InvestorQ : What could be the implications of SEBI permitting FPIs to trade in commodity derivatives?
NISHA Nayak made post

What could be the implications of SEBI permitting FPIs to trade in commodity derivatives?

Priyanka N answered.
2 months ago

During the week, SEBI allowed foreign portfolio investors, or FPIs as they are generally referred to, participate in exchange-traded commodity derivatives (ETCD) market. As of now certain eligible foreign parties are allowed to participate in the commodity derivatives market but that is only for managing an underlying risk exposure. Not otherwise. Now, FPIs can actually trade in commodity derivatives for cash settlement, even if they do not have an underlying positions. Effectively, this opens ETCD to all FPIs in a bigger way.

In India, the registered commodity derivative exchanges like MCX and the NCDEX trade in commodity derivatives and offer futures and options contracts on individual commodities as well as on select commodity indices. It is estimated that this move will provide more depth, liquidity and research driven trading in the commodity market, which is lacking today. Now, all registered FPIs, including alternate investment funds (AIFs), can participate in commodity derivatives trading even when there is no underlying commodity exposure.

However, it is not a blanket permission as of now. Currently, SEBI has not yet permitted FPIs into agricultural commodities, which is a lot more of a sensitive area. They can freely trade in commodity derivatives pertaining to the other 3 categories viz. Precious metals, energy products and industrial metals. Apart from liquidity, this move will also enable greater institutional participation. That means global best practices on research, execution and algorithmic low latency trading will also come to commodity derivatives trading.

FPIs are one of the largest and most dominant participants in the equity futures and options space. It is just logical that they are also allowed into ETCD market, which is again cash settled. The final word on additional risk mitigation measures required is not yet communicated. Positions limits will continue to apply just like in the case of currency derivatives. In a nutshell, FPIs will bring more price efficiency, and the more rampant use of algorithms and low latency trading. ETCD markets should benefit overall.