RBI, govt don't converge on agri derivatives' settlement

MUMBAI: There appears to be a divergence between the recent Reserve Bank of India (RBI) recommendations and the government’s declared policy with regard to the settlement mechanism for agriculture commodity derivatives.

The central bank has shown preference for cash-settled commodity derivatives, while the existing policy of the government does not allow such provisions. The report of the working group on commodity futures, set up by the RBI, feels physical delivery of commodities would be a burden for banks.

As per market reports, the government, however, wants to make agriculture commodity derivatives delivery-specific.

Currently, all contracts must incorporate a physical delivery mechanism. However, physical delivery in many contracts depends on the “both options� principle, making it essentially cash-settled.

In these contracts, delivery happens if both the buyer and seller agree. The chairman of the regulator, S Sundareshan, said that the subject was under the “active� consideration of the Forwards Market Commission.

Ravindra Sachdev, head of Legal department in NCDEX said that the Forward Contracts (Regulation) Act indirectly pre empts the possibility of purely cash-settled futures.

In ’98, the government made an attempt to introduce a cash-settled contract. The bill (No. XLV) was passed by the Rajya Sabha but was later put in cold storage. It lapsed in ’03, as it was not passed by the Lok Sabha. The amendment clearly tried to define “futures contract� as “not a specific delivery contract.�

Fear is that a purely cash settled contract in agriculture commodities may inadvertently draw the attention of more speculators. Though the role of speculators is important in a commodity market, too much speculation can ruin the underlying spot market.

Apart from bullion and specie, currently, banks are not permitted to participate in commodity business, be it physical or derivatives. Section 8 of the Banking Regulation Act 1949 prohibits banks from participating in commodity trade. The banks can only finance commodity business.

The RBI has also suggested a way out in cases where a purely cash-settled contract is not available. The group recommended, “While no restriction may be placed in this regard, banks may be persuaded to preferably close their positions and cash settle the contracts.�

In other countries, banks are not only directly allowed to trade but also participate in physical deliveries. In the US, banks are allowed to take physical delivery of commodity derivatives which are certified by the US regulator, CFTC.