Clear regulations

Address regulatory gaps for digital gold

The Securities and Exchange Board of India (Sebi) recently issued an advisory, forbidding registered investment advisers from engaging in unregulated activities such as providing platforms for dealing in unregulated products, or otherwise facilitating such trades. While assets like cryptocurrencies and non-fungible token (NFT) do fall in this category, the regulator specifically mentioned digital gold. However, unlike cryptocurrencies and NFTs, digital gold consists of assets backed by the physical metal. The players in this market are all well-known, organised entities, including government-owned entities. The regulator has proposed an institutional framework for electronic gold trading exchanges but this is yet to be adopted and there are no such exchanges in practice. There’s always greater activity in this segment at the festive season and instead of discouraging such trades, the regulator should consider letting them continue until such time as gold exchanges are established.

Digital gold consists of digital certificates issued against holdings of the physical metal. These assets can be traded digitally or redeemed in metal, as the holder chooses. These are similar to gold exchange-traded funds (ETFs) and the government’s own sovereign gold bonds. But unlike sovereign bonds, private digital gold certificates and gold ETFs are not interest-bearing. The physical metal backing digital gold is stored in insured warehouses, controlled by certified entities. A joint venture between government–owned MMTC and Switzerland’s PAMP is among the largest players in this market. Digital gold vendors include banks, listed companies like Titan and PC Jewellers, fintech players like Paytm, and stockbrokers like HDFC Securities. The tax treatment is clear enough. Successive governments have pushed sovereign digital gold schemes and gold ETFs to reduce pressure on the trade account and plug loopholes for tax evasion.
 

In sum, digital gold is a segment of the broader commodity market although it is fragmented and run by multiple players. It has in some senses been encouraged by government policy. Since it is run by well-known, regulated entities, it is in many respects superior to the unorganised pawn-broking market or the trade in physical gold. Households that are interested in precious metal holdings can accumulate digital gold in small quantities transparently instead of buying and holding the metal itself. Households that wish to liquidate gold holdings can also do so via this route. But digital gold falls in a regulatory grey zone in certain key respects at the moment. The instrument itself does not come directly under the purview of any financial sector regulator, and it is not currently traded on recognised financial exchanges.

In August 2021, Sebi flagged deals in this product as a breach of the Securities Contracts (Regulation) Rules (SCRR), 1957. In response to that ruling by the regulator, the National Stock Exchange instructed its members, including stockbrokers and wealth managers, to wind down trades in digital gold by September 10. This has led to an artificial thinning out of the market during the festive season, when demand is high. Instead of this, the regulator should be looking to remove the grey areas, and to accelerate the transition to setting up full-fledged gold exchanges. Concerns like quality of assay and security of storage can be easily met, given that all the entities in the segment are well-known. Sebi’s proposed framework for new gold exchanges will certainly help bring more clarity and transparency, once such exchanges are up and running. Until such time however, the regulator should not discourage known entities from offering this instrument.