The Securities and Exchange Board of India (SEBI) is gearing up to usher the next set of reforms in the commodity market by allowing mutual funds to participate in the segment while also actively considering allowing derivatives on commodity indices.
A SEBI committee is separately looking into the issue of physical settlement for commodity derivative contracts. This comes two months after the regulator made it mandatory for stock derivatives to move to the physical settlement mechanism in a phased manner.
“The proposal for allowing mutual funds and portfolio management services (PMS) in the commodity derivatives segment is awaiting final approval by SEBI, which is also actively considering allowing derivatives on commodity indices,” said a person who is directly involved in the discussions.
The Commodity Derivatives Advisory Committee, which met recently, deliberated upon the issue of physical settlement in commodity derivatives and formed a subgroup to look into this specific matter. Based on the suggestions of the advisory committee, the regulator is soon expected to issue a consultation paper before framing the final guidelines.
“There seems to be a perception that there is a lot of speculative trading in the commodity segment and hence the points about physical settlement were raised,” said another person familiar with the development.
Physical settlements
“Initial discussions have happened and the committee has formed a subgroup to deliberate further. Data will be analysed along with the other dynamics of the commodity market and then suggestions would be framed,” he added, wishing not to be named since the discussions are not yet public.
Physical settlement refers to the system where the contract on the day of expiry is settled through the delivery of the underlying commodity instead of the current practice of cash. This assumes significance as currently only about 1-2% of the total turnover of certain commodities is settled by way of physical delivery.
The regulator, however, will have to first frame the warehousing guidelines for non-agriculture commodities before going ahead with physical settlement. In September 2016, SEBI introduced warehousing norms for agri-commodities to ensure that exchanges do not face any default risk while the settlement and delivery of the commodity is assured.
Equity exchanges BSE and NSE, which plan to start commodity trading from October, have asked SEBI to allow co-location in the commodity derivatives segment as well.
Co-location refers to the facility wherein brokerages can house their servers inside the exchange to get better speed for trade execution. Since the broker's server is placed close to that of the exchange, the latency is reduced.
It is believed that the two leading commodity bourses, Multi Commodity Exchange of India and National Commodity and Derivatives Exchange, have conveyed to SEBI that while they do not oppose co-location, they need to be given adequate time to put in place the required infrastructure for offering co-location facilities.