The markets regulator has proposed easing physical settlement rules for select agricultural commodity derivatives to boost liquidity and participation in a market that has struggled with weak volumes and operational hurdles.
In a Tuesday consultation paper, the Securities and Exchange Board of India (Sebi) proposed a phased framework under which some agri commodity contracts can initially trade as cash-settled contracts before transitioning to mandatory physical delivery.
Mint explains:
What are the proposed changes?
Sebi has recommended allowing exchanges to launch or revive select agricultural commodity derivatives contracts as financially settled products in the initial phase, before mandatorily shifting them to physical settlement once they meet predefined thresholds. These thresholds could include average daily traded volume, open interest levels or a maximum period of two years, whichever is earlier.
The proposal marks a shift from the regulator's current framework, under which physical delivery is the preferred mode of settlement for commodity derivatives contracts. Cash settlement is presently allowed only in exceptional circumstances, such as commodities that are difficult to store, transport or physically handle.
Under the proposed framework, contracts in select agricultural commodities that have historically suffered from low liquidity or repeated discontinuation could first build trading activity and market participation through cash settlement. Sebi has suggested that commodities such as maize, chilli and groundnut could be considered under a pilot programme.
Why are the changes needed?
Sebi said the existing framework, while improving market discipline and strengthening the link between futures and spot prices, has also led to structural issues in India’s agri-derivatives market. Several agricultural contracts continue to suffer from weak volumes, low open interest and limited participation from genuine hedgers.
“Although accredited warehouses and assaying mechanisms have expanded, their utilization in certain commodities remains limited,” it said in the draft paper. This has made it difficult for new or revived contracts to sustain liquidity.
“Agri commodity derivatives volumes in India have remained weak due to operational complexity around physical delivery. Mandatory physical settlement discourages participation from traders, hedgers, and market makers because of warehousing, logistics, quality certification, and financing challenges,” said Raj Shah, executive director and co-founder at EPP Securities.
He added that Sebi is trying to revive liquidity and participation in agri contracts through a phased and more flexible settlement framework. “The proposal also reflects recognition that India’s agri-derivatives market needs easier onboarding before deeper physical participation can develop,” Shah said.
Will the proposal help improve volumes?
Market participants said the proposal could improve liquidity and participation, but not dramatically. By lowering the operational hurdles associated with delivery-based contracts, the framework is expected to attract more traders, arbitrageurs, and smaller participants who currently avoid agricultural derivatives due to delivery risk.
“Partially, cash settlement will help create liquidity in the agri-commodity market. But speculation is possible in some select commodities, as these may not always be delivered. In the past, we have seen that potatoes are selling in the market at ₹5 per kg, but their contracts are settled at ₹20 per kg. It is a conscious decision to keep the threat of physical delivery,” said Narinder Wadhwa, managing director at SKI Capital Services.
At the same time, they said that settlement reform alone may not be enough to fully revive India’s agri-derivatives market. Frequent policy interventions, including export restrictions, stock limits and trading bans, continue to create uncertainty for traders and hedgers.
The proposal could also open the door for greater foreign investor participation in select internationally traded agricultural commodities. “India is a consumption story, and foreign portfolio investors want to be a part of it. FPI participation will be allowed only in international agri commodities where there are cash settlements of trades,” said Wadhwa.
Should Sebi move to a cash-settlement regime for farm goods?
There is divided sentiment on whether Sebi should eventually move to a fully cash-settled regime for agricultural commodities. Some participants said cash settlement can improve participation in fragmented or operationally difficult commodities, while others argue that physical delivery helps preserve the credibility of the futures markets.
“For some commodities, Sebi should move to a completely cash-settled regime—especially illiquid or highly fragmented commodities where physical delivery is operationally difficult,” said Shah of EPP Securities.
However, Sebi introduced physical settlement to curb excessive market manipulation and speculation arising from differences between futures and spot prices of commodities.
“A hybrid framework is preferable with physical settlement for major benchmark contracts, cash settlement for smaller or illiquid contracts, and optional delivery for intermediate contracts,” Shah said.
What are some other proposals?
In a separate consultation paper on Tuesday, the regulator proposed reviewing client-level position limits and penalties levied on violations of these limits in commodity derivatives.
Position limits are a risk-control tool in commodity markets. They cap the number of contracts a trader can hold in a commodity at any given time to prevent excessive speculation, concentration of positions, and potential price manipulation.
Position limits on different types of commodities, namely broad, sensitive and narrow commodities, were doubled to 2%, 0.5% and 1%, meaning that traders can now take larger positions in each farm good. Penalties levied for violating position limits were also eased by capping them at ₹2 lakh. There is no upper limit as of now.
“There was a need to revise the position limits as demand, supply and import of agri commodities have changed. At its current market size, one cannot have just a few lots of a commodity. The limits were very small and too little to play with,” said Wadhwa. “The penalties were very harsh. The proposal helps ease it for players who might accidentally breach the position limits a few times.”