Govt panel suggests reforms in domestic markets

Panel seeks removal of ambiguities on taxation, investor participation to bring markets on a par with offshore ones

Mumbai: A government-appointed panel has recommended the removal of several ambiguities related to taxation, investor participation and product innovation to bring the domestic currency, equity and commodity derivatives markets on a par with offshore markets.

The committee has suggested that the exchanges should be given more powers to decide on trade timing and product specifications, while the government can look at easing the strict know your customer (KYC) rules and consider removal of securities transaction tax (STT) in the case of equity derivatives. Allowing banks and mutual funds into the commodity futures segment should also be considered, the committee said.

A report listing all the recommendations has been prepared by the finance ministry’s standing council on international competitiveness of the Indian financial sector.

“This committee recommends that the ministry of finance and financial sector regulators should analyse every regulatory question from the viewpoint of global competitiveness to identify the areas in which we fall short," the report said.

“For India to compete in the new globalized world of finance, our markets must match these competitor markets in three respects: rationalize and ultimately remove capital controls, achieve technically sound financial regulation, and shift to residence-based taxation," adds the report.

The committee has listed a set of short-term actions, along with medium- and long-term goals that need to be achieved, to make India more competitive.

According to the panel, short-term actions can be implemented within the next six months, while medium-term goals need to be evaluated but can be implemented within two years. Long-term goals would require significant changes in existing policies and rules, including moving towards fuller capital account convertibility.

For the currency derivatives market, the tax department must clear ambiguities in the direct tax treatment of exchange-traded derivative products for domestic firms, the expert panel recommended.

For example, a stamp duty of 0.002% of the turnover is applied on Indian exchanges. While competing markets such as Dubai and Singapore follow a residence-based taxation regime, India follows a source-based direct taxation regime, except in the case of Mauritius and Singapore where India has specific tax treaties in place.

Further, the Reserve Bank of India (RBI) should ease requirements to do with the provision of documents proving an underlying foreign exchange exposure before allowing an entity to take positions in the derivatives markets. The panel is also against any form of restriction on the participation of domestic institutions in the exchange-traded currency derivatives market.

“There should be no ban on market participation," said the panel, adding that the exchanges should be given the freedom to select what currency pairs to trade.

Currently, RBI allows trading based on four currency pairs such as the US dollar-rupee, Japanese yen-rupee, euro-rupee and pound sterling-rupee.

For currency derivatives, the long-term road map should include considering internationalization of the Indian currency, said the panel.

The government and regulators should “consider a time-bound plan for the internationalization of the rupee, in line with the plans of the Chinese government for the internationalization of the renminbi," the panel suggested.

“It all hinges upon full capital account convertibility and how open we are for free movement of the currency. RBI has done a substantial amount of convertibility in a calibrated manner. Actually, there is not much of a problem for investors to trade freely, as is evident from the trade volumes," said N.S. Venkatesh, executive director, treasury and international banking at IDBI Bank Ltd.

“Of course, more needs to be done before the rupee can be internationalized but that (current regulation) is not hampering free trade," Venkatesh said.

In the case of equity derivatives, the committee has suggested the removal of STT and stamp duty, along with extended trade timings and regulatory clarity on participatory notes (PNs), as part of the short-term actions. As part of the medium-term goals for equity derivatives, the committee has recommended the removal of regulatory restrictions on domestic financial institutions’ participation in equity derivatives. A committee should also be set up to rationalize margins vis-a-vis competitor markets such as the Singapore Exchange.

For commodity derivatives, the committee has recommended forming a high-level panel to create a robust warehousing system to strengthen delivery against contracts and a well-functioning market for warehouse receipt financing.

The medium-term goals for this segment include allowing foreign entities with commodity exposure to participate in the Indian commodity derivatives market. The panel also suggested that the central government’s powers to ban commodity derivatives trading in a specific commodity be taken away.

In the past, a surge in the price of agricultural commodities has prompted the government to ban futures trade in such commodities.

As a long-term goal for the derivative markets, the committee wants all regulators and the government to move to a residence-based taxation system.

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