High transaction costs in the futures market were an impediment to arbitrage and these could be reduced by allowing banks and financial institutions, including foreign institutional investors (FIIs), to participate in commodity futures trading, a five-member committee headed by D S Kolamkar, senior economic advisor in the finance ministry, told the government. The panel had given a report on ‘steps to fulfil the objectives of price discovery and risk management of the commodity derivatives market’ on April 28; this was released by the Forward Markets Commission (FMC) on Monday. The committee had M S Sahoo, secretary, Institute of Company Secretaries of India; C K G Nair, advisor in the finance ministry; Susan Thomas, professor, Indira Gandhi Institute of Development Research; and Usha Suresh, economic advisor, FMC. “These are the old recommendations of several groups. Bank and FII participation in the commodity futures market should be agreed to by other regulators as well. While banks’ entry will have to be cleared by the Reserve Bank of India (RBI), the Securities & Exchange Board of India needs to allow FII participation,” said Madan Sabnavis, chief economist, CARE Ratings. A number of policies and regulatory restrictions restrict banks and financial institutions from participating in the futures market. Restrictions on banks, under the Banking Regulation Act, and other -regulated entities had to be removed to widen participation in these markets, the committee said. The existing system of limits on open interest and risk management provided adequate safeguards against the risk of allowing foreign participation in Indian markets, the panel said, adding high warehousing and assaying costs added to the transaction costs of hedgers.
As modernisation of scientific storages and grading facilities would reduce friction in arbitrage, the finance ministry should engage with the Warehousing Development and Regulatory Authority to pursue a work programme to assist negotiability of warehouse receipts and their trading in spot markets, the panel said. It added the government should exempt arbitrageurs from restrictions on holding inventory. It strongly objected to abrupt suspensions of trading in commodities and recommended the FMC voluntarily adopt the regulatory governance of the draft Indian Financial Code to reduce legal and regulatory risks in the eyes of financial firms. The committee recommended the FMC focus on addressing market failures through consumer protection and micro-prudential regulations. The regulator should ensure owners and managers of exchanges had incentives that were aligned with these objectives and set up regular monitoring and reporting systems, the panel said. Also, the FMC should gradually step away from micro-managing contract design and market design. A review of contract designs should be undertaken periodically to ensure these reflected spot market realities and provided effective hedging opportunities to participants, the committee said.