SEBI-FMC merger: what the market regulator needs to do

The Budget has proposed the merger of the SEBI and FMC. The Centre has given some breathing time to the FMC on existing guidelines until Forward Contracts (Regulation) Act, 1956 is repealed. The effect of SEBI-FMC merger will soon be felt in regulation, product-market innovation and surveillance and risk management. In other words, SEBI has been entrusted with dual responsibility – regulation of capital markets and commodity derivative markets. This can have several implications to existing regional and national level commodity exchanges, trading-cum-clearing/institutional clearing agents and investors.

Regulatory supervision of economic behaviour (of agents) may be increased manifold, justifying the role of commodity exchanges in price discovery or risk management. Adoption of good governance practices, on one hand, could help rationalise their existence and constitution of a diversified board through succession planning, on the other, may be a desired outcome of SEBI-FMC merger. A principle-based regulatory structure will help rope in commodity and financial eco-system and infuse more rationality in the commodity trade. The new regulator could be able to resolve the inherent conflicts between the principal and agents. However, experiential learning of FMC could help SEBI understand commodities markets and their mechanics.

Market environment plays a key role in transaction between related parties. However, consequence of trading activity can affect unrelated third parties what is known as externality, for example, notion of general public on price rise of pulses and cereals in 2007-08. The merger could oversee this problem in a logical manner. SEBI can issue a directive indicating the incentive structure for affected individuals or groups that may be pro-governance measure. This has twin benefits: one is minimal direct intervention of SEBI and the other one, bargaining mechanism may bring about an optimal outcome given low negotiation/transaction costs.

FMC, before merger, has adopted a score of measures for awareness drive relating to capacity building, sensitisation of stakeholders and policymakers in agriculture since 2007-08. In 2012-13, the commission has organised several awareness programmes in association with various institutions, market agencies, and commodity exchanges.

The commission also consented to extend the price dissemination project in the proximity of post offices, rural branches of banks, warehouses, co-operatives and other remote areas. For instance, FMC initiated price dissemination project had installed 1,863 price tickers across various parts of the country.

The new regulator, SEBI, might collaborate with management and policy-level institutions for research that could bridge the gap between theories and practice and thus, enhance the veracity of research in commodities.

Traders will be more financial literate of market mechanics that can strengthen their strategy formulation. However, participants’ gut feeling in exercising the contract need to be checked as information and communication pattern often impacts the decision making processes. As they perceive the markets differently based on their risk-return quotients, adoption of governance practices will enhance investor awareness.

While hedgers remain risk-averse, speculators prefer to bear the risk. Arbitrageurs, on the other, attempt to optimise risk-return metrics considering time and space potentially. Therefore, the new regulator needs to explore psychologies and prospects of investors – commercial users and financial market participants.

The above discussion might draw the attention of practitioners and policy makers to an innocuous environment of trading and mutually beneficial platform for intended buyers and sellers that the new regulator is poised to deliver. But the blanket application of the global practices may not bolster the functioning of commodity exchanges. Since the futures market reduces price uncertainty and influences the decision of stakeholders in investment and marketing or moderate their risk-return perception, the new regulator needs to assess the utility of existing exchanges. Probably, a thorough survey may address the concerns of SEBI: “Small is beautiful or big is better”. While changes were made to FC(R)A Bill, 2010, the new regulator should be cautious while implementing changes in commodities markets.

The writer is a Post-Doctoral Fellow of the Centre for Management in Agriculture, IIM-Ahmedabad. Views are personal.