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The SEBI-FMC Merger!

Published on Sat, Sep 26,2015 | 16:22, Updated at Mon, Sep 28 at 22:19Source : CNBC-TV18 |   Watch Video :

In December last year the prices of castor saw an unusual upmove accompanied by high volatility and the build-up of open interest in the commodity on the NCDEX. In June, similar movements were witnessed in coriander prices. Alarmed by the volatility, commodities regulator FMC – Forward Markets Commission – imposed higher margins and trading strictures. But it could do little else. FMC could neither investigate the price movements nor penalise manipulators. That’s because it doesn’t have direct jurisdiction over commodity brokers. FMC Chairman Ramesh Abhishek says the 60 year old law that created the regulator never gave it enough powers.

Ramesh Abhishek
Chairman, FMC

“The regulatory framework was inadequate to the extent that it was not the modern, powers of the regulators was missing. Since 2003, there have been attempts to strengthen this regulatory framework.”

India’s commodity markets date back 140 years. In 1952 the Forward Contracts Regulation Act was Independent India’s first law to regulate commodities trading. But as the name suggests, the act covers only commodity futures. The next year the FMC or Forward Markets Commission was set up to implement the act. In time it came to oversee 20 commodity exchanges trading in 42 commodities. In 2002, electronic commodity exchanges were permitted for the first time. The setting up of NCDEX, MCX and NMCE marked a big leap forward for India’s commodity markets but their regulator and the law stayed locked in time.

Ramesh Abhishek
Chairman, FMC

“After 2003 there was a bit of a mismatch between the growth the market had seen and the regulatory powers that existed in FMC...so there were many issues with sugar contracts around 2007, with tur dal, with turmeric later on, and wheat and later on guar gum and guar seed in 2011-12. After the guar seed episode, we have examined all these episode and we brought about very significant reforms in the way Agri futures were traded.”

But nothing prepared FMC for the NSEL collapse. In 2013, commodity spot exchange NSEL ran into payment troubles. On investigation it was discovered that NSEL was running a ponzi scheme of sorts. But FMC could do nothing as spot exchanges did not come under its jurisdiction. They existed in a regulatory blind-spot- some say a blind spot consciously created by political masters. As NSEL collpased it took down Rs 5600 crores of investor money, led to the arrest of Jignesh Shah, the founder of MCX and NSEL, exposed broker malpractice and investor vulnerabilities. The NSEL collapse catalysed government into strengthening commodity market regulation. Soon after, a committee looking into financial sector legislative reforms proposed the merger of FMC with SEBI.

Ramesh Abhishek
Chairman, FMC

“The proposal to amend the FCRA was in the works for a long time. And I think now in the meantime we have this FSLCRC report. So I think that financial sector reforms are very important and this move now that the report has come and the government is considering implementing that report, I think this is the possibly the best move we could have had.”

Sajeet Manghat
CNBC TV18

“On September 28th the commodity markets will open under the supervision of a new regulator. SEBI, strengthened by 22 officers from FMC will set up a separate division for commodity markets. The first big challenge that self-funded SEBI will face is to find the funds to expand its oversight. A temporary government grant may help.”

UK Sinha
Chairman, SEBI (June24th)

“I do hope they will give some support; they are already giving support to FMC. However SEBI is very proud of the fact that it has never received any support from the government from day 1. It received a loan in the early years of SEBI, that loan was also returned by SEBI to government of India with interest. So we believe that we have to be financially independent. May be initial period, I can’t even say what time period; I have to go to my board and seek their guidance. May be initial time period we will require some support otherwise we will not require any support…”

SEBI’s next big challenge will be tackling a big reduction in the number of commodity brokers. So far a jeweler or a metal trader could also register as brokers at a commodity exchange. But SEBI broker regulations don’t permit that.

Parveen Kumar Singhal
Joint MD, MCX

“In our market there are different category of brokers like some are just trading members, some are trading cum clearing members. There are lots of brokers who are for different segments ...like lot of jewelers are having members hip of bullion only there are lot of members who have membership of base metals only all those things in the SEBI regulations there are no such concept...”

Commodity exchanges expect their broker networks to shrink by atleast 50%. SEBI could be soon faced by dwindling volumes and shallow markets among other issues.

Samir Shah
MD & CEO, NCDEX

“It needs to be recognised that commodities firms have inherently a large business in the physical commodities market and they need to hedge on to the exchange and which why they need to participate in the exchange. Now by restricting them from carrying out any other activity other than derivatives one cannot say to commodity firms that you have to stop your physical activities...you have Ruchi, Adani or ITC. You cannot tell ITC that you have to stop your food processing business. If you want to participate on the exchange.”              

The physical settlement of commodities will present another conundrum. Even in the securities market, SEBI has not been in favour of physical settlement of derivatives because the regulator believes it increases default risk. In the commodities market that risk is magnified due to a weak regulation of warehouses. Currently, physical settlement of commodities requires delivery via warehouses. But the warehousing law of 2007 doesn’t compel warehouses to register, hence leaving many un-supervised. Commodity exchanges have attemped to safeguard trades by providing that commodity settlements can only be done via registered warehouses. Now SEBI will have to decide to whether such exchange supervision is enough? Or whether it should regulate warehouses as market intermediaries?

Ramesh Abhishek
Chairman, FMC

“Now when this market is regulated by SEBI from 28th of this month, they will have this additional choice because there regulations may permit warehouses to be used as intermediaries also...after they take over they will have to examine this issue...and they will have to take a view on that. We have never thought about that because we never had provisions under our act.”

Parveen Kumar Singhal
Joint MD, MCX

“I dont think SEBI will do that. Even FMC was doing it initially. Subsequently FMC in their right wisdom decided not to do that because it is not their work. Registration of warehouses is now with WDRA, and it should be done by WDRA only.”

Then there’s the un-resolved problem of spot exchanges. 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.

Ramesh Abhishek
Chairman, FMC

“I think price polling which has been used as a reference price for the future price settlement has been a major issue in our market. And in the past several attempts have been made to see whether we can have a better fixation of reference prices. What we have done in last December is that we have got the entire price pooling system transparently displayed on the websites of the exchanges. so that all the market participants are aware as to from which location what prices are quoted for which commodity twice a day or 3 times a day. “

Manoj Vaish
Former CEO, BSE
Former CEO, MCX

“This is always been a challenge wherever there is a price polling as the method for determining the settlement price, that challenge will remain till we have very active spot exchanges which can be used as references.”

Sajeet Manghat
CNBC TV18

“By the way SEBI will have as little or no control over spot exchanges as FMC did. NSEL has shut down. But NCDEX e-markets is still functioning in the same regulatory blind spot that NSEL did. Speaking of exchanges – the other challenge SEBI faces is to ensure commodity exchanges comply with the various criteria that apply to stock exchanges.”

For instance - a stock exchange must have a clearing corporation as a separate entity with a minimum networth of Rs 300 crores. Commodity exchanges have done the clearing function in-house. They now have 3 years to create a distinct entity and meet the net worth criteria. That should be easy for MCX – it has Rs 1200 crores in net worth. But NCDEX’s net worth is just Rs 350 crores.

Samir Shah
MD & CEO, NCDEX

“NCDEX runs a clearing house which is actually a clearing activity run within the exchange. We also have our own 100% subsidiary called NCCL that is capable to evolve itself into a full fledged clearing corporation. And we will do whatever is required over the next 3 years to bring ourselves in line...”

Then there’s the problem of listed exchanges. None of India’s stock exchanges are listed – mostly because they’ve found it tough to meet SEBI’s specific listing criteria for stock exchanges. But commodity exchange MCX did not have to meet those criteria when it listed in March 2012. Some criteria – such as a net worth of Rs 100 crores may be easy for MCX to meet, but not for NCDEX if it wants to list. Given these varying capabilities and the need for a level playing field, both exchanges suggest SEBI should issue new regulations for the listing of stock and commodity exchanges.

Parveen Kumar Singhal
Joint MD, MCX

“SEBI probably will come out with a parameter how those exchanges can go for a listing and whatever parameters they lay down for them, some parameters they will like MCX to do it...and for that they will give us some time period to comply...”

Eventually the unified regulator may also have to provide for universal exchanges.

Parveen Kumar Singhal
Joint MD, MCX

“Stock exchanges are also looking at the commodity field... one of the exchange was thinking of promoting a separate company for the commodity trading now they need not to do that it will come as a segment.“  

Samir Shah
MD & CEO, NCDEX

“SEBI has said that on day one they will not be allowing cross listing of segments and it will happen at a subsequent period of time with certain conditions and under certain situations so we will have wait and understand how those unfold and what opportunities that presents to us and what risks that posses to us as well in terms of competitive challenges. “

Challenges aside..there are also areas of regulatory commonality. Risk management systems are similar in commodity and stock exchanges.

Manoj Vaish
Former CEO & MD, BSE & MCX

“A lot of convergence has already happened, if you look at the way risk has been managed in commodities market or in t he stock market there are lot of similarities whether it is at a stage of taking a member and requiring a base capital your various margins and collaterals whether it is based on volatility based margins, mark to market margins, so by and large the risk management system has converged.”

And the good news is that SEBI has always had more power than FMC did. For instance, SEBI has jurisdiction over exchanges and intermediaries such as brokers. FMC never did.

Parveen Kumar Singhal
Joint MD, MCX

“Presently the broker are not governed by the regulator FMC directly, whenever some action has to be taken against the broker the regulator used to take through the exchanges. so now SEBI will be having direct powers to penalise the wrong doing of any broker also. Definitely one thing is unquestionable that whether the governance will improve or not...100% the governance will improve with the merger of FMC with SEBI.”

As the shutters come down on the FMC Mumbai headquarters, SEBI’S workload will undoubtedly increase. Besides harmonising regulations and overseeing physical settlements, it will also have to work towards developing the commodities market, adding new products and reducing volatility.

Ramesh Abhishek
Chairman, FMC

“How do you get depth in the market so that the price discovery is credible and some large fellow is not able to move prices in a particular way, for that you need to have more participants more instruments so that there is more liquidity so that there is more participation. That is the real challenge.”

Sajeet Manghat
CNBC TV18

Commodity market participants, commodity exchanges and even the outgoing Chairman of FMC all say a unified regulator is the right move. But SEBI’S going to have to hit the ground running to ensure that it brings the same scrutiny to commodity markets as it does with the securities market.
 
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