Exchanges say it’ll help trade in illiquid commodities; FMC weighs pros, cons and own monitoring ability.
The commodity derivatives market regulator, the Forward Markets Commission (FMC), is considering a proposal to allow market makers in commodity futures.
Market makers both buy and sell quotes, ensuring liquidity in the contract being traded. This provides an opportunity to hedgers and investors to buy or sell the commodity, as someone is always there to complete the transaction.
Such arrangements are useful for commodities or contracts that are not traded or are illiquid. Of a little over 100 commodities listed for futures on various exchanges, two-thirds see close to no trade. Market makers can be helpful in activating trading in such cases.
“We have received the proposal from the exchanges and we are examining it. Before taking any decision, we will also study how far market making has been useful in global markets. We will not take any hasty decision,” said B C Khatua, chairman of FMC.
This is not for the first time FMC has studied such a proposal from the commodity exchanges. Four years earlier, under the chairmanship of S Sundareshan, it considered this but did not proceed due to the lack of skilled manpower with the regulator and, more important, its restricted penal powers. The situation on this front has not changed, but an exchange official has said that, “Several contracts having good potential for hedging are not traded as there is lack of liquidity in these and the market has grown multi-fold. Hence, it is the right time to permit market makers to provide liquidity in such contracts.”
When exchanges permit market making, members offering these are given incentives, including fees. FMC feels there is a need to check and monitor the activities of market making and the result it generates.
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However, some still believe that market makers will not be introduced so long as statury powers like an independent regulator’s status are not conferred on to the FMC. The amendment Bill in this regard is pending in Parliament.
ISSUES
Generally, around half a dozen active and powerful traders are identified as market makers to generate volume in illiquid contracts. In developed markets like the US, market makers have predominantly generated huge volumes in active contracts on the COMEX, Nasdaq and CME. The same model was followed by the London Metal Exchange and the Shanghai Futures Exchange in China.
On commodity exchanges in India, a quote-driven system is prevalent, in which traders only provide one-way quotes for either the buy or sell side. The exchanges propose that market makers have to be exchange-specific or commodity-specific.
FMC is cautiously weighing the proposal because at times, the market size of some illiquid commodities is very small. If a handful of traders are officially allowed to control the volume, then they may corner the entire commodity for their own interests.
“FMC also lacks skilled manpower with deep knowledge of commodities. Hence, unless FMC gets full power and permission to hire more professionals to monitor the commodity trade in India without any government intervention, it would not be fair for the regulator to allow such practices,” said the official, who is not in favour of allowing market makers at this stage.
The capital markets regulator, the Securities and Exchange Board of India (Sebi) is considering allowing market making, on the suggestion of the Bombay Stock Exchange and the National Stock Exchange. BSE wants this for activating the dormant derivative segment, while NSE has proposed to allow this in its proposed trading in overseas indices like the S&P 500.