SEBI allows FPIs to participate trade in the commodity derivatives market.
On 29th September, the Securities & Exchange Board of India (SEBI) permitted Foreign Portfolio Investors (FPIs) to participate in the exchange traded commodity derivatives (ETCD) segment to increase depth and liquidity in the market. One question that comes to mind is; were the FPIs not allowed into commodity derivatives in 2018 itself? Back then, the FPIs were only allowed to trade in exchange traded commodity derivatives (ETCD) if they had an underlying exposure. That means only hedged transactions. Now FPIs can also trade exchange traded commodity derivatives (ETCD) from a trading perspective.
However, the regulator has underlined that the participation of FPIs in the exchange traded commodity derivatives (ETCD) segment would be subject to certain conditions. For instance, the FPIs would only be allowed to participate in cash settled non-agricultural commodity derivative contracts. Even in the case of indices, they cannot trade in agricultural indices. The idea is to avoid agricultural price volatility due to institutional participation. The agri market is extremely sensitive in India; both economically and politically. Hence on this subject, the regulator is treading very carefully.
Apart from the restrictions of only participating in cash settled futures and in non-agricultural derivatives, there are other conditions too. For example, FPIs desirous of participating in exchange traded commodity derivatives (ETCD) will be subject to risk management measures applicable, from time to time. In addition, the position limits will continue to apply for FPIs for trading in exchange traded commodity derivatives (ETCD). Within the FPIs, investors belonging to categories; individuals, family offices and corporates would be allowed position limits of 20% of client level position in a particular ETCD contract.
That will not be the end of the story. In fact, SEBI has clarified that the stock exchanges and the clearing corporations would be allowed to specify additional safeguards from time to time to manage risk and ensure orderly trading in exchange traded commodity derivatives (ETCD). To simplify the participation of FPIs, the existing route of Eligible Foreign Entity (EFE) has been discontinued. Under the EFE route, the FPI needed actual exposure to Indian physical commodities to be eligible for ETCD trading. With the EFE scrapped, FPIs can automatically trade in commodity futures, even without any underlying exposure.
Just a brief history on this subject. Back in October 2018, SEBI had permitted the EFEs having actual exposure to Indian commodity markets, to participate in the exchange traded commodity derivatives (ETCD) segment of stock exchanges, primarily for hedging their exposure. However, this did not excite the EFEs in exchange traded commodity derivatives (ETCD) segment even after nearly 4 years of existence. The commodity derivatives advisory committee had recommended discontinuing the existing EFE route, which was accepted by SEBI. With the EFE discontinuance, ETCDs don’t need underlying exposure any longer.
The commodity market has been suffering from falling volumes ever since CTT was introduced. With more than 10,800 FPIs registered, the regulator is betting that even a small percentage of participation from these FPIs would be good enough to make the markets deeper and wider. Like in the F&O market in equity and equity indices, it is estimated that the participation of the FPIs would also bring down transaction costs in the commodity futures segment. After all, in this business, it is the economies of scale that really matters.
One of the big changes brought about in the exchange traded commodity derivatives (ETCD) was the concentration of regulation with SEBI. The markets did get some widening with the introduction of indices and options, but the growth has still be quite disappointing since 2013. The government needs to seriously reconsider the logic of charging CTT. That should hopefully give the much needed fillip to the commodity derivatives market. After all, if the CTT cost is distorting the exchange traded commodity derivatives (ETCD) market, then there is sufficient reason to take a fresh look at that aspect.
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