SEBI may allow FPIs to engage in the commodity derivatives market

An Overview

India is considering enabling foreign portfolio investors (FPIs) to trade commodity futures listed on local markets, at a time when China is permitting more offshore investment into commodities.

According to sources, the Securities and Exchange Board of India (SEBI) recently held a meeting with leading international commodity trading firms, FPIs, banks, and one of the bourses to understand their perspectives on the subject.

Foreign corporations are prohibited from taking positions in exchange traded commodity derivatives, unlike other financial assets such as stocks, bonds, gilts, and currency.

After filing necessary paperwork demonstrating their export or import of commodities with an Indian party, ‘foreign eligible entities’ are allowed to ‘hedge’ their positions in a domestic commodity market. However, these are one-way trades limited to the amount of their physical market exposure, as laws prevent them from freely buying and selling commodities futures.

Further Key Takeaways

Allowing FPIs and other foreign investors to have position restrictions in commodity futures will only necessitate modifications to SEBI regulations, not legislative changes. The Securities Regulation Act currently recognised commodity futures (together with equities and corporate bonds) as “security.”

The invitations came from Sebi, while one of the commodity exchanges took an active interest in the conference. As a result, they may be assessing the benefits and drawbacks of enabling FPIs to trade non-agricultural and non-sensitive commodities such as gold, silver, and other precious metals. China, too, is making it simpler for foreign capital to trade commodities, according to a source.

China announced new guidelines in November 2020 to make it simpler for international institutional investors to access the commodity futures market. Unlike previous laws that only allowed foreign funds to engage in stock index futures, the new framework allows foreign funds to invest in bond futures listed on the Chinese Financial Futures Exchange as well as commodity futures and options trading on Dalian, Shanghai, and Zhengzhou exchanges. RBD palm olein options became the first option product for international investors to trade in China on June 18, 2021.

A Bigger Role

On Indian commodity markets, the daily traded volume is between Rs 30,000 crore and Rs 40,000 crore. “The position restrictions on global markets are enormous. As a result, the government and regulators must raise the limitations in order to attract FPIs. Documentation requirements for commerce should be eliminated. Furthermore, there should be more tax certainty. Because a foreign fund has no presence in India, it will opt for cash settled transactions. An FPI may wish to diversify its portfolio with commodity futures rather than hedging,” remarked an expert.

Even with other securities, FPIs do not hedge their risk aggressively. While they hedge against foreign exchange losses on a big portion of their bond holdings when gains are limited, they only hedge about 10-20 percent of their stock exposure. The regulator may have a plan to see India emerge as a price-settler in some commodities in the long run, in addition to pushing for more transparency and price discovery through bigger volumes and liquidity.

However, in the past, deregulation of commodity futures has run into roadblocks due to false expectations that futures prices will influence physical market pricing. FPI could be allowed in such a way that inflows do not push up the headline and consumer inflation in certain circumstances. Many governments, including China, have had to strike a delicate balance and adopt a measured approach when allowing foreign funds to trade commodities futures.

Frequently Asked Questions (FAQs)

Q1. What is the definition of a commodity derivative?

Monetary tools known as commodity derivatives allow investors to profit from commodities without having purchased them. A derivatives contract gives the buyer the right to exchange a commodity at a specific price at a future date.

Q2. What forms of commodity derivatives are there?

Futures and forwards are two types of commodity derivatives used in derivatives markets; these derivatives contracts use the spot market as the underlying asset and provide the owner control of it at a point in the future for a price agreed upon in the present.