 "Risk management needs substantial improvement: Rajeev Kumar Agarwal")
Rajeev Kumar Agarwal spent over five years as a member with the then commodity regulator, Forward Markets Commission (FMC), and has since been a whole time member, Securities and Exchange Board of India (Sebi) for the past four years. He is in charge of commodity derivatives and secondary markets along with other responsibilities. In an interview with Rajesh Bhayani, he said that mutual funds have emerged as a strong counter party to foreign investors when they buy or sell. On speculation in commodity derivatives, he said that Sebi has enough tools to deal with speculators and manipulators and there is no proposal to suspend trading in any commodities.
The markets have been very volatile. One reason is that foreign portfolio investors (FPIs) exercise a huge influence on our markets. Do you agree that there are no strong counter-party buyers to provide support?
FPIs have substantial holdings in index stocks. With reference to floating stocks, it becomes even higher. We need more, as well as stronger, counter-parties to absorb the 'sell' or 'buy' of FPIs. A very good development in the past financial year was that mutual funds, on the strength of very strong net inflow of Rs 75,000 crore in their equity schemes, have played a very strong counter-party, absorbing a little more than 60 per of the selling done by FPIs. The reforms undertaken by Sebi from 2012 onwards have played an important role in the growth of MF industry in last few years.
Is the short-term nature of FPI investment responsible for high volatility?
Flows are mixed. Substantial investment is long-term too. However, I feel there is a need to attract more long-term funds from Global Pension Funds and Sovereign Wealth Funds especially for infrastructure sector. As this is a 50-trillion-dollar industry, there are possibilities of higher allocations to India. In this direction, Sebi, next year, is going to host Annual Conference of Pacific Pension Institute, which has top Global Pension Funds as its members. This will be an opportunity to showcase India's growth story to a large number of Pension Funds on a single platform.
How do you see the capital markets growing going forward?
Our domestic savings are substantial at more than 30 per cent of GDP, but our capital requirement is also very high, considering our ambition of achieving 9 per cent growth rate and investment of $1 trillion (Rs 67 lakh crore) in infrastructure in the current five-year plan alone. We will have to, therefore, use the available capital in the most efficient manner.
As capital markets provide for more efficient allocation of capital, their role needs to expand. For facilitating the long-term funding of infrastructure, further expansion and deepening of the bond markets is being advocated by all experts. At present, only three per cent of our financial savings is being channelised through the capital markets. We will have to substantially increase this percentage. Mutual fund industry is playing very important role in this regard. Larger and deeper capital markets also attract larger foreign capital flows which are so important for our economy which is having current account deficit.
How have commodity derivative regulations evolved after the segment came under Sebi?
Taking over the regulation of the commodities markets and bringing it at par with the securities markets was a lengthy process which involved gap analysis, amendments to various regulations, integration of trade data with our Integrated Surveillance System, upgrading the risk management framework, improving governance system of exchanges and laying down an elaborate mechanism for investor grievance redressal and arbitration.
We have made substantial progress during the past six months. Now, Sebi is in the process of substantially overhauling the risk management framework, surveillance system and warehousing framework of the exchanges as they are crucial for improving the confidence level of the participants.
Which other reforms for commodities are under consideration?
Sebi is taking counsel on this from its advisory committee, international advisory board and consultants. We have set up three sub-groups under the commodity market advisory committee. One for introducing new products like options trading in commodities and indices and index futures, and improving the participation of hedgers. Second, for reviewing the polling mechanism to get spot prices, which are important for fair settlement. The third group will give recommendations on position limits, etc, for various agricultural commodities. Sebi will go for reforms in these areas once the reports are ready.
Sebi has taken some measures to curb speculation in commodities. Will you suspend trading in any of these if the speculation continues?
In the commodities in which we are witnessing volatility, we are controlling the speculative interest by reducing leveraging. Recently, margins have been increased in chana as well as sugar. Further, our surveillance system is monitoring all these contracts to ensure that no one is able to manipulate the market. Sebi will take very stern action against those who make any such attempt.
As far as the question regarding suspension of trading is concerned we are not considering any such proposal. We have enough tools to deal with the situation.
Did you find risk management at commodity exchanges robust enough, in general?
Going forward, the Risk Management System at commodity exchanges needs substantial improvement for which a task force was set up. Implementation of recommendations regarding margining system, Settlement Guarantee Fund, Stress testing, back testing for credit and liquidity risks, detection of early warning signal and methodology to liquidate the defaulting members position, will bring a paradigm change in the risk management framework of commodity markets.
Do you think suspension of castor futures by NCDEX has thrown light on the fact that more needs to be done to improve surveillance at exchanges?
Sebi dealt professionally with the castor matter. It examined the issue from the angle of systemic risk, governance of the exchange, market integrity and investor grievance. A task force was set to examine systemic issues, including risk management at exchanges. The board of the exchange was advised to fix responsibility if there had been lapses in risk management. And, an interim order barring 22 entities from the market was passed.
On grievance redressal, NCDEX has been directed to facilitate the sale of stocks of those who were on the sale side and did not get an opportunity to give delivery. It has also been asked to consider monetary compensation, if required.
Unlike equity derivatives, commodity futures can be settled in deliveries and agri commodities are a sensitive segment here.
The physical delivery in the commodity market is very crucial for keeping the futures market linked to the spot markets. It is necessary to always have threat of delivery alive in the market to keep the speculation under control. Sebi has therefore, mandated the exchanges to ensure good delivery by regulation at the time of merger of FMC itself. Now, Sebi is going to inspect whether exchanges have put adequate mechanism in place to ensure good delivery. Guarantee of good delivery is very crucial for improving hedgers' participation in the market.
We are also laying down minimum quality standards for the warehouses to ensure a good warehousing network of the exchanges as the futures market coupled with good warehousing network and warehouse receipt system may act as a very important building block of the credit and marketing network for the farmers.
Sebi has reduced position limits. Will it not impact liquidity of the market?
Position limits have only been rationalised considering the present liquidity of the markets to avoid excessive speculative interest which may distort the price discovery. Higher limits for hedging will continue to facilitate hedging activity.
The markets have been very volatile. One reason is that foreign portfolio investors (FPIs) exercise a huge influence on our markets. Do you agree that there are no strong counter-party buyers to provide support?
FPIs have substantial holdings in index stocks. With reference to floating stocks, it becomes even higher. We need more, as well as stronger, counter-parties to absorb the 'sell' or 'buy' of FPIs. A very good development in the past financial year was that mutual funds, on the strength of very strong net inflow of Rs 75,000 crore in their equity schemes, have played a very strong counter-party, absorbing a little more than 60 per of the selling done by FPIs. The reforms undertaken by Sebi from 2012 onwards have played an important role in the growth of MF industry in last few years.
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Flows are mixed. Substantial investment is long-term too. However, I feel there is a need to attract more long-term funds from Global Pension Funds and Sovereign Wealth Funds especially for infrastructure sector. As this is a 50-trillion-dollar industry, there are possibilities of higher allocations to India. In this direction, Sebi, next year, is going to host Annual Conference of Pacific Pension Institute, which has top Global Pension Funds as its members. This will be an opportunity to showcase India's growth story to a large number of Pension Funds on a single platform.
How do you see the capital markets growing going forward?
Our domestic savings are substantial at more than 30 per cent of GDP, but our capital requirement is also very high, considering our ambition of achieving 9 per cent growth rate and investment of $1 trillion (Rs 67 lakh crore) in infrastructure in the current five-year plan alone. We will have to, therefore, use the available capital in the most efficient manner.
As capital markets provide for more efficient allocation of capital, their role needs to expand. For facilitating the long-term funding of infrastructure, further expansion and deepening of the bond markets is being advocated by all experts. At present, only three per cent of our financial savings is being channelised through the capital markets. We will have to substantially increase this percentage. Mutual fund industry is playing very important role in this regard. Larger and deeper capital markets also attract larger foreign capital flows which are so important for our economy which is having current account deficit.
How have commodity derivative regulations evolved after the segment came under Sebi?
Taking over the regulation of the commodities markets and bringing it at par with the securities markets was a lengthy process which involved gap analysis, amendments to various regulations, integration of trade data with our Integrated Surveillance System, upgrading the risk management framework, improving governance system of exchanges and laying down an elaborate mechanism for investor grievance redressal and arbitration.
We have made substantial progress during the past six months. Now, Sebi is in the process of substantially overhauling the risk management framework, surveillance system and warehousing framework of the exchanges as they are crucial for improving the confidence level of the participants.
Which other reforms for commodities are under consideration?
Sebi is taking counsel on this from its advisory committee, international advisory board and consultants. We have set up three sub-groups under the commodity market advisory committee. One for introducing new products like options trading in commodities and indices and index futures, and improving the participation of hedgers. Second, for reviewing the polling mechanism to get spot prices, which are important for fair settlement. The third group will give recommendations on position limits, etc, for various agricultural commodities. Sebi will go for reforms in these areas once the reports are ready.
Sebi has taken some measures to curb speculation in commodities. Will you suspend trading in any of these if the speculation continues?
In the commodities in which we are witnessing volatility, we are controlling the speculative interest by reducing leveraging. Recently, margins have been increased in chana as well as sugar. Further, our surveillance system is monitoring all these contracts to ensure that no one is able to manipulate the market. Sebi will take very stern action against those who make any such attempt.
As far as the question regarding suspension of trading is concerned we are not considering any such proposal. We have enough tools to deal with the situation.
Did you find risk management at commodity exchanges robust enough, in general?
Going forward, the Risk Management System at commodity exchanges needs substantial improvement for which a task force was set up. Implementation of recommendations regarding margining system, Settlement Guarantee Fund, Stress testing, back testing for credit and liquidity risks, detection of early warning signal and methodology to liquidate the defaulting members position, will bring a paradigm change in the risk management framework of commodity markets.
Do you think suspension of castor futures by NCDEX has thrown light on the fact that more needs to be done to improve surveillance at exchanges?
Sebi dealt professionally with the castor matter. It examined the issue from the angle of systemic risk, governance of the exchange, market integrity and investor grievance. A task force was set to examine systemic issues, including risk management at exchanges. The board of the exchange was advised to fix responsibility if there had been lapses in risk management. And, an interim order barring 22 entities from the market was passed.
On grievance redressal, NCDEX has been directed to facilitate the sale of stocks of those who were on the sale side and did not get an opportunity to give delivery. It has also been asked to consider monetary compensation, if required.
Unlike equity derivatives, commodity futures can be settled in deliveries and agri commodities are a sensitive segment here.
The physical delivery in the commodity market is very crucial for keeping the futures market linked to the spot markets. It is necessary to always have threat of delivery alive in the market to keep the speculation under control. Sebi has therefore, mandated the exchanges to ensure good delivery by regulation at the time of merger of FMC itself. Now, Sebi is going to inspect whether exchanges have put adequate mechanism in place to ensure good delivery. Guarantee of good delivery is very crucial for improving hedgers' participation in the market.
We are also laying down minimum quality standards for the warehouses to ensure a good warehousing network of the exchanges as the futures market coupled with good warehousing network and warehouse receipt system may act as a very important building block of the credit and marketing network for the farmers.
Sebi has reduced position limits. Will it not impact liquidity of the market?
Position limits have only been rationalised considering the present liquidity of the markets to avoid excessive speculative interest which may distort the price discovery. Higher limits for hedging will continue to facilitate hedging activity.