SEBI Proposes Wider Commodity Derivatives Access for FPIs

The Securities and Exchange Board of India (SEBI) has proposed allowing Foreign Portfolio Investors (FPIs) to participate in physically settled, non-agricultural commodity derivative contracts on Indian exchanges.

At present, FPIs can participate in exchange-traded commodity derivatives, but their participation is largely limited to cash-settled non-agricultural commodity derivatives and related indices. The proposed framework would expand their access to contracts where the underlying commodity can ultimately be delivered physically.

How the proposed framework would work

Under the proposal, FPIs would be allowed to trade physically settled non-agricultural commodity contracts, but they would not be permitted to carry their positions into the delivery period.

FPIs would have to either:

• Square off their open positions, or
• Roll over their positions to a later contract

before the tender period begins. The proposed cut-off would be three days before expiry. If an FPI does not exit its position within the prescribed period, a designated trading or clearing member would step in and take over the open position.

What happens if an FPI does not exit?

FPIs that want to participate in these contracts would need to have an arrangement with a designated broker or clearing member. An FPI would be permitted to have such an arrangement with only one broker.

The FPI could continue to square off or roll over its position until the end of trading on the day before the tender period begins. If a position remains open after that point, it would automatically be transferred to the designated broker's proprietary account.

The transfer would take place at the closing price or the daily settlement price declared by the exchange.

Delivery risk would shift to the broker

The proposed mechanism is designed to ensure that FPIs do not enter the physical delivery process. If a position is transferred, the designated broker would have to take it into its own proprietary account and manage the resulting exposure. The clearing member would also provide information about the FPI's open position and the margin requirement in advance, giving the broker time to arrange the required margin.

If the transferred position causes the broker to breach applicable position limits, the broker would be given two trading days to bring the position back within the prescribed limits.

To prevent FPIs from increasing their exposure immediately before the compulsory exit, clearing members would not be allowed to accept trades that increase an FPI's open position in a near-month physically deliverable contract on the day before the tender period.

Possible charges for FPIs

The agreement between an FPI and its designated broker could include a pre-agreed charge if the FPI fails to close or roll over its position and the broker has to take it over.

Such a charge would be separate from any penalty imposed by the exchange or clearing corporation for violations such as exceeding position limits.

Any transfer trade would also be treated as a normal market transaction and would attract applicable transaction charges, SEBI turnover fees, Commodity Transaction Tax, stamp duty and GST on turnover charges.

Why the proposal matters

SEBI's proposal would broaden the role of FPIs in India's commodity derivatives market. Physically settled contracts include commodities such as crude oil, natural gas, gold and silver.

SEBI had allowed FPIs to participate in exchange-traded commodity derivatives in 2022, but physical delivery contracts were kept outside their permitted participation because of operational and tax-related challenges associated with taking or making delivery in India.

The proposed exit mechanism is intended to address those challenges while allowing FPIs greater access to the commodity derivatives market. SEBI has said that wider participation could help deepen liquidity and improve price discovery. The proposal is currently a regulatory proposal and is not yet a final rule.

(Source: Moneycontrol)

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