B C Khatua was recently given a year’s extension as chairman of the Forward Markets Commission (FMC), the commodity futures market regulatory body. He has been given credit for convincing the government that commodity futures and capital market regulators should be separate. Then last week, the Cabinet cleared amendments to the Forward Contracts (Regulation) Act, giving the FMC autonomy and including various provisions aimed at developing the market. Rajesh Bhayani spoke to Khatua on how the amendments will impact the markets once it comes into force. Excerpts:
When do you expect the amendments to the Forward Contracts (Regulation) Act to come in to force — assuming all goes well in Parliament?
The amendments to the Act will become effective after the Bill is passed by both Houses of Parliament, approved by the President and notified in the Gazette. Thereafter, rules under the amended Act have to be notified by the government and various regulations have to be framed by the FMC. Other formalities, such as service rules for employees, also have to be formulated and the commission reconstituted. These processes will take three to six months. Action by Reserve Bank of India (RBI), Securities and Exchange Board of India (Sebi) and the finance ministry to permit participation by banks, financial institutions and mutual funds and so on will also take about as much time.
What kind of volume growth can be expected once options and index futures begin?
Volumes are expected to grow after options and index futures are introduced but we are primarily looking at the value addition these derivative products would bring to futures market participants. Such products would enable the market to reach a higher level of sophistication and impart greater efficiency in both the price discovery and risk management processes. They would also enable greater participation in the futures market since there will be something to suit the needs of every participant. The introduction of options is expected to facilitate farmers’ participation on the futures platform, a development that has been the FMC and the government’s endeavour all these years.
What is the FMC’s preparedness for implementing the changes?
The FMC has been anticipating the amendments for a long while so it has kept itself in a state of readiness. Most of the rules and regulations have been framed and may only require a final look before they are put into operation. The organisational changes have also been worked out, by and large. The FMC has also been in touch with other regulatory bodies on important issues such as the participation of banks and mutual funds in the market.
In what way will the FMC be strengthened after the Act is amended?
First and foremost, the FMC will gain financial and administrative autonomy after the Act is amended. This in itself will strengthen its hands by increasing the complement of skilled human resources to carry out its regulatory, research and developmental functions more effectively. The FMC’s monitoring and surveillance and inspection functions will also get an instant fillip once the amendments come into effect. It will be in a position to independently conduct investigations and impose deterrent penalties on market manipulation, trading irregularities and illegal trading. It will be responsible for the registration of all intermediaries. These measures would bring greater discipline and accountability to the market.
Is our market ready for new products like weather and freight indices? Will there be options trading in that too? Existing exchanges are also preparing and disseminating indices, will you allow trading in those?
The amendments to Forward Contracts (Regulation) Act, 1952, will insert an enabling provision for futures and options trading in various indices (such as freight and weather). The FMC will be extremely cautious about introducing these products; it will permit them only when sufficient awareness of the associated risks has been created among market participants. The asymmetric risk profile of options (which is perfect risk insurance product otherwise), especially in intangibles, makes it a highly risky product if not used properly.
What are your views on allowing the entry of mutual funds, banks, financial institutions and foreign institutional investors (FIIs) and how will you move in this direction?
The FMC has already initiated steps to permit banks, mutual funds and financial institutions to participate in the market. The participation of banks and financial institutions would require RBI and finance ministry approval via a notification under Section 6 of the Banking Regulation Act. Permission for mutual funds would require Sebi’s consent. On FIIs, this is not an appropriate time to enter the Indian commodity derivative market. We would like the markets to mature first and attain sufficient liquidity and depth with domestic institutional and corporate participants in the next few years.
Where do you feel constrained and will the new powers help?
At present, the FMC is constrained in discharging its functions efficiently owing to the lack of financial and administrative autonomy and its inability to enhance its human resources base and its skill sets owing to the constant migration of deputed employees. So far, the FMC has done a stupendous job of regulating the markets given the constraints under which it has been functioning. Administrative and financial autonomy will allow the FMC to raise resources and induct adequate skilled manpower to strengthen regulatory oversight.
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You have said eight national level exchanges are enough for the time being. Don’t you think even that could lead to consolidation since even the existing exchanges have not been able to do much if we look at their market share as of today?
The number of exchanges will eventually be decided by the market. If the market feels there is scope for fewer exchanges, then consolidation is a possibility. We will have to see how the markets shape up, especially after other products are introduced and institutional and corporate players enter. But we can see the experience of the global exchanges where the process of consolidation has already set in. China had a large number of commodity exchanges, which eventually consolidated into three exchanges, each having its own product specialisation. So that possibility in the medium to long term cannot be ruled out.
Agri-futures need strong linkages with physical markets. How that can be ensured?
The FMC has called for a synergistic approach to the regulation of Warehouse Receipts (WRs), the electronic spot markets and the commodity futures markets. Since the FMC already had regulatory capabilities in this area, it was thought that bringing warehousing regulation and development including WRs and the national electronic spot markets under its purview would be the best option. Doing so would have not only facilitated the regulation and development of warehouses but also facilitated the trading of negotiable warehouse receipts (NWRs) in the spot and futures market, thereby enhancing the utility and efficacy of the NWRs in revitalising the commodity eco-system. There is, however, a different point of view on this and it is understood that a separate Warehousing Development and Regulation Authority for the warehousing sector is being set up. In the circumstances, effective coordination between the two regulators is imperative. For electronic spot exchanges, steps are being initiated to strengthen and integrate their regulation with futures market regulation to the extent desirable and necessary.