INTRODUCTION:
Forward Market Commission (FMC):
FMC headquartered at Mumbai, was a regulatory authority, overseen by the Ministry of Finance,
Department of Economic affairs, Government of India. It was a statutory body set up in 1953
under the Forward Contracts (Regulation) Act, 1952. The commission regulated the commodity
derivative market in India. The FMC was originally overseen by the Ministry of consumer
affairs; however from September 2013 post the Rs 5600 Crore National Spot Exchange Limited
(NSEL) Scam which surfaced in July 2013 the commission’s responsibility was moved to the
Ministry of Finance, to reflect the fact that futures’ trading was becoming more of a financial
activity. The NSEL Scam was considered to be one of the biggest scams in the history of
financial markets in India.
The Forward contract (Regulation act), 1952 under which FMC was constituted was more of an
enabling act and the FMC was a kind of an advisory and a monitoring body rather than a full
fledged regulatory organization. The real regulatory powers under the act were still vested with
the Union Government. Not being sufficiently empowered served as major hindrance for FMC in
discharging its regulatory role and this was considered to be the trigger due to which the NSEL
Scam took place.
In the year 2010 the government approved amendments to the Forward contract Regulation act
by introducing the Forward contract regulations amendment bill, 2010 in the parliament.
However, the bill lapsed and could not be passed. The passage of the bill would have provided
more powers to the FMC and would convert it to an independent regulator (similar to SEBI)
thereby strengthening the regulation of the commodity future market.
In fact post the NSEL Scam and the Imposition of Commodity Transaction Tax (CTT) of 0.01 %
by the Government of India on all non agricultural and some agricultural commodities in the
year 2013, the volumes in the commodities market were significantly hit. During the period April
2013 to December 2013, the total turnover of all commodity exchanges fell from Rs 787,433
crore to 292,292 crore. Of all the national commodity exchanges, MCX was the most severely
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hit. Other commodity exchanges were also hit but they could recover modestly by the end of
December 2013. The details of how individual commodity exchanges suffered in terms of loss of
volume during this period are provided in Exhibit I. The happening of the scam and the
consequent decline in the volumes in the commodities market was majorly attributed to the fact
that FMC had not been sufficiently empowered to discharge its role as a regulator.
The Securities and Exchange Board of India (SEBI):
The Securities and Exchange Board of India was enacted on April 12, 1992 in accordance with
the provisions of the Securities and Exchange Board of India Act, 1992. SEBI has its
headquarters at the business district of the Bandra- Kurla complex in Mumbai with regional
offices spread all across major cities in India. The Preamble of the Securities and Exchange
Board of India describes the basic functions of the Securities and Exchange Board of India as
“...to protect the interests of investors in securities and to promote the development of, and to
regulate the securities market and for matters connected therewith or incidental thereto”. SEBI
has been granted statutory powers with respect to a) protecting the interests of investors in
securities (b) promoting the development of the securities market and (c) regulating the securities
market. Its regulatory jurisdiction extends over corporate in the issuance of capital and transfer
of securities, in addition to all intermediaries and persons associated with securities market.
Structure:
SEBI has a corporate framework comprising various departments each managed by a department
head. There are about 20+ departments under SEBI. Some of these departments are corporation
finance, economic and policy analysis, debt and hybrid securities, enforcement, human
resources, investment management, commodity derivatives market regulation, legal affairs, and
more.
The hierarchical structure of SEBI consists of the following members:

The chairman of SEBI is nominated by the Union Government of India.

Two officers from the Union Finance Ministry will be a part of this structure.

One member will be appointed from the Reserve Bank of India.

Five other members will be nominated by the Union Government of India.
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Functions:

SEBI is primarily set up to protect the interests of investors in the securities market.

It promotes the development of the securities market and regulates the business.

SEBI provides a platform for stockbrokers, sub-brokers, portfolio managers, investment
advisers, share transfer agents, bankers, merchant bankers, trustees of trust deeds,
registrars, underwriters, and other associated people to register and regulate work.

It regulates the operations of depositories, participants, custodians of securities, foreign
portfolio investors, and credit rating agencies.

It prohibits inner trades in securities, i.e. fraudulent and unfair trade practices related to
the securities market.

It ensures that investors are educated on the intermediaries of securities markets.

It monitors substantial acquisitions of shares and take-over of companies.

SEBI takes care of research and development to ensure the securities market is efficient
at all times.
Powers:
The SEBI has three main powers:
i. Quasi-Judicial:
SEBI has the authority to deliver judgments related to fraud and other unethical practices in
terms of the securities market. This helps to ensure fairness, transparency, and accountability in
the securities market.
ii. Quasi-Executive:
SEBI is empowered to implement the regulations and judgments made and to take legal action
against the violators. It is also authorized to inspect Books of accounts and other documents if it
comes across any violation of the regulations.
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iii. Quasi-Legislative:
SEBI reserves the right to frame rules and regulations to protect the interests of the investors.
Some of its regulations consist of insider trading regulations, listing obligation, and disclosure
requirements. These have been formulated to keep malpractices at bay.
Despite the powers, the results of SEBI’s functions still have to go through the Securities
Appellate Tribunal and the Supreme Court of India.
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FMC MERGES WITH SEBI:
The most awaited budget speech for the year 2015- 16 was being delivered. “I propose to merge
the FMC with SEBI to strengthen the regulation of the commodity forward market and reduce
wild speculation,” finance minister Arum Jaitley said while delivering the speech. The coming
together of two of the most critical regulators was thus announced. This was the first major case
of two regulators being merged as against a more popular practice of creating new regulatory
authorities by carving out new bodies from existing ones. Their coming together was in line with
a recommendation made by the Financial Sector Legislative Reforms Committee (FSLRC) set up
in the year 2013 which had called for a unified regulator across financial products including
capital markets, insurance, pensions and commodities. The stock of Multi state Commodity
Exchange (MCX), the largest commodity exchange of India reacted to this announcement of
merger and gained almost 6 % and touched a 52 week high of Rs 1144 on the Bombay Stock
Exchange (BSE). A long standing debate on merging between the stock market and commodities
market with arguments for it and against it was finally put to rest on the September, 28, 2015
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with the coming together of the two regulators. Earlier SEBI used to regulate the stock and
currency markets only and FMC was empowered to regulate commodity markets in India. So the
stock exchanges namely the National Stock Exchange (NSE) and the Bombay Stock Exchange
(BSE) were under the jurisdiction of SEBI, whereas the commodity exchanges which include the
six major national exchanges, Multi Commodity Exchange of India Ltd (Mumbai), National
Commodity and Derivatives Exchange Ltd (Mumbai), National Multi Commodity Exchange of
India Ltd (Ahmadabad), ACE Derivatives and Commodity Exchange Ltd (Mumbai), Indian
commodity Exchange Limited (New Delhi) and Universal Commodity exchange ltd (Navi
Mumbai), apart from the 16 regional commodity exchanges were under the jurisdiction of the
FMC. Now with FMC no longer in existence with effect from September 28, 2015, even the
commodities market would come under the jurisdiction of SEBI.
Things may change now on; soon we may see commodities like sugar, chana and metals being
available for trading on NSE and BSE trading terminals and shares of companies being displayed
on trading screens of MCX and NCDEX. In the light of this background, this case study by first
providing an overview of the two regulatory bodies (The FMC and SEBI), proceeds to provide
insights into the motives, implications and technicalities associated with the merging and thereby
aims to provide a perspective on such and related issues.
In the first ever merger of two regulators, over 60-year-old commodities market, the forward
market commission [FMC] legislative body merged with SEBI’s capital markets watchdog on
28th September 2015 with finance minister Arun Jaitley ringing the usual bell of the stock market
to formalize the merger.
Chairperson U.K sinha of India’s Securities exchange board of India [SEBI] said commodities
market organizations would have a timeframe of up to one year to adapt to the new laws as they
would have to follow the same standards that apply to their equity segment colleagues.

The congress government scheduled this merger between the SEBI and the FMC has its
origins in the 2014-2015 Union budget.

The national spot exchange ltd. The scam has precipitated a merger involving more than
Rs. 5000 Crore in a payment crisis. This was considered by the FMC to be a regulatory
failure.
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
Finance minister arun jaitley suggests that this merger would help enhance the country’s
market regulation and enhance the company environment in turn.

Since 1953, the FMC has regulated commodity markets, but the absence of powers has
resulted in wild fluctuations and supposed irregularities in this market segment remaining
untamed.

This is the first major case of the merging of two regulators in India.
The SEBI chief also said that “everything has been well thought out” throughout the process,
and the regulator also produced a handbook for the benefit of all entities to make them aware
of different rules and regulations.
SEBI’s Whole-time Member Rajeev kumar Agarwal would oversee the regulation of the
commodity market in the merged entity under the overall guidance of the SEBI Chairman.
At the event, Secretary of Economics Affairs Shaktikanta das said, “Unleashing the reform
process is a continuous process. We’re not waiting for the budget.”
SEBI was established in1988 as a non legislative body for the regulation of securities
markets, while in 1992 it became an autonomous body with fully independent powers. FMC,
on the other hand, has been regulating commodities markets since 1953, but lack of powers
has led to wild fluctuations and alleged irregularities untamed in this market segment.
The commodity market has been known to be more prone to speculative activity compared to
the better-regulated stock market, while illegal activities such as Dabba trading’ have also
been more frequent in this segment.
The high- profile NSEL scam has also hit this industry in the latest past, and the ensuring
regulatory and government interventions in this situation ultimately caused the government
to announce the merger of FMC with SEBI.
The announcement for the merger was made earlier this year by the finance minister in his
budget speech, and today he ran the usual bell to formalize the merger.
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This is the first major case of the merger of two regulators, as opposed to the relatively more
frequent practice in the world of creating new regulatory authorities, including the creation of
new bodies from existing bodies.
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BACKSTORY OF SEBI-FMC MERGER:
On September 28, the outgoing chairman of the erstwhile Forward Markets Commission (FMC)
Ramesh Abhishek presented to the Securities and Exchange Board of India (SEBI) chairman UK
Sinha a file of documents to indicate the merger of the two entities.
The symbolic gesture was done before a packed audience in Mumbai and in the presence of
Finance Minister Arun Jaitley, who had proposed the amalgamation of the commodities futures
regulator FMC with its capital markets counterpart SEBI in his Budget speech of 2015. With the
fusion, the governance and inspection of existing exchanges, market intermediaries (brokers),
futures contracts (or derivatives), risk management and product development in the commodities
market has come under the jurisdiction of SEBI. The merger of the two market regulators, that
followed 12 years of deliberations, was an unprecedented event in India’s financial market
history.
Like the merger, the reaction of brokers to the same was also unprecedented. “Never before have
market participants so eagerly awaited a regulator; generally, regulations are met with
skepticism. But with SEBI taking over [the regulation of the commodities market], it brings hope
that the market for commodities derivatives can not only revive but also draw more participants
over the next few years,” says Girish Dev, chief executive officer and managing director at
Geofin Comtrade, a commodities trading firm.
This revival is expected to happen once SEBI gets a firm grip over the commodities market. For
now, it has explicitly sounded a note of caution in this phase of transition. “This merger will
have an impact on regulation and the larger economy and will bring in economy of scope and
scale. I was not sure that we could arrive at a position so early and so fast,” said Sinha at the time
of the merger. “We will be cautious to avoid making mistakes or taking missteps and try for
better price merging [between futures prices and spot prices],” he added, while releasing a rule
book on the framework of how SEBI will regulate the commodities markets.
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But what led Jaitley and the government to end 62 years of governance by the FMC and repeal
the Forward Contracts (Regulation) Act (FCRA), 1952, under which it operated?
The FMC has been regulating the commodities markets since 1953, but it was seen to have
lacked the muscle to tame the alleged irregularities in this market segment. A low-profile
regulator, the location of FMC’s headquarters on the third floor of the nondescript ‘Everest’
building in South Mumbai, sans any guards, automated gates or biometric control systems,
underscores its lack of power. Its office has the appearance of any other state-run tax department,
but with fewer people. The FMC chairman is a government appointee and it conducts its
activities through plan and non-plan funds from budget grants and its staff recruitment system is
dependent on what the government plans. This is in stark contrast with SEBI, an autonomous
body with wide, sweeping powers to control and develop capital markets, mutual funds,
exchanges and intermediaries.
In the absence of a powerful regulator, the commodities market has been more prone to illegal
activities like ‘dabba trading’ (where a stockbroker executes a customer’s trade done through his
local books, but not reflecting at the exchange, with the hope of making some gains at a future
date) compared to the better-regulated stock market.
At the SEBI-FMC merger event, the outgoing FMC chairman Abhishek summed up the
organization’s limitations: “The FMC did not have the powers of a modern regulator—to enact
regulations, regulate intermediaries, investigate and impose [stringent] monetary penalties,”
adding, “With this merger, this mismatch between a growing commodities derivatives market
and the regulatory structure has been addressed by the government.”
A helpless regulator apart, the commodities market was also plagued by falling trading volumes
on exchanges in the recent past, after the government in July 2013 re-introduced commodity
transaction tax (CTT) on bullion, crude oil and base metals. This government saw it as a move to
earn more revenues. Prior to the SEBI-FMC merger, there were nine commodity exchanges in
India—now called ‘deemed stock exchanges’—down from 17 two years ago. In the past 15
months, three national exchanges—the Ace Derivatives and Commodity Exchange Limited,
Indian Commodity Exchange Limited and Universal Commodity Exchange Limited—have
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either shut down or suspended new contracts. All the existing commodity exchanges showed a
combined 39 percent drop in turnover to Rs 60 laky crore in 2014-15 from over Rs 101 laky
crore in the previous fiscal, according to official data, hurt by low trading volumes, high
transaction costs and a slump in commodity prices.
But the immediate trigger to bring commodities trading under Sebi was the collapse of India’s
largest—and still unregulated—commodities spot exchange, the National Spot Exchange Ltd
(NSEL) in 2013. NSEL and the commodity markets were rocked by a scam involving
irregularities in trading and warehousing practices resulting in a Rs 5,689 crore loss to investors.
NSEL is part of the Financial Technologies (India) Ltd group, promoted by entrepreneur Jignesh
Shah. Only 6.7 percent (or Rs 379.81 crore) of the loss has been recovered so far, according to
the latest data on NSEL’s website.
In the aftermath of the scam, the oversight of the FMC was transferred from the department of
consumer affairs (DCA) under the ministry of consumer affairs, food and public distribution to
the department of economic affairs under the ministry of finance in September 2013. The move
was aimed at improving “coordination among regulators,” policymakers had said. But, this was
also one of the latest signals that a merger was in the making.
However, calls for the amalgamation of the two regulators predate the events at NSEL by about a
decade. Economist Ajay Shah, a professor at the National Institute of Public Finance and Policy
(NIPFP), in his personal blog, wrote last month about the committees which had recommended a
merger since 2003.
The first such recommendation was made by Wajahat Habibullah, who was secretary of the
DCA, in 2003 followed by the Percy Mistry Committee that suggested unification of all
organized financial trading under SEBI in 2007. This was further endorsed by the current RBI
Governor Raghuram Rajan in a 2009 report, which argued for all trading venues and forms of
trading to come under SEBI. The Financial Sector Legislative Reforms Commission (FSLRC)
has also recommended the formation of a Unified Financial Authority by merging SEBI, FMC,
IRDA (Insurance Regulatory and Development Authority of India) and PFRDA (Pension Fund
Regulatory and Development Authority of India).
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“I am confident that we need similar levels of regulatory governance for commodity and
financial markets,” says Shubho Roy, a legal consultant at the New Delhi-based NIPFP.
This greater confidence that policymakers have in SEBI comes from the fact that it has been
regulating and developing India’s equity derivatives markets for the past 15 years.
Exchange officials and brokers, too, are confident about the role SEBI will play in the coming
months. “I am confident that the three key requirements of the industry i.e. new products like
options & indices, introduction of new participants like mutual funds, banks and foreign
institutional investors and the operational ease for intermediaries will be addressed by SEBI over
the next several months,” says Jayant Manglik, president of Religare Securities, which is one of
the largest commodities intermediaries in India. “Given SEBI’s experience, resources and its
image as a strong regulator, the commodity business will flourish just as equities have over the
last 25 years,” adds Manglik.
MCX’s joint managing director and board member PK Singhal says with powers to raid, search
and take penal action, SEBI can discipline wrongdoers and control ‘dabba trade’. “This merger
will fill the present regulatory vacuum,” adds Singhal, who was himself a regulator, at both SEBI
and FMC.
Samir Shah, MD and CEO of National Commodity & Derivatives Exchange Limited (NCDEX)
says: “The key priority at SEBI is to ensure seamless integration of the markets, build capacity
and have an enhanced risk management framework.”
SEBI officials publicly accept with grace the additional regulatory responsibility brought on it by
virtue of its success since getting autonomy in 1992. In the months leading up to the merger,
SEBI officials visited the FMC, commodity exchanges, mandis (agricultural markets and market
towns), assayers and gold vaults across Gujarat, Delhi and Mumbai. SEBI has formed a separate
commodities derivatives cell within its organization for regulation, exchange administration,
inspection and risk management.
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On its part, the FMC too has been facilitating the merger. Several measures were introduced by
Abhishek, which have helped bridge the regulatory gap between securities and commodities
markets. This includes tightening the shareholding norms of commodity exchanges, improving
corporate governance and revamping risk management, warehousing and investor protection
norms.
Some market participants, though, simply eye SEBI’s new responsibilities as a burden. Says a
broker, after a recent meeting with a Sebi official: “They have not yet got to ground zero. It’s
like dealing from 30,000 feet up.” Says another broker with an agro-based commodity brokerage,
on condition of anonymity: “We do not expect much to happen for at least another year. SEBI
will just wait and watch and act only if an untoward incident happens.”’
Not everyone is skeptical though. With the abolition of the FCRA, under which the FMC
operated, in September, some analysts are hopeful that options trading and other exotic
derivative products like weather could find their way into India’s financial markets. When the
FMC was set up in 1953 under the FCRA, futures and options trading in commodities were
barred. Futures’ trading was revived in a calibrated manner between the 1980s and 2000s.
However, options trading (trading in financial instruments like calls and puts) in commodities are
still not permitted.
Gautam Chhaochharia, head of India research at UBS Securities makes the case for options
trading to be introduced, adding that it could be a game changer, particularly for the fortunes of
the market leader MCX. “Commodity options account for only 13 percent of total derivatives
volumes globally; the proportion is arguably expected to be much higher in India. This is evident
from the example of NSE, where options account for around 79 percent of futures & options
volumes,” says Chhaochharia in a report to clients.
SEBI’s Sinha has promised more products like options or index-linked futures as well as reforms
like the entry of banks and foreign institutions into commodities and allowing stock exchanges to
commence commodities trading. But, nowhere has he indicated a time frame to achieve any of
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this. Sinha’s term is set to end in February 2016 and open-ended statements may augur well for
his successor but not necessarily for the markets. NIPFP’s Roy says: “One cannot have an ad
infinitum period for the launch of [commodities] options trading in India. SEBI should have
come out with a white paper on futures market products, along with a tentative deadline.”
Several Organization for Economic Cooperation and Development (OECD) countries work with
a ‘file and launch’ system where the introduction of a new product does not depend on the
blessings of the regulator.
Another challenge in the new regime is that the underlying commodity derivatives—the physical
commodity—is not within the regulatory purview of SEBI. Quality checks and safe-keeping of
physical commodities at warehouses is carried out by an independent agency, the Warehousing
Development and Regulatory Authority (WDRA). A merging of regulation between SEBI and
WDRA will be required, to prevent another NSEL-type crisis.
In this scenario, there is a concern that SEBI may push for trading in commodities to be settled
through financial products, instead of physical delivery unlike the system of physical deliveries,
largely seen at exchanges like NCDEX.
Last month at the event, Jaitley sought to explain the need for the merger. “Markets thrive where
there is confidence and integrity. In the long term, this requires transparency and good
regulation. Farmers, producers and consumers need to have confidence that the derivatives
markets are free from manipulation,” Jaitley said. “If such incidents [like NSEL] occur in future,
I am sure the regulator will now be strong enough to deal with them.”
SEBI’s task is certainly daunting. In India, futures trading in food-related commodities always
has an element of political sensitivity, unlike equity derivatives. Expectations from the merger
are high from market participants, investors and the government itself. If new products like
options or index futures in commodities do not come or new participants do not enter the
markets, it will be merely a case of ‘regulatory laziness’. And that is something which India’s
commodities derivatives markets cannot afford at this stage.
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WHAT WERE THE MOTIVES BEHIND THE MERGE OF FMC-SEBI?
Both the markets are fundamentally and structurally quite different and in the background of
these differences the issue of merging between them has been debated and discussed at various
policy forms with arguments being put for it and against it . All in all, many committees had
suggested the merger of both the regulators- The FMC and the SEBI (Subsequent to the Wajahat
Habibullah committee in 2003, later it was again suggested in 2007 by The Percy Mistry
committee and in 2009 by The Raghuram Rajan Committee).
FSLRC in the year 2013 set up under the chairmanship of Justice B N Srikrishna also called up
for the establishment of a unified regulator across financial products including capital markets,
insurance, pensions and commodities. The commission opined that regulatory merging is one of
the ways for markets to move in sync and extract economies of scale and scope. Also post NSEL
Scam, the need for strengthening the FMC so as to enable it to effectively regulate the
commodities market became much more felt. The Chronology of events that the commodities
market has gone through right from the year 2002 when the government withdrew prohibition of
trading in commodity derivatives till the year 2015 when the merger took place.
The Forward Markets Commission (FMC) has finally merged with the Securities and Exchange
Board of India (SEBI) on 28 September, with the repeal of the Forward Contracts (Regulation)
Act, 1952 (FCRA). Commodity exchanges will therefore now be regulated by SEBI, instead of
by FMC. Does this merger have any impact from an income tax perspective for traders in
commodity derivatives?
Under the Income-tax Act, 1961, business losses from speculative transactions can only be set
off against business profits from speculative transactions. The law contains certain exclusions
from the definition of “speculative transaction". Two such exclusions are derivatives transactions
carried out on a recognized stock exchange, and commodity derivatives transactions carried out
on a recognized association (commodity exchange).
For an association (commodity exchange) to be treated as recognized, it has to be a recognized
association under section 2(j) of the Forward Contracts (Regulation) Act, 1952, has to fulfill
certain prescribed conditions and has to be notified by the central government under the incometax Act for the purpose of exclusion from securities transactions. Currently, National Commodity
and Derivatives Exchange Ltd (NCDEX), Universal Commodity Exchange Ltd (UCX), Multi
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Commodity Exchange of India Ltd (MCX), and Ace Derivatives and Commodity Exchange Ltd
(ACE) have been notified for this purpose.
By amendment made by the Finance Act, 2015, FCRA was to be repealed from a notified date
(now 28 September, 2015). Under the amendment, all recognized associations under FCRA are
deemed to be recognized stock exchanges under the Securities Contracts (Regulation) Act, 1956
(SCRA). Therefore, all commodity exchanges approved by FMC under FCRA now become
stock exchanges approved under SCRA by SEBI.
Would transactions on such commodity exchanges, which are now stock exchanges, qualify for
the exclusion from the definition of speculative transaction after repeal of FCRA? On a bare
reading of the exclusion provision, it initially appears that they would not qualify, since the
commodity derivatives transactions are now not being carried out on recognized associations
under the provisions of FCRA, but on recognized stock exchanges under the provisions of
SCRA. This would give rise to a peculiar situation where commodity derivative transactions
prior to 28 September would not be speculative, while those after would be.
However, this would not be the correct interpretation. Firstly, one of the principles of
interpretation of law is the principle of incorporation by reference. This is when a provision of
law is enacted (in this case, the exclusion provision under the income-tax Act), the reference to
another law (FCRA) contained in this law (income-tax Act), would have to be understood as
referring to that law (FCRA) as it stood when the provision (for exclusion) was enacted, even if
that law (FCRA) subsequently undergoes a change or is repealed. Therefore, commodity
exchanges, though now regarded as recognized stock exchanges, would still remain approved
associations under FCRA, with commodity derivatives traded on them, therefore qualifying for
the exclusion, since they also remain notified under the income-tax Act.
Secondly, even commodity derivatives are derivatives as defined under SCRA. In fact, a few
years ago, when currency futures were to be introduced, there was a dispute between the
regulators on who had the jurisdiction to regulate currency futures. Since currency futures also
qualified as derivatives under SCRA, ultimately the role was assigned to SEBI. Therefore,
trading in commodity derivatives on a commodity exchange would amount to trading in
derivatives on a recognized stock exchange, and would qualify for an exclusion.
Lastly, commodity derivatives transactions continue to attract commodity transaction tax, which
is payable only in respect of contracts traded in recognized associations, which indicates that
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such transactions are still treated as being traded in recognized associations. Consequently, the
benefit of the exclusion would still be available for commodity transactions.
In any case, to avoid any possible unintended controversy, the Central Board of Direct Taxes
(CBDT) should come out with a clarification, that commodity derivatives transactions would still
qualify for exclusion from the definition of speculative transaction, and should amend the law in
the next budget accordingly.
One aspect which merits serious consideration is whether there is any need to treat market
transactions as speculative at all. Today, share derivatives, currency derivatives and commodity
derivatives transactions are all excluded from the ambit of speculative transactions. Only
transactions in shares and debt securities squared up on the same day without delivery are
regarded as speculative.
The logic for exclusion of derivatives transactions is that there is an audit trail in respect of such
transactions, which can prevent manipulation. Such audit trail is available even for transactions
in shares and debt securities carried out on the same exchanges. Further, SEBI surveillance is
capable of unearthing manipulative transactions, as it has in the case of share prices of lesser
known companies being ramped up to create bogus exempt long-term capital gains. Therefore,
the logic of the original provision prohibiting set off of speculation loss, i.e. to prevent claiming
of losses by market manipulation, no longer holds good.
Exclusion of all market transactions from the definition of speculative transactions would be a
significant simplification of law, which the government should seriously consider. This would go
a long way in rationalization of the law, and reducing unnecessary litigation on the subject.
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SEBI-FMC MERGER- New possibilities and Outcome:
The Budget has proposed the merger of the SEBI and FMC. The Centre has given some
breathing time to the FMC on existing guidelines until Forward Contracts (Regulation) Act, 1956
is repealed. The effect of SEBI-FMC merger will soon be felt in regulation, product-market
innovation and surveillance and risk management. In other words, SEBI has been entrusted with
dual responsibility – regulation of capital markets and commodity derivative markets. This can
have several implications to existing regional and national level commodity exchanges, tradingcum-clearing/ institutional clearing agents and investors.
Amplification of regulation:
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Regulatory supervision of economic behavior (of agents) may be increased manifold, justifying
the role of commodity exchanges in price discovery or risk management. Adoption of good
governance practices, on one hand, could help rationalize their existence and constitution of a
diversified board through succession planning, on the other, may be a desired outcome of SEBIFMC merger. A principle-based regulatory structure will help rope in commodity and financial
eco-system and infuse more rationality in the commodity trade. The new regulator could be able
to resolve the inherent conflicts between the principal and agents. However, experiential learning
of FMC could help SEBI understand commodities markets and their mechanics.
Trading environment:
Market environment plays a key role in transaction between related parties. However,
consequence of trading activity can affect unrelated third parties what is known as externality,
for example, notion of general public on price rise of pulses and cereals in 2007-08. The merger
could oversee this problem in a logical manner. SEBI can issue a directive indicating the
incentive structure for affected individuals or groups that may be pro-governance measure. This
has twin benefits: one is minimal direct intervention of SEBI and the other one, bargaining
mechanism may bring about an optimal outcome given low negotiation/transaction costs.
Awareness drive:
FMC, before merger, has adopted scores of measures for awareness drive relating to capacity
building, sensitization of stakeholders and policymakers in agriculture since 2007-08. In 201213, the commission has organized several awareness programs in association with various
institutions, market agencies, and commodity exchanges. The commission also consented to
extend the price dissemination project in the proximity of post offices, rural branches of banks,
warehouses, co-operatives and other remote areas. For instance, FMC initiated price
dissemination project had installed 1,863 price tickers across various parts of the country. The
new regulator, SEBI, might collaborate with management and policy-level institutions for
research that could bridge the gap between theories and practice and thus, enhance the veracity
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of research in commodities. Traders will be more financial literate of market mechanics that can
strengthen their strategy formulation. However, participants’ gut feeling in exercising the
contract need to be checked as information and communication pattern often impacts the
decision making processes. As they perceive the markets differently based on their risk-return
quotients, adoption of governance practices will enhance investor awareness. While hedgers
remain risk-averse, speculators prefer to bear the risk. Arbitrageurs, on the other, attempt to
optimize risk-return metrics considering time and space potentially. Therefore, the new regulator
needs to explore psychologies and prospects of investors – commercial users and financial
market participants.
Optimism with caution:
The above discussion might draw the attention of practitioners and policy makers to an
innocuous environment of trading and mutually beneficial platform for intended buyers and
sellers that the new regulator is poised to deliver. But the blanket application of the global
practices may not bolster the functioning of commodity exchanges. Since the futures market
reduces price uncertainty and influences the decision of stakeholders in investment and
marketing or moderate their risk-return perception, the new regulator needs to assess the utility
of existing exchanges. Probably, a thorough survey may address the concerns of SEBI: “Small is
beautiful or big is better”. While changes were made to FC(R)A Bill, 2010, the new regulator
should be cautious while implementing changes in commodities markets.
Drastic Changes after the Merger:
Convergence in Commodity Prices
Convergence means the futures and spot commodity prices congregate or come together at the
time of the termination of the contract. Net hedging hypothesis5 tells that the spot price and the
future price will converge at the end of the future contract or at expiration (Future price = Spot
price). Lack of convergence is yet another challenge SEBI has to address. Established markets
like US’s Chicago Board of Trade (CBOT) had a major convergence problem on the wheat
futures contract in April-September 2009. The speculator continued to intervene in the market
and anomaly in convergence continued in other commodity prices. If this can happen in the US
20
market at the operational level, it can happen in our economy; hence, we cannot afford to take
such a stand for essential commodities.
Consolidation and Downsizing
Established brokerage firms will have a separate front and back office team dedicated to equity
and commodity trade. With the merger, the clearing and settlement will be same and this will
make the back office team for commodity redundant. Hence, there will be huge consolidation at
the operational level. Commodity exchange clearing and settlement was an in-house activity for
the exchange. Centralized clearing will weaken the exchange autonomy.
Product Redundancy
Now there is no reason one should prefer gold future to Gold Exchange Traded Fund (ETF).
Since both are traded on the same platform, both will have similar benefits. The timing of trade
is also very important for commodities since commodity prices discover internationally. SEBI
should allow trading beyond the normal hours as global market will be active from 7:30 p.m. to
9:30 p.m. Mutual funds’ and other financial institutions’ participation should be considered in a
phased manner. At present, in the commodity derivative segment, only commodity futures are
traded.6 If commodity options are introduced, then there is a need for upgrading the technology
and spending on investor education.
To Acquire or create?
The National Stock Exchange (NSE) can consider acquiring National Commodity and
Derivatives Exchange Limited (NCDEX).7 NSE is the largest Indian stock exchange and the
world’s largest in terms of number of equity trade.8 NSE has 15 percentage9 holding in
NCDEX, which means it can acquire NCDEX and bring in synergy to offer a rich platform for
both equity and commodity trade. NCDEX is known for its spread of agricultural commodity
futures trade and price discovery. Or, create a commodity derivative platform afresh in Bombay
Stock Exchange (BSE).10 It may be economical and faster to set up a segment of own
commodity trading wing.
Diversity of Commodity to Equity
21
Commodity is a unique asset class in comparison to equity; commodities derivatives as an asset
are different because commodities futures are derivative contracts not claims on perpetual
corporations’ equity valuation. Equity valuation is done based on the present value of futures
cash flow, interstate and net present value. All this does not influence commodity prices.
Commodities have distinct seasonal characteristics and have short maturity claims on real assets.
Commodity prices are influenced by global market and the price gets discovered by play of
global supply and demand, for example, gold, silver, crude, etc. Clearing a rubber future to
turmeric futures, the contract specifications will be very different. Margin requirements differ;
margin for gold commodity futures is 8%, whereas for equity stock it is 15% to 20%. Warehouse
Receipts (WR) are used as a base for delivery of commodity derivatives. WR as an instrument
has a far-reaching impact on commodity spot market, credit/ collateral or financing market.
Replacing Forward Contracts (Regulation) Act (FC(R) A), 1952
It was only in January 2008 that FMC got the status of independent regulator; until then it was
attached to the office of Ministry of Consumer Affairs, Food and Public Distribution. This
change has brought in more economic freedom and operational autonomy to FMC.
Indian market still operates under the regulation of Forward Contracts (Regulation) Act
(FC(R)A), 1952, and many of the latest contracts are not available in (FC(R)A), 1952. This is a
big bottleneck which will be addressed now. The Amendment Bill (2010) was recommended by
the Parliamentary Standing Committee of the Ministry of Consumer Affairs, Food and Public
Distribution, on December 19, 2011, and the entire case took a twist after the merger
announcement.
22
HISTORICAL REFLECTIONS: Other Countries Experience:
If we look at the US, we can see multiple regulators—one for the capital market at the primary
federal level is the Securities and Exchange Commission (SEC)2 and for commodity market
Commodity Exchange Trading Commission (CETC). The US economy is prominently a
production cum export-oriented economy where physical delivery of commodity derivatives
takes place on a large scale, where there is greater emphasis on warehousing, production quality,
shelf life and specialized knowledge of the product. Hence, there was a need for greater
emphasis on trading/ settlement and physical delivery of the commodity. Technically, it is
inappropriate for a single regulator to conduct trading of commodity futures and equities.
23
The UK had a single regulator, Financial Services Authority (FSA). But from April 2013, the
responsibilities have been divided into multiple regulators, namely, Prudential Regulation
Authority (PRA) and Financial Conduct Authority (FCA). FCA regulates the commodity market.
The UK could afford to keep a single regulator so long because the majority share of commodity
futures trade is in non-perishable commodities like copper3 and nickel where the delivery,
storage and quality specification are not as critical as they are for perishable commodities in the
US.
India being a predominately agriculture economy, it will be a challenge for SEBI to keep the
physical delivery and warehousing issues intact. During Sharad Pawar’s tenure as India’s
Minister of Agriculture, he wanted to follow the US style of a dedicated regulator for commodity
market which will take care of the nuances of standardization and shortage issues. There was a
need to connect to the state and central disparities in regulation and slowly integrate commodity
futures trade to the commodity spot market. But the National Spot Exchange Limited (NSEL)
scam acted as a trigger for this merger.
SECURITIES AND EXCHANGE BOARD OF INDIA
Memorandum to the Board
Budget Announcement regarding integration of brokers in Equity Markets
and
Commodity Derivative Markets
Objective:
24
Integration of broking activities in equity markets and commodity derivative Markets under
single entity.
1. Background:
1.1. Honorable Minister of Finance, Government of India, in his speech while presenting the
Budget for FY 2017-18 on February 01, 2017, announced that the commodities and
securities derivative markets will be further integrated by integrating the participants,
brokers, and operational frameworks.
2. Current Scenario in Registration of Stock Brokers / Clearing Members dealing in Commodity
Derivatives and Equity/ Equity Derivatives :
2.1. Pursuant to the merger of Forward Market Commission's (FMC) with Securities and
Exchange Board of India (SEBI), the supervision and regulation of commodity
derivatives brokers has been vested with SEBI. Accordingly, amendments were made to
SEBI (Stock Brokers and Sub-brokers) Regulations, 1992 (Stock Broker Regulations) to
provide for the regulation and the supervision of brokers dealing in commodity
derivatives as stock brokers. SEBI also clarified by issuing a circular that all existing
members of commodity derivatives exchanges were required to meet the eligibility
criteria as specified under Rule 8 of Securities Contract (Regulation) Rules, 1957
(SCRR) and Stock Broker Regulations, within a period of one year from the merger of
FMC with SEBI i.e., by September 28, 2016.
2.2. Rule 8(1)(f) and Rule 8(3)(f) of the SCRR disqualifies the persons, engaged as principal
or employee in any business other than that of securities or commodity derivatives
except as a broker or agent not involving any personal financial liability, to be elected as
a member of a Stock Exchange. To facilitate continuity in activities of brokers dealing in
commodity derivatives, it was further clarified that, “business in goods related to the
underlying” and/ or “business in connection with or incidental to or consequential to
trades in commodity derivatives” by a member of a commodity derivatives exchange,
would not be disqualified under Rule 8(1) (f) and Rule 8(3)(f) of the SCRR .
2.3. SEBI, in the year 2014, eased the operational requirements for registration as a stock
broker and clearing member and allowed single registration process for stock brokers
and clearing members that allows them to operate across stock exchanges / clearing
25
corporations, without the requirement of coming back to SEBI. The single registration
procedure is also made applicable for stock brokers operating in commodity derivatives.
3. Examination of the proposal:
3.1. The first proviso to Rule 8 (1) (f) of SCRR states as follows:
3.1.1. "no member may conduct business in commodity derivatives, except by setting up
of a separate company which shall comply with the regulatory requirements, such
as, net worth, capital adequacy, margins and exposure norms as may be specified by
the Forward Market Commission, from time to time".
3.2. Regulation 18C Stock Brokers Regulations states as follows:
3.2.1. 18C. (1) A stock broker carrying on the activity of buying, selling or dealing in
securities, other than commodity derivatives, shall not undertake the activity of
buying, selling or dealing in commodity derivatives, unless permitted by the Board.
3.2.2. A stock broker carrying on the activity of buying, selling or dealing in commodity
derivatives, shall not undertake the activity of buying, selling or dealing in securities
other than commodity derivatives, unless permitted by the Board."
3.3. Thus, currently, as per aforementioned provisions of SCRR and Stock Broker
Regulations, a stock broker / clearing member carrying on the activity of buying, selling
or dealing in securities, other than commodity derivatives, cannot undertake the activity
of buying, selling or dealing in commodity derivatives, or vice versa except by setting up
of a separate entity i.e. at present, a single entity can hold memberships of equity cash,
equity derivatives, currency derivatives and debt segments across exchanges, but can
hold membership of commodity derivatives exchange by setting up a separate entity.
3.4. The matter of allowing the same entity to act as stock broker / clearing member in the
equity and the commodity derivatives markets was taken up during the financial year
2016-17. The issue was discussed in various meetings with the stock exchanges,
depositories, stock brokers, depository participants and their associations. The following
are the views that emerged during discussions:
3.4.1. Since erstwhile FMC has been merged with SEBI in September 2015 and all the
stock exchanges and their members are now under the same regulator i.e. SEBI, it
makes a good case for a single entity to be permitted to be a member of all stock
exchanges under SEBI.
26
3.4.2. Consequent to merger of FMC with SEBI, various regulatory provisions in
respect of the functioning of the stock brokers across equity / equity derivatives
markets and commodity derivatives markets viz., segregation of funds and
securities, running account settlement, contract note, KYC, AML, inspections,
internal / system audit, investor grievance redressal mechanism, arbitration,
maintenance and preservation of records, change in control / constitution, surrender
of membership, outsourcing of activities for brokers, authorized persons, etc. have
now been harmonized.
3.4.3. In order to increase robustness and to streamline the risk management and
margining framework across commodity derivatives exchanges, norms have been
issued by SEBI which inter alia prescribe guidelines for margin calculations, margin
collection, Base Minimum Capital, acceptable forms of Liquid Asset deposits with
appropriate haircuts and concentration limits, etc.
3.4.4. SEBI has over a period of time taken steps by issuing circulars to harmonize the
operational, functional, risk management etc. framework between brokers operating
in equities and commodity derivatives. Accordingly, the next logical step would be
to permit the stock broker / clearing member buying, selling or dealing in securities
other than commodity derivatives to buy, sell or deal in commodity derivative
without setting up separate entity and vice versa.
3.4.5. Integration of the brokers in equity and commodity derivative markets may
benefit the investors, brokers, Stock Exchanges and SEBI as there are many
commonalities between the two markets in terms of trading and settlement
mechanism, risk management, redressal of investor grievances etc. Integration
would also have following benefits:
3.4.5.1.
A unified entity offering intermediation across asset classes would
provide for efficiency of capital use to the investors and thus enhancing the value
to the overall financial services ecosystem in Indian securities markets.
3.4.5.2.
It will also enhance the economic efficiency in terms of meeting the
operational as well as compliance obligations at a Member level resulting in ease
of doing business and would result in efficient utilization of the collaterals across
asset classes and segments.
27
3.4.5.3.
The said integration would help in widening market penetration leading to
greater financial inclusion for participants across all market segments and would
facilitate effective regulatory oversight by Stock Exchanges and SEBI.
3.4.5.4.
Additionally, a unified entity will have much better risk management
capabilities as against separate risk management systems for equity and
commodity broking and extend the benefits of economies of scale
3.4.5.5.
To enable integration of the brokers in equity and commodity derivative
markets, deletion of the first proviso to Rule 8 (1) (f) of SCRR and Regulation
18C Stock Brokers Regulations would be required. Further, an intimation may be
issued by way of a circular to the market that a single entity can act as stock
broker / clearing member in commodity derivative markets as well as in the
equity markets.
4. Proposal:
4.1. In view of the above, it is proposed that Stock Brokers Regulations and SCRR may be
amended by deletion of Regulation 18C of the Stock Brokers Regulations and the first
proviso to Rule 8 (1) (f) of SCRR to permit a single entity to act as stock broker /
clearing member in commodity derivative markets as well as in the equity markets.
4.2. The Board is requested to approve the above proposal and authorize the Chairman to
carry out necessary amendments to the SEBI (Stock Brokers and Sub Brokers)
Regulations, 1992 with consequential changes, as may be required and to take up the
matter of amending Securities Contracts (Regulation) Rules, 1957 with the Government
of India.
28
Integration of trading in commodity derivatives market with other segments
of securities market at exchange level:
1. Objective:
1.1. This memorandum seeks to take necessary steps for enabling integration of trading in
commodity derivatives masttirket with other segments of securities market viz., equity,
equity derivatives, debt and currency derivatives segments etc., at the level of
exchanges, thereby enabling a single exchange to provide trading for all segments.
2. Background:
2.1. .In the Budget Speech of 2015, Honorable Finance Minister announced the merger of
the Forwards Markets Commission (FMC) with SEBI. Prior to that, FMC had the
regulatory oversight over the commodity derivatives markets under Forward Contracts
(Regulation) Act, 1952 (“FCRA”). Through the Finance Act, 2015, FCRA, was repealed
w.e.f. September 28, 2015. Consequently, all recognized associations (i.e. commodity
derivatives exchanges) under FCRA have been deemed to be recognized stock
exchanges under the Securities Contracts (Regulation) Act, 1956(“SCRA”)and SEBI
started regulating the commodity derivatives market with effect from the above date.
2.2. .At the time of merger of FMC with SEBI, the International Advisory Board (IAB) of SEBI
in its meeting held on May 1 & 2, 2015, inter alia, advised the following:
“SEBI should concentrate more on studying the risks and the structure of the market,
including various aspects like contract design, warehouse receipts and quality control of
underlying commodities in the initial period. The emphasis during this period should be
on avoiding any crisis in the market. Market development may be visited only after fully
understanding the strengths and weaknesses of commodities markets.”
2.3. Considering the aforesaid inputs, SEBI decided that during initial phase, focus shall be
more on understanding and strengthening the existing micro-structure of the
commodity derivatives markets and the market development may be visited thereafter.
Accordingly, two markets viz., commodity derivatives and rest of the securities markets
were kept segregated initially. Hence, the Securities Contracts (Regulation) (Stock
29
Exchanges and Clearing Corporation) Regulations, 2012(“SECC Regulations”) was
amended with effect from September 28, 2015 to provide for following:44C. A recognized stock exchange, including a commodity derivatives exchange, shall
not introduce any new segment without the prior approval of the Board.”
2.4. .Thus, the commodity derivatives market was kept separate from other segments of
the securities market. It was felt that time should be given to commodity derivatives
exchanges to come at par with the stock exchanges with respect to certain regulatory
norms e.g. net worth requirements, shareholding norms, clearing through separate
clearing corporations etc. Accordingly, the commodity derivatives exchanges were
provided timeline to fill those gaps in order to bring them at par with the stock
exchanges. Some of these objectives related to clearing of trades through clearing
corporation and shareholding norms are yet to be achieved. Timeline for commodity
derivatives exchanges for clearing through separate Clearing Corporation has been
stipulated as within three years from merger i.e. by September 28, 2018.
2.5. .In his budget speech for 2017-18 the Honorable Finance Minister inter-alia proposed
that:“The commodities and securities derivative markets will be further integrated by
integrating the participants, brokers, and operational frameworks.”
2.6. For the sake of smoother implementation of the above budget announcement
regarding integration between commodity derivatives and rest of the securities Page 3
of 9 markets, it was decided that the integration would be achieved in two phases. In
Phase-I, it was proposed to have integration at Intermediary level. In Phase II,
necessary steps would be taken to enable a single exchange to operate various
segments such as equity, equity derivatives, commodity derivatives, currency
derivatives, interest rate futures & debt etc.
2.7. .After due consultation with various market participants, a Board Memorandum was
placed before the Board in its meeting held on April 26, 2017 to enable proposed
integration at intermediary level. The memorandum covered proposals to make
necessary amendments to relevant provisions in the SEBI (Stock Brokers and Sub30
Brokers) Regulations, 1992 (“Broker Regulations”) and Securities Contracts (Regulation)
Rules, 1957(“SCRR”). The Board has approved the proposal contained in the
memorandum.
2.8. The Government of India, on recommendation of SEBI, have notified necessary
amendments to relevant provisions of the SCRR in the Gazette of India on June 27,
2017. SEBI has notified necessary amendments to the relevant provisions of the
Brokers Regulation and made effective from July 13, 2017. Further, SEBI after
considering the comments/inputs of the market participants issued circular on
September 21, 2017 on ‘Integration of broking activities in Equity Markets and
Commodity Derivatives Markets under single entity’.
2.9. Thus, all necessary steps required to enable integration of commodity derivatives
market with rest of the securities markets at intermediary’s level have been taken by
SEBI
3. Convergence at Exchange Level:
3.1. .The next step to implement the convergence between commodity derivatives and rest
of the securities market is to implement phase II i.e. to permit trading of commodity
derivatives and other segments of securities market on single exchange.
3.2. The matter was deliberated with various stakeholders as well as all recognized stock
exchanges including commodity derivatives exchanges. In the meeting, representatives
from the commodity derivatives exchanges were of the opinion that there is lack of
level playing field between commodity derivatives exchanges and other stock
exchanges and hence all products under single exchange entity may be allowed after
another two to three years. On the other hand, the representatives from stock
exchanges (other than commodity derivatives) were of the opinion that all products
under single exchange entity should be allowed in the country as already two years
have passed since the merger of erstwhile FMC with SEBI
3.3. After detailed deliberations it is proposed that amendments to enable convergence at
exchange level may be made effective from October 1, 2018 i.e. after completion of 3
31
years since the merger of FMC with SEBI and when clearing corporations are to be in
place for commodity derivatives exchanges, as per the timelines prescribed.
4. Legal Provisions:
4.1. At the time of merger of FMC with SEBI in September 2015, in terms of Section 131[B]
of Finance Act, 2015, all the existing commodity derivatives exchanges were deemed to
be recognized stock exchanges under SCRA. The Act however, made specific condition
that such deemed stock exchanges shall not deal with any other segment except for
dealing with commodity derivatives till they are specifically permitted by SEBI.
Accordingly necessary provisions specific to these commodity derivatives exchanges
were inserted in SECC Regulations to enshrine that commodity derivatives exchanges
shall assist, regulate or control the business of buying, selling or dealing in commodity
derivatives and option in securities with the prior approval of the Board. Also these
exchanges were clearing their trades themselves. In light of the proposal to enable all
the recognized stock exchanges to deal with all the segments of the securities market,
all such provisions in SECC Regulations along with the separate definition of commodity
derivatives exchanges would be required to be deleted/amended.
4.2. Further, the circulars/guidelines issued to the national commodity derivatives
exchanges shall also be made applicable to the commodity derivatives segments of all
recognized stock exchanges.
EFFECTS OF FMC-SEBI MERGER IN INDIA:
1. Comparison of trading volumes and trends across various countries Global Trading Scenario.
2. Liquorice chupa chups applicake apple pie cupcake brownie bear claw cake gingerbread
cotton candy. Bear claw croissant apple pie. Croissant cake sweet puff Oreo sugar plum
32
muffin sugar plum bonbon biscuit macaroon. Gummies fruitcake marzipan drops brownie
toffee sugar plum marshmallow toffee Business Strategy > The total number of futures and
options traded on exchanges worldwide rose to around 30 billion contracts in 2016 Futures
and Options Market > Exchanges in Asia-Pacific accounted for 39% of the global listed
derivatives market share, the maximum in any region > Asia-Pacific grew by 33.7%, while
the region of North America had a negative growth rate and Europe growing by 8.2%, clearly
showing the massive potential in Asian markets > Record Amount of Commodity Trading:
Total number of equity index futures and options rose 13.7% to 8.34 billion contracts.
Currency contracts jumped 31.2% to 2.78 billion. Commodity contracts, which include
futures and options based on energy, agriculture, precious metals and non-precious metals,
rose 22.6% to 4.6 billion contracts.
3. Commodity Exchanges Worldwide Liquorice chupa chups applicake apple pie cupcake
brownie bear claw cake gingerbread cotton candy. Bear claw croissant apple pie. Croissant
cake sweet puff Oreo sugar plum muffin sugar plum bonbon biscuit macaroon. Gummies
fruitcake marzipan. Data Analysis One We see that there has been a surge in the volume of
commodity derivatives. This surge was mainly driven by market innovation in Asia,
especially in China and India. Volumes were driven by the pickup in energy assets such as
natural gas and oil, metals including silver and iron ore, and agricultural commodities like
soybean and sugar. Growth Trend Chicago Mercantile Exchange continues to be the biggest
exchange with trade volumes of 350 Mn contracts followed by Zhengzhou Commodity
Exchange. The Exchange Story Futures rule the roost with a much higher volume than
options. In Futures, Asia has the highest volume whereas in options, it has the lowest (no
options in India yet) Futures vs. Options.
4. 1st in Silver INDIA VS THE WORLD > Size of Indian commodity futures market at Rs,
200,000 billion, turnover next only to USA and China > Top four commodities (gold, silver,
copper, oil) form 85% of MCX’s business, NCDEX primarily for metal and agro >
Composition of trading has drastically changed – Shift from agricultural commodities to
precious metals. Bullion continues to be the highest traded. Agro and energy products have a
much higher trade volume globally with respect to India 2nd in Gold, Copper &Natural Gas
33
3rd in Crude Oil 5th largest amongst global commodity exchanges by number of future
contracts traded Distribution In India Global Distribution.
5. History of Commodity Markets in India 9 1939 Commodity derivatives trading banned by
Government of Bombay. Thought to be detrimental to farmers and healthy functioning of
markets. 1943 Forward trading was prohibited in many commodities including food grains,
spices, vegetable oils, sugar and cloth 1875 Bombay Cotton Trade Association – set up a
decade after Chicago Board of Trade was set up in US Early 1900s Multiple commodities
were being traded at Kolkata, Hapur etc. 1952 Enactment of FCRA Establishment of FMC
and 3 tier Regulation.
i. Exchange – Day to day basis
ii. FMC – Regulatory Authority
iii. Central Government – Ultimate governing body 1960s Due to severe droughts, farmers
defaulted on forward contracts. Government banned forward trading and market went
underground and remained dormant for 4 decades 2003-2005 GOI permitted futures
trading in all commodities. Options are still prohibited, Establishment of 3 national
exchanges. 2015 Announcement of FMC and SEBI merger and issuance of notice to
repeal the FCRA Act of 1952 & 2017 SEBI passed, a circular inviting opinions on the
inclusion of options trading in commodities.

Financial Regulatory Bodies in India:
1. Reserve Bank of India:
a. Apex monetary institution and central bank of India.
b. Established in 1935 – Originally privately owned. After nationalization in 1949,
fully owned by Government of India.
c. Primary functions include formulating monetary policy with a view to securing
monetary stability in the country.
2. Insurance Regulatory and Development Authority:
a. Formed by a Parliamentary Act of 1999.
34
b. Regulates, promotes and ensures orderly growth of the insurance industry.
3. Securities and Exchange Board of India:
a. Regulator associated with securities market
b. Established in 1988 as a non-statutory body
c. Became an autonomous body with more powers after the SEBI Act of 1992
Forward markets Commission
d. Statutory body set up in 1953 under the Forward Contracts (Regulation) Act,
1952
e. Oversaw the commodities trading in India across 26 regional and National
Exchanges until the recent merger with SEBI
4. Warehouse Development and Regulatory Authority:
a. Regulation of warehouses
b. Regulations of Negotiability of Warehouse Receipts and promotes orderly growth
of the warehousing business. Pension Fund Regulatory & Development Authority
c. Pension related authority established in 2003 by GOI Helps in promoting income
security of old age by regulating and also developing pension fund.
5. Forward Market Commission:
a. Established in 1953 under the FCRA Act.
b. FMC formed to ensure integrity of commodity markets & protect participants
from fraud and insolvency.
c. Keeps markets under observation to take any action in relation to them.
d. Make recommendations to improve the working of forward market.
e. Undertake inspection of accounts and other documents
f. Collect and publish information regarding trading condition.

National Spot Exchange Limited (NSEL) Scam:
NSEL being a spot trading exchange was unregulated as it was not covered under the
FMC. The exchange collapsed in 2013 resulting in Rs. 5600 Cr. loss to the investors due
to non-payment of dues. As per law, spot exchange cannot have contracts beyond T+11
Settlement. However, trading of contracts up to settlements T+35 was taking place in
Agro-Products. The arbitrage opportunity between longer and shorter term contracts was
35
exploited by brokers and investors (including public sector units). The profits for NSEL
and the investors soared for the next two years. Only after, it came under the scrutiny of
the Dept. of Consumer Affairs which stopped the trading of illegal contracts. Panic broke
out in the market when investors realized that NSEL had no physical stock in its
warehouses and the trading of commodities was conducted only on paper. Only 6.7 % of
losses could be recovered before the promoter, Jignesh Shah was arrested on multiple
counts of fraud.

Improper handling of Guar contracts by FMC:
a. Guar Gum, produced from Guar Seed, is used in Shale Gas Fracking.
b. In India, Guar Seed is produced in Jodhpur and its surrounding areas, which
accounts for 80% of global production.
c. In 2012, Guar prices became hazardously volatile as Shale Gas exploration
increased.
d. The trading volumes for Guar futures contracts on NCDEX grew 10 fold within a
year.
e. FMC alleged trading irregularities, but couldn’t take any effective measures to halt
the hyper-surge in prices.
f. Finally, in March 2012, they halted all trading on Guar contracts in India.
g. Similarly, FMC, in the period 2003 to 2015, halted, de-listed and re- listed several
commodities on Indian Exchanges, which led to low level of stability in the sector.

Challenges unique to the Indian Commodity Sector:
a. Development of warehousing norms is a recent phenomenon in India (WDRA)
b. Implementation of these norms is still far from ideal.
c. Major
supply-demand
gap
for
quality
agro-commodity
warehousing
infrastructure.
i) Taxation:
a. Till GST gets implemented fully, taxation norms restrict efficient price discovery
and free movement and storage of goods
ii) Limited Investors:
36
a. Small farm sizes and low literacy prove to be impediments for farmers to trade.
b. Retail investors don’t understand the dynamics of commodity markets.
iii) Low Financial Strength of Exchanges:
a. Financial Exchanges are not very profitable in the current scenario
b. FMC has not been able to help struggling exchanges survive, leading to closures.

MCX surges 20% in two-days on proposed FMC-SEBI Merger.

Impact of Merger:
1. Pooling of resources:
a. Depositories and clearing houses can now be regulated by SEBI and used by
commodity traders.
b. Will lead to improved standards of warehouses in the future.
c.
Some measures are: Minimum net-worth of 25crores for WSP or storage value of
goods not to exceed 33 times the net worth.
2. Strengthening of delivery infrastructure:
a. Essential for winning the trust of traders and investors.
b. SEBI has shifted ‘good delivery’ from a ‘moral’ to a ‘legal’ responsibility.
c. Earlier it was a huge challenge in the commodities market.
3. Enhanced oversight in commodities market:
a. Earlier FMC was comparatively a powerless body.
b. Many irregularities in prices and other undesirable behavior like ‘dabba’ trading.
c. SEBI has taken action against parties 18 times in the last year under Section 11B of
the SEBI Act.
4. Grievance redressal measures:
a. Tightly linked to good delivery issue
b. Formation of Investor Grievance Redressal Committee and Investor Service Centers
c. Any investor queries that haven’t been resolved within 15 days can be brought
before the IGRC
5. Online mechanism for registration
37
a. SEBI introduced online registration mechanism for commodity traders
b. Will enable faster and more cost- effective way for brokers and traders to complete
their regulatory filings
c. Similar systems for equity and other security markets are also being introduced by
SEBI.
6. Capacity building:
a. Training for regulatory personnel in collaboration with NISM and CTFC Capacity
building
b. NISM has also come up with a certification course to familiarize participants with
the regulatory and taxation aspects of commodities trading.
c. 220 officers were trained so far in commodity derivative trading
7. Strengthening risk management
a. SEBI placed regulations for enhanced initial margins for better risk coverage
b. Concentration margins for big positions and regulations to reduce volatility also put
in place
c. Could lead to some downside as the higher requirements may discourage some
traders from participating.
8. Other measures:
a.
SEBI now allows trading in options for commodities
b. New commodities for futures trading such as diamond, brass, pig iron, eggs, cocoa
and tea.
c. Plans to rope in more hedgers in the commodity markets to improve liquidity.
d. New regulations for disaster recovery, system audits, exit policy for commodity
exchanges and cyber security.

Integration issues:
Challenges:
a) Price discovery of commodities (especially agricultural commodities) is difficult
since there is no effective spot market for them.
38
b) Delivery of commodities may include physical delivery – therefore SEBI will need to
come up with quality norms for warehouses as well as regulatory norms. Does SEBI
have the expertise and specialized knowledge to do this?
c) Dangers of treating the commodities market at par with securities market backfired in
the US – Sharp increase in crude oil futures prices affected the price of the underlying
commodity which led to destabilization. Political implications of commodity trading
must be taken into account as well.
d) Political implications of commodity trading must be taken into account as well.

Way ahead:
1. Spot and Derivative Market Integration:
a. The proposal to set up an expert committee to study and promote creation of an
operational and legal framework to integrate the spot and derivatives market in the
agricultural sector.
b. Will help farmers improve their post-harvest risk by hedging on the commodity
exchanges and improving their realizations.
c. Will help the derivative commodity exchange include more delivery centers based on
the quality of the produce and farmers’ interest.
d. The price polling mechanism conducted by commodity exchanges to settle futures
contracts can become more transparent with the emergence of an online national
agriculture market.
2. Price Discovery:
a. SEBI will have regulatory power only over commodity futures. But physical
settlements in the futures market rely on prices determined in the spot markets. And
SEBI has no control over spot market price discovery.
3. Quality Enforcement:
a.
SEBI needs to find ways to increase the number of hedgers as opposed to speculators
in the market, strengthen control systems at commodities exchanges and reinforce
warehousing norms, especially for agricultural commodities.
39
b. Norms are also needed to ensure that quality of goods entering warehouses is kept
intact.
c. Finalize warehousing norms to increase transparency of deliveries.
d. Settlement guarantee fund for commodities market- fund to be used to meet
settlement obligations in the event of a default.
4. FIIs:
a.
Currently, FIIs are restricted from participating in commodities trading at exchanges.
SEBI may allow FII participation in commodities trading going forward. This will
provide more depth to the markets, leading to:
i. Increase liquidity
ii. Investor participation
iii. Better price discovery.
5. BANKS, MFs and Insurers:
a. SEBI in the future is also allowing Banks, Mutual Funds and Insurance companies to
participate in commodity market. This will address:
i. Banks need to manage risks arising from commodity price volatility.
ii. Banks can act as intermediaries, facilitating the risk management actions of
farmers and other small players who on their own may face considerable
barriers in entering this market.
iii. Increase the number of hedgers as opposed to speculators in the market – SMEs
can hedge through banks.
6. New Products:
Three new commodities are expected to be included in futures trading:
 Freight
 Weather
 Electricity.
40
POST MERGER SCENARIOS OF FMC-SEBI:
The amalgamation of Forward Markets Commission (FMC), the erstwhile commodities
regulatory body, with capital markets watchdog Securities and Exchange Board of India (SEBI)
came into effect today, marking the first major case of two regulators being merged.
41
Although, the merger of these two independent regulatory bodies was under discussion for long
time, the move gathered pace, especially, after the commodity market was rocked by the
outbreak of a multi-crore scam at National Spot Exchange (NSEL) unearthed two years back.
Now that the merger has been done with, below is the drawdown of the journey of the
commodities regulatory body and what led to the eventual convergence with the capital markets
regulator SEBI.
1) History of the two regulatory bodies:
The Forward Markets Commission regulated commodities market since 1953, while the
Securities and Exchange Board of India was set up in 1988 as a non-statutory body for regulating
the securities markets and became an autonomous body in 1992 with full independent powers.
Currently, India boasts of three national and six regional bourses for commodity futures in the
country. The persisting global economic slowdown coupled with slackening growth in China
fuelled a sharp fall in commodity prices over the past year or so. So much so that the
consolidated turnover of all the exchanges put together fell to nearly Rs 60 lakh crore in 2014-15
from over Rs 101 lakh crore in the preceding financial year.
2) Issues stifling commodities markets:
FMC oversaw the commodities market for over 60 years, but it lacked powers which led to wild
fluctuations and alleged irregularities remaining untamed in this market segment. Also, the
commodities market faced challenges with respect to speculative activities and illegal activities
like 'dabba trading' flourishing in this segment. Cautioning small investors, SEBI chairman UK
Sinha had once said, "If you put your hard-earned money into this market, it may not be
ultimately good for you. The commodities market is for those who are experts in this space. For
non-experts, it is a risky area."
3) Talks of merger:
The merger talks between the two regulatory bodies was first mooted in 2003, and continued in
next few years before the Rajan committee in 2009 reiterated consolidation of all financial sector
regulators under one umbrella. In the events before the outbreak of NSEL crisis came to light,
Justice BN Srikrishna-led FSLRC recommended unified regulation. But the fallout of NSEL
42
prompted finance ministry to bring FMC under its fold in that same year. Finally, in his budget
speech this year in February, finance minister Arun Jaitley announced the merger of FMC with
SEBI.
4) What merger aims to achieve:
The merger is aimed at streamlining the regulations and curb wild speculations in the
commodities market, while facilitating further growth there. “The merger will increase
economies of scope and economies of scale for the government, exchanges, financial firms and
stakeholders,” finance minister Arun Jaitley has been quoted as saying in reports. The minister
also promised a more steps measures to further develop the market. He said there is no reason
why the commodities market should not have options or index futures. He also said in future
banks and foreign portfolio investors will also be allowed to participate in the markets.
5) Measures by SEBI:
SEBI has also created a separate Commodity Cell and has set up new departments for regulation
of commodities derivatives market. SEBI has formed a Commodity Cell by posting its senior
officials, while two internal departmental committees (one each in Integrated Surveillance
Department and Market Intermediaries Regulation and Supervision Department) have been set
up. The market regulator has also sought help from the Agriculture Ministry with regard to the
data sources for the prices and to improve the methodology for determination of final settlement
price. It will also give up to one year time for those in commodities market to adjust to new
regulations.
DEVELOPMENTS IN COMMODITY MARKETS:
SEBI took over the Regulation of the Commodity Derivatives market on September 28, 2015 as
a result of merger of FMC with SEBI. The merger of two Regulators is an unique and rare event
across the world. It was also a heartening moment for SEBI as an organization that Government
43
had reposed faith in its regulatory capacity while entrusting regulation of a new sector. Taking
over the Regulation of the new sector and bringing it at par with the Regulation of the securities
market was a lengthy process which involved Gap Analyses, widespread consultation with
stakeholders, amendment to various Regulations, integration of trade data with our integrated
surveillance system, upgrading the risk management framework, improving governance system
of Exchanges and laying down an elaborate mechanism for investor grievance redressal and
arbitration, capacity building and necessary organizational restructuring.
We have made substantial progress in the past one year. The Government has also taken the eAgro market initiative to link spot markets for agricultural commodities across the country. This
will also improve linkage of futures market with spot market.
At the time of the merger, priorities of SEBI were:1. Ensuring proper risk management so as to avoid any major instance of misconduct.
2. Ensuring non-disruptive transitions of the Exchanges as well as brokers to the new
regulatory regime.
3. Improving the surveillance of the market and putting in place an enforcement mechanism to
ensure market integrity – integration of markets with integrated surveillance system of SEBI.
4. Putting in place an adequate mechanism for grievance redressal and arbitration.
5. Building capacity within and outside the Regulator.
Various steps were taken to ensure the above.
Strengthening of risk management
Few of the important steps and their impact are mentioned as under:
1. Position limits in the agro commodities were reduced to align with the existing liquidity and
to curb excessive speculative interest and consequential breach of market integrity.
2. Daily Circuit filter limits were also reduced in the agro commodities from 6% to 4% to
reduce volatility.
44
3. A new risk management system was put in place on September 1, 2016 introducing new
concepts/ tools to deal with the risk prevalent in the commodities markets. Some important
features of the new system are as under:a. Enhancement in initial margins to have better risk coverage.
b. Concentration margins on big positions
c. Tools for handling default such as liquidation in normal market, auction of positions,
voluntary tear-up and partial tear up etc.
4. To bring the risk management system at par with securities market, SEBI mandated forming
of clearing corporations by the exchanges. Three years’ time was provided to the
Commodities markets, in this regard. However, to make the existing system adequately
robust, even before the formation of clearing corporation, the following measures have been
taken regarding Settlement Guarantee Fund:
a. Uniform default waterfall
b. Stress test criteria and
c. Criteria for contribution by exchanges to SGFs.
Surveillance of market and Enforcement
Immediately after taking over the Regulations of the Commodities markets, the markets were
integrated with the Integrated Surveillance System of SEBI which is being used for the
securities market. This enhanced the vigil over the commodities markets very substantially and
enabled SEBI in taking action against the instances of misconduct. Action in the case of 18
entities was also taken under Section 11B of the SEBI Act, debarring them from participating in
the market as an interim measure.
Online registration of Brokers
To facilitate time bound, speedy and easy transition of brokers from the old system to the new
system, online registration was successfully implemented.
45
1) Strengthening of delivery infrastructure
Ensuring good delivery, which is so necessary for winning the confidence of the participants
in the Commodities markets, has always been a challenge. Considering this, SEBI in the
beginning itself made “good delivery” a legal responsibility of the Exchanges which used to
be a moral responsibility earlier. The Exchanges were also mandated to put in place
necessary infrastructure to ensure discharge of this legal responsibility.
2) Further, to improve the standard of warehouses and develop the warehousing sector elaborate
guidelines for `minimum standards’ and `governance’ have been laid down by SEBI
recently. Key features of the norms for WSPs (Warehouse Service Provider) are as follows:
a) Minimum net worth requirement of Rs. 25 crores for multi commodity WSPs.
b) Storage value of goods in warehouse not to exceed 33 times of the net worth of WSP.
c) Fit and proper criteria.
d) Compulsory accreditation of assayers.
Grievance Redressal Measures
The Grievance redressal system of the Commodities Markets has been brought almost at par with
the securities market. Formation of Investor Grievance Redressal Committee (IGRC), setting up
of Investor Service Centre at important places and formation of panel of arbitrators at the
exchanges are notable steps in this direction.
Capacity Building
a) NISM has been entrusted with responsibility of training the officers. So far, 220 Officers were
given training on Commodity Derivatives by NISM.
b) SEBI has also collaborated with US Regulator of Commodities i.e., Commodity Futures
Trading Commission (CFTC) in this regard.
c) A certification course at NISM for commodity market professionals is being put in place.
Other Developmental Efforts
46
1) Though the top priority of SEBI at the time of merger was risk management and
enforcement, SEBI is conscious of the fact that the further development of the market is
important from the angle of improving the liquidity of the market and making the benefits of
the market reach to all the stakeholders. SEBI, therefore, constituted an Advisory Committee
headed by Prof. Ramesh Chand, Member of NITI Aayog, which had representatives from
different segments of the stakeholders.
2) SEBI has allowed trading in options and now the exchanges have been allowed to submit the
proposal for option contracts.
3) On the recommendation of SEBI, the Government has notified following new
commodities for futures trading.
a) Diamond
b) Brass
c) Pig
d) Iron
e) Eggs
f) Cocoa
g) Tea
4) This committee is deliberating on the most important issues of the market such as improving
hedgers participation, improving liquidity of the contracts, having objective criteria
for introducing new commodities to futures trading, improving price polling
mechanism and bringing new participants, institutional as well as non-institutional, to
the market.
Other major regulatory initiatives
Some of the other circulars that SEBI has issued are on aspects of business continuity plan (BCP)
and disaster recovery (DR), annual system audit, testing of software, exit policy for commodity
exchanges, client code modification and cyber security and cyber resilience framework.
IMPLICATIONS OF MERGER:
47
In September 2015 FMC ultimately got merged with SEBI (Securities Exchange Board of India),
and thus begun a new era for commodity trading in India. The merger of SEBI and FMC was
first suggested in 2003. In 2007, the committee headed by Percy Mistry, a former World Banker,
submitted a report suggesting to bring regulation of all securities trading across stocks, bonds,
forex and commodities under SEBI. This view was also endorsed by a committee on financial
sector reforms headed by Raghuram Rajan in 2009 and the Financial Sector Legislative Reforms
Commission (FSLRC) in 2013.
SEBI is currently developing a makeover plan for commodity trading exchanges in India. As a
part of the plan, SEBI has already formulated a Commodity Derivative Advisory Committee. In
a recent circular (September, 2016) SEBI has allowed option trading in commodity market for
the first time. The prospective regulatory development that is most relevant for this research
work is that SEBI is also planning to allow trading in weather derivatives. The idea was first
mentioned during the presentation of Union Budget of 2016 and has already been discussed in
the first meeting of the Commodity Derivatives Market Advisory Committee in the first week of
March, 2016. Representatives from SEBI, commodity exchange officials and of the Agricultural
and Processed Food Products Export Development Authority were present during the meeting.
SEBI has set up a panel to analyze pricing models on such derivatives and the infrastructure
needed for its implementation. This work has discussed the basics of such an instrument and its
probable pricing structure. This may serve as a good starting point and useful direction for the
analysis of weather derivative product that SEBI is currently contemplating to introduce in
Indian capital market.
The implications of this merger are significant, firstly the stock exchanges would now become
universal exchanges were not only stocks, currencies and debt is traded but also commodity
derivatives. The same infrastructure which was earlier available to stock traders would also now
be available to commodity traders. Would could also happen is consolidation and acquisitions in
the commodity space, the big players would probably retain their presence, the smaller ones may
get acquired. Commodity options and commodity index investing which till now have not been
allowed would gradually be initiated thereby lending more liquidity, depth and breadth to the
market. Index based products offer a distinct advantage as they are not delivery based and
mitigate the problems associated with delivery of commodities. Many of the sustainability
48
related products such as weather derivatives which in a way are very similar to crop insurance
products floated by banks in the market are index based and non-deliverable. Trading in
commodity options has been allowed worldwide and is of immense significance from the
hedging and risk management perspective primarily because of the non linear payoffs associated
with options. Both these products options as well as index based products are forms of insurance
and would be very viable for a sustainable development. Probably both of these could see the
light of the day post the merger.
Commodity index investing which is also very popular worldwide would gain acceptability and
commodity indices developed by India by MCX and NCDEX which as of now are just for
information, would be then available for trading. With the presence of a strong regulator like
SEBI, the RBI could think of allowing banks to participate directly in the commodities market.
Participation of banks in the commodity markets would not only enable banks to serve the
function of an aggregator but also enable them to hedge their own risks arising out of commodity
exposure. Not to mention the associated liquidity benefits, reduction in transaction costs and all
in all strengthening of the price discovery and price risk management mechanism of the
commodity market (The very purpose of its existence). A stronger, unified and a fully
empowered regulator would also ensure that the illegal off exchange derivative trading in the
form of dabba trading is curbed. The merger of the two regulators would make it easy to track
money movements in financial markets. The brokers and the investors also stand to benefit from
such a merger, from the brokers perspective who are operating in both the markets there would
be huge savings in costs as common resources would be shared. Compliance with regulatory
norms would become much simpler, as of now the brokers have to get compliance audits done
separately by individual exchanges, SEBI and FMC which is highly cumbersome. Managing
margin money and fund transfers for brokers and traders would also become easier.
The investors would be in a position to reap the benefits of diversification by investing in
portfolios across asset classes, in fact empirical research has in most of the cases clearly brought
out the significance of commodities as an asset class from the diversification perspective due to
the negative correlation aspects between them and stocks and due to the very fact that investing
in them serves as a hedge against inflation as prices of commodities rise with a rise in Inflation.
The merger would also open up opportunities for foreign participation in the market thereby
49
enhancing liquidity. Post merger how soon would SEBI allow foreign investors and hedge funds
to participate in the commodity markets remains to be seen.
Opportunities for innovative derivative products in the form of carbon credit derivatives and
weather derivatives would open up. SEBI’s sophisticated market surveillance mechanism would
now get extended to the commodities market as well. Ironically FMC did not have any
surveillance mechanism. Any NSEL kind of scams most probably would not repeat under the
watchful eyes of SEBI.
A key challenge that SEBI would have to face in the light of this merger would be to manage the
perception of the impact of derivative trading on common man as commodity prices especially
agricultural commodity prices have significant implications for the common man. Another major
challenge for SEBI would be to gain an understanding of the physical settlements in the
commodity market; the issue gets more complicated because the spot commodities market would
not be with SEBI. SEBI could draw from the experiential learning of FMC to understand the
nuances associated with the functioning of the commodities market. SEBI has already started
giving effect to this by creating a separate Commodity Derivatives Market Regulation
Department for the regulation of commodity derivatives including exchange administration,
market policies, risk management and products and handling of inspections and complaints.
Additional divisions for intermediary registration, surveillance, investigation, enforcement,
regulatory assistance and research of commodity markets have also been created within existing
Departments of SEBI which will aid the merging of both markets and build capacity.
50
RESEARCH METHODOLOGY:
In the Union Budget for FY 2015-16, the Honorable Union Finance Minister proposed merger of
Forward Markets Commission (FMC) with the Securities and Exchange Board of India (SEBI).
The merger was supposed to bring convergence of regulations, harnessing economies of scope
and economies of scale for the exchanges, financial firms, and other stakeholders. Given SEBI‟s
expertise in effectively regulating the securities market for more than 25 years and the wider
powers it has to regulate the markets, it was also expected that under SEBI the commodity
derivatives market will be brought at par with the securities market in all aspects – technology,
new products and participants, regulation/code of conduct for intermediaries, risk management,
regulations, supervision, surveillance, investor protection and the enforcement framework.
Pursuant to Central Government notifications F. No. 1/9/SM/2015 S.O. 2362 (E) and F. No.
1/9/SM/2015 S.O. 2363 (E) under the powers conferred by Finance Act, 2015, the FMC was
merged with SEBI on September 28, 2015 and the Securities Contracts (Regulation) Act, 1956
was amended to include commodity derivatives within the definition of securities and Forward
Contracts (Regulation) Act, 1952 (FCRA) was repealed. To ensure smooth transition and merger
process SEBI started working towards merger right after the announcement by Honorable
Finance Minister in Union Budget and following steps were taken by SEBI:
1) Merger Planning:
• Formation of Commodity Cell and various Committees by posting of senior officials who were
given dedicated responsibility for preparing road map and successful execution of the merger
process and also coordination across various departments and entities.
2) Consultation with International Experts:
• To understand the regulatory framework for commodity derivatives markets in other countries,
interaction
was
done
through
teleconferences/video
conferences
with
international
regulators/exchanges.
• International Advisory Board (IAB) of SEBI was apprised of the progress of the merger
process. IAB inter alia advised that the emphasis during initial phase of merger should be on
51
avoiding any crisis in the market and market development may be visited only after fully
understanding the strengths and weaknesses of commodities markets.
3) Gap Analysis:
• Departments within SEBI carried out the gap analysis of SEBI Regulations/norms in
equity/equity derivatives market vis-à-vis norms in commodity derivatives markets.
• Necessary changes in various regulations especially the Securities Contracts (Regulation)
(Stock Exchanges and Clearing Corporations) (Amendment) Regulations, 2015 and SEBI (Stock
Brokers and Sub-brokers) (Amendment) Regulations, 2015 were brought in.
4) Organizational Structure:
• To bring out the maximum benefit out of merger and enable faster integration of work
culture/Expertise FMC was horizontally merged with SEBI, however, for focusing on the policy
issues in Commodity Derivatives market a separate department ‘’Commodity Derivatives Market
Regulation Department (CDMRD)‟ was created.
• In other departments such as Market Intermediaries Regulation & Supervision Department
(MIRSD), Integrated Surveillance Department (ISD), Investigations Department (IVD),
Department of Economic Policy and Analysis (DEPA), Legal Affairs Department (LAD),
Enforcement Department (EFD) the work related to commodity derivatives market was
completely merged at department level by creating dedicated divisions.
• The manpower requirement for these new departments/divisions was met by having suitable
mix of officers from FMC and SEBI to ensure continuity and expertise in regulating the
commodity derivatives market.
5) Risk Management:
• In order to increase robustness and to streamline the Risk management and margining
framework across National Commodity Derivatives Exchanges, norms were issued by SEBI
52
right after the merger which inter alia prescribed guidelines for margin calculations, margin
collection, Base Minimum Capital, acceptable forms of Liquid Asset deposits with appropriate
haircuts and concentration limits etc. Subsequently, Risk management norms for regional
commodity derivatives exchanges were also prescribed by SEBI. 6) Surveillance of commodity
derivatives market
• To bring the surveillance of the commodity derivatives market at par with Equity markets, data
acquisition equipment’s were installed and connectivity was established with national
commodity derivatives exchanges thereby integrating trading data with IMSS (Integrated Market
Surveillance System) and DWBIS (Data Warehousing and Business Intelligence System)
surveillance systems of SEBI. Data Integration facilitated in generation of commodity market
reports and alerts in DWBIS and IMSS systems.
7) Capacity Building:
• Various presentations/workshops were held with FMC/Commodity Derivatives Exchanges/
Commodity Derivatives Brokers/Market experts/ Consultants for understanding the nuances of
commodity derivatives market and its ecosystem.
• Various teams of SEBI officials visited commodity market ecosystem such as exchanges,
warehouses, mandis, and vaults etc. to understand the process of deposit, delivery and storage of
commodities.
• SEBI officials were also provided training on the commodity derivatives market by market
experts.
53
THE WAY AHEAD:
With both the regulatory agencies now being under the same ministry the merger definitely
became much easier. The Finance bill (2015) had laid down the road map for the merger and
various legislative changes have been incorporated in the same. The Forward contract
(Regulation) act, 1952 was repealed with effect from September 29, 2015 paving the way for the
merger. As per the Finance Act, 2015, the bye-laws, circulars, or any like instrument made by a
recognized association under the Forward Contracts (Regulation) Act (FCRA) shall continue to
be applicable for a period of one year from the date on which that Act is repealed, or till such
time as notified by the Security Board, as if the Forward Contracts Act had not been repealed,
whichever is earlier. SEBI in order to effect the merger, has amended Securities Contracts
(Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 (SECC
Regulations) and SEBI (Stock Broker and Sub-Broker) Regulations, 1992 and SEBI (Regulatory
Fee on Stock Exchanges) on September 09, 2015. These regulations enable functioning of the
commodities derivatives exchanges and its brokers under SEBI norms and integration of
commodities derivatives and securities trading in an orderly manner. The bill provides that
commodity market intermediaries, including exchanges and brokers would be given one year to
comply with SEBI regulations once the FCRA is repealed. The Banking Regulation act, 1948
would have to be suitably amended if banks were to be allowed to participate in the commodity
market which is currently prohibited by the said act. In a meeting held in August 2015 conducted
by SEBI to sort out issues over its merger with FMC, it was decided that a time limit of up to
three years would be granted to commodity exchanges to have separate clearing corporations
which they do not have currently and which is also a mandate under the SEBI Act. Also it was
decided that a net worth of Rs 100 crore will have to be acquired by the national commodity
exchanges by 2017 along with regional commodity exchanges within three years of the merger.
An official notification issued by SEBI on the 24th August 2015 said “The Board approved draft
amendment to the regulations to be notified on September 28, 2015 pursuant to the proposed
repealing of the Forward Contracts Regulation Act, 1952 (FCRA) making way for merger of
Forward Market Commission with SEBI,”
54
The merger thus got effective from September 28.2015. Shri Arun Jaitley, Honorable Union
Finance Minister, unveiled the historic merger at an event in Mumbai,. Shri Jaitley also released
the new regulations that were notified. SEBI is of the view that at least a year’s time would be
required to ensure a smooth merger and compliance with the new guidelines and therefore stock
exchanges would have to wait for at least a year to launch commodity segments on their existing
platforms.
A key issue of contention is whether commodities should operate as a separate division under
SEBI or not. It would always be better that commodities operate as a separate division under
SEBI, specialized personnel familiar with commodities futures, physical trading and operation
could be appointed to run that separate division .An awareness drive related to the sensitization
of stakeholders if conducted at regular intervals post merger would definitely be useful. The job
of establishing a national level and transparent spot market for commodities in India would also
have to be undertaken. Legislative reforms in this direction are much called for.
All said and done it has to be ensured that while implementing changes in commodities market
the key aspect of commodity futures trading in terms of it providing a platform for price
discovery and risk management is not compromised.
55
CONCLUSION:
As has been brought out in the case, this merger can serve multiple purposes if implemented in
the right spirit and in the right manner. It is one of the major steps taken by the government and
it has the capacity to provide a major positive pay off resulting in the development of the
commodities market in India and raising it to the level of its global counterparts, also
Institutional changes have always been seen as the remedial measure to post crisis scenarios, Just
like SEBI was born in the aftermath of the Harshad Mehta Scam, The Rs, 5600 CR, NSEL Scam
has been the triggering event in the proposed merger of the two regulators. The merger thus was
the need of the hour. Certain questions would emerge for discussion and debate post this merger
primarily whether it would have advisable to allow FMC to retain its individual identity keeping
in view the significant differences between the two markets and empower it through an
amendment to the FCRA, rather than having it merged with SEBI and second being that could
this merger be an indication that India is moving towards having a super regulator across
financial markets. In fact the FSLRC has recommended merger of not only SEBI and FMC but
also the Insurance Regulatory Development Authority (IRDA) and the Pension Fund Regulatory
Development Authority (PFRDA) into a single entity called Unified Financial Agency (UFA).
Behind every market, there is brilliant regulation and the regulators. There is an inherent fear that
outsized regulators will lose focus on authentic agricultural derivatives and focus more on
similar commodity/equity derivatives like gold or crude futures. There is more price fluctuation
in agriculture commodities due to the time lag between demand and supply, i.e., one harvest
season. This means the short-term production and consumption elasticity are low. Production
responsiveness is low due to one period lag between sowing of a crop and the new demand. For
plantation crops like cashew, tea and rubber, it takes two to seven years to respond to demand or
price increase. This is where the commodity risk management techniques11 have the potential to
improve the fluctuation of the agriculture supply and demand mechanism. There is a need for
integration of commodity market with security market for streamlining the system, and then
disintegrating commodity regulation from equity to give a specialized focus like in the US and
the UK. This one is, for sure, a complex system and hence coming up with a single solution is
difficult.
56
BIBLOGRAPHY:
1. Habibullah, W. (2003). Report of the Inter-ministerial task force on merging of securities and
commodity derivative markets. The ministry of consumer affairs, Government of India.
2. Percy, M. (2007). Report of the high powered expert committee on Making Mumbai an
international financial center. The Ministry of Finance, Government of India.
3. Raghuram, R. (2009). Report of the committee on Financial sector reforms. Ministry of
Finance, Government of India.
4. Srikrishna, B. N. (2013). Report of Financial Sector Legislative reforms commission. The
Ministry of Finance, Government of India.
5. Source: http://www.indiainfoline.com/article/research-articles/what-is-commodity-transaction-
tax
57
ANNEXURE:
Exhibit I: Loss in volume of the Major National commodity exchanges over the period April
2013 - December 2013 (All Figures in Rs- crore)
Period
MCX
NCDEX
NMCE
ICE
ACE
April 01-15
7,01,247
68,972
6041
6579
3440
July 01-15
3,59,690
36,691
6514
1977
1498
July 16-31
4,16,434
47,518
5407
2082
1504
September
01- 2,71,348
48,108
6175
2192
1175
December 16-31 2,19,986
55,269
7442
3389
1492
16
Source: FMC
Exhibit II- Chronology of Events leading to the FMC-SEBI Merger
Year 2002: The Government of India withdraws prohibition on Derivatives trading in
commodities. Year 2003: SEBI appointed KR Ramamoorthy committee recommends allowing
security brokers in commodities future market.
Year 2004: Wajahat Habibullah Committee recommends merger FMC with SEBI. Report
submitted to the Ministry of Consumer Affairs, Government of India.
Year 2007: Percy Mistry Panel suggests bringing regulation of all securities trading across
stocks, bonds, forex and commodities under SEBI. Report submitted to the Ministry of Finance,
Government of India.
Year 2009: Raghuram Rajan Committee reiterates consolidation of all financial sector regulators
under one roof. Report submitted to the Ministry of Finance, Government of India.
Year 2013: Justice B N SriKrishna led FSLRC recommends unified regulation of not only SEBI
and FMC but also the IRDA and the PFRDA into as single entity called Unified Financial
Agency (UFA), Report submitted to the Ministry of Finance, Government of India.
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Year 2013: FMC shifted from consumer affairs ministry to Finance ministry post, the Rs 5600 Cr
NSEL Scam Year
2015: The Hon. Finance Minister, Shri Arun Jaitley announces merger of FMC with SEBI in his
annual budget speech.
Year 2015: Union Government notifies the merger to be effective from September 28, 2015.
Year 2015: On September 28, 2015, FMC merges into SEBI, the FCRA stands repealed.
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