Missing pieces in commodity markets

Missing pieces in commodity markets

Finance minister Arun Jaitley’s Budget 2017 speech did mention that the commodities markets require reforms for the benefit of farmers. He also called for an operational and legal framework to integrate spot and derivatives markets for commodity trading, which is unexceptionable. The capital markets regulator, Sebi, faces legal difficulties in allowing options trading in commodities, and has reportedly decided to focus, for now, on attracting more institutional players to the commodity futures market. But such segmented approach in market design will not do.
The point is to have a sophisticated and well-developed financial system to better manage myriad risks across currencies, securities and derivative contracts. Options — which give the buyer the right but not the obligation to buy (or sell) a certain asset — in commodities would lead to much-needed flexibility in the futures market. Yet, we lack a firm legal framework for commodity options. The Forward Contracts (Regulation) Act (FCRA), 1952, does have provisions that give rise to a measure of uncertainty in futures trading. While the FCRA is under the Union List, trades on the underlying commodities fall under the State List for agricultural commodities. There are various other standalone laws, such as the Warehousing Act, 2007, or the Food Safety Act, 2006, or the APMC Act that produce an incoherent ecosystem for commodity derivatives.
The reported Sebi game plan is to let private equity funds and venture funds into commodity futures, to be followed by mutual funds. And, in the next phase, insurers and other financial institutions would gain entry. But artificially compartmentalized, isolated financial markets would be wholly suboptimal and avoidable. Better market design, please.