Since the beginning of this year India’s regulator the Securities Exchange Board of India (SEBI) has made major strides in regulating and opening up the country’s commodities markets, exciting news for active traders and investors in India.
The regulator, which now oversees both India’s equities and commodities markets, has for the first time set out a framework for the listing of commodity derivatives. Although there are around 50 types of commodities traded on India’s three commodity exchanges, up until now there has been no regulation in place defining what is required for the commodity to be listed – or even the minimum requirements for trading.
From April, commodities on which the exchanges propose to launch a new contract will have to satisfy a minimum annual turnover requirement, be homogenous, so that market participants are confident they understand what exactly they are trading, and be durable and storable. Commodities with highly volatile prices, a very seasonal nature and traded globally are seen as good candidates for derivatives contracts while commodities prone to price control and with excessive restrictions are not.
One of SEBI’s key requirements for derivatives listing is that the commodity’s annual turnover has been at least Rs5 billion ($74 million) across all national commodity derivatives exchanges in at least one of the last three financial years.
This criterion applies not only for new derivatives contracts but also contracts already traded on the country’s three commodity exchanges: Multi Commodity Exchange (MCX), National Commodity & Derivatives Exchange (NCDEX) and the rubber-focused National Multi Commodity Exchange (NMCE).
On MCX, the largest of the exchanges, the most actively traded contracts are crude oil, gold, zinc, copper, silver and natural gas. They are based on major international derivatives contracts – gold is a mirror contract of Comex gold, base metals are based on London Metal Exchange metal contracts and oil on the NYMEX WTI crude contract.
The smaller player, the online-based National Commodity and Derivatives Exchange (NCDEX), accounts for around 11% of monthly volumes of trade and lists a whole range of exotic commodities such as Guar Gum, Turmeric, Jeera, Cotton Seed, Oilcake and Mustard seeds. Non agricultural products are mostly steel, oil, gold, silver and copper. NMCE focuses mainly on rubber.
The majority of commodity contracts already trading on the exchanges satisfy SEBI’s size criteria except the NCDEX’s steel contract. SEBI has asked the exchanges to apply the new parameters to each of the commodities they are trading and to submit the results to the within the next three months.
The new criteria will make it easier for exchanges to consider launching new contracts because it makes it clear what kind of success criteria will be required by the regulator, exchange sources said.
Of the more than 50 types of commodities that are traded in India only about 10 to 15 are actually liquid enough. The most liquid contracts are oil, gold and silver, and base metals like copper, nickel and zinc. Natural gas is also fairly liquid. But some of the agricultural commodities, in particularly spices such as cinnamon and cardamom have lower volumes of trade.
Contracts with extremely shallow liquidity can cause problems for regulators, as they are more vulnerable to false trading or price manipulation. This type of manipulation is one of the main reasons for the major clean-up of the derivatives trade.
A large-scale scam on the National Spot Exchange (NSEL) in 2013 rocked India’s commodities market and has triggered the process of better regulation.
In the wake of the scandal the country’s then commodity regulator Forward Markets Commission merged in 2015 with SEBI, which at the time was in charge of overseeing the equities markets. Ever since then SEBI has been working on better regulating and opening up the commodities market, including making options trading available.
As ever, the process is not straight forward and although commodity exchanges started preparing for offering options trading in late 2016 this has now been put on hold because of legal hurdles. Also, SEBI’s more recent decisions have shifted the focus on different issues.
The new direction in the market stems from SEBI’s desire to align the regulation in commodity markets closer to existing regulation in the equity markets in which all the mentioned participants are already taking part in trade. Another aspect of aligning the commodity and equity markets is SEBI’s decision to ease up the roles for commodity brokerages.
The majority of brokerages, at least the larger ones, already trade both equities and commodities. Up until now equity brokerages had to set up a separate corporate entity to trade commodities but under the new rules the same brokerages will be able to trade in both equities and commodities.
SEBI’s new framework is being formulated as India is going through a tough process of financial cleansing. Late last year the government removed two main notes from circulation in order to cut down on money laundering, tax evasion and bribery, which is a routine part of the local business culture. At the same time it imposed limits on how much money can be withdrawn from ATMs on a daily and monthly basis, a move which stifled trade in December and January.
Trade on some of the smaller derivatives nearly ground to a halt in the past two months because a lot of the trade is done by individuals or farmers who don’t have large accounts, don’t accept check payments and generally prefer to operate in cash.
The Armchair Trader says:
Given the size and sophistication of the Indian retail trading market, some form of clean-up of the current practises is to be welcomed. With the additional likelihood of more participation of foreign brokers, Indian traders and investors should be offered a wider range of choice when it comes to trading futures, and hopefully be less exposed to fraud and market manipulation locally. The changes represent an important step to improving India’s futures market infrastructure.