Being hailed as a game changer, the much expected merger of Forward Market Commission (FMC) with Securities and Exchange Board of India (SEBI) will ‘increase economies of scope and economies of scale for the government, exchanges, financial firms and stakeholders’. Read on to get the complete story.
When Finance Minister Arun Jaitley struck the gong on the historic event of merger of Forward Market Commission (FMC) with Securities and Exchange Board of India (SEBI) at Mumbai on the 29th of September this year, it marked a beginning of another chapter in India’s financial reforms. The event was marked as a landmark event in India’s financial markets, especially in terms of regulation. The commodity futures market in India will now be overseen by Sebi, making for an integrated regulation of both the securities and commodities markets in India. Speaking on the occasion, the Finance Minister said, “The merger will increase the economies of scope and scale as there are strong commonalities between all kinds of trading.”
When two years ago National Spot Exchange Limited (NSEL) scam came to surface, it triggered the need for a better and stronger regulator to safeguard investor interest and restore confidence. NSEL, promoted by Jignesh Shah and Financial Technologies India Limited, in 2013 had suspended trading of all its contracts after a Department of Consumer Affairs (DCA) notice, resulting in a loss of over ` 5,600 crore to the investors. The then UPA government started thinking about the merger seriously and finally, after two years of NSEL scam, the Forwards Market Commission, the commodities market regulator, has been merged with the Securities and Exchange Board of India. It is the first and biggest regulatory merger ever to happen in the country.
However, this merger has not come about suddenly and easily. Much sweat, toil and blood have been spent on it. In fact, the idea for a unified regulator was discussed and debated much before the NSEL scam. Many commissions were set up to study the idea and they all recommended convergence of these two. Most recently, the Financial Sector Legislative Reforms Commission (FSLRC) led by Justice Srikrishna also stressed on the need to move away from sector-wise regulation. FSLRC proposed a system in which RBI would regulate the banking and payments system, and a Unified Financial Agency (UFA) would subsume all other financial sector regulators such as SEBI, IRDA, PFRDA and FMC, to regulate the rest of the financial markets. But these recommendations never saw the light of the day as the matter was caught up between the battles within the government and corporate rivalries.
However, on February 28 last year, in his budget speech, the new Finance Minister Arun Jaitley proposed the merger of Forward Markets Commission (FMC) with stock market watchdog Sebi. The Finance Minister said: “I also propose to merge the Forward Markets Commission with Sebi to strengthen regulation of commodity forward markets and reduce wild speculation. Enabling legislation, amending the Government Securities Act and the RBI Act is proposed in the Finance Bill 2015”.
The merger of FMC with Sebi will strengthen regulation of commodity forward markets and reduce wild speculation, said the finance minister. In response to the announcement MCX, the country’s largest commodity bourse, rose 13 per cent. “This is a game changer,” Sameer Shah, MD & CEO of NCDEX, the country’s largest farm futures commodity exchange promoted by NSE, which was then regulated by FMC was quoted as saying.
According to a report submitted to the government by one of the committees, most of the regulatory powers in respect of the commodity derivative markets were with the Central Government, and the Forward Markets Commission exercised the delegated powers or played a recommendatory role. Forward Markets Commission acted as a subordinate office of the Government department and had no autonomy to garner resources – human, financial and infrastructural – to discharge the responsibility expected of a regulator in the dramatically changed environment. The securities market had also faced a similar situation when it was liberalized in the early nineties. Establishment of an independent regulator with adequate resources and empowerment changed the very face of the market, though the path was not smooth and episode-free.
The report pointed out that any rationale for convergence should hinge upon its capacity to ensure growth, liquidity and safety of the market as well as to improve accessibility to the public by spreading the network and reducing the transaction costs. Sizable investment has gone into building India’s securities infrastructure. This infrastructure can be used to start trading in commodity derivatives.
Till the merger, the commodities market was regulated by the Forward Contracts Regulation Act (FCRA) which stands repealed after the merger, and the regulation of the commodity derivatives market shifts to Sebi under the Securities Contracts Regulation Act (SCRA), 1956. FCRA was essentially an enabling Act, and the FMC, set up under the provisions of the Act, was more an advisory and monitoring body than one with regulatory powers. As pointed out earlier, the real regulatory powers remained in the hands of the Central Government, while the FMC’s role was supposed to be that of being one of offering recommendation and advice to the Ministry.
Since SCRA is a stronger law, and gives more powers to Sebi than FCRA offered to FMC, one hopes that commodity markets will now be better regulated, with more stringent processes and will thus evoke greater confidence. The FMC only regulated the exchanges, and had no direct control over brokers. But, Sebi has direct control over the brokers and has far superior surveillance, risk monitoring and enforcement mechanism that will give more confidence to the investors.
SEBI in order to effect the merger, has amended Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 (SECC Regulations) and SEBI (Stock Broker and Sub-Broker) Regulations, 1992 and SEBI (Regulatory Fee on Stock Exchanges). This will allow functioning of the commodities derivatives exchanges and its brokers under SEBI norms and integration of commodities derivatives and securities trading in an orderly manner.
With the Forward Markets Commission (FMC) formally getting merged with Sebi, its Chairman UK Sinha said the first priority would be to develop trust in the commodities market and then the focus would be on developing the market.
FMC lacked powers which led to wild fluctuations and gross irregularities. Also, the commodities market faced challenges with respect to speculative activities and illegal activities like ‘dabba trading’ flourishing in this segment. The situation was so bad that the Sebi chairman UK Sinha had once cautioned the investors, “If you put your hard earned money into this market, it may not be ultimately good for you. The commodities market is for those who are experts in this space. For non experts, it is a risky area.”
So, developing the trust of the investors is important at this stage. Ever since commodity derivative trading was allowed in India in the new millennium, there has been a trust deficit.
The Finance Minister has also expressed hope that Sebi is prepared to regulate the commodity derivatives market as the merger will increase the scope and scale of trading tremendously.
When the commodities market was opening up more than a decade ago, the idea of merger of FMC was taken up by the government, and in 2003, an interministerial task force on convergence of the securities and commodity derivatives market was set up under the chairmanship of the bureaucrat Wajahat Habibullah who was then the consumer affairs secretary.
The task force noted that even though there were some differences in commodity and financial derivatives markets they had close resemblance in so far as trade practices and mechanism were concerned.
“If derivatives in commodities resemble securities, then the developmental challenge of obtaining sound institutions for trading commodity derivatives can be eased by using the stable and mature institutions that are found in the securities markets.”
The report also said, “If the institutions of the securities markets are used, this would speed up the pace at which modern market institutions become available to farmers, and accelerate the growth rate of the agricultural sector.”
Other benefits of the merger, pointed out the task force, included economies of scale and scope, the possibility of strengthening the commodity spot market, better serving of stakeholders, strengthening the price discovery for farmers and desirable impact on the informal market.
But the Wajahat Habibullah panel’s proposals were never implemented and two new committees were set up— one chaired by Percy Mistry and another by Raghuram Rajan. Both these committees also endorsed consolidating securities and derivatives regulation in Sebi. When Manmohan Singh became the Prime minister, he envisaged reforming the commodities markets. But he led a coalition government and commodities was the turf of Sharad Pawar who was not in favour of merging FMC with Sebi.
In 2008, the Finance Ministry again moved to revive the idea of convergence. By then electronic commodity exchanges, especially the Financial Technologies promoted MCX and the NSE promoted NCDEX had started functioning and they were trading high volumes.
The PMO office then took up the matter, but due to difference in the opinion between the consumer affairs secretary and the finance secretary the matter was postponed for another three years.
Then the government constituted the Financial Sector Legislative Reforms Commission (FSLRC) chaired by Justice BN Srikrishna in 2011 to suggest ways to reform the institutional framework governing the financial sector in the country. The setting up of the Commission was the result of a felt need that the legal and institutional structures of the financial sector in India need to be reviewed and recast in tune with the contemporary requirements of the sector.
The committee submitted its report in March 2013. One of its key recommendations was unifying Sebi, FMC, IRDA and PFRDA into one single regulatory entity. However, when irregularity at the NSEL became known, the Consumer Affairs Ministry, then headed by minister KV Thomas, handed over the FMC to the Finance Ministry.
The historic merger is aimed at streamlining the regulations and curbing wild speculations in the commodities market, while facilitating further growth there. “The merger will increase economies of scope and economies of scale for the government, exchanges, financial firms and stakeholders,” finance minister Arun Jaitley has said. He has also promised more measures to further develop the market. He said there was no reason why the commodities market should not have options or index futures. He also said in future banks will also be allowed to participate in the markets.
While foreign institutional investors are allowed to invest in Indian equities and debt markets, they are currently restricted from participating in commodities trading at exchanges. According to media reports, Sebi may allow FII participation in commodities trading to provide more depth to the markets, and increase liquidity, investor participation and better price discovery. Brokers, according to newspaper reports, also feel Sebi may introduce option contracts (call and put options) in commodities trading, thereby providing better hedging tools to investors.
Sebi has all necessary infrastructures to regulate the commodities market, and several FMC official will move to SEBI to provide knowledge and expertise. There has been some resentment among the staff and they have moved the Bombay High Court which has accepted their plea. These are teething problems and one hopes that the government will sort out the issue.
SEBI has put in place new norms for the country’s commodity derivatives market and its brokers. The norms emphasizes on strengthening of risk management and investor protection norms for commodity derivatives exchanges. These will enable functioning of the commodities derivatives market and its brokers under SEBI norms and integration of commodities derivatives and securities trading in an orderly manner.
As the Finance Minister emphasized that the market participants and the regulators had to brace themselves to face the challenges thrown by global developments and integration of markets, the Sebi member Rajeev Kumar Agarwal, who would oversee the commodities market regulation in the new entity under the overall guidance of the Sebi chairman UK Sinha, said that he would “spare no efforts” to build robust commodity markets in India.
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