Look beyond FCRA amendments: Financial Express: 5th October 2010

The possibility of the Forward Contracts (Regulation) Act (FCRA) being amended raises some interesting issues in the context of financial markets in India. There is, of course, the question of what this means for the commodity market. But, at the broader level, it also provokes some introspection of the regulatory issues in the financial space.

The immediate euphoria is in the commodity markets, as the constituents have been hoping for the same for quite some time now. What this means is that if Parliament passes these amendments, then the FMC would become autonomous and could bring in the changes that are needed to galvanise a market that is quite lopsided today. The immediate thoughts that strike us are that the market can expect options and indices to be introduced soon. Also, the FMC will have more powers to control the markets, though admittedly, the FMC and market have functioned well so far without such explicit power being given to the FMC.

Once the amendment is passed, four questions may be posed. The first is whether FMC, being an independent regulator, will really help the cause? The FMC will have to gear up and hone its skills to understand the market and defend it. Being independent is one thing, to act independently is another. Suppose prices of chana or sugar were to increase sharply leading to high food inflation, can the independent FMC stand up and tell the government to lay off? Second, the issue of regulatory overlap is still not addressed. It may be recollected that the FMC had given permission to FIIs and mutual funds to trade in non-agricultural commodities several years ago. Yet their own regulators have not allowed this action. Will the FCRA amendment address this issue?

Third, while options sound good, the prospects for business per se are quite limited. Today, globally, around 10% of energy contracts, 7-8% of metals and almost nil of agriculture trading are in options. One should not overstate the case of farmers using options, considering that they have yet to trade in futures and trading in options on futures (which is what it will be) will be even more daunting for them. Fourth, commodity indices are not widely traded on exchanges unlike stock indices, which should curb the enthusiasm on the business front.

The second set of issues is institutional, which has to be addressed at some point in time. Today, there are a plethora of regulators in the financial markets: RBI, Sebi, FMC, Nabard, Sidbi, Irda, PFRDA, CEA, APMCs, etc. There are evidently no answers to the question of whether there should be more or fewer regulators. The Raghuram Rajan committee pitched for fewer while there is another school of thought that argues that specialisation is better than creating a behemoth that loses touch with reality—the same debate as with centralisation or decentralisation and empowerment.

The issue is more about the players being caught between different regulators. Today, financial products stretch across markets and regulators, which create potential conflict. Electricity is under CEA but FMC runs the derivatives market, which can involve delivery. The same holds for any physical commodity or ETF where the underlying has a different set up from the derivative product. Physical gold is not regulated but futures are under FMC but the ETF falls under Sebi. If it is a physical product, APMCs regulate, say, wheat, while the derivative is under FMC and we could have the ETF being traded on NSE under Sebi? The Ulips created their own controversies with Sebi and Irda coming to the discussion table. Banks can operate through subsidiaries in the stock market but on their own can sell mutual funds products but not deal directly as they deal with deposit money, which is RBI’s domain. Forex derivatives impact currency markets but come under Sebi though technically this is okay since RBI deals with physical currency, which does not come into the picture now. Also, the institutions have different capital structures. RBI allows 40% ownership for individual entrepreneurs while Sebi has a 5% ceiling for exchanges. FMC gives time for shareholding patterns to evolve while Irda provides a longer window.

Therefore, the broader issue is that while there is merit in having more regulators with specialisation, we need to iron out these conflict zones so that markets can evolve with minimum upheavals. Currently, there is excess caution being exercised to ensure that risk from one segment does not spill over to another when the players are the same. This has led to a certain level of intransigence between regulators, which has been compounded by the differences in ministries overseeing these departments. The next stage of regulatory reform should logically be in this area before moving down to the markets per se. That will be pragmatic and useful.