry of Consumer Affairs through its notification dated February 6, 2012, which stated that all information and returns relating to the trade as and when asked for should be provided by the commodity spot exchanges to the Central Government or the FMC, the designated authority.

Clearly, until it is empowered to do so, the FMC has no locus standi to regulate spot markets.