FCRA: A step in the 'forward' direction

The Forward Contracts (Regulation) Amendment Bill, 2010, is a significant reform to the Forward Contract Regulation Act, 1952 (the Principal Act), which essentially deals with commodities future markets. Once passed by both the Houses of Parliament, the amendment Bill will place the commodity futures market regulator, the Forward Markets Commission (FMC), on a par with capital markets regulator Sebi, making it an autonomous regulator which currently is overseen by the Ministry of Consumer Affairs, Food and Public Distribution. The Wajahat Habibullah Committee had recommended in 2003 that there should be a unified regulatory regime for the commodities futures market and the securities market, as is the case in most jurisdictions, whereas this Bill seeks to create a new autonomous body. The main objective of this Bill is to permit and regulate a financial instrument which enables buyers and sellers of commodities to effectively manage risk from price fluctuations and open the door for the introduction of new intangible products like options and indices trading in the commodities futures market. At present, in the equity market, trading is allowed only in stocks, futures and index.

The Bill transforms the role of the FMC by conferring statutory powers on the body. One of the loop holes in this Bill is that it proposes to levy lower penalty for the same kind of offence in comparison to the penalty levied in the Sebi Act. While the FMC is to regulate all commodity derivatives, the markets for the underlying goods will be regulated by state governments, which could lead to duplication in regulation.

The Parliamentary standing committee has suggested inclusion of financial institutions and banks, mutual funds and insurance companies to participate in forward markets so as to ensure better price discovery and lower the volatility in the market. Some of the major changes which this amendment proposes to make are as follows: the Bill amends the definition of a 'ready delivery contract' to include all contracts that provide for the delivery of goods and payment of the price within 30 days. Currently, ready delivery contracts needs to be delivered and paid for immediately or within 11 days but this legislative piece extends this period of the ready (spot) delivery to 30 days.

The Bill defines 'commodity derivatives' and permits trading in them, the Bill requires all exchanges to be corporatised and demutualised by a date to be decided by FMC. Corporatisation means the exchange will have to convert from being a body of individuals or a society to a company. Demutualisation means trading rights of members are separate from ownership and management of the company. The Bill proposes to empower the FMC to issue franchisee registration certificates to sub-brokers of member-brokers of commodity exchanges and to take decisions of increasing salaries of its member-directors and other office bearers.

The number of members of the FMC has also been increased from four to nine, including one chairperson, of which eight members will be selected by the central government, and one by the Reserve Bank of India. The Bill does not provide for the process of establishing a search committee for selecting the members of the committee. The Bill allows the FMC to impose penalties in cases of failure to furnish information or comply with the directions of the Commission, indulging in insider trading or fraudulent and unfair trade practices and in any other case of contravention of the provisions of the Principal Act. All sums collected by way of penalties shall be credited to the Consolidated Fund of India and appeals shall lie from the order of the FMC to the Securities Appellate Tribunal established under the Sebi Act.

The Bill makes a provision for the transfer of duties and functions presently performed by a clearing house to a clearing corporation. The central government has the power to prohibit forward contracts or options in goods or commodity derivatives by notification in some cases to issue directions to the FMC on matters of policy and to supersede it in certain cases.

Furthermore, the central government is also empowered to suspend a member on appropriate grounds. On balance, this Bill has tightened the noose and made an effort to regulate the commodities future market and bring more clarity in the existing provisions. The main beneficiaries of these reforms will be the companies that either produce commodities or need raw materials to produce them, since options would provide useful price signals to producers and farmers which in turn would gain more security in the volatile markets.

FMC will become an autonomous regulator like Sebi and will have autonomy to raise funds from exchanges and recognise and derecognise them. FMC currently depends on funds from the Consolidated Funds of India, but will be able to raise funds from deals on exchanges and from brokers once the Bill is passed. This will enable it to offer competitive salaries to attract talent. It will also be able to levy penalties, something which it cannot do now. A stronger regulator will thus be able to lay the framework for the entry of institutional players who can function as effective counterparties for large corporates to trade on the homegrown exchanges.

Kumkum Sen is a partner at Bharucha & Partners Delhi Office and can be reached at kumkum.sen@bharucha.in