Home / Industry / Sebi said to have concerns about forward contracts

Mumbai: Securities and Exchange Board of India (Sebi), which is set to take over regulation of commodities markets as well, is not comfortable with forward contracts in commodity exchanges, two people directly involved in the discussions between Sebi and exchange officials said.

According to them, Sebi’s concern stems from two facts: one, unlike futures contracts, forward contracts are not standardised; two, there’s greater counterparty risk associated with forward contracts.

Under the Forward Contracts (Regulation) Act, 1952, which regulates commodity trading in India, a forward contract is a contract for the actual delivery of goods, unlike a futures contract where the buyer can settle the contract in cash as well. Forward contracts were introduced in the commodity market last year, but they are not permitted in stock market.

Globally, the bulk of the forward contracts in commodities happens outside the exchange platform. Only futures and options are traded on leading commodity exchanges such as those belonging to the Chicago Mercantile Exchange (CME Group) and the London Metal Exchange (LME).

“The prime concern of Sebi is that a forward contract is not a standardized contract with complete counter-party risk guarantee, even though it is being traded on the exchange platform. Such an instrument is not allowed in the securities market and Sebi does not want to start regulating commodities with such grey areas," said one of the people.

Currently, the National Commodity and Derivatives Exchange Ltd (NCDEX) and the National Multi-Commodity Exchange of India Ltd (NMCE) offer forward trading in various commodities. While NMCE recently launched forward contracts in rubber, NCDEX has a basket of more than 25 commodities for forward trades. Multi-Commodity Exchange of India Ltd (MCX) currently does not offer forward contracts.

“It is unlikely that Sebi would allow forward trading in the current form. It has been discussed extensively in the meetings between regulatory and exchange officials. As such, the product has not really taken off and there would be no market wide impact (if it is discontinued)," said the second person. Both the people requested anonymity.

Responding to an email query, an NCDEX spokesperson said the subject of forward contracts came up in a number of meetings between exchange and Sebi officials to discuss various aspects of the functioning and regulation of the commodity markets, but no concern was raised. “During discussions with the exchange, Sebi officials have not expressed any concern about forward contracts. NCDEX offers a refined version of forward contract... that retains innate features such as flexibility to negotiate trading parameters, while increasing ease of trading by providing a firm legal underpinning to reduce counter-party risks," said the spokesperson.

As per NCDEX data, forward contracts worth less than 59 crore were traded between December and June; the bulk of the trade happened in commodities such castor seed and chana.

R.S. Loona, managing partner of Alliance Corporate Lawyers, a corporate law firm, said there have been certain issues in the commodities market with forward contracts in the past and this may weigh on Sebi’s mind. Currently, Sebi permits only futures and options in the derivatives segment.

“Sebi might try to bring the commodity contracts on par with that of the futures and options segment of the equities market. I am sure Sebi will do a lot of brainstorming on whether forwards should be allowed in commodities. Sebi is a strong and effective regulator and even if it allows, then it can monitor and regulate it," says Loona, a former executive director with the legal department of Sebi.

The NCDEX spokesperson added that the exchange is of the view that its forward contracts introduced under the provisions of FCRA will be within the definitions included in the SCRA (Securities Contracts Regulation Act) under the Finance Act 2015.

“With the kind of resources it has, it will be relatively easy for Sebi (compared to FMC) to monitor forward trading. Ideally, Sebi would not want to start regulating commodities with any grey area, but it should look at forward trading with better regulatory framework with complete counter-party risk guarantee that is a given for any exchange-traded product," says Girish Dev, managing director and chief executive officer, Geofin Comtrade Ltd, a commodities brokerage entity.

Emails sent to Sebi, FMC and the MCX remained unanswered till the time of going to press.

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