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Report of the Committee Appointed by the SEBI on

Report of the K.R. Ramamoorthy Committee on

Participation by Securities Brokers in Commodity Futures Markets

 

The Government of India has been taking major initiatives to activate the Commodity Exchanges for enhancing the role of commodity futures as a major risk containment tool in the commodity sector. Participation of securities brokers in commodities futures market is considered generally as a welcome initiative for commodity market development. However, the existing legal framework does not permit the engagement of securities brokers in any business other than that of securities. SEBI constituted a Committee under the Chairmanship of Shri K R Ramamoorthy to examine the various aspects relating to participation of securities market brokers in the commodity futures market. The Committee dwelt upon the issue at length and made recommendations which are contained in the following Report. A view would, however, be taken by SEBI on the basis of feedback from market participants and public on this issue. Interested persons and entities may mail in their comments on this issue to Mr. N. Parakh at parakh@sebi.gov.in or Mr. Ritam Roy at ritamr@sebi.gov.in by February 21, 2003. Suggestions/ comments may also be sent by post to the Derivatives Cell, Securities and Exchange Board of India, Mittal Court, B-Wing, 1st Floor, 224, Nariman Point, Mumbai-400021.

 


 

Report of the Committee Appointed by the SEBI on

Participation by Securities Brokers in Commodity Futures Markets under the Chairmanship of

Shri K.R. Ramamoorthy

 

(February 5, 2003)

 

 

PARTICIPATION BY SECURITIES BROKERS IN

COMMODITY FUTURES MARKETS

Securities and Exchange Board of India: February 2003

 

 

Executive Summary

 

 

1.         The Government of India has been taking major initiatives to activate the Commodity Exchanges for enhancing the role of commodity futures as a major risk containment tool in the commodity sector. Entry of securities brokers in commodities futures market, though considered generally as a welcome initiative for commodity market development, could not be taken forward as the existing legal framework does not permit the engagement of securities brokers in any business other than that of securities.  The Forward Markets Commission (FMC), the regulatory body set up under the Forward Contracts (Regulation) Act, 1952, to monitor forward trading in various commodities, has also been requesting SEBI to permit brokers in the securities market to take up membership of commodity exchanges and engage in the business of intermediation in the commodity markets as well.    

 

2.         The Securities and Exchange Board of India therefore constituted a Committee under the Chairmanship of Shri K R Ramamoorthy, Advisor, CRISIL and formerly Chairman of Corporation Bank, to examine the various aspects relating to participation of securities market brokers in the commodity market, with specific focus on the following key issues:

 

(1) Whether securities brokers could participate in commodities market;

(2 What should be the risk containment measures, so that risk of one market does not spill over to the other; and

(3) Whether the existing infrastructure of stock exchanges could be used for the commodities futures market.

 

3.         The Committee, after due deliberations, has recommended participation of securities brokers in the commodity futures market.  In the following paragraphs, the key recommendations of the Committee are captured.

 

 

3.1.1    Participation of Securities Brokers in Commodity Futures Market

 

a)                  The Committee is of the unanimous view that participation of intermediaries like securities brokers in the commodity futures market is welcome as it could inter alia increase the number of quality players, infuse healthy competition, boost trading volumes in commodities and in turn provide greater liquidity and provide impetus to the overall growth of the commodity market. The Committee accordingly recommends that that securities broker be permitted to participate in the commodity futures market. (paragraph 3.12.1)

 

b)         Since the commodity market falls under the regulatory purview of a separate regulatory authority viz., Forward Market Commission, to ensure effective regulatory oversight by the Forward Market Commission, and to avoid any possible regulatory overlap, the pre-condition for such entry by intending participating securities brokers in the commodity futures market would be through a separate legal entity, either subsidiary or otherwise.  Such entity should conform from time to time to the regulatory prescriptions of Forward Market Commission, with reference to capital adequacy, net worth, membership fee, margins, etc. (paragraph 3.12.2)

 

c)         The Committee took note of the fact that the existing provisions of the Securities Contracts (Regulation) Rules, 1957 forbid a person to be elected as a member of a recognized stock exchange if he is engaged as principal or employee in any business other than that of securities, except as a broker or agent not involving any personal financial liability. The Committee recommends that the above provisions in the Securities Contract (Regulations) Rules be removed/amended suitably to facilitate securities brokers' participation/engagement in commodity futures.  (paragraph 3.12.3)

 

d)         While recognizing the benefits of participation of securities brokers in the commodity futures market, the Committee, however, appreciates that there are certain distinctive features of commodity markets, which the intermediaries like securities brokers should be alive of.  An important felt need was the necessity to improve market awareness of trading and contracts in commodities. The Committee therefore recommends the Forward Market Commission take appropriate initiatives in training the market participants.  (paragraph  3.12.4)

 

 

3.1.2.  Risk containment measures

    

In the background of the Forward Market Commission’s report on risk containment measures currently obtaining in commodity markets and the Committee’s recommendation to permit security brokers’ participation in commodities markets only through a separate legal entity, the Committee considers that ensuring strict compliance of the regulatory prescriptions like net worth, capital adequacy, margins, exposure norms, etc., by the respective market regulators, and due oversight would be an adequate safeguard to ensure that the risks are not transmitted from one market to the other. (paragraph 4.5)

 

3.1.3.   Utilization of existing infrastructure of stock exchanges

 

a)         There were no legal/regulatory impediments in the Stock Exchanges sharing their physical infrastructure with commodity exchanges and it would be solely dependent on commercial considerations. (paragraph 5.7.1)

 

(b)        On the issue of convergence / integration of the securities market and commodities market, that is, of allowing stock exchanges to trade in commodity derivatives and vice versa, the Committee was of the view that in the current statutory and regulatory framework and existence of two separate and established regulators, the issue of integration of the two markets would require a detailed examination, particularly for the purpose of defining clearly the scope of regulatory purview and responsibility. Also, given the concerns raised by a section of members that such integration may lead to further fragmentation of volumes and liquidity in the nascent commodity markets, the Committee was of the view that the issue of integration of markets could be taken up for consideration at a future date as the two markets mature further.  (paragraph 5.7.2)

 

4.                  Conclusion

 

            While the Committee appreciates the need to secure the participation of securities brokers in commodity markets in order to help boost the volumes in the commodity markets as well as provide fillip to the growth impetus and facilitate market maturity, it recognizes the need for taking cognizance of the extant regulatory complexities, risk containment concerns and coordination issues prevailing due to the existence of two separate regulators. Accordingly, it has made an effort to facilitate the participation of securities brokers in commodity  futures markets by recommending the removal of statutory restrictions in this regard, supporting the proposition that stock exchanges may share their surplus physical infrastructure with commodity exchanges or set up fully owned subsidiaries to function as Commodity Exchange. The distinctive operational characteristics of commodity market, contrasted to the securities market, point out the imperative need of training and guidance to market intermediaries like securities brokers, and thus enable them to acquire the requisite specialized  knowledge and skills to operate in the chosen niche of the commodity markets. However, the Committee has stopped short of recommending full fledged convergence of the two markets and their trading and settlement systems, and feels that this issue could be taken up in future only after the commodities market reaches an advanced state of modernization and operational maturity. 

                       

 

 

 

 

 

 

 

REPORT OF THE K. R. RAMAMOORTHY COMMITTEE ON

 PARTICIPATION BY SECURITIES BROKERS IN

COMMODITY FORWARD MARKETS

Securities and Exchange Board of India: January 2003

 

 

I.                   BACKGROUND

 

1.1              The Government of India has been taking major initiatives to activate the Commodity Exchanges for enhancing the role of commodity futures as a major risk containment tool in the commodity sector. These initiatives include fostering professionalism, adoption of modern technology, setting up of clearing corporations, trade / settlement guarantee funds, adoption of global best practices, adding new commodities as underlying for futures transactions, etc. However, despite these initiatives, the commodity exchanges continue to be languishing, witnessing low volumes and low growth. The Government has granted national status to two of the Commodity Exchanges viz., The Online Commodity Exchange of India Ltd., Ahmedabad, and the National Board of Trade, Indore, for undertaking futures trading in various commodities, in order to create an open, transparent and efficient futures market in commodities.

 

1.2              One of the main reasons said to be contributing to the phenomenon of low volume and growth is the limited number of active trading members and lack of high quality of intermediation in the commodity markets.

 

1.3              It is widely perceived that securities brokers have developed significant expertise and experience in operating in mature stock markets and such expertise could be gainfully employed in the commodity markets.  Presence of such established securities brokers, with adequate infrastructure and greater access to financial resources would provide impetus to the commodities market and this in turn would generate higher volumes. Since the functioning of commodity exchanges/markets is similar to that of stock exchanges/markets, securities brokers would be able to quickly adapt themselves to the needs of the commodities market and bring to play their skills and expertise, in developing the market.

 

1.4              Entry of securities brokers in commodities market, though considered generally as a welcome initiative for commodity market development, could not be taken forward as the existing legal framework does not permit the engagement of securities brokers in any business other than that of securities.  Rule 8(1)(f), of the Securities Contract (Regulation) Rules 1957 (SCRR) which prescribes inter alia the eligibility norm of a person to become a member of a recognised stock exchange, stipulates that no member shall be eligible to be elected as a member if “he is engaged as principal or employee in any business other than that of securities except as a broker or agent not involving any personal financial liability unless he undertakes on admission to severe his connection with such business”. The proviso to this rule states that the Securities and Exchange Board of India (SEBI) may, for reasons sufficient in the opinion of the said Board, permit a recognized stock exchange to suspend the enforcement of this clause for a specified period on the condition that the applicant is not associated with or is a member of or subscriber to or shareholder or debenture holder in or connected through a partner or employee with any other organization, institution, association, company or corporation in India where forward business of any kind whether in goods or commodities or otherwise is carried on or is not engaged as a principal or employee in any such business.

 

            Rule 8(3)(f) further states that no person who is a member at the time of application for recognition or subsequently admitted as a member shall continue as such if he engages either as principal or employee in any business other than that of securities except as a broker or agent not involving any personal financial liability, provided that - (i) the governing body may, for reasons to be recorded in writing, permit a member to engage himself as principal or employee in any such business, if the member in question ceases to carry on business on the stock exchange either as an individual or as a partner in a firm, (ii) in the case of those members who were under the rules in force at the time of such application permitted to engage in any such business and were actually engaged on the date of such application, a period of three years from the date of the grant of recognition shall be allowed for severing their connection with any such business, (iii) nothing herein shall affect members of a recognized stock exchange, permitted under the proviso to clause (f) of sub-rule (1) (of Rule 8) to suspend the enforcement of the aforesaid clause, for so long as such suspension is effective, except that no member of such exchange shall engage in forward business of any kind whether in goods or commodities or otherwise and, if actually so engaged on the date of such application, he shall severe his connection with any such business within a period of three years from the date of the grant of recognition.

 

            In this background, it was considered that removal of the extant restriction in the Securities Contract (Regulation) Rules, 1957 on securities brokers participation could facilitate their participation in the commodity market and provide impetus to its  future growth.

 

1.5              The Forward Markets Commission (FMC), the regulatory body set up under the Forward Contracts (Regulation) Act, 1952, to monitor forward trading in various commodities, has also been requesting SEBI to permit brokers in the securities market to take up membership of commodity exchanges and engage in the business of intermediation in the commodity markets as well.    

 

1.6              Accordingly, the SEBI Board decided to constitute a committee to look into the various aspects relating to participation of securities market brokers in the commodity market. The committee was required to look at the ways in which the experience and expertise of brokers in securities trading could be gainfully employed in the commodity markets and the commodity exchanges could be allowed to use the infrastructure available with the stock exchanges without the possibility of transmission of risk from one market to the other.

 

 

II.        CONSTITUTION OF THE COMMITTEE AND ITS TERM OF

            REFERENCE

          

 

2.1       The Committee was appointed by the Securities and Exchange Board of India (SEBI) by a Board resolution dated August 9, 2002 to examine the various aspects relating to participation of securities market brokers in the commodity market, with specific focus on the following key issues:

 

(a)          Whether securities brokers could participate in commodities market;

(b)         What should be the risk containment measures, so that risk of one market does not spill over to the other; and

(c)          Whether the existing infrastructure of stock exchanges could be used for the commodities market.

 

           

The   embershipmembership of the Committee was diverse and so constituted to ensure that it had the benefit of exchange of ideas amongst the representatives from the broking community, stock exchanges, regulators of the securities and commodity markets, Ministry of Finance and independent authorities on the subject. The names of the members of the Committee are appended in the Annexure.

 

2.2              The Committee had two sittings on  the 10th October 2002 and 21st November 2002 whereat members extensively participated and articulated their views. Some members also supplemented their viewpoints with written briefs on the issues under consideration. These were all taken on record by the Committee and circulated to the members for deliberations.  Notable among such written briefs were the letters sent by Ministry of Finance, the Forward Market Commission, the Ministry of Consumer Affairs, Food and Public Distribution, and the BSE Brokers’ Forum. The representatives of National Stock Exchange and the Association of NSE Members of India also circulated notes on some of the issues at hand. In the following paragraphs, the views of the Committee on the key issues and its recommendations are discussed.

 


III.       PARTICIPATION OF SECURITIES BROKERS IN COMMODITY

            FUTURES MARKET

           

            Whether securities brokers could participate in commodities futures  market?

 

            Benefits of Securities Brokers’ participation:

 

         

3.1              The commodity forward markets in the country had a chequered development due to the policy interventions/restrictions from time to time on movement of commodities and control of prices. In view of the current thrust on agricultural sector, and the ongoing market reforms, including the dismantling of various controls and regulations in agricultural commodity markets, the Committee recognizes that it would but be necessary to rejuvenate the commodity derivatives markets. Unofficial commodities markets were already in existence in Delhi. Although these markets did not have facilities similar to the stock exchanges, they were still transacting reasonable volume of business. With increased intermediation/ facilitation, such business could be channelised to the official / formal commodity exchanges and the experience and expertise of securities brokers would prove beneficial in this regard.

 

3.2              The Indian securities market has undergone massive structural and systemic transformation over the past one decade and has become a modernized, efficient and transparent market. Brokers in the securities market, in general, have the necessary skills and expertise in managing risks. They have also the capacity to take risks and make available the risk capital to the market forces The experience and expertise of brokers trading in securities could be gainfully used by the commodity exchanges in imparting greater procedural and cost efficiencies in commodity futures trading. In particular, it would increase the number of quality players in the market and boost trading volumes in commodities. Increased trading volumes would in turn provide greater liquidity in the commodity markets.  Such participation in commodity futures market  would also incidentally help the securities brokers expand their own business.

 

3.3              The Committee, therefore, was of the unanimous view was that participation by a larger number of intermediaries like securities brokers in the commodity futures market was welcome and this could infuse healthy competition and provide impetus to the growth the commodity market in the medium term.

 

           

 

 

 
 
            Modalities of securities broker participation in commodity futures market 

 

3.4       The Committee examined the modalities of permitting the securities brokers’ participation in the commodity futures market under two alternative models, either through a separate legal entity, distinct and separate from the securities market broking outfit or through the existing broking entity itself, conforming of course to the regulatory prescriptions of both SEBI and Forward Market Commission.  In support of the second alternative, some members of the Committee advocated that by allowing common set of brokers to intermediate in different markets, more economic use of capital, infrastructure, technology, etc could be achieved. The cost savings from such integrated arrangements could be passed on to the investors in the different markets. Though there were reportedly over 9000 brokers in the equity markets in India, the number of brokers who would wish to actively participate in the commodity markets might be fewer in number, particularly so if securities brokers’ participation is permitted only through a separate legal entity, which has to conform to separate capital adequacy, net worth and other regulatory prescriptions of Forward Market Commission.   The members further expressed that brokers wishing to participate in commodities exchanges, if asked to pay separate membership fee and shoulder additional costs for such participation, may not evince interest in participating in commodity markets and this may negate the very objective of enlarging the participation of intermediaries in the commodity market to give fillip to its future growth.  

 

            Advocating the first alternative of permitting securities brokers to operate in commodity futures market, through a separate legal entity, some members stressed that security market was now being regulated by SEBI, while the commodity market by a separate regulatory body viz., Forward Market Commission (FMC) and there could arise issues of regulatory overlap, despite all earnest endeavours to ensure seamless coordination between these two regulatory agencies. As a measure of risk containment and to avoid the possibility of a transfer of risk from commodity market to stock market and vice versa, it would but be desirable to ensure the separation of membership. It would therefore be desirable to stipulate securities brokers’ participation only through a separate legal entity, conforming to the capital adequacy, margin and other regulatory prescriptions of Forward Market Commission. 

 

 

3.5              The Forward Markets Commission (FMC) endorsed the view that in their opinion, allowing securities brokers’ participation in the commodity derivative market through a separate legal entity with separate capital adequacy and net worth, would be more neat and readily implementable in the present context, obviating the need for regulatory coordination. In other words, while the stock broking entities would be governed under SEBI regulations, the commodity market broking entities would be regulated separately by the FMC. The FMC further expressed that “allowing securities brokers to operate in different markets like securities, debt and commodities markets, with a common capital adequacy / net worth requirement, and subject to institutionalized regulatory coordination (i.e., default by a broker in one market/segment would render a broker defaulter in all the segments in which he was registered as a member)”, in their view, though appeared to be market friendly, would be difficult of implementation in the existing legal / regulatory framework where different regulators regulate market segments, viz., securities (SEBI), money (RBI), and commodities (FMC).

 

3.6              The Ministry of Finance representatives expressed their reservations in adopting the second alternative on two counts viz., a) inadequacies of existing exchange oversight systems in monitoring and regulating the activities of its membership, which currently number over 9000 and b) the imperative need to spell out the regulatory responsibility of enforcement of regulations relating to common brokers in the commodity and stock markets, amongst Stock Exchanges, SEBI and FMC, and commodity exchanges, to avoid any regulatory gap or overlap.

 

3.7       After careful consideration of the views articulated by members in regard to the two alternative models of participation, the Committee came to the conclusion that in facilitating the entry of securities brokers in the commodity futures market, the Committee should not lose sight of the possibility of risk contagion spilling over from one market to the other. With that end in view, it would but be desirable to permit the securities brokers participation in the commodity market through a separate legal entity, as articulated in the first alternative. Such entity would fall under the regulatory supervision of Forward Market Commission and should conform to its regulatory prescriptions from time to time, with reference to capital adequacy, net worth, membership fee, margins, etc. The Committee recognizes that a final decision whether to enter the commodity market or not would be dictated by the securities brokers’ commercial judgment, their expertise, their own business vision and perceptions.

 

3.8.      The Committee took note of the fact that the existing provisions of the Securities Contracts (Regulation) Rules, 1957 forbids a person to be elected as a member of a recognized stock exchange if he is engaged as principal or employee in any business other than that of securities, except as a broker or agent not involving any personal financial liability. The proviso to the said rule empowering Securities & Exchange Board of India to permit a recognized stock exchange to suspend the enforcement of this clause stipulate that such relaxation should not be granted to an entity “where forward business of any kind whether in goods or commodities or otherwise is carried on.” The relevant extract of rule 8 (1)(f) is cited below:

                  8.Qualifications for membership of a recognized stock exchange:

                (1) No person shall be eligible to be elected as a member if - ……

            (f)   he is engaged as principal or employee in any business other than that of securities except as a broker or agent not involving any personal financial liability unless he undertakes on admission to sever his connection with such business.

            Provided that the Securities & Exchange Board of India may, for reasons sufficient in the opinion of the said Board permit a recognized stock exchange to suspend the enforcement of this clause for a specified period on condition that the applicant is not associated with or is a member of or subscriber to or shareholder or debenture holder in or connected through a partner or employee with any other organization, institution, association, company, or corporation in India where forward business of any kind whether in goods or commodities or otherwise is carried on or is not engaged as a principal or employee in any such business;”    

 

 

3.9       In view of the above prohibition, members of stock exchanges cannot be permitted to be members of commodities exchanges. The Committee is of the considered view that the above provisions in the Securities Contract (Regulations) Rules be removed/amended suitably to facilitate securities brokers’ participation/ engagement in commodity futures.

 

            Need for training and education of intermediaries

 

3.10.    While recognizing the benefits of participation of securities brokers in the commodity futures market, the Committee, however, appreciates that there are certain distinctive features of commodity markets, which the intermediaries like securities brokers should be alive of.  Illustratively,

 

(i)         In stock exchanges, there is sufficient and clear data regarding the volume that is available in the market, i.e., the number of shares, which have been issued by a company and those, which are traded. In case of commodities, there is no certainty in this regard. Therefore, the technical factors affecting trading (even though theoretically identical) are practically different. The stock market is affected by the economic growth to the extent that it affects the general earnings.  In the case of stocks, a broker needs to know the fundamentals and technicals of the company as well as certain aspects of the industry in which it operates, as the stocks are dependent on specific company and industry fundamentals.  In the case of stocks, liquidity could fluctuate even though the issued capital of the company remains static.

 

(ii)        In the case of commodity markets, particularly agricultural commodities, demand and supply widely fluctuate. For instance, factors like carry over inventories, plantings, weather/crop progress, final harvest results, major crops arrivals, etc. influence the supply side of the market. On the demand side, domestic and global demand, consumer preferences, government programmes, would all have an impact. Thus in the case of commodities, extensive knowledge of the commodity market and the numerous variables influencing the demand and supply would become critical for the intermediaries to successfully operate.

 

(iii)       Whilst, in the case of commodities, the demand arises out of consumption needs, which is real, in the case of stocks, the demand is only investment demand, fuelled by technical and fundamental factors.

 

(iv)       In case of shares, absence of trading does not necessarily lead to fall in prices or cause problems to the holder of security, whereas in case of commodities, absence of trading may lead to fall in prices owing to problems related to storage, cost of carry, or perishability, etc.

 

(v)        The geographic dispersion of trade, absence of grades and standards in certain commodities, lack of market information, etc., also add to the complexities of the commodity market.

 

3.11          An important felt need was therefore the necessity to improve market awareness of trading nuances and contracts in commodity market. The Committee members agreed that efforts had to be put to train and educate market participants, including securities brokers, on the distinctive competencies and specialized knowledge and skills required to operate in commodity markets. The importance of learning from the experience of internationally developed commodity markets to develop our own commodity markets need not be over emphasized.  The Committee therefore recommends the Forward Market Commission may take appropriate initiatives  in training the market participants.

 

3. 12    Recommendations

 

3.12.1  The Committee is of the unanimous view that participation of intermediaries like securities brokers in the commodity futures market is welcome as it could inter alia increase the number of quality players in the commodity markets, infuse healthy competition, boost trading volumes in commodities and in turn provide greater liquidity and provide impetus to the overall growth of the commodity market. The Committee accordingly recommends that that securities brokers be permitted to participate in the commodity futures market.

 

3.12.2    Since the commodity market falls under the regulatory purview of a separate regulatory authority viz., Forward Market Commission, to ensure effective regulatory oversight by the said Forward Market Commission, and to avoid any possible regulatory overlap, the pre-condition for such entry by intending participating securities brokers in the commodity market, would be through a separate legal entity, either subsidiary or otherwise.  Such entity should conform from time to time to the regulatory prescriptions of Forward Market Commission, with reference to capital adequacy, net worth, membership fee, margins, etc.

 

3.12.3  The Committee took note of the fact that the existing provisions of the Securities Contracts (Regulation) Rules, 1957 forbids a person to be elected as a member of a recognized stock exchange if he is engaged as principal or employee in any business other than that of securities, except as a broker or agent not involving any personal financial liability. The Committee recommends that the above provisions in the Securities Contract (Regulations) Rules be removed/amended suitably to facilitate securities brokers' participation/engagement in commodity futures.

 

3.12.4 While recognizing the benefits of participation of securities brokers in the commodity futures market, the Committee, however, appreciates that there are certain distinctive features of commodity markets, which the intermediaries like securities brokers should be alive of. An important felt need was the necessity to improve market awareness of trading and contracts in commodities.  The Committee therefore recommends the Forward Market Commission take appropriate initiatives in training the market participants.

 

 

IV.       RISK CONTAINMENT MEASURES

 

What should be the risk containment measures, so that risk of one market does not spill over to the other?

 

 

4.1       Members agreed that adequate risk containment measures are but necessary to prevent transmission of risk between securities and commodities market, particularly since they are governed by different legislative enactments and are regulated by two different authorities viz., Securities and Exchange Board of India and Forward Market Commission.

 

4.2              The Committee took on board the briefings of the Forward Market Commission to the Committee on  the various risk containment systems that are in place in the Commodity Exchanges for ensuring safety of trading, clearing and settlement of commodity trades. Members noted that outstanding contracts on the commodity markets are marked to market on a daily basis, that risks are not allowed to be accumulated by collecting mark to market margins on a daily basis and that to deal with any sustained abnormal volatility, Forward Market Commission also imposes special margins and that all the risk management variables are worked out in a holistic manner, so that the members do not transmit the risk to any other market. 

 

4.3              The Committee also noted that Commodity Exchanges have also been asked to set up trade guarantee fund commensurate with the volume trade at the exchanges and FMC has developed a market monitoring and surveillance software. The Committee noted the views of FMC that the existing risk containment measures were adequate to ensure that risk in securities market does not flow to commodity derivative market and vice versa.

 

4.4              The Committee, on examining the pros and cons of permitting stock exchanges to deal on commodity futures, deferred the issue of such seamless integration / convergence of the two markets for reasons set out in para 5.3 below. Further the Committee has recommended that securities brokers could participate in the commodity futures market only through a separate legal entity and conform to the regulatory prescriptions of capital adequacy, net worth, membership fee, margins, etc., as may be stipulated by Forward Market Commission from time to time Hence the need for devising risk containment mechanisms for risks arising out of integration / convergence (e.g., common settlement systems) did not arise at present. In this background and taking note of the risk containment measures currently obtaining in the commodity market, the Committee considered the existing regulatory prescriptions in respect of brokers/dealers and sub brokers, etc., of SEBI and FMC were sufficient with regard to their respective markets.

 

 

4.5       Recommendations:

       

In the background of the Forward Market Commission’s report on risk containment measures currently obtaining in commodity markets and the Committee’s recommendation to permit security brokers’ participation in commodities futures market only through a separate legal entity, the Committee considers that ensuring strict compliance of the regulatory prescriptions like net worth, capital adequacy, margins, exposure norms, etc., by the respective market regulators, and due oversight would be an adequate safeguard to ensure that the risks are not transmitted from one market to the other.

 

 

V.        UTILIZATION OF EXISTING INFRASTRUCTURE OF STOCK         EXCHANGES

 

Whether the existing infrastructure of stock exchanges could be used for   the commodities market?

 

 

 Utilization of physical infrastructure:

 

 

5.1       There was broad agreement amongst members that the surplus physical infrastructure that was presently available with the stock exchanges, particularly the regional stock exchanges, could be gainfully employed by allowing commodity exchanges to operate from these premises. The Committee was of the view that there were no legal restrictions on stock exchanges letting out their surplus infrastructure to commodity exchanges on mutually agreeable commercial terms. Moreover, some of the stock exchanges were already sharing their physical infrastructure with commodity exchanges – e.g., Bangalore Stock  Exchange and Ahmedabad Stock Exchange. Sharing of physical infrastructure between stock exchanges and commodity exchanges would be solely dependent on commercial considerations only.

 

 

Trading of Commodity Futures on Stock Exchanges (Convergence of markets and systems)

 

 

5.2       Some members shared the view that the deliberations and recommendations of the Committee should not be confined to the narrow contours of mere utilization of physical infrastructure of the stock exchanges, but traverse beyond to bring about integration of the operations in the two markets. It should encompass other key issue as to whether the commodity futures can be traded on the stock exchanges, so that the stock exchange infrastructure in broader terms - market players, brokers, investors and the physical infrastructure - could be optimally used. The commodity exchanges are also being modernized and computerized and a number of risk containment measures are being implemented in these exchanges. In this scenario, allowing commodities to be traded on stock exchanges would enable the commodity markets to reap the benefits of the synergies expected to arise from the proposed arrangement of participation of securities brokers in the commodity market, subject of course to the satisfactory resolution of issues of regulatory overlap. On the apprehension of regulatory overlap, it was expressed that at present, stock exchanges (NSE/BSE) were already operating successfully in two or more different markets / segments (e.g., cash market, derivatives market, wholesale debt market) within the ambit of a single securities exchange, with adequate risk containment measures, so as to achieve necessary segregation of the markets. Further, a broker who is declared a defaulter in one segment of the securities market was automatically declared a defaulter in the other segments. This arrangement could be expanded to include the commodity market/segment too. 

 

5.3              After extensive deliberations, the Committee came to the conclusion that allowing commodity futures to be traded on stock exchanges is a material issue of considerable policy import in the sense that this would require a hybridization / seamless convergence of systems between securities trading and commodity trading, a matter that could have extensive legal, regulatory, risk management, logics and other ramifications. With respect to the existing arrangement in the securities market, whereby a broker who is declared a defaulter in one segment of the securities market was automatically declared a defaulter in the other segments, the Committee felt that the arrangement could work out fine where all such segments were regulated by a single regulator (that is, SEBI in the existing scenario in the securities market). However, to simultaneously declare a broker defaulter in the securities and commodities markets would require an institutionalized regulatory coordination between two separate regulators, SEBI and FMC, which would be very hard to implement at present.  A section of the members also expressed hat such integration may lead to further fragmentation of volumes and liquidity in the nascent commodity markets.  The Committee was therefore of the view that the issue of integration of markets could be taken up for consideration at a future date as the two markets mature further. 

 

Formation of subsidiaries by Stock Exchanges to operate as Commodity   Exchanges

 

Whilst on this, the Committee also took note of the reported move of some the Stock Exchanges seeking Forward Market Commission’s permission to deal in Commodity markets.  The issue was discussed at length and in the light of the regulatory overlap and other concerns shared by members, the Committee came to the conclusion that the intending Stock Exchanges might have to float a separate legal entity to deal in commodity markets, conform to the regulatory requirements of FMC and be subjected to the latter’s regulatory oversight.  It was further decided that the legal provisions be examined as to whether a Stock Exchanges could float a subsidiary to deal in commodity market and, if there exists any limitation/prohibition, the Committee may recommend suitable enabling provisions in the  Securities Contract (Regulation) Act,1956 or Regulations thereunder.  The provisions of the Securities Contract (Regulation) Act, 1956 and the Rules under were accordingly got legally examined by the SEBI secretariat and the legal view was that there was no express prohibition under the Securities Contracts (Regulation) Act, 1956 or the rules thereunder for a recognized stock exchange setting up setting up a subsidiary.  

                                        

 

 

                                                     

5.7       Recommendations

 

5.7.1    There were no legal/regulatory impediments in the Stock Exchanges sharing their physical infrastructure with commodity exchanges and it would be solely dependent on commercial considerations.

 

5.7.2        On the issue of convergence / integration of the securities market and commodities market, that is, of allowing stock exchanges to trade in commodity derivatives and vice versa, the Committee was of the view that in the current statutory and regulatory framework and existence of two separate and established regulators, the issue of integration of the two markets would require a detailed examination, particularly for the purpose of defining clearly the scope of regulatory purview and responsibility. Also, given the concerns raised by a section of members that such integration may lead to further fragmentation of volumes and liquidity in the nascent commodity markets, the Committee was of the view that the issue of integration of markets could be taken up for consideration at a future date as the two markets mature further. 

 

VI.       END NOTE

 

            While the Committee appreciates the need to secure the participation of securities brokers in commodity markets in order to help boost the volumes in the commodity markets as well as provide fillip to the growth impetus and facilitate market maturity, it recognizes the need for taking cognizance of the extant regulatory complexities, risk containment concerns and coordination issues prevailing due to the existence of two separate regulators. Accordingly, it has made an effort to facilitate the participation of securities brokers in commodity  futures markets by recommending the removal of statutory restrictions in this regard, supporting the proposition that stock exchanges may share their surplus physical infrastructure with commodity exchanges or set up fully owned subsidiaries to function as Commodity Exchange. The distinctive operational characteristics of commodity market, contrasted to the securities market, point out the imperative need of training and guidance to market intermediaries like securities brokers, and thus enable them to  acquire the requisite specialized  knowledge and skills to operate in the chosen niche of the commodity markets. However, the Committee  has stopped short of recommending full fledged convergence of the two markets and their trading and settlement systems, and feels that this issue could be taken up in future only after the commodities market reaches an advanced state of modernization and operational maturity. 

                       

 

                                                            _________

Annexure

 

 

 

Members of the Committee

 

 

Chairman of the Committee

Shri K. R. Ramamoorthy, Advisor, CRISIL (formerly: Chairman, Corporation Bank and The Vysya Bank Limited)

 

Members:

Shri. Pratip Kar, Executive Director, SEBI

Shri. N. Parakh, Chief General Manager, SEBI – Member Secretary

Shri. C.K.G. Nair, Director, Ministry of Consumer Affairs, Food and Public Distribution

▪ Dr. Shashank Saksena, Joint . Director (Stock Exchange), Ministry of Finance

Shri. D.S. Kolamkar, Director, Forward Markets Commission

Shri. S.T. Gerela, Director, Bombay Stock Exchange

Shri. P.K. Singhal, Executive Director, Delhi Stock Exchange

▪ Ms. K. Kamla, Executive Director, Bangalore Stock Exchange

Shri. J. Ravichandran, Senior.Vice President, National Stock Exchange

Shri. Suresh Kotak, President, Indian Merchants’ Chambers

Shri. Vijay Bhushan, President, Federation of Indian Stock Exchanges

Shri. Rajesh Bajaj, representative of Association of NSE Members of India

Shri. R.B. Khandelwal, representative of BSE Brokers’ Forum