How many Sebis?

A key element for modernising Indian agriculture is well-functioning markets for agricultural products. Way back in 1952, a Forward Contracts (Regulation) Act was passed, which was about banning all kinds of transactions. The authors of this Act had no idea about modern markets. As an accident of history, the administration of this Act was placed in the department of consumer affairs (DCA). Today, when we look at commodity futures trading using contemporary knowledge, it is clear that commodity futures are a financial asset. Every issue in a commodity futures market is just an issue of financial regulation. There will be competing exchanges, with member firms. There will be computerised matching of orders. There will be clearing corporations which become the legal counter-party, and thus remove counter-party risk. This will, in turn, require sophisticated risk-management systems based on "value at risk", computed in real-time. Commodity futures markets will need enforcement against market manipulation through surveillance departments, which enforce various kinds of position limits, watch for unusual volumes and price movements, and so on. There will be settlement using de-materialised securities or de-materialised warehouse receipts.

All these issues are the same for financial and commodity futures trading. If India has one single securities industry, this will yield enormous benefits in terms of economies of scale and economies of scope. There will be greater competition between exchanges, each of which could make its own commercial decisions about what kinds of trading it wants to compete in. Securities firms will be able to unify screens with all kinds of products trading in a single place. The end-participants of markets will benefit by getting single-point access to all kinds of products""and these could range from nickel to PVC, and from DRAMs to natural gas. Most importantly, the difficult and painful business of learning and institution-building, done over the last 15 years for securities, will become available "for free" for commodity futures trading.

It should be obvious from this that commodity futures trading and securities trading must be merged into a single industry, regulated by the same regulator (Sebi). This is the way every single mature market economy in the world operates. Unfortunately, the government is about to make an important policy blunder, by forcing an artificial separation between the two industries. This would be as absurd as saying that since Tata Engineering makes trucks, it must be prohibited from making cars. A single firm such as ICICI Direct will be forced to create two separate companies, one for trading financials and one for trading commodity futures: this is cumbersome and wastes capital.

Extravagant claims are being made about how the DCA will take better care of the interests of small farmers. These claims are merely posturing to mask turf battles. Small farmers' interests will be better served by economies of scale, which will lead to lower costs, and mature regulatory capacity, which will take years for the DCA to develop. Even if some kind of bone needs to be thrown to the DCA, there is no case for nickel futures or natural gas futures to be handled by the DCA. A compromise that could still rescue a bit of sense would be one where Sebi handles all non-agricultural commodities and the DCA handles agriculturals.