SEBI permits foreign portfolio investors in commodity trading

SEBI permits FPIs in commodities derivatives
SEBI permits FPIs in commodities derivatives

by 5paisa Research Team Last Updated: Jun 30, 2022 - 01:31 pm 23.3k Views

In a move that was long in the offing, the Securities and Exchange Board of India (SEBI) has allowed foreign portfolio investors (FPIs) to actively participate in the exchange-traded commodity derivatives (ETCD) market. This refers to the trades put through the registered commodity derivative exchanges like the MCX and the NCDEX in India. This wide permission to FPIs to indulge in commodity derivatives was long in the offing and has finally been cleared. It is expected to provide more depth, liquidity and research driven trading.

Let us first look at a background. It is not that foreign players could not participate in the ETCD market. However, they could only take offsetting positions in the ETCD market against underlying exposures. For example, if a large trading house had exposure to crude oil, they could hedge that risk in the ETCD market. Now, all registered FPIs, including the alternate investment funds (AIFs), can also participate in the commodity derivatives trading even on cash settlement mode. That means; underlying exposure to the commodity is not needed.

However, even in the current form, there are some restrictions. SEBI has not permitted FPIs into agricultural commodities but only into the other three categories viz. Precious metals, energy products and industrial metals. However, the very fact that FPIs have been allowed to participate in the ETCD segment in cash settlement mode, means that the market will become wider and broader. This will not only enable greater liquidity but institutional participation would also mean that top-of-the-line research comes into play in ETCD.

Till date, the argument was that since the FPIs are financial investors, they must not be allowed to participate in the ETCD segment. However, when the FPIs continue to be one of the largest and dominant players in the equity futures and options space, there was no reason to keep them out of the ambit of ETCD market, which is also cash settled. However, a final word is yet to be out on whether any additional risk management and risk mitigation measures are required at this point in the larger interests of market integrity.

There would be applicable position limits for the FPIs too. For now, the position limits for FPIs, other than individuals, family offices and corporate bodies will be at par with the norms and rules presently applicable for mutual fund schemes. For example, the FPIs belonging to categories like individuals, family offices and corporates; are allowed position limits of 20% of the client level position limit of a specific commodity derivatives contract. This is almost at par with the limits prescribed for trading in currency derivatives segment.

For the foreign portfolio investors, there would be some distinct benefits that would accrue from participation in the exchange traded commodity derivatives (ETCD) market. In case they want to hedge their holdings in pure commodity holding or a basket of commodities, they can use the commodity indices to do a beta hedge. FPIs also bring more price efficiency, typically through greater use of algorithms and low latency trading. Overall, the ETCD market is likely to be a net beneficiary from greater FPI participation in ETCD markets.

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