Mumbai: The government is likely to introduce stringent norms for commodities spot markets to prevent payment crises such as the one that surfaced at National Spot Exchange Ltd (NSEL) in 2013 and was later exposed to be a case of fraud, two people with direct knowledge of the government’s plans said.
The commodities spot market may also be integrated with the derivatives market to improve regulatory control, the two people said, requesting anonymity as the plans are at an initial stage.
“There is a lack of transparency in spot trades and their bearings on prices of futures contracts,” said one of the two cited above. “In order to deter participants from breaking the conventional relationships between spot and derivative prices, especially in agri-commodities space, there may be much stricter margining system than the one applied to the existing commodities derivative market.”
An e-mail sent to the finance ministry’s department of economic affairs, which is tasked with integrating the two markets, did not elicit a response.
The government is planning to form an expert panel to recommend ways to integrate the two markets.
“The government has consulted the Securities and Exchange Board of India or Sebi and commodities market experts,” said the first person.
The entire ecosystem of commodities trading will benefit from the integration of spot and derivatives markets, said Naveen Mathur, head of business development at Multi Commodity Exchange of India Ltd.
“Right now they function as two standalone markets even though prices of derivatives are supposed to be based on the prices of the underlying commodities which are traded in the spot market,” Mathur said.
The government panel will examine the correlation between the spot and futures markets and how a break in co-relation can be resolved without imposing liquidity risks, he said.
Finance minister Arun Jaitley, in the Union budget on 1 February, proposed to integrate the spot market with the derivatives market.
Regulatory gaps in the spot market were first exposed in 2013 when a Rs5,500 crore payout crisis broke out at NSEL, promoted by Jignesh Shah’s Financial Technologies India Ltd. An exemption from Forward Contracts (Regulation) Act (FCRA) granted by the consumer affairs ministry to NSEL led the exchange to launch one-day forward contracts. The absence of autonomous regulators led to lax supervision of the stocks held by 24 NSEL members and their ability to pay or deliver stocks on the days of contract maturities. When the government imposed a ban on trading of long-dated contracts in July 2013, it triggered a payments crisis at NSEL. A major portion of the dues owed to investors by their members at NSEL involved spot market trades in agricultural commodities.
Agriculture Produce Market Committees (APMCs), national electronic agri spot market platform (e-NAM) and state-level e-mandis are some of the known spot market models. On the other hand, NCDEX and MCX are the two nationwide bourses that trade in futures derivative contracts with commodities as the underlying.
Spot markets primarily involves trading in commodities from different regions of the country with varying qualities.
“So, there are both regional and seasonal parameters in the production and pricing of agri-commodities. Keeping this in mind, the government is looking to first define the exact meaning of integrated spot and derivatives market and the likely results of an integration of the two,” said the second person.
A committee for integrating the two markets is about to be formed by the government; a separate panel under Sebi—Commodity Derivatives Advisory Committee (CDAC)—has been working since 2015-end to suggest ways to improve the rules governing commodity derivatives.
In India, futures contracts are based on 90 underlying commodities with most of these falling either in the metals category and some in agricultural commodities segment. Of these, about 15-20 contracts are in the illiquid category and CDAC has suggested the market regulator remove illiquid contracts from exchanges to reduce the clutter and curb price manipulation.
Apart from finding ways to improve transparency in trades and check default risks, Sebi’s relook at commodity market rules is also aimed at improving volumes of exchange-traded commodity futures contracts, which have somewhat stagnated.
The combined monthly turnover of futures contracts traded on MCX and NCDEX stood at Rs5 trillion for March this year as compared to Rs5.69 trillion in March last year.