The Securities and Exchange Board of India (SEBI) is reviewing a proposal to allow foreign portfolio investors (FPIs) to trade in non-cash settled, non-agricultural commodity derivatives. This move aims to broaden the domestic commodity market and increase investor participation. SEBI’s Chairman, Tuhin Kanta Pandey, brought into light that a committee is being formed to develop the non-agricultural commodity space, including metals like gold, silver, zinc and lead.
Current Regulatory Framework
Presently, FPIs can trade only in financially settled non-agricultural commodity contracts such as crude oil, natural gas, and index futures. However, they are barred from trading in physically settled commodities like base metals and precious metals. The existing system restricts foreign investors from participating in segments where India is global player.
Proposed Changes for Foreign Portfolio Investors
If approved, FPIs will be permitted to trade in non-cash settled contracts of base metals and precious metals. These include gold, silver, zinc, and lead. This would enable FPIs to engage in commodities with a strong Indian presence and improve their ability to manage capital post-market hours. The move will enhance foreign investor access to India’s commodity derivatives market.
Rationale Behind the Proposal
The primary aim is to deepen the commodity market by attracting more institutional investors. Greater participation will improve price discovery and market efficiency. FPIs bring monetary strength and research expertise, which can add value. Increased liquidity from FPIs could extend market depth beyond the current one-month horizon, benefiting industrial users who rely on hedging.
Impact on Market Liquidity and Hedging
Currently, liquidity in Indian commodity markets is limited to short durations. This forces industrial participants to roll over positions frequently, increasing costs. With FPIs allowed to trade in deliverable commodities, risk capital can flow into longer-dated contracts. This would build liquidity in far-month contracts, helping Indian corporates hedge domestically instead of relying on international exchanges.
Strategic Importance Amid Geopolitical Concerns
SEBI’s consideration of this proposal coincides with fragile geopolitical conditions. A liquid and well-developed commodity derivatives market is crucial for India’s economic stability. Allowing FPIs to trade in physically settled commodities would strengthen domestic market resilience and reduce dependency on external markets.
Future Developments
SEBI plans to form a working group focused on non-agricultural commodities to recommend further reforms. This initiative follows the recent approval of a single automatic window for foreign investors, aimed at streamlining foreign investment processes. The changes signal SEBI’s commitment to integrating India’s commodity markets with global investors.
Questions for UPSC:
- Discuss the role of foreign portfolio investors in deepening domestic financial markets. How can their participation impact market efficiency and liquidity?
- Critically examine the significance of commodity derivatives markets in India’s economic development. What challenges do these markets face?
- Explain the concept of price discovery in commodity markets. How does increased institutional participation influence this process?
- With suitable examples, discuss the impact of geopolitical tensions on global commodity markets and the measures countries can take to mitigate related risks.
