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MUMBAI : Foreign portfolio investors (FPIs) can participate in the exchange traded commodity derivatives (ETCDs) market subject to certain risk management measures, the Securities and Exchange Board of India (Sebi) decided at its board meeting on Wednesday.

The regulator has set up a working group comprising its representatives and market participants to determine whether any new risk management regulation for FPIs is necessary.

The moves come after the regulator in February floated a discussion paper with respect to allowing FPIs in ETCDs, after FPIs and custodians expressed strong interest in participating in them.

FPIs will be allowed to trade in all non-agricultural commodity derivatives and select non-agricultural benchmark indices, Sebi said. Initially, they will be allowed only in cash-settled contracts.

“We welcome the decision of Sebi to allow foreign entities to participate in the Indian Exchange Traded Commodity Derivative market through the FPI route. Though they limited the participation to only non-agriculture and cash-settled contracts for now, it may be a small step towards expanding the reach of our markets. As India grows as an economic behemoth, it is important to integrate our commodity markets with global markets. Thus, this step opens up the gates for free flow of capital and ease of trading by foreigners, which will reduce pricing gaps and would help enhance the liquidity in our markets," said Kishore Narne, head, commodities and currencies, Motilal Oswal Financial Services Ltd.

Allowing FPIs to participate in ETCDs is likely to increase depth and liquidity in commodity derivative markets, the capital markets regulator said. Enhanced liquidity can gradually enable the Indian commodity derivative market to serve as a global benchmark for commodities and thus make India a price setter instead of being a price taker, Sebi said.

The previously used Eligible Foreign Entity (EFE) method has been terminated as it needed genuine exposure to Indian physical goods, Sebi said. Foreign investors may participate in Indian ETCDs through the FPI route, with or without actual exposure to Indian physical commodities, it said.

The regulator has already implemented the participation of category III alternate investment funds (AIFs), portfolio management services, and mutual funds in commodities markets.

Similar to the position restrictions set forth for currency derivatives, FPIs belonging to the categories of persons, family offices, and corporations will be permitted a position limit of 20% of the customer level position limit in a specific commodity derivatives contract, the regulator said.

Whilst there have been apprehensions that opening up the exchange traded commodities derivatives segment for FPIs may lead to a lot of volatility, it can be argued that such participation with adequate checks and balances put in place (through adequate risk management measures as contemplated) will enhance market’s ability to absorb relatively large orders without significantly impacting the price - thereby increasing liquidity, and will also help in efficient price discovery, said Gaurav Mistry, Partner, DSK Legal.

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