SEBI Proposes Opening Physically-Settled Commodity Derivatives To FPIs With New Delivery Safeguards

The Securities and Exchange Board of India (SEBI) has proposed a major expansion of foreign investor participation in the commodity derivatives market by allowing Foreign Portfolio Investors (FPIs) to trade in physically-settled non-agricultural commodity derivative contracts such as gold, silver, crude oil, natural gas and base metals futures.

At present, FPIs are allowed to participate only in cash-settled non-agricultural commodity derivative contracts and commodity indices comprising such contracts. FPIs can trade products where positions are settled in cash and do not result in delivery obligations. They are not permitted to participate in physically-settled commodity contracts because any position carried into the tender or delivery period can require market participants to take or make delivery of the underlying commodity.

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SEBI has noted that FPIs may not be equipped to handle such obligations due to the absence of a permanent establishment in India and the requirement for GST registration to buy or sell physical commodities. The proposal, through a consultation paper dated August 11, follows representations from exchanges and market participants seeking broader foreign participation in commodity derivatives.

According to SEBI, allowing FPIs into physically-settled non-agricultural commodity contracts would broaden the participant base, improve market depth, increase liquidity, enhance price discovery and strengthen convergence between derivatives and physical markets. The regulator also said the move would help integrate Indian commodity markets more closely with global markets, where foreign investors are already active participants in physically-settled contracts.

A key feature of the consultation paper is a new operational framework that allows FPIs to trade physically-settled contracts while ensuring they never enter the delivery process. Before participating, FPIs must enter into a tripartite agreement with a Professional Clearing Member (PCM) and Trading Member (TM), or a bipartite agreement with a Trading-cum-Clearing Member (TCM).

The agreement will establish a pre-designated intermediary that can assume the position if the FPI fails to exit before delivery obligations arise. Trading in deliverable contracts will be enabled only after such arrangements are registered with the exchange and clearing corporation. SEBI's proposal requires FPIs to square off or roll over positions before the commencement of the tender or staggered delivery period. Voluntary square-off or rollover remains the preferred route.

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However, the regulator has proposed a two-tier safeguard mechanism to deal with positions that remain open close to delivery. If an FPI has not exited its position by the close of trading on T-3, the safeguard process is triggered. On T-2, the Professional Clearing Member will notify the designated Trading Member of the FPI's open positions, allowing time to arrange the necessary margins.

On T-1, FPIs will not be allowed to increase positions in the expiring deliverable contract. The most significant change is the introduction of an automatic post-close transfer mechanism. If the FPI still holds an open position at the end of T-1, the exchange and clearing corporation will automatically transfer that position to the designated TM or TCM after market hours and before end-of-day clearing activities. The transfer will occur at the exchange-determined closing price or daily settlement price, ensuring an objective and transparent valuation.

SEBI has compared the mechanism to the post-close window used in equity markets, where transactions are executed at a predetermined closing price rather than through bilateral negotiation. Following the transfer, the FPI's position will be deemed closed and the investor will cease to have any rights, obligations or exposure related to the contract. Any delivery obligations arising thereafter will rest solely with the designated TM or TCM. To compensate intermediaries for taking on this exposure, SEBI has proposed a "Proprietary Risk Absorption Charge", over and above any service fee agreed between the parties.

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The charge is intended to discourage FPIs from relying on the automatic transfer mechanism instead of voluntarily closing their positions. SEBI has also proposed temporary relief for brokers who inherit such positions. Where the transferred position causes a Trading Member's proprietary account to exceed prescribed position limits, the intermediary will be given up to two trading days to reduce the position without attracting penal action.

Separately, the regulator has proposed allowing FPIs to participate in all non-agricultural commodity index derivatives regardless of whether the underlying contracts are cash-settled or physically-settled, since the index derivatives themselves are cash settled and do not create delivery obligations. If implemented, the proposal would mark the biggest expansion of FPI access to India's commodity derivatives market since foreign investors were first allowed into the segment in 2022.

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