Industry Backs SEBI’s FPI Commodity Proposal, Seeks Changes to Physical Delivery Framework

Market participants have backed SEBI’s proposal to open a wider part of India’s commodity derivatives market to foreign portfolio investors (FPIs), but they want changes to the way positions are handled as contracts move closer to physical delivery. 

Invest in Indian Markets and Unlock Future Potential With 5paisa!

Open Account Now

The industry’s concerns centre on one part of the proposed framework: transferring an FPI’s remaining position to a designated domestic broker if the foreign investor fails to exit before the delivery period. 

Instead, market participants want squaring off or rolling over positions through the market to remain the normal route. Moving an outstanding position to a trading or clearing member, they have suggested, should be kept as a fallback rather than becoming the primary exit mechanism. 

What Has SEBI Proposed? 

SEBI released a consultation paper on August 11 proposing that FPIs be allowed to participate in non-agricultural commodity derivatives, including contracts that are physically settled. 

That would cover commodities such as gold, silver, copper and other base metals. 

The proposal is intended to widen foreign participation in India’s commodity derivatives market, while improving liquidity and price discovery. 

The industry is broadly supportive of that direction. The disagreement is over what happens when an FPI still has an open position as a contract enters the physical delivery stage. 

Industry Wants Market Exit to Remain the First Option 

In its feedback to SEBI, the IMC Task Force on Capital Markets, headed by former MCX managing director and CEO Mrugank Paranjpe, has sought a clear distinction between trading a physically settled derivative and actually taking delivery of the underlying commodity. 

Under its suggested approach, FPIs would continue to square off or roll over expiring contracts through the market. If an investor exits before the tender period begins, merely having traded the contract should not create a physical delivery obligation. 

The task force sees this clarification as important not only for foreign investors, but also for custodians, trading members and clearing members involved in these transactions. 

Who Takes the Position if an FPI Cannot Exit? 

The more complicated issue arises when an FPI is unable to close its position before delivery. 

SEBI’s proposed mechanism allows the residual position to be moved into the proprietary account of a designated trading member or trading-cum-clearing member. 

Market participants see a practical problem with this arrangement. 

A significant part of the clearing and broking capacity in commodities sits with banks and their subsidiaries. RBI restrictions, however, prevent them from holding proprietary positions in commodity derivatives. 

That could leave smaller non-bank intermediaries carrying positions that larger and better-capitalised institutions cannot absorb. 

The industry has therefore sought commodity-wise limits on how much exposure a designated member can take. An FPI’s near-month position, under this approach, would not be allowed to exceed the broker’s pre-approved capacity to absorb it. 

Margin and Position-Limit Questions Remain 

There are operational questions as well. 

Market participants want greater clarity on when an FPI’s margin would be released, when margin would be collected from the designated member and how the position would move between the two. 

They have also flagged the absence of a clear ceiling on the amount of risk that can build up with a single broker. 

Another unresolved issue is who would own the margin and bear any profit or loss while a position is being transferred. Differences between futures and options position limits could create further complications when residual positions change hands. 

India has tried a physical-delivery route for foreign investors before. Between 2018 and 2022, foreign investors were allowed to take physical delivery through authorised brokers. That framework was eventually withdrawn following low participation. 

Industry Suggests a Phased Start 

Rather than opening the framework widely from the beginning, some market participants have suggested a phased introduction. 

One option is to start with FPIs based in GIFT City’s International Financial Services Centre (IFSC). Participation could then be extended to bullion and energy contracts before eventually moving into base metals. 

The consultation period on SEBI’s proposal closed on September 1. The regulator is expected to issue its final circular after considering the feedback received from stakeholders. 

For the industry, the broader direction has found support. The remaining debate is over the plumbing of the system particularly how FPIs leave expiring contracts without shifting an outsized delivery and market risk onto domestic intermediaries.