New Delhi: Markets regulator Securities and Exchange Board of India (Sebi) on Monday asked exchanges to prefer physical settlement system for commodities derivatives contracts—a move that is expected to help hedgers manage risk better as well as curb excessive manipulation.

“The first preference of settlement type shall always be by the way of physical delivery," Sebi said in a circular. However, any exemption from physical settlement would be considered in certain scenario with a proper justification. Cash settlement route would be considered in case physical delivery is difficult to implement due to any reason including commodity is intangible; difficult to store due to low shelf life or inadequate storage infrastructure; and difficult to physically handle and transport the commodity because of inadequate logistics and transport infrastructure.

In order to effectively discharge their hedging function, Sebi said that commodity derivative contracts must be anchored to their respective underlying physical markets. An appropriate settlement mode plays a crucial role in ensuring convergence of prices between the derivatives market and the spot market, it added. The new framework would come into force from Monday.

Reliable benchmark price of the commodity should be used as reference for settlement price. The regulator asked exchanges to satisfy themselves that the reference spot price is robust—a fair indicator of prevailing prices and not susceptible to any distortion and manipulation. “... Both cash settled and physically settled derivative contracts on the same commodity may also be considered for trading, in case basis of price discovery of the proposed contracts is different," Sebi said.

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