Regulating commodities

Given the Securities and Exchange Board of India’s (Sebi) patchy track record in regulating the country’s stock exchanges, more so with so many of its orders routinely being quashed by the Securities Appellate Tribunal (SAT), it’s easy to go along with Agriculture Minister Sharad Pawar’s view that the country’s commodity exchanges should not be regulated by Sebi.

The problem, however, is that commodity trading in most markets is usually several times as large as that in shares, and therefore commodity trading in India is set to grow by leaps and bounds.

When it does, it will need rigorous monitoring systems, preferably ones that operate on a dynamic basis to calculate value-at-risk and broker terminals that get cut off when regulatory limits (such as those on margin money) get breached.

Whatever else one might say about Sebi, the fact is that over the years stock market trading in India (primarily through the stock exchanges led by the National Stock Exchange) has developed these systems, and so it is logical that Sebi’s sway should be extended to the commodity markets as well.

What makes a common regulator for both markets even more logical is the fact that since money is fungible, it is often the same set of operators who deal in all markets, whether they’re stock markets, bond markets, commodity markets, or even currency markets.

So if the margins in the country’s stock markets are hiked in such a manner as to restrict trade, this money will immediately flow to some other market where the regulatory regime is less strict, be this the bond or the commodity market.

So, from an economy’s point of view, if you’re curbing runaway speculation in the stock market, and the commodity market is governed by a different set of rules, all that might happen is that the speculation will get transferred to this market.

India’s history of scams, ranging from Harshad Mehta to Ketan Parekh, has shown that problems arise when there are different regulators for what are essentially linked markets, though each one may be distinct by virtue of the goods or commodities dealt with.

The counter-argument goes that commodities are very different from stocks, and indeed every agricultural commodity is also different from the other since each has a different crop cycle and supply constraints.

This is obviously true, but then no one argues that a Wipro share is the same as that of Modi Rubber. What matters from the trader’s point of view is the volatility of the stock’s price movements, whether it is a share, a commodity or a currency.

This is where knowledge of the crop cycle and other such supply side factors comes in—everything goes into what is eventually a statistical exercise in calculating volatility, and it is on this basis that margins and other regulatory structures are constructed.

So, if the Forward Markets Commission has this domain knowledge and Sebi doesn't, there's a case for combining some part of the FMC with Sebi or for Sebi acquiring such domain knowledge.

If we are to avoid the kind of wild speculation that was seen in the case of crops like guar gum some months ago, serious thought needs to be paid to how commodity markets are to be regulated.

Keeping them as isolated enclaves, depending upon the particular ministry in charge of the product being exchanged, is to ask for trouble down the line.