Marriage of Regulators
- Sebi, a body with fully independent powers, regulates the securities market
- FMC had been regulating the commodities market but its lack of powers left this market prone to speculative trading
- The high-profile NSEL scam led intensified talks of bringing FMC under Sebi’s fold
- FMC’s merger with Sebi is aimed at streamlining regulations and curbing wild speculations in the commodities market
For the first time ever two financial market regulators, the Forward Market Commission (FMC) and Securities and Exchange Board of India (Sebi) merged today, thanks largely to Jignesh Shah and the NSEL scam. Though the idea of a common regulator was mooted 12 years ago, it took a scam to make the finance ministry re-think about a single market regulator.
The jury is still out on the benefits of the merger. But before we look at the pros and cons of the merger, let’s focus on what the two regulators do.
Sebi is the securities market watchdog with statutory powers which is responsive to the needs of the issuers of securities, investors and market intermediaries. FMC is the chief regulator of the commodities market. The key difference between the two regulators was that FMC did not have powers to control irregularities that took place in the commodities market.
Rather than merging the two regulators, many market observers felt the need to give FMC more teeth as the body understood the needs and functioning of the commodities market. Since most of the existing team from FMC would still monitor operations in the commodities market, this time under the banner of Sebi, many felt it may have been less cumbersome to give more powers to FMC instead.
With the merger, Sebi will regulate all markets trading electronically across the country. But that is easier said than done. There is scepticism in the commodities market on Sebi’s role. At the same time, there is a school of thought that believes that Sebi is the best thing that could have happened to the commodity markets.
We look at five pros and cons of the Sebi-FMC marriage.
Case for the Merger
It is expected to give a significant boost to the integrity of the commodities market. The NSEL scandal took a number of players away from the commodity markets. Faith in the market will improve and volumes are expected to increase.
Globally commodities markets see higher volumes than equity markets. This is mainly because commodities are easier to understand and relate to than individual companies, who are known to hide their performance behind numbers. With commodities now being regulated by Sebi, expectations are that banks and institutional players will be allowed in this market. India is among the largest producers of a number of soft (agriculture) commodities and one of the largest consumers of hard commodities (metals). Further, it is also a big player in the energy market (oil). Development of these markets with more depth from institutional players will be beneficial for the economy and attract more players.
Under a common regulator, margin norms and single KYC (know your client) requirement should help develop the commodity market. Reduction in margin money and compliance costs will help lower transaction costs for market participants.
Diversification will be possible for an investor without moving around his money. So if equity markets remain volatile, the investor can use his money to move to gold without transferring his money through the banking channel.
Brokers and sub-brokers of commodity markets will benefit from multi-asset broking. Reports say that commodity exchanges will start equity trading post the merger. A better controlled market can help increase volume and revenue opportunity for brokers.
Possible Roadblocks
More than 50 percent commodity market brokers have a direct interest in the commodities they trade. For example, most jewellers in Mumbai’s Zaveri Bazar are members of the commodity exchange since they have interest in trading in precious metals. Sebi rules do not allow brokers to undertake any other activity. So expectations are that the merger will prevent these merchants to participate as brokers.
One of the main reasons commodity markets attracted retail participants was that the margin requirement in the exchange was very low compared to share markets. Recent comments by Sebi chairman, UK Sinha, suggests that margin requirements in the commodity markets would be tightened which would impact volumes, especially the arbitrage volume.
Brokers’ registration fees are expected to rise post the merger, which will then be passed on to consumers. Already the imposition of a commodity transaction tax has impacted margins severely. A 2013 Nielsen report said that ‘dabba’ trading (off-exchange trading which is banned in India) volumes increased by five to seven times after the commodity transaction tax was introduced in July 2013. Also, commodity exchanges will have to shore up more capital to meet the networth criteria of Sebi. This will of course be passed on to brokers who in turn would pile it on customers. Low transaction cost is crucial in attracting volume on the exchanges. Since most of the commodities traded in India are also traded globally, low transaction cost will play an important role in attracting foreign money.
Sebi will find it difficult to apply the same set of rules it uses for companies on commodities, since there is no single owner of the commodity as compared to promoters in the case of companies. Also, with the spot market being out of the purview of the commodity exchanges and thus Sebi, the task of controlling price rigging will be difficult.
Sebi might become a victim of its own efficiency and transparency. Given the nature of non-standardised commodities, especially in soft commodities, Sebi might face the problem of increasing complaints from across the country. It has an online complaint system which will be put to test in commodities more than it did in equities. An internal study commissioned by Sebi feels that complaints might flow in from semi-urban and rural clientele of commodity bourses post-merger.
(The writer is a Mumbai-based market analyst)