22 Jan 2018 15:31 IST

5 things to know about the integration of equity and commodities markets

Margin fungibility at the client level became possible in September 2017

Come October, you need to make a choice of where you want to trade — NSE/BSE or MCX/NCDEX, when it comes to commodity derivative contracts.

With markets regulator SEBI approving integration of commodity derivatives and other segments of the securities market at the exchange level, NSE and BSE are gearing up to offer commodity derivative contracts.

So, what is going to change?

Not much for you and me. Margin fungibility at the client level became possible in September 2017 itself when SEBI gave the green flag to brokers to merge their commodity and equity businesses.

Now, with SEBI’s latest move, competition among exchanges may see transaction costs for brokers come down. If they pass it on, then clients may see some saving in their brokerage.

Some applaud the regulator’s move for it may expand the commodity derivatives market. But unless institutional players come in and exchanges launch new products, volumes in commodity derivatives may not grow as jobbers don’t find this market lucrative.

In fact, if the move results in volumes in commodity derivatives getting fragmented between three/four exchanges, then liquidity will be poor and annoy even the current commodity traders.

There are many myths in the market today about commodity exchanges. There are doubts over their risk management and surveillance framework.

Here is an attempt to clear the confusion.

Here’s what you should know before you make a decision on where to trade after October when it comes to commodity derivatives.

Stock brokers are in it already

In September 2017, SEBI allowed integration of broking activities in equity markets and commodity derivatives market under a single entity by amending the Securities Contract Regulation Rules on the logic that all the stock exchanges and their members are under the same regulator.

Previously, a stock broker carrying on the activity of buying/selling in securities other than commodity derivatives was not allowed to undertake buying/selling in commodity derivatives, or vice versa except by setting up a separate entity.

The amendment in September 2017 has already given brokers such as Nirmal Bang, Karvy and Geojit Financial Services, the option to merge their equity and commodity operations. They can even now pitch commodities to equity clients and equity to commodity clients.

Margin fungibility

Margin fungibility — where the client can use one trading account to buy/sell equities and commodities — depends on whether your broker has integrated his equity and commodity operations.

So, even after October when all equity and commodity dealing can be done through a single exchange, you may not have the benefit of interoperability of margins if your broker hasn’t integrated operations at his end or if he hasn’t decided to operate equities and commodity derivatives under a single entity.

None of the brokers who currently have both equity and commodity businesses have yet announced integration of the two segments. Some say they are waiting for guidelines from the different exchanges.

Commodity exchanges too robust

With SEBI taking over regulation of commodity derivative segments, MCX and NCDEX too now have a robust risk management structure.

After taking over the reins of FMC in 2015, SEBI increased the minimum networth required for commodity derivative exchanges to ₹100 crore, prescribed guidelines for margin calculation and collection, improved grievance redressal mechanism and clearly laid down the amount of Investor Protection Fund (constituted by all the penalties levied and collected by the exchange except for those related to settlement plus 1 per cent of the turnover fee charged from the member/broker or ₹25 lakh whichever is lower in a financial year), and the claims that can be accepted against the fund.

It also set a three-year deadline for commodity derivative exchanges to transfer the function of clearing and settlement to a separate clearing corporation (which ends by September 2018). In September 2016, it also released guidelines on the spot polling mechanism of exchanges.

As far as ‘Settlement Guarantee Fund’ goes, SEBI allowed the guidelines of the erstwhile FMC to continue, but removed the 5 per cent (of gross revenue net of income tax) yearly cap for contribution to SGF.

It is only a myth that commodity exchanges do not have SGF. Their SGF is built of — 5 per cent of gross revenue of preceding financial year subject to a minimum of ₹10 crore plus base minimum capital of members along with interest earned on this amount plus all penalties charged from members and all accrued interest on investments. In September 2017, the SGF of MCX was ₹223 crore. For NCDEX, the SGF stood at ₹120.88 crore. There is thus, no reason to believe that MCX/NCDEX are loosely regulated.

Clearing corporations gear up

MCX and NCDEX do their clearing and settlement themselves. NSE and BSE do it through the National Securities Clearing Corporation (NSCCL) and Indian Clearing Corporation (ICCL), respectively, which are their subsidiaries. These Clearing Corporations are separately capitalised and are separate legal entities. The objective of having a separate Clearing Corporation is to give it the duties of trade and fund settlement plus responsibility of providing counter-party risk guarantee to the corporation and letting the exchange just do the job of providing the trading platform. Given that the three-year deadline for setting up of Clearing Corporations for commodity derivative exchanges ends in September this year, both MCX and NCDEX are ready to begin operations of their Clearing Corporation. With this, the only sore point with respect to commodity exchanges also gets addressed.

Transaction costs may drop

Once NSE and BSE launch their commodities platform, competition among exchanges will intensify. In a bid to capture market share, NSE and BSE may cut transaction charges. This will mean lower charges for brokers, and, translate into lower broking cost for their clients. But before getting into commodities trading, do note that the market is very different from equities — both in terms of factors that influence price and your cost. Margin requirements in commodities may be relatively higher as lot sizes are bigger; also, not all contracts are cash-settled.

(The article first appeared in The Hindu BusinessLine.)