SEBI Pushes A ‘Blue Ocean Strategy’ With ‘One Commodity One Exchange’

SEBI’s proposed policy will help in consolidating domestic liquidity. To be a global price-setter, much more needs to be done.

<div class="paragraphs"><p>Piles of cotton prior to an auction at the APMC in Rajkot, Gujarat, India, on Monday, Nov. 29, 2021. (Photographer: Prashanth Vishwanathan/Bloomberg)</p></div>
Piles of cotton prior to an auction at the APMC in Rajkot, Gujarat, India, on Monday, Nov. 29, 2021. (Photographer: Prashanth Vishwanathan/Bloomberg)

→ Would such a move make India a global price-setter in some commodities?

The Securities and Exchange Board of India recently published a consultation paper soliciting views on a proposed “One Commodity One Exchange” policy. The main objective of SEBI’s proposal is to create an ecosystem for the Indian commodity exchanges to develop exchange-specific unique sets of unfragmented, liquid contracts on commodities. In this direction, to broad-base the Indian commodity market, in October 2018, SEBI brought in the concept of a universal exchange—in which exchanges can offer securities and commodities trading under one roof. Since then, BSE and NSE have introduced derivatives contracts in commodities with NSE concentrating on metal and energy commodities and BSE foraying into agri-commodities in addition to metal and energy commodities.

The Rationale

Highlighting the importance of liquidity in the commodity derivatives market, the consultation paper cites examples of major international commodity exchanges not launching derivatives contracts on a commodity that is already listed on another exchange. Liquid derivatives contracts benefit commodity value chain partners and financial investors as they can enter and exit the market with ease. This in turn attracts more traders to the exchange platform thus creating a virtuous cycle conforming to the notion of ‘liquidity begets liquidity’.

Once a commodity contract in a given exchange attracts sufficient liquidity, the futures price of that commodity becomes a global benchmark price and that exchange or country becomes the price setter for that commodity. In fact, the consultation paper also goes on to mention the names of a few commodities to have achieved price-setter status in the global arena.

The consultation paper also highlights how the concept of universal exchange is leading to unhealthy competition among Indian exchanges.

At present, exchanges often list a commodity contract that has already been launched by some other exchange and undertake various predatory pricing mechanisms such as providing cash discounts or cross-subsidy on transaction fees to attract traders to their own platform without undertaking market and product development exercises.

The Evidence So Far

An important dimension of the SEBI proposal is that One Commodity One Exchange is only applicable to “narrow” commodities, thus leaving the competition for “broad” commodities wide open to all exchanges. Going by the experience of international exchanges and also drawing upon the recent development in almond contracts traded at BSE, OCOE makes a strong case. Almond contracts of BSE have got significant traction in a short period of time corroborated by a significant increase in traded volume and physical delivery.

As per the BSE annual report for 2020-21, since the contract debuted, 1.20 lakh kilograms of Almond have been delivered through the BSE platform. Probably this has been possible as no other commodity exchange is offering almond contracts at this point in time. In fact, on Dec. 11, 2020, BSE launched BEAM (BSE E-Agriculture Markets) pan-India electronic spot trading platform for agriproducts, and BEAM started its journey with almond trading on the first day itself.

A parallel can also be drawn with Indian Gas Exchange. In a short period of time, the IGX has been able to transform the spot trading and delivery of natural gas in India. It is for sure, if the Petroleum and Natural Gas Regulatory Board, the regulator of IGX, allows another player in this space, the first thing the new player would do is to catch the low-hanging fruits and acquire existing traders of IGX.

Carving Out Areas Of Competence

Realising the importance of restricting a single commodity to a single exchange, even without any regulatory intervention, MCX and NCDEX have steered clear of each other’s territory except for a few agri-commodities such as kapas, cotton, and crude palm oil.

Though ICEX offers many contracts that overlap with MCX and NCDEX, it has not been able to attract significant trading volumes in most commodities, except for diamond.

This too lends credence to the proposed OCOE policy, as with time exchanges develop core competency in a few commodities.

Scope To Grow

The SEBI proposal also highlights that of 91 commodities that are available for trading under the Securities Contracts Regulation Act issued in September 2016, at present Indian exchanges are offering derivative contracts on only 40 commodities, indicating sufficient scope to offer contracts on new commodities.

For example:

  • India is the second-largest producer of groundnuts after China, and currently produces about 6.8 million tonnes. India earns about Rs 5,600 crore annually from groundnut export.

  • India is the second-largest producer of sesame seed in the world and earns around Rs 2,000 crore annually from sesame exports.

  • India is also a major exporter as well as an importer of coconut copra.

  • Ragi’s demand as a health millet is increasing not only in India but also in the international market. Considering that 2023 has been declared as the International Year of Millets, ragi and other millet production and consumption are expected to increase significantly in days to come.

Building Safeguards With Learnings

SEBI’s consultation paper proposes some safeguards to check possible undesirable outcomes as a result of such a move. What if an exchange were to get exclusivity status on a commodity for five years, and then fail to carry out adequate product and market development to bring sufficient liquidity to that commodity? With exclusive rights to launch the entire range of products such as futures, futures on options, and options on goods, would such failure to build liquidity completely block out the trade of any form of contracts on that commodity?

To address this issue, SEBI’s proposal indicates that an exchange has to prepare a commodity checklist, commodity scorecard, finalise a product advisory committee, and product specification before SEBI permits the exclusivity status. The deterrent against an exchange submitting a shallow application, is to bar that exchange from blocking the same commodity for the subsequent year.

Normally, when contracts on a new commodity are introduced, they attract higher trading volume in the initial months, which may taper off subsequently. There have also been many instances when Indian commodity exchanges have introduced new commodity contracts which never took off – some counters did not generate a single trade.

To anticipate and prevent further such instances, SEBI should enage with the exchanges and understand why and how they went about choosing a new commodity to list, why some of these new commodities did not garner a single trade, what difficulties the exchanges faced, whether a good faith business attempt was made to develop the market, or if there was any attempt to game the system.

SEBI can then factor in these insights into the exclusivity granting process, so that exchanges do not repeat past mistakes.

More Needs To Be Done

To conclude, SEBI’s OCOE seems to be a blue ocean strategy to facilitate Indian exchanges getting unfettered access to a few commodities over the next 3-5 years, develop the spot and derivatives market ecosystem for these commodities and reap the attendant benefits that comes with a monopoly. In fact, a poor spot market ecosystem has been the Achilles heel for the Indian commodity sector. SEBI’s OCOE policy will give a much-needed boost to developing the same.

It is to be noted here that SEBI is being over-ambitious if it is expecting that only an OCOE policy will make Indian commodity exchanges price setter in the global market.

This policy will help in consolidating domestic liquidity, but to be a global price setter, SEBI and the Government of India need to do so much more. To start with, the flip-flop policy of banning commodity derivatives almost at regular interval need to stop.

Prabina Rajib is Professor of Finance and Accounting at the Vinod Gupta School of Management, IIT Kharagpur. Views are personal.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.