The Sebi-CERC turf war over control of trading in energy as a commodity

As several exciting futures markets for commodities in the energy sector--chiefly electricity but also gas and coal--spring up, differences within the government about who should run them could be a spoiler. The differences may not remain academic. Unsavoury developments in the futures markets for commodities from gold to castor seed forced the government to bring all of them under the regulatory watch of the Securities and Exchange Board of India (Sebi) in 2015. It began as turf war and then threatened to become a political storm engulfing senior ministers in the UPA government such as Sharad Pawar and later Pranab Mukherjee. In the process it impacted the career of more than one senior bureaucrat. 

CERC is expanding the spot market for electricity and has approved a trading product with a validity of 11 days, the outer limit beyond which Sebi’s mandate would kick in automatically. A commodity contract beyond 11 days becomes a future trade as per Indian securities market rules, and operates under the purview of Sebi. 

The market regulator is not amused and has pointed to the risk of rogue traders using regulatory arbitrage, as had happened under the watch of erstwhile Forward Markets Commission. Incidentally, some of the institutions involved on both sides now have histories which also connect them with the commodities market scam.

The stakes are indeed steep because international traders in this market are often massive entities who could swamp a regulator with little experience. Traders in commodity markets sit at the intersection of financial instruments and commodities, with access to vast banking networks. They often engage in shadow banking activity as this Financial Times commentary points out. “Glencore, one of the world’s largest commodity traders, has already recorded almost $15bn in bank credit for 2020”. As India opens its energy markets including power, gas and coal to the world, these risks multiply. 

However there are no political differences this time around, since both the power and the finance ministry are run by the same party in the union government, the BJP. Yet the battle for who should regulate the markets between the Central Electricity Regulatory Commission (CERC) and Sebi is already with the Supreme Court since 2015. At times of stress, which is inevitable in any market, these differences could hurt. Because of the sensitivities involved no one from the two ministries--power or finance--is willing to speak on record for this piece.

A new commodities market:

For the past few years, the possibility of exchange-traded power has begun to attract interest from investors. The largest platform for the trade is Indian Energy Exchange (IEX) with a massive 95 per cent of the share of the market. It was set up by erstwhile Financial Technologies in 2008 but was divested when the parent company ran into trouble in the wake of the commodities forwards market scam. Rivals like Power Exchange India Limited—promoted by NSE and NCDEX and the recently recognised Pranurja Solutions (BSE, PTC and ICICI Bank) will, however, hope to offer stiff competition. They have reasons to be hopeful as the CERC plans to introduce an order matching mechanism for trades—market coupling, which will allow for same price discovery for electricity on all platforms. In which case, it will be the efficiency of the trading platform which will attract volumes instead of giving any advantage to the first mover like IEX. Market coupling is the basis on which most of the European power market has been harmonised. 

The central government wants to move more buyers and sellers of power on to these exchanges. The reasons are obvious. The power buyers are largely the state-run distribution companies (discom), the sellers are the power plants; their ranks now include the renewable companies too. The discoms mostly depend on long-term power purchase agreements instead of shopping for their needs on the power exchange. Such agreements account for 88 per cent of the power market. The business coming to the exchanges is only four per cent, the rest is through bilateral deals, through traders and as last-minute unscheduled purchases. In the process these discoms owe more than Rs 90,000 crore to the generation companies. The bad debts of the sector to the banks exceed Rs 1.08 trillion. 

If the government has its way and as the profusion of exchanges shows, it is on the right path, PPAs could become history and all the contracts for drawing the 360 Gw plus power India generates could occur through exchanges like IEX. All these mean futures in electricity is already on its way to become big time opportunity. This makes it important to decide who shall run the market! Nascent markets for gas and for coal already announced by the respective ministries, will also decide the futures market mode they shall adopt based on the resolution of the dispute between CERC and Sebi. Incidentally the spot market for power is mostly run by the sector regulators. Seven European electricity exchanges for example have developed the joint price coupling mechanism.  

The legal position: 

Under the Securities Contract (Regulation) Act, of 1956, all trading in the futures price of a commodity is supposed to be under Sebi’s watch. The definition of futures market means trade in underlying contracts which promise to sell or buy the goods in future. In the case of electricity, CERC has argued that since all the products for the electricity markets it has approved result in delivery of the commodity after eleven days, the trades qualify as a spot market. Only if it permits a non-deliverable market, does Sebi need to walk in. The Supreme Court, it claims has also agreed to this position and just has to ratify the same. A decision from the Court can be expected any time soon. A senior power ministry official said, “We understand the (Supreme) Court has reserved the order and it should come out soon, sorting the jurisdictional issues”. An Economic Times report quotes a source to say “Decks have been cleared for the start of the electricity futures market in India with regulators reaching a broad understanding on how to go about it while allowing derivative instruments for market participants.” Sebi and the finance ministry disagree.

In the power exchanges now, there are effectively three types of products, the Real Time, Day Ahead and Term Market. The first, Real Time market, as its name implies, offers matching of electricity produced and sold throughout the day. They are designed as half-hourly markets through the day where auctions are held at intervals of 15 minutes each and then a period to make the delivery. It is a popular product globally. 

The next is the Day Ahead market, where the demand and supply is matched for delivery with a 24-hour lag. The Term Market allows participants to trade electricity contracts for up to 11 days ahead. There are also the Renewable Energy certificates but those are not contested territory. 

It is the Term Market which is at the centre of the argument. While Sebi is convinced that irrespective of delivery, the term market is a futures product. CERC is equally convinced that it is not. It has noted that since there is a delivery of the electricity in eleven days, it qualifies as a spot market. Only if the trade was squared off in rupees would it qualify as a futures trade and be open for Sebi to decide upon. 

But a 2016 notification issued by the department of economic affairs in the finance ministry has complicated matters. It lists the goods which qualify for “forwards” market. The definition makes no distinction between deliverable and non-deliverable market. Electricity figures in the list. So as per the notification it is the market regulator Sebi, which will not only run the show but shall also decide if a trade in a particular commodity qualifies as a futures one. 

At heart the problem is simple. Does CERC have the right to decide penalties for a default in a trading environment like the Term Market? Because for any contract just beyond 11 days, the market will come under the Sebi. "Two markets for the same commodity cannot be run by two regulatory agencies,” Sebi has raised in its contention with the government. 

Any forwards market will bring in traders with different financial abilities. If a trade fails, will the differences in the regulatory remit of CERC and Sebi hurt market integrity? More so, there is a provision in the Act for state-level regulators to also have similar powers. The Electricity Act makes no distinction in the powers of the two. Does it mean that if a trade defaults in an electricity trade, both can get into the act?

There is no other market in India where such a dichotomy exists. A perusal of the Electricity Act shows it offers the rights to the electricity regulator to facilitate electricity trading only in connection with delivery to the final user. 

Sub section 71 of Section 2 of the Act just defines trading to mean “purchase of electricity for resale thereof”. Section 178 (o) says it shall lay down the “duties of electricity trader” but those shall apply “in relation to supply and trading in electricity”. The role of a financial market in electricity is not in the domain of the Act. It has domain over areas like how the power supply should move. For instance, it has issued a concept paper on Market Based Economic Dispatch (MBED) which  aims to ensure electricity flow makes the least demand on a system load yet also remains the cheapest but giving preference to the least cost generation mix.

Historical legacy: 

But this, according to Sebi, does not offer a clear cut reason for CERC to run a commodities market for power. For example, who shall decide on the futures market rules once electricity is opened for trans-national trading by the Indian government? As pointed out earlier the stakes the translational commodity traders shall bring will need the expertise of a market regulator connected with global developments to keep a tab on. The government plans to expand the electricity market to the subcontinent. Can a sector regulator have the jurisdiction to decide on inter-country market? The Central Electricity Authority has decided to issue regulations in this context that have been contested by some of the Bimstec countries. India has ambitious plans to move the trade in all energy materials on to the exchange platforms. NITI Aayog and other agencies have pointed out this helps in better price discovery, helping consumers and producers both. 

There is a history to this turf battle. In 2009, commodity market platform MCX decided to introduce forward trading in electricity to expand its portfolio. But CERC, after initial approval, denied it permission because Financial Technologies promoted IEX was already in the business. It became a court battle and stretched for years. MCX claimed CERC was “usurping jurisdiction over forward and futures contracts”, whereas forward trading in any commodity was the preserve of the then regulator, Forwards Market Commission. The case travelled to the Bombay High Court and then the Supreme Court. The case has not got settled, since the Commission was meanwhile merged with Sebi. The current Sebi position, extends this argument. 

Table 1: Market share of electricity products

Marker share	2009	2019
Long-tern (including PPA)	93.86	88.30
Short-term	6.14	11.70
of which	.	.
- Exchanges	0.4	4.0
- Through traders	3.2	4.1
- Direct bilateral	0.5	1.5
- Unscheduled interchange	2.1	2.0

All figures in percentages

Table 2: Term Ahead Market

Weekly	3,784,102
Day ahead contingency	3,522,904
Intraday	2,214,857
Daily	2,087,126

All figures in MWh for four types of contracts