Sebi seeks to ramp up hedging in commodities

Groups set up for introducing new products, reviewing polling, position limits

The Securities and Exchange Board of India (Sebi) has asked the commodity market advisory committee headed by Ramesh Chand, agriculture expert and full-time member of Niti Aayog, to recommend measures to increase hedgers' participation in commodity derivatives.

Hedging is the core function of the commodity derivatives market and trading and speculation are permitted with regulations only to provide liquidity.

WHAT IS HEDGING ?
Futures contracts have two sides: A long, or buyer, and a short, or seller. An airline concerned about a future rise in the price of jet fuel might buy oil futures now and take a long position. If crude oil jumps from $40 to $60 a barrel, the corresponding increase in the value of the airline’s futures position will help offset the higher price it will pay fuel suppliers when it actually buys jet fuel.  

CONVERSELY
An international oil producer worried that crude oil will fall from $40 a barrel to $25 might sell, or go short, in oil futures, locking in the sale price at $40 a barrel.
When the Forward Markets Commission was regulating commodity derivatives, it allowed margin relaxations for hedging. Sebi, with more powers and resources at its disposal, has asked the committee to take a holistic view on rules to make hedging easy.

Hedging is low in commodity derivatives, especially in farm commodities, because the market lacks depth. When banks and other financial players are permitted in commodities and new instruments are allowed, hedging is expected to increase.

Sebi has given priority to hedging without waiting for new products and participants. According to sources familiar with the development, while permitting new products, Sebi might give priority to hedgers’ interests.

The commodity derivatives advisory committee has started work on introducing new products like options and index derivatives. At present, commodity exchanges are allowed to offer only commodity-specific futures. Commodity futures, in their new form, were permitted in 2003 after remaining suspended for several decades.

The committee has set up three sub-groups. One will look at introducing new products. Basic products like options and index derivatives (futures and options) are priority.

The process of introducing new products is to be completed by the end of this financial year as announced in the Union Budget. After the committee makes its suggestions, Sebi will put out draft discussion papers and its board will finalise them later.

The second sub-committee will look into polling of spot prices. The latter are required to declare the settlement price of futures and are collected by polling, which is not an efficient mechanism. Sebi has decided to review this and a sub-committee has been formed.

A National Agriculture Market is also being set up linking mandis electronically. The Sebi committee will consider whether the new market is helpful in arriving at spot prices.

The third sub-committee will review position limits. It has been argued that position limits in commodity derivatives are low and they restrict participation. Increasing the limits without proper checks could be risky and, hence, the sub-committee will look into the matter.