Exchanges want sweeping changes in proposed liquidity enhancement scheme

Want it for only new schemes, for limited periods and with checks on anti-competitive effects

The liquidity enhancement scheme (LES) proposed by the Forward Markets Commission (FMC) on commodity futures exchanges require a change in format to make it successful, feel the latter.

To make commodities eligible for LES, the regulator has proposed a daily turnover of Rs 100 crore in agricultural and Rs 500 crore in non-agricultural commodities across all contracts in the previous three months. It had sought public comment on the proposal by January 21.

Under this provision, 18 or 67 per cent of the 27 running contracts would come under LES eligibility on the Multi Commodity Exchange (MCX). Of a little over 100 commodities allowed for trading in futures exchanges, around 80 would require LES support.

However, the exchanges want the scheme to be made available only for new contracts. “Unless LES is confined to new or illiquid contracts, the bigger exchanges can buy out the existing liquidity prevalent on smaller exchanges. This can drive the smaller players out of the market, which bodes ill for competition and market efficiency. Further, the regulator must give 18-24 months for other exchanges to launch the same or similar contracts, to allow sufficient time for the build-up of liquidity in that contract,” said an MCX spokesperson.

Barring iron ore and cotton, there has been no new contract launch in four years. The cotton one was successful, with a physical market linked design. The one in iron ore could not succeed due to absence of any differentiating feature.

FMC proposed a maximum of three LES’ for any commodity, for two years cumulatively. Once the scheme is discontinued, it can be re-introduced on the same commodity within three years.

“It is very important that LES programmes are targeted for a limited period, towards stimulating specific areas which need this initial support. It should not become a tool to incentivise traders for their orders,” said a spokesperson of the National Commodities and Derivatives Exchange. “Volumes drop substantially after the end of LES, since the incentivised volumes disappear overnight. More, such aggressive LES schemes also take a toll on the exchange’s financial health.”

Analysts fear an exchange will go on reducing transaction charges to grab the market share of others. Hence, LES should not be allowed in contracts with adequate liquidity in one exchange, only for the sake of promoting it on another, they said.

Globally, market makers are big banks or financial institutions with the wherewithal to manage the risk. Their volume is so large that once they enter  the exchange, they will be able to suck a huge amount of saving in the form of transaction charges. Big players are building the markets by incurring some losses right now because they are confident of more than recovering it when the market becomes liquid. They will also have freedom to develop the market.

“Commodities markets need a liquidity provider (market maker) who can take financial risk. Indian commodity markets require a big push from committed organisations. They should be allowed with a transparent disclosure system, especially for the positions held. These players do not require entering into delivery but to be adequately financially compensated. So, these players trade in commodities for price discovery and risk management. But, without market making, commodities exchanges cannot perform up to their potential,” said a senior exchange official.

The MCX spokesperson said market making has succeeded globally only for a new commodity and at new exchanges.