To stimulate participation in low liquidity contracts, the Forward Markets Commission (FMC) is considering allowing ‘market making’ in commodities.
The commodity derivatives market regulator proposes to set a benchmark of contracts with daily turnover of Rs 100 crore in agricultural and Rs 500 crore in non-agricultural commodities to qualify for ‘market making’ during the last 90 days or 36 months from introduction of a scheme, whichever is earlier.
Formally termed ‘liquidity enhancement schemes (LES)’, market making is an attempt to incentivise brokers and traders to participate. FMC has allowed futures trading in a little over 100 contracts, of which 20 are actively traded. Another 20-25 per cent see occasional but insignificant liquidity. The remaining contracts, however, witness no liquidity at all. A number of contracts remained illiquid after strong participation in the initial days of a launch.
FMC has now sought public comment within three weeks on introduction of market making in low liquid commodities’ contracts. “Trading is a function of demand and supply, and liquidity is generated by active participation of various market participants. However, to bring in initial liquidity, certain special efforts may be required by exchanges,” it has stated.
The existing guidelines are silent on market making. For enabling LES introduction by exchanges, FMC has proposed broad guidelines. Market making was allowed in equities trading, in the futures and options segment, after a committee constituted by the Securities and Exchange Board of India (Sebi) recommended it. Sebi listed guidelines for market makers in January 2000.
“LES is a globally accepted tool to enhance participation. As market making is allowed in the futures and options segment in equities, it should be allowed in commodities, too,” said Jayant Manglik, president, Religare Securities.
In the proposed FMC guidelines, the scheme shall have prior approval of the board of the commodity exchange. The guidelines do not allow exchanges to extend incentives for traders where the counter-party is oneself, with the same unique client code on both sides of the transaction.
Commodity exchanges may formulate own benchmarks in product selection for liquidity enhancement. It proposes to allow at least three liquidity enhancement providers for each commodity in which futures contracts are traded. Any eligible member with a net worth at least of Rs 1 crore shall deposit Rs 0.25 crore with the exchange as advance towards margins and be free to participate in the scheme.
Total incentives provided by the exchange during a financial year are to be capped at 25 per cent of net profit earned the previous year. The exchanges are allowed to fix discounts, adjustments in transaction, admission fees and other membership charges. The exchange should not compromise on risk management.