Big Picture. Ringing in a new era for commodity market

After 12 years of debate between the Centre and various parties, the Forward Markets Commission (FMC) has finally merged with the Securities and Exchange Board of India (SEBI).

The Forward Contracts Regulation Act (FCRA) now stands repealed. Commodity derivatives will be governed by rules of the Securities Contract Regulation Act (SCRA) and commodity exchanges will now become deemed stock exchanges. This paves the way for new products and opens the door for banks, mutual funds and other institutions to start commodity trading. What helped the case for a merger this time was the scam at NSEL and the public furore that followed.

Since the spot commodity market was governed by State Governments, FMC did not have enough powers to take action against NSEL. The collapse of the exchange resulted in a loss of about ₹5,300 crore for more than 13,000 investors.

Now, with SEBI having taken up arms, the commodity market is all set to regain investor trust.

While FMC has been in existence only since 2003, SEBI has over 25 years of experience in regulating markets. Market participants expect a more disciplined commodity market under SEBI’s governance. The watchdog has powers to search, confiscate, attach property and arrest defaulters. Interestingly, while FMC didn’t have direct powers to regulate brokers, SEBI can do that too. In 2013-14, SEBI inspected 160 stock brokers and 57 sub-brokers for regulatory compliance, investor grievance redressal and clearing operations. It investigated over 100 cases for reasons including market manipulation and price rigging.

Regulatory action was taken against 1,436 entities — with 619 of them facing penalties.

The other benefit is better processes and systems for commodity derivatives trading. UK Sinha has already indicated that the price polling mechanism will be reformed. As settlement in the futures market takes place at the price discovered through the polling process in the spot commodity exchanges, it is crucial that the polling is done in a transparent manner.

Though in the last few years FMC has been asking commodity exchanges to disclose details of the price polling process, participants continue to complain about the opacity of this process.

Commodity investors will also have new investment products to trade in over the next few months. As the SCRA allows trading in index futures and instruments, such as options, these will now be available for commodity traders too.

According to brokers, commodity options will appeal to traders because CTT will be applicable only on the premium and trading cost will be lower relative to futures.

Liquidity on commodity contracts is also set to improve as the regulator is open to let institutional investors trade on commodities. Banks, mutual funds and even FPIs may come in. Many large gold manufacturers hedge their gold exposure outside India since it is difficult to find counter-parties for the large volumes they transact in.

Introduction of long-term contracts will also be beneficial to hedgers.

There will be benefits for farmers and middlemen too. SEBI may look at improving the physical delivery mechanism and warehouse logistics, say market experts. Samir Shah, MD and CEO of NCDEX, says, “The last couple of years have seen a host of warehousing reforms towards stronger governance and improved quality standards in exchange-approved warehouses. With the warehousing sector under the regulation of WDRA, a synergistic approach between the two regulators will pave the way for robust market development.”

With the equity and commodity regulators merging, equity exchanges can open commodity platforms and vice versa.

MCX’s Joint MD, PK Singhal, in an interview earlier with BusinessLine indicated that he sees both the NSE and the BSE getting ready to launch a commodities platform and MCX getting ready to face competition.

Market participants will then choose the best platform, based on the technological superiority as well as transaction cost. A trader in both equity and commodity may opt for an exchange that offers both these platforms, thus allowing fungibility of margins and single KYC.

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