Mumbai: The Securities and Exchange Board of India (Sebi) may soon allow mutual funds (MFs) to trade in commodity derivatives on exchanges, giving retail investors indirect exposure to the commodities market for the first time.
Sebi chairman U.K. Sinha said on Friday that the regulator will amend existing norms within a month or so to allow MFs to invest and trade in commodity derivatives on exchanges.
He told reporters on the sidelines of a conference that low participation of producers and hedgers is a concern for the market regulator, while the launch of new products such as options will need amendments to the Securities Contracts (Regulation) Act or SCRA.
Mint first reported in March last year that Sebi was planning to change commodity market rules to introduce transparency, reduce risks and include new participants such as banks, mutual funds, foreign portfolio investors (FPIs) and alternative investment funds, in an effort to improve liquidity.
In fact, on 17 March 2016, the SCRA was amended to include commodity derivatives as “eligible securities", which essentially meant that institutions such as FPIs and MFs could invest in the commodity derivatives market. However, the respective regulations for MFs and FPIs are yet to be amended to enable participation of these institutional investors in the commodity derivatives market.
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The changes were proposed by Sebi’s Commodity Derivatives Advisory Committee, which was formed after the erstwhile commodities market regulator, the Forward Markets Commission (FMC), was merged with Sebi in September 2015.
Allowing entry of new categories of investors in the commodities trading space will mitigate risks of volatility and defaults by deepening the market for hedgers, according to the panel.
G. Chandrasekhar, an independent commodity market expert, said, “Commodities market is somewhat risky, especially in the agricultural space. It does not have retail investors at present and mutual funds’ participation will give an indirect exposure to retail investors. Although entry of mutual funds will help in deepening the commodities derivative market, ideally, mutual funds should not be allowed to invest in derivatives based on agricultural commodities since this sector is prone to higher domestic risks such as inflation and it will unnecessarily increase investment risks for small retail investors.
“Initially, mutual funds should be allowed to invest in metal and energy-based commodities because they are more regulated, more liquid and internationally traded. Ideally, there should be a capping for mutual fund investments in commodities, similar to what banks have for equity market investments," he added.
Sinha, whose term ends on 1 March, said that in order to facilitate options trading in commodities, the regulator may allow exchanges to launch a special type of commodity options whose settlement may be done like commodity futures—on maturity.
To weed out trading risks to investors because of limitations in the types of commodities contracts, the panel also proposed the introduction of new exchange-traded products such as options based on commodities.
Options contracts give hedgers a form of price insurance, the cost of which is the option premium determined during its trading. They give option buyers the opportunity to limit losses, but ensure profits from favourable changes in futures prices.
Trading in commodity derivatives and options contracts may allow banks to offer customized derivative products, suiting hedging requirements of their clients by blending credit products with hedging products, according to a commodity market expert who is aware of Sebi’s plans. The person spoke on condition of anonymity.
On 20 January, the market regulator floated a discussion paper inviting comments on how to settle and price commodity options contracts, the absence of which was making it difficult for exchanges to launch the product. For this, the regulator proposed amendments to Stock Exchanges and Clearing Corporations regulations.