MUMBAI: In a move aimed at deepening India’s commodity derivatives market, the Securities and Exchange Board of India (Sebi) is holding early-stage discussions with market infrastructure institutions to allow foreign portfolio investors to trade bullion derivatives without participating in physical settlement, according to two people familiar with the matter.
Foreign portfolio investors (FPIs) are currently allowed to trade only in non-agri commodity derivatives that are cash settled, such as crude oil and natural gas contracts. Sebi had opened up that segment to foreign investors in June 2022. Bullion, base metals and agri derivatives, however, are compulsorily deliverable upon contract expiry.
"Sebi is considering allowing foreign investors to rollover an expiring contract to the next contract to participate across the bullion derivatives suite (include futures and options). This would enable their participation without physical settlement,” said one of the two people mentioned above.
The discussions, ongoing for the last four months, have centred on allowing FPIs to rollover or square off positions before contracts enter the delivery period, the people said. Sebi has not taken a final decision yet.
For instance, gold futures on the Multi Commodity Exchange of India (MCX) are bi-monthly contracts that normally expire on the fifth day of an expiry month. The tender period, during which outstanding buy-sell positions result in delivery, usually starts on the first day of the expiry month and continues till expiry.
The proposal seeks to ensure FPIs exit or roll over positions before entering the delivery cycle. In gold futures contracts, this would require investors to roll over positions six times a year, said the second person.
An emailed query to Sebi remained unanswered.
Deepening markets
"Permitting FPIs into bullion derivatives will help deepen the market as more informed speculators enter in the form of FPIs," said Naveen Mathur, director, commodities and currencies, Anand Rathi Share and Stock Brokers Ltd.
Mathur said commodity markets require a diverse set of participants for hedgers to transfer risk to financial investors such as hedge funds and proprietary traders.
Hedging involves taking opposite positions in the spot and derivatives markets. For instance, a jeweller holding physical gold inventory may sell gold futures to protect against a fall in underlying prices.
If gold prices decline, gains from the futures position help offset losses in the value of the spot inventory. Greater participation from both physical users and financial investors is needed to enhance liquidity in such trades, Mathur said, adding that the entry of FPIs into bullion derivatives could help deepen the market.
"If a hedger anticipates a fall and sells forward, the speculator who takes an informed decision buys as he thinks prices would rise. This way the impact cost or cost to execute the trade would narrow, making the market liquid," said Sudhir Joshi, director, Khambatta Securities.
MCX, which began operations in 2003, runs the country’s most liquid commodity derivatives segment, followed by the National Stock Exchange (NSE), which entered the segment in 2018. BSE, which also launched commodity derivatives trading in 2018, has negligible volumes in the segment, while NCDEX offers trading in specified agricultural derivatives, according to Sebi data.
Highlighting the contribution of FPIs to the energy segment on MCX, Praveena Rai, its managing director and chief executive officer, said during the company’s recent quarterly earnings call that FPIs contributed in double digits to energy segment turnover, while accounting for 2-3% of overall turnover, with participation growing every quarter.
MCX commands a 99.9% share of the bullion derivatives market, including futures and options, while NSE accounts for the remainder. NSE has stepped up its focus on commodity derivatives over the past year through differentiated bullion and energy contracts.
BSE, meanwhile, plans to focus on the segment in due course, its managing director and chief executive officer S Ramamurthy said recently.