Fixing commodity trading

Amend and pass new regulatory framework

The transfer of administrative control of the regulator for commodity trading, the Forward Markets Commission (FMC), from the consumer affairs ministry to the finance ministry seems a typical government response to a crisis like the one besetting the National Spot Exchange Ltd (NSEL). But it is a sensible step that should have been taken much earlier, although it will not suffice to regulate exchange-based commodity trading - be it spot trading or forward trading. That requires a strong and autonomous regulator with sufficient expertise and infrastructure, as well as the authority to take expeditious action and effectively enforce its orders. The FMC currently lacks all these. The legal regime governing the commodities business is outmoded and is unable to take up the challenge of ensuring fair and transparent transactions. The over 60-year-old Forward Contracts Regulation Act, 1952 (FCRA), was enacted at a time when the futures trading in commodities was confined to a handful of items with limited local trader participation. The statute, therefore, provided for the creation of only a small regulatory commission with limited powers as an appendage of the ministry.

The situation has completely changed after the emergence of the exchange-based online trading with global trader access. That transformed commodity trading into a huge sector, growing faster in terms of volumes and turnover than the equity market. A large number of commodities - including bullion, ferrous and non-ferrous metals, energy and agricultural products - are now traded in a score of futures and spot commodity exchanges. Their turnover is estimated to have risen in the last fiscal year alone by some 52 per cent to over Rs 181 lakh crore. Both the FMC and the FCRA have proved incapable of coping with the ongoing change. This apart, there has emerged a flourishing parallel illicit forward trading in commodities - known as "dabba trading" - which has a turnover in multiples of the legal business. It attracts a large number of players, both speculators and hedgers, because of its low transaction costs and the provision for options contracts that are not yet allowed on the approved exchange platforms. The FMC simply doesn't have the power to shut it down.

There is, therefore, an urgent need to strengthen and revamp the commodity market regulator and equip it with adequate autonomy and powers akin to those of the capital market regulator, the Securities and Exchange Board of India. A Bill to this effect was drafted several years ago and was even introduced in Parliament in December 2010 after being vetted by several committees; it is yet to be converted into a law. This Bill urgently needs to be amended in accordance with the present market realities. Steps like capping position limits or increasing margins, which is all the present FMC is empowered to take, are insufficient to effectively curb speculation and price manipulation. The regulator needs to possess commodity-specific expertise capable of foreseeing the scope for excessive speculation and stemming it through timely advance action. These issues should be addressed without delay.