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Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

More power for Sebi is good; but some checks are needed

Among other things, the government must ensure that crucial appointments at Sebi are above-the-board

The central government has done well to move on the proposal to merge Forward Markets Commission (FMC) with Securities and Exchange Board of India (Sebi). As this column has argued before, it’s best that surveillance and regulation of organized markets be done by the same regulator, across asset classes. See: bit.ly/1BPvLS8

The finance minister has also brought oversight of trading in government bonds, earlier done by the central bank, under Sebi, a reading of the Finance Bill suggests. (Although this may take at least another two years, as this will happen after the setting up of the Public Debt Management Office.) Not too long ago, the securities market regulator also got powers from the government to regulate collective investment schemes that had a corpus of over 100 crore.

With great power, comes great responsibility. Among other things, the government must ensure that crucial appointments at Sebi are above-the-board. In the past, Sebi appointments have been a subject of controversy. With greater powers and oversight over more markets, financial markets can ill afford a lapse on this front.

Of course, as pointed earlier, there’s a great deal of good that’ll come from the merger, and this is not to question the government’s move just because there are some risks. For instance, often, the same market participants take positions across different asset classes and it makes no sense to have different regulators oversee different parts of their trading behaviour, as this can also result in regulatory arbitrage.

Besides, with Sebi having proven its mettle as the most disciplined regulator in India, with fairly robust governance processes, there’s no point reinventing the wheel. It makes sense that all organized markets benefit from the same quality of regulatory oversight, such as the equity markets.

With assets such as gold, there has been confusion on whether it is a financial asset or a commodity, and who should be regulating trading on related products. In fact, in one such turf battle, Sebi had to back off when FMC claimed its stake on gold-related trading.

Another major issue was that previous governments always faced a stalemate when they attempted to amend the Forward Contract Regulation Act (FCRA), to develop the commodity futures market and empower FMC. There has never been enough political capital to back this move. Instead, repealing the FCRA, dissolving FMC, and bringing commodity derivatives regulation under Sebi has proved to be far easier. Now, commodity futures exchanges should be able to launch new products such as options, and should also expect new participants such as banks and foreign investors, which were among the aims of the FCRA amendment. It’s little wonder that shares of Multi-Commodity Exchange of India have risen by 17% in the past two trading sessions. It is being suggested that commodity exchanges may also be able to be launch equity trading. But this can’t be taken as a given, nor can it be considered to be an unqualified positive–the case of MCX Stock Exchange is a clear example.

Of course, the process for merging FMC with Sebi started soon after the National Spot Exchange Ltd crisis erupted in July 2013, and it became evident that regulation of commodity trading needed strengthening. FMC was quickly brought under the finance ministry, which has eventually made the merger with Sebi possible.

A reading of the Finance Bill suggests that although FMC will be dissolved, some of its staff will be transferred to Sebi, while some will be redeployed in other government services. It’s imperative that the transition is handled sensitively, and FMC’s domain knowledge is not lost. While many brand FMC as a weak regulator, it is largely a function of weak regulations.

In fact, FMC has done fairly well, keeping in mind its various constraints. The organized commodities market got a thumbs-up from the Maharashtra state government, when it procured sugar from National Commodities and Derivatives Exchange’s (NCDEX) spot segment, and ended up with annualized savings worth 50 crore, compared to its earlier procurement method.

NCDEX has also launched forward contracts for some commodities, including the sensitive tur and urad contracts, in which futures trading was banned. Over-the-counter trades from regulatory purview, and those who trade in this form have to bear counter-party risk. Forward contracts done through an exchange platform will have the added comfort of having a central counterparty. Besides, while futures contracts necessitate dealing in standard quantities and grades, market participants and end users can trade in any quantity and any grade of these commodities in the forward market. The merger process should ensure that these gains are not withered away, and that key FMC officials with domain knowledge are retained.

Sebi can also inspire greater confidence in its processes by voluntarily meeting all the benchmarks set by the Financial Sector Legislative Reforms Commission for regulators.

While there’s little doubt that Sebi has earned the respect it has got from policy makers, it must realize that with its increased powers, the bar has just been raised.

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