by- Jayant Manglik, President of Retail Distribution at Religare Securities Limited
Commodity markets are set to help India find its rightful place in the sun. Well, almost – if the FCRA (Forward Contracts Regulation Act) Amendment Bill is cleared soon. It has been passed by the earlier cabinet and was set to be approved by Parliament more than once. With the new government in place, no doubt it will be referred to the Standing Committee and this time it will proceed as planned. Indeed, it must because within the existing regulatory framework, the commodity exchange sector in India has largely run its course – there are few drivers for further development and only new policy and direction will ensure healthy growth from here on.
The journey till now has been one of fast growth where the commodity industry in India grew quickly till it was stymied by a triple whammy – the sequential imposition of CTT, increased margins and the NSEL fiasco within a period of three months last year. There have been some major wins – impact costs in several commodities are low (barring man-made taxes) and our commodity industry is now known and tracked for certain listed commodities. But this is where it all begins to stagnate if we don’t seriously alter the existing regulatory framework.
Large broking companies have been aggressive in hiring as well as increasing the market size and disseminating knowledge and information to clients in association with the regulator and with exchanges. They also have commodity-specific branches in mandis where there is significant physical agri trading. But farmer cooperatives and procurement agencies – both government and foreign – are not yet keen to actively come on to the exchanges. Most also run a corporate desk to cater to the hedging and risk management needs of corporate clients, which is one key reason why these markets were conceived in the first place. But a very small percentage of Indian corporate clients who are exposed to commodity price risks trade on the exchanges and the volumes generated by them have not reached anything approaching relevance. The situation is exactly the opposite in developed countries. Here’s why.
Because one key function of the exchanges is risk mitigation and try as we might, we are unable to do it effectively. Risk is never destroyed, it can only be transferred. Which means we have to be part of a larger risk basket if hedgers have to come in and for proper risk management the risk should ideally flow out of the commodity ecosystem. Therefore, large counterparties are needed e.g. banks, mutual funds and FIs. The depth and liquidity provided by them will also attract more speculators who will take on the risk from the hedgers in the quest for profits. These players may also be taking risks in other assets like equities and currencies. To align to international markets, open interest is important and only big players can provide it. Secondly, hedging cannot be done only using futures and it is imperative to add several other 2nd tier products like options. Any number of large Indian corporates with significant physical exposure are forced to hedge abroad. They hedge anyway, so why not in Indian markets with the same products available abroad? Besides, price and output swings make options an unusually appropriate product for India. Similarly indexes and synthetic products are required in response to market needs. But all this will need a new regulatory framework.
The other key function of exchanges is price discovery. True price discovery can only happen if all stake holders are participating in the process e.g. large corporates who have commodity exposure but who do not enter the markets because of lack of suitable products. So you are left with a skewed market with few real hedgers, a handful of arbitrageurs, and some speculators whose risk-taking role goes largely unappreciated. Only a new regulatory framework can facilitate this.
Then there is India’s medium-term aim of becoming a price-setter in the commodities that matter to us because of the tremendous impact prices have on our economy and our people. So why would we want to trade wheat or sugar or gold abroad when the physicals are here? In the medium to long term, our commodity markets need fresh and proactive legislation to make India a commodities trading hub. As we try to move from being price takers to price makers, we will also have to appreciate that other foreign participants who are stakeholders for a particular commodity must use our markets for hedging if we are to have legitimate price discovery here. This will require mindset change rather than just changes in laws.
Finally if we are to become Asia’s or one of the world’s financial hubs, there is no way you can do it without having a vibrant commodity market which is equal to or better than the rest of the world. Inevitably, all of this will need a new regulatory framework.
The existing regulatory framework was designed and conceived sixty years ago to prohibit forward trading in commodities. The FCRA Amendment must be passed now so that an enabling regulatory framework is in place & the good work done so far by the FMC, the exchanges and the intermediaries is allowed to reach its true potential of a healthy global market with proper price discovery and risk management having all stakeholders as participants. An enhanced FCRA will deepen the markets, bring professional practices, add new products and attract other participants. So the question is not whether a change is needed but how soon can we do it. With the introduction of electronic Spot Markets and the Warehousing Development Act, it is the right time for a more enabling regulatory framework. Our exchanges have done well even in a restrictive environment; imagine if there is a fair, open system with globally referenced regulation. In a world where commodity markets are becoming central to the world economy, this alone can ensure India’s rightful place the economic world order