To begin with, foreign entities may be allowed to hedge their exposures with derivatives trading in only those commodities where India has a large production, consumption or export share globally, barring the sensitive commodities.
Proposing a detailed set of norms for eligibility criteria, disclosure and KYC requirements, code of conduct and safeguards against any unwanted price fluctuations, Sebi, in a consultation paper said that the final regulations would be framed after taking into account public comments till June 18.
The proposal follows recommendation from the regulator's Commodity Derivatives Advisory Committee (CDAC) for allowing in this market the hedge funds (category III alternative investment funds), portfolio management service (PMS) firms, mutual funds and direct participation of foreign participants having exposure to commodities in the first phase.
In the second phase, the CDAC has proposed to allow banks, insurers, foreign portfolio investors and pension funds in the commodity derivatives market.
Earlier last year, Sebi had issued consultation papers for allowing mutual funds, portfolio managers and hedge funds, among others.
Sebi said it has been advised by the CDAC to adopt a calibrated approach before opening up the commodity derivatives market to foreign participation where, presently the domestic institutional participation is also not allowed.
According to Sebi, allowing direct participation of foreign entities having actual exposure to commodities may make Indian commodity derivative markets more broadbased, vibrant, deep and efficient. Further, it may also add to the depth and liquidity in the far-month contracts.
"The participation by these entities may in the long run, pave way for Indian markets in becoming price setters for some of the global commodities," the regulator noted.
Foreign entities, having actual exposure to Indian physical commodity markets, may be termed as –Eligible Foreign Entities (EFEs).
Such EFE is not resident in India; may be Non-Resident Indian (NRIs), provided that such NRIs are engaged in physical commodity trading businesses with India. The minimum networth requirement for such EFE should be USD 1 million and however this limit may be gradually reviewed based on experience of EFE participation in the market.
With regard to registration, Sebi said that EFEs desirous of taking hedge positions in Indian commodity derivatives market should approach Authorised Stock Brokers (ASBs), from amongst the brokers which are registered under Sebi.
The exchanges should jointly frame guidelines regarding the eligibility criteria for the ASBs approved by their risk management committees.
Besides, EFE need to be required to meet the KYC requirements.
The commodity derivatives exchanges will put in place appropriate risk management systems in place for allowing EFE to take positions in eligible commodities as well as a mechanism to monitor the limits as well as physical exposure of an EFE, which may include seeking periodical reports.
The position limits should be governed by the hedge policy of the commodity derivatives exchanges and no separate client trading limits should be allowed for EFEs. Such exchanges should issue a separate hedge code for easy identification of EFEs.
However, Sebi can place restrictions based on the need to maintain market integrity.
Hedge limits for a commodity will be determined on a case to case basis, depending on the applicant's hedging requirement and other factors which the commodity derivatives exchange deems appropriate in the interest of the market.
Regarding disclosure, Sebi said that commodity derivatives exchanges on daily basis need to disclose on their website the positions as well as hedge limit allocated to EFEs, indicating the period for which approval is valid, in an anonymous manner.