The Securities and Exchange Board of India is exploring the viability of introducing crude oil exchange-traded funds (ETFs) in India.
Such ETFs own futures contracts on crude oil instead of the commodity itself. The ETF price will mimic the spot price. The funds will allow direct participation in the crude oil market without the need for physical delivery or investing in crude oil derivatives.
Regulatory Challenges
“Such ETFs can be a diversification tool for investors. A change in regulations will be required, however, given that current norms do not allow for synthetic ETFs and need a physical backing of the underlying (gold, silver, stocks),” said a senior MF official.
“These ETFs will be cash-settled and are feasible but may result in undue speculative activity. It can even pose a headache for the government if the participation grows large enough to meaningfully impact crude oil prices in the country,” said another MF official.
An email sent to SEBI did not immediately get a response.
Crude oil is the most actively traded commodity on MCX. The combined value of crude oil across all futures contracts traded daily on MCX, on average, was ₹1,459 crore as of May this year.
Some of the largest crude oil ETFs globally are the United States Oil Fund (USO), Invesco DB Oil Fund and ProShares K-1 Free Crude Oil Strategy ETF.
Two large fund houses had, in the past, initiated discussions with the regulator to launch the product, said a person familiar with the matter. The regulator had expressed reservations at that time.
A recent note published in SEBI’s monthly bulletin, however, said that crude oil ETFs can provide investors with a simple way to take a view on oil prices and allow for portfolio diversification. “The risky and volatile nature of the product and its suitability to investors can be dealt with through mandatory disclosures, restrictions on the quantum of investment, information through risk-o-meter and other awareness initiatives,” it said.
Crude oil ETFs tend to hold oil futures contracts on a continuous basis and require rolling of near-month futures positions to far-month contracts. This may lead to rollover costs resulting in deviation of the performance of the ETF vis-a-vis the spot markets. There is also the risk of black swan events, resulting in the price of next-month crude oil futures contracts falling to a negative value.
Crude oil prices can be volatile, especially during geopolitical conflicts, leading to volatile returns. A benchmark index comprising near-month futures contracts in the crude oil to reflect the performance of the spot price is necessary as far-month contract prices may not give a true picture and are hard to track.