Perils of Unified Financial Regulatory Agency

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Perils of Unified Financial Regulatory Agency

FEEDBACK TO FSLRCS APPROACH PAPER

Madhoo Pavaskar1
Terms of Reference of FSLRC The Financial Sector Legislative Reforms Commission (FSLRC) was constituted by a government resolution of March 24, 2011. The FSLRC has been essentially set up to review and recast the legal and institutional structures of the financial sector so as to be in tune with the contemporary requirements of the sector. The Commissions terms of reference (ToR) comprises mainly the following: Review, simplify and rewrite the legislations affecting financial markets in India, focussing on broad principles Evolve a common set of principles for governance of financial sector regulatory institutions Remove inconsistencies and uncertainties in legislations/rules and regulations Make legislations consistent with each other Make legislations dynamic to automatically bring them in tune with the changing financial landscape Streamline the regulatory architecture of financial markets out by the FSLRC in its approach paper seem pretty commendable, and are undoubtedly overdue. There is no doubt that many of the prevailing financial legislations are age-old and also obsolete, and need to be revamped and even replaced altogether by new ones in keeping with the present economic and financial needs, as also in accordance with the current technology based financial ecosystem and trading systems. The FSLRCs suggestions on providing pathways to accountability through avoiding conflicting objectives, developing a well-structured rulemaking process; establishing firmly the rule of law, and building a transparent reporting system, appear to be undoubtedly praiseworthy indeed. So also is its ardent desire for consumer protection, which seems to be at the heart of all its recommendations. Its recommendation on micro-prudence regulation to prevent failures of financial firms and institutions seems to be equally laudable. Above all, its resolution mechanism to resolve the consequences of disruptive failures of financial firms in both the public and private sectors also deserves kudos, indeed! Unified Financial Regulatory Agency Whats perhaps disturbing, however, is the Commissions suggestion for setting up a Unified Financial Regulatory Agency (UFA). Well before finalizing its recommendations, the Commission has surprisingly summarized in its approach paper itself the changes that it proposes to make in the financial regulatory architecture, and has unambiguously recommended a UFA for regulating organised trading in, inter alia, equities, government bonds, currencies, commodity derivatives, corporate bonds, and so on. For that purpose, the commission has proposed that the existing four regulatory agencies, namely, Sebi, FMC, IRDA, and PFRDA should be unified into a UFA. According to the Commission, such a unified financial regulatory agency that would deal with all financial firms, other than banking and payments, would yield benefits in economies of scope and scales in the financial system, reduce the number of agencies in the financial sector to only one, help deal with the difficulties of finding the appropriate talent, and yield consistent treatment in consumer protection and microprudential regulation across all such firms and financial

Approach Paper After deliberating on the issues arising out of the major ToR, both within the Commission and through consultation/ interaction with a wide spectrum of experts and stakeholders, the Commission brought out a substantive research-based approach paper on October 4, 2012, showing the broad contours of the legal-institutional framework that the FSLRC may recommend, albeit, provisionally. The FSLRC now seeks feedback on the proposals framed in its approach paper from all stakeholders by October 31, 2012. Since the Commissions tenure will end on March 23, 2013, it seems that the Commission will need to evolve its thinking on the problems before it, after receiving the feedback from various stakeholders, during less than five months from the beginning of November 2012, and make final legalinstitutional recommendations to the government, before its tenure ends, or alternatively may seek extension of its tenure to submit its final report. Commendable Recommendations Quite a few of the preliminary recommendations spelt
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This paper is a slightly edited version of the original paper submitted to the Financial Sector Legislative Reforms Commission (FSLRC) by the author as a feedback to its Approach Paper released for comments by stakeholders and others. The views expressed in this paper are personal and not necessarily those of either the Financial Technologies India Limited (FTIL), or the Research & Strategy Division of FTIL, which he heads as director.

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Financial Vision, Volume 1/Issue 2/March 2013 So too are their economic impacts and outcomes on not only the participants in the respective trades, but, more importantly, on the society at large. All are, no doubt, market trades; but to compare one market with another is like comparing apples and oranges, both are fruits, though. Comparative Differences The differences among these different and disparate markets are not just many in their objectives, but the economic consequences of the trades in them may also be conflicting, and are not infrequently diverse, on the both the economy and society, as also on the different sections of the society. Securities markets primarily aim at developing an active and vibrant capital market in the economy to attract wide investor interest in stocks and bonds of varied hues for facilitating private and public sector companies, governments, and local organizations to raise easy and speedy finances at reasonable terms and with least possible costs. The securities market has essentially three categories of participantsthe issuer of the securities, the investors in the securities, and the intermediaries. The issuers are the borrowers or deficit savers, who issue securities to raise funds. The investors, who are surplus savers, deploy their savings by subscribing to these securities. The intermediaries are the agents who match the needs of the users and the suppliers of funds for a commission. These intermediaries function to help both the issuers and the investors to achieve their respective goals. There are a large variety and number of intermediaries providing various services in the Indian securities market.3 Aside from the new issues primary market for IPOs, which enables companies to raise or borrow capital, the secondary securities market essentially comprises two segments: (1) Cash segment, which is essentially a market for buying and selling of listed shares and bonds in either physical or demat form; and (2) Futures and options (F&O) segment, in which transactions are cash settled. Traders in both cash and F&O segments of the securities markets are principally investors, either retail or institutional, with surplus savings. Their sole purpose for investing is to earn returns on their surplus savings. While almost 90% of the securities market trades are in the F&O segment, over half of the volumes in the F&O segment are actually in various cash-settled index contracts. Though a few listed shares are also traded in the F&O segment, these trades are confined to mostly institutional investors, and are purely speculative and not for any risk management. After all, those who hold securities do so in the hope of earning profits from them through expected rise in their prices, and are scarcely interested in hedging against the risks of price fall in them. If they were to hedge those securities in futures, they obviously would be forgoing possible gains from the rise in their prices, unless they enter into put options. Most traders enter into naked options, however, to benefit from them when prices move in their favour, but waive their right to exercise them with adverse price movements.

market organizations. Not a New Concept The concept of a UFA is not new. As it is, as early as in 200405, the Union budget had announced the governments intention to integrate commodity futures markets with securities markets. This announcement followed the submission of the draft report of the InterMinisterial Task Force, appointed by the Union Ministry of Consumer Affairs in May 2003, on the Convergence of the Securities and Commodity Derivatives Markets. The idea of convergence of the securities and commodity derivatives markets players and regulators, was actually mooted in a communication by the then Union Minister of Finance to the Union Minister of Consumer Affairs in early 2003, in response to which the task force was set up.1 After several debates on this matter of not only the unification of the FMC and the Sebi, the regulators of commodity exchanges and stock exchanges respectively, but also the merger of commodity exchanges with stock exchanges so as to provide an integrated platform for trading in both securities and commodities under a common exchange organization, and subsequent tte-tte discussions by all commodity exchanges in the country with the Union Finance Minister and the Union Minister of Agriculture, Food, and Consumer Affairs in 2006, the proposal mooted for convergence of exchanges and their regulators was dropped by the government for its impracticality and possible disastrous consequences on the functioning of markets and activities of the respective market players. Commodity exchanges and the FMC heaved a sigh of relief. But like the proverbial cat with nine lives, the FSLRC has resurrected the proposal in the new avatar of UFA that seeks to bring about unification of not only the Sebi and the FMC, but also lapping with them the IRDA and the PFRDA, too. In its enthusiasm to reduce multifarious regulatory legislations, and consolidate a legal-institutional regulatory framework, the FSLRC has altogether overlooked the economic functions and objectives of different markets, securities, commodities, currencies, insurance, and pension funds. Economic policies cannot be determined by legislative statutes and institutional frameworks. No doubt, economic policies need legislative and institutional support for their effective and efficient implementation; but such support cannot form the basis to draw economically meaningful and useful policies. That is like putting the cart before the horse. Laws and institutions are mere means for execution of economic policies. But policies must be designed independently to meet effectively the objectives of different economic activities. After all, commodity exchanges are not stock exchanges.2 So also, insurance markets are not designed for pension funds, nor are these two in anyway akin to either commodity derivative markets, or security, currency, and bond markets, in their economic, commercial, and social utilities, purposes, and goals. True, trades in these diverse markets are financial transactions. But their motives and intentions are different.

As stated earlier, traders in securities markets are mainly investors, both retail and institutional. Institutional investors predominate in the Indian securities markets, and largely drive the markets one way or the other. Neither price discovery nor risk management functions are of any import to the players in the securities markets. Their sole intent is to gain from their trades, and not to avert or avoid price risks, as most of them dont have any underlying securities. To be fair, investors in stock markets have, by and large, a much higher risk appetite, and are far from averse to price risks. Had futures in stocks been discovering prices, the cash segment turnover would not have almost halved through the past two years in the face of the 10% rise in the turnover in the derivative segment. Not being innately averse to price risks, investors in stock markets have, by and large, little interest in price risk management as well, especially as they do not hold securities either in physical or demat form. As it is, price discovery and price risk management are really the two sides of the same coin. Paradoxical as it may appear, price discovery is needed to carry out successfully the economic function of price risk management on physical market trades. For, price discovery essentially implies providing for reference prices to those desirous of entering into forward (not futures) contracts for physical or demat deliveries of goods. Unlike stock futures prices, commodity futures prices lead to price discovery insofar as such prices facilitate the physical market functionaries to enter into forward delivery contracts in either domestic or export/import markets for receiving or making shipments of goods. Having entered into around the reference prices provided by the commodity futures market, such forward contracts could easily be forthwith hedged at or around the prevailing futures prices. Naturally, these hedges are ipso facto almost fully efficient in eliminating price risks faced on the corresponding forward contracts. While price discovery and price risk management are germane to the commodity derivative markets, futures prices prevailing in securities markets at any time cannot be likewise viewed as price discoveries. For one thing, forward contracts for physical or demat deliveries of securities are not permitted in stock exchanges. For the other, as already explained earlier, the need for risk management runs counter to the very concept of the investment function of the securities market. In contrast with the scope and functions of securities markets, commodity derivative markets are for all intents and purposes principally hedging markets. Price risk management is the raison dtre of these markets. For sure, that is the sole underlying principle and purpose of commodity derivative markets. In fact, even more than 50 years back, after accumulating quantitative statistical evidence, Holbrook Working had proved that hedging is the basis for futures trading.4 In his words, in a commodity futures market, hedging is like the driver, and speculation in futures like the companion going where hedging gives it opportunity to go.5 Contrary to the commodity futures market, speculation drives the securities market to encourage investment in listed equities and bonds.

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With such wide differences in the scope and purposes of commodity and securities derivative markets, one wonders whether it is at all possible to write a common statute for regulating both these diverse markets, with a view to establishing a common regulatory agency for them to derive the alleged benefits of economies of scope and scale. Disappointingly, the FSLRC has nowhere spelled out in its approach paper the types of economies of scope and scale that can be derived from a unified legislation and regulatory agency. When the scopes of the two markets, commodities and securities, are different, and the nature of trades in them are different, too, what kinds of economies of scope and scale can be derived from a UFA? The insurance market too is much different from either commodity derivative or securities market. Both life and general insurance products sold to the insured individuals cannot be traded by the latter in any secondary market, nor can either the same or even similar regulations like those applied to commodity derivative or securities markets be employed for them. The IRDA was established mainly to protecting the interests of the holders of insurance policies, and expanding the insurance network across the country to widen the insurance coverage in up-country and rural areas, where most of the population has remained uninsured. At the same time, insurance products and the premium rates thereon are essentially based on the actuarial assessments of different kinds of risks involved in diverse types of insurance policies for life, property, and goodsmovable and immovable, serving different strata and substrata of society. How on earth can a UFA regulate such varied products and premium rates for several assorted insurance policies, without having a separate team of actuaries and insurance experts, is a moot question, indeed? The PFRDA is yet another autonomous body set up by the Central government to develop and regulate the pension market in India. The pension market devised by the PFRDA is a whole new ballgamein no way akin to the securities, commodities, or insurance market. The PFRDA seeks sustainable solutions to the problem of providing adequate retirement income to government and other employees under its new pension system (NPS). The PFRDA has appointed numerous intermediaries in the system, such as Central Recordkeeping Agency (CRA), Pension Funds (PFs) and Pension Fund Managers (PFMs), Points of Presence (POPs), Annuity Service Providers (ASPs), Trustee Bank, NPS Trust, Custodian, and a host of others, for operationalizing the NPS. POPs consist of the existing network of thousands of bank branches and post offices across the country, which have been authorized by the PFRDA to collect contributions from the subscribers of NPS. While NPS was mandatory initially for only the Central government employees (except armed forces) recruited from the beginning of the year 2004, states and Union territories have also subsequently signed agreements with the intermediaries appointed by the PFRDA for the application of NPS to their new employees. Of late,

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Financial Vision, Volume 1/Issue 2/March 2013 country. Commodity prices also vary with their quality characteristics and preferred end-uses in different locations. Most commodity prices, especially those of farm produce, disclose distinct seasonal trends, too. Given the unavoidable variations in commodity prices over varieties, space and time, commodity market functionaries face much larger price risks than those holding or acquiring securities. In commodities and their products, not only merchants, but also processors and manufacturers as well as exporters and importers, are required to enter into forward (not futures) purchases and sale orders to ensure regular supplies and sales. Hence, the need for an active futures market for efficient reference pricing and effective price risk management is absolutely critical for physicalmarket players in commodities and their products. Actually, this need is acutely felt through the whole supply chain in commodities and their products. Securities markets are devoid of similar supply chains. This is not all. Commodity market prices determine the trend and pattern of supply and demand for different commodities. Whereas the factors determining the price of a security are not many (its supply is almost fixed, with demand varying as per the financial performance of the company, or the authority, and general market expectations), the factors affecting commodity prices are far too many and complex. The supply of a commodity depends on conditions such as area, weather, infrastructure, or processing/manufacturing capacity, inputs like water, power, seeds, yields or processing/manufacturing out-turns, imports, exports, and many more, besides, of course, price elasticities. Each of these, in turn, is influenced by several factors. The demand for commodities, on the other hand, is determined by factors like population growth and shifts in demographic characteristics, changes in incomes and exports, besides the diverse elasticities of incomes and prices. Unlike securities, where demand is for investment or speculation, the demand for commodities is of two types for inventories and for consumption. Inventory demand is influenced by the availability of the present and prospective supplies of specific grades, processing/manufacturing and storage capacity, and uncovered sale orders. Consumption demand for a commodity is determined by the requirements of industry, trade and consumers, and frequently varies from season to season, and with changes in tastes, nutritional standards, and fashion. As a consequence of all these diverse factors and forces affecting supply and demand, price discovery is of immense value to commodity functionaries in their production, merchandising, stocking, and manufacturing activities. Price discovery, however, is not all that consequential to security market operators. Because financial futures generally have actively traded cash markets, cash prices are generally not discovered in the futures market (italics added).6 A sharp upswing in the prices of securities or stock futures indices is merely a feel good factor for stock-

NPS has opened its doors to every citizen of the country on a voluntary basis. Whereas the pension contributions of government employees covered by NPS are being invested by professional PFMs in accordance with investment guidelines of the government applicable to non-government provident funds, the voluntary subscribers are offered a basket of varied investment choices and fund managers. The NPS Trust oversees the functions and activities of PFs and PFMs. The NPS Trust comprises members representing diverse fields, and brings together a wide range of talent to the regulatory framework of the PFRDA. ASPs are responsible for providing regular monthly pensions to subscribers after either their attaining the normal retirement age of 60 years, or their exit from the NPS. It is obvious that the pension market that concerns with the lives and future of mostly lower- and middle-rank employees after their retirement, needs micro-prudential and dedicated attention and surveillance over the activities of multifarious intermediaries functioning in it from a solitary specialized regulator. To leave the pension market in the hands of a UFA is really playing with the lives of millions of employees across the country. True, insurance companies and pension funds invest their assets in the securities market; but these institutions are not so much investors as guardians of the insured folk on the one hand, and employees looking for a quiet retired life on the other. These institutions are already in the safe hands of their respective independent regulators. In the proposed UFA regime, they will get lost, for sure, with disastrous consequences to the millions of insured and retirees. Commodities vs. Securities Be that as it may, the purpose of this paper is not so much to build a case for the independent presence of either the IRDA or the PFRDA as to underscore the need for a strong and autonomous independent regulator for commodity derivative markets. For, not only are commodity exchanges in no way akin to securities exchanges in their features and objectives, but, unlike the derivatives in stock exchanges, are also an integral part of marketing of physical commodities and their products, which account for all the output of primary and secondary sectors of the economy, and consequently contribute to almost half, or even a little more, to the GDP of the country. Though physical commodities, by and large, do not pass through the gates of commodity exchanges, commodity derivatives perform a valuable auxiliary function of price making, and avoidance of price risks, in physical market transactions. As explained earlier, stock market derivatives do not perform a similar function for cash trades in securities. More importantly, cash market for securities is a part of a stock exchange. It is one of the segments of the securities market place. Physical markets in commodities are spread across the breadth and length of the country, however. Unlike a spot security price determined at a stock exchange, there is no single unique cash price quotation for a commodity valid for every nook and cranny of the

exchange players. But physical market functionaries in commodities are always in search for true equilibrium prices as defined by the underlying supply and demand. These prices help them to prepare their production and distribution plans. While firm uptrend in security prices are welcome by both the stock market players and the government authorities, a firm price trend in commodities is really a cause for serious concern to the government authorities, the industry, and, above all, the people at large. A firm trend in commodity prices signifies inflation, and results in depressed demand and consumption. A strong upward trend in even agricultural commodity prices may prove disastrous to farmers as well, as it affects, in the long run, demand, encourages imports, distorts the cropping pattern and brings about cyclical movements in farm production in the long run. What farmers and consumers actually need are stable commodity prices. An active commodity futures market seeks to achieve precisely that by reducing seasonal and abnormal cyclical swings. A stable stock market, in contrast, is anathema to stock exchange speculators as well as investors. To be sure, one of the major functions of a commodity derivative market is to stabilize commodity prices at or around their equilibrium level; commodity prices are characterized by the cobweb theorem, though. This is because not infrequently production lags and price expectations also influence commodity prices. Security prices are free from cobwebs. But, aside from intricate supplydemand models, based on many heterogeneous variables, the presence of indeterminate cobwebs further complicates the price determining and price analysis process in commodities. More importantly, the Inter-Ministerial Task Force on the Convergence of the Securities and Commodity Derivatives Markets, appointed by the Union Ministry of Consumer Affairs in May 2003 had clearly perceived that unlike the securities market, where the impact of the price volatility is on the willing participants in the market, namely, the investors in securities, the impact of the sharp rise or fall in price in commodities is borne by the entire economy, i e, largely by innocent bystanders. 7 Going a step ahead, the task force also emphasizes that the most important policy goal, and policy concern (of the commodity exchanges), is safeguarding of the interests of the producersfarmers in particular, consumers as well as manufacturers and other functionaries in the supply chain (words in parenthesis added).8 The focus of stock exchanges, in contrast, is on providing liquidity to securities for enabling companies, governments, and other organizations to raise finances through stock and bond issues. Yet another significant difference between security derivative and commodity derivative lies in contract designing. Defining futures contracts for individual equity scrips or for even indices of either major securities or groups of securities is a simple exercise. Futures contracts for security indices calls for simply finding appropriate weights, based on either trading volumes or turnover, for the different securities included in such indices. An individual security futures contract does not even involve that.

Perils of Unified Financial Regulatory Agency Designing a commodity futures contract, however, is a far more complex exercise. Not only has one to select a suitable representative basis variety and prescribe its origin and quality specifications, but the deliverable varieties, with their precise specifications and appropriate on and off allowances, also need to be determined carefully, besides selecting suitable delivery locations, to facilitate efficient risk management by diverse market functionaries trading in physical markets for unalike varieties at various locations. It is equally important to ensure that a commodity futures contract is neither too broad nor too narrow. A too broad contract with a large number of heterogeneous deliverable varieties of several distinct origins, having widely different quality specifications and many delivery centres, would render it bearish, impairing the relationship between the physical and futures prices and thereby its utility for either risk management or price discovery. A too narrow contract, with limited deliverable supplies, on the other hand, may be open to easy manipulation and will not serve any interest of market functionaries. Such contracts need to be avoided at all costs. Although delivery is not the essence of a commodity futures contract, commodity exchanges must ensure that contract specifications on quality and origin of goods deliverable are widely traded and acceptable to the physical markets for delivery. Contract specifications for a specific commodity need to conform to the trading and delivery practices prevailing in the physical market for that commodity. That helps to build an economically useful healthy relation between the physical and futures markets, which is unequivocally required for price risk management. A particularly useful function of exchanges is the facilitation and oversight of contract expirations and the related settlement. Exchanges not only set the terms of delivery, but also oversee the actual delivery as well as the credit verification of members making or taking delivery. For financial derivative transactions, exchange delivery mechanisms and oversight are less necessary and can be alternatively accomplished as cash transactions through other institutions or inter-institutional arrangements.9 While a commodity futures contract needs to be designed primarily to meet the demand requirements of buyers, the interests of sellers must also not be overlooked, as the producers also need the facility for hedging. Ideally, a commodity futures contract should serve as a catalytic agent to inspire producers to improve the quality of their produce. In that way, a commodity futures contract can give a fillip to the growth of the commodity production economy to adequately meet consumer demand for both quality and quantity. A security derivative has scarcely any such growth objective. Though commodity futures contracts are fungible, the underlying commodities are actually not. Unlike securities, not only are different commodities not interchangeable and cannot be substituted for one another, but also different varieties of the same commodity are not easily exchangeable inter se,

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Financial Vision, Volume 1/Issue 2/March 2013 only should regulators seek for such expert talent, but must have that expertise among themselves. How could one recognise such talent, if one were to lack it in oneself ? How can the proposed UFA then overcome the difficulties of finding appropriate talent for regulating efficiently commodity derivative markets? While recommending a UFA for helping to yield consistent treatment in consumer protection, the FSLRC has overlooked the fact that the consumers affected by commodity derivative markets are far different in nature from those affected by securities markets. In the latter, only the stakeholders are affected. In the former, the entire population of the country is affected, and that too in different ways. Commodity derivative markets do not affect producers and consumers alike. In such a situation, consistent treatment may prove to be more damaging than beneficial. In truth, micro-prudential regulation across all firms and organizations in different markets does not call for a UFA, but distinctive specialized regulatory bodies for each type of markets. The examples of the UK and Australia are inappropriate. So also, that of China, where even otherwise all markets are state-owned and controlled. A large agricultural economy like India can be compared only with the U.S., which has separate regulatory bodies for different markets. Moreover, considering that India aspires to become a super power soon, a monolithic UFA will be disastrous for its markets, and a deathtrap for nonsecurity markets like commodity, insurance, and pension.11 It is indeed too idealistic to even imagine that such gargantuan regulatory organization can serve with equity and justice the diverse interests of different markets, and the conflicting interests of their varied consumers. Even the search for suitable talents for such a colossal body will be a herculean task for the government. This is not all. If truth were to be told, the diverse financial markets in the countrybe they for commodities, securities, bonds, currencies, insurance, and pensionscry for not so much micro-prudential regulation as microprudential development. Almost all these markets lack depth, and have hardly penetrated beyond major cities and towns. The investor class in the securities markets is still miniscule. Investment culture has scarcely spread. Up-country producers and processors have still not been touched by commodity exchanges, and they are left to fend for themselves against price risks. Not surprisingly, for want of warehousing and financing through risk management, many of them easily fall prey to rapacious money lenders and itinerary traders. The insurance market has as yet barely tapped the countryside, and the pension market is still far from protecting retirees from the unorganized sector, small businesses, and selfemployed multitude. A UFA is obviously not the solution for such hopelessly inadequate coverage of diverse financial markets. The need of the hour is to strengthen the independent specialized agencies by endowing them with developmental powers, besides the regulatory ones. No doubt, consumer protection is necessary; but the

owing to their diverse quality characteristics and enduses. Moreover, even if commodity futures contracts were squared off mostly, delivery is the essence of such contracts; otherwise these would be termed as wagering contracts and would automatically become void ab initio under the Indian Contract Act. Surely, the option to issue or demand physical delivery during the maturity month of a commodity futures contract is critical for its smooth functioning so as to ensure that the futures price moves in close alignment with the physical-market prices. That is not the case with securities derivatives contracts. Not merely is delivery not intended, but it is not also the essence of security derivatives. Regulatory Prudence and Expertise The FSLRC seems to believe that besides securing economies of scope and scale in regulating such diverse markets as securities, commodities, insurance, and pension, a UFA will help deal with the difficulties of finding appropriate talent, and yield consistent treatment in consumer protection and micro-prudential regulation across all such firms and financial market organizations. As there is scarcely anything common among these different markets, this belief of the FSLRC is clearly inapt. For different markets, different forms of prudence and expertise are required. A jack of all trades will not do. Even the InterMinisterial Task Force had realised that the possibilities of convergence are limited, insofar as commodity futures trading requires highly specialized knowledge, which is different from that required for securities trading. Unlike the securities market, the factors affecting commodity prices are more complex and commodity specific.10 To be sure, except for the fact that speculation, which helps promote liquidity, is the common denominator for both security and commodity derivative markets, the two markets are poles apart in that they differ significantly in their nature, functions, and objectives. Evidently, it is indeed nave to believe that securities market regulators can regulate commodity derivative markets. Whereas security market regulators require very good knowledge of financial economics, commodity derivative market regulators need to have excellent knowledge of commodity economics. But commodity market regulators should also have superb knowledge of agricultural economics, industrial economics, economics of international trade, aside from macro and microeconomics. Unlike security market regulators, who seek to curb manipulations and insider trading, commodity market regulation does not imply simply regulation of corners and squeezes. Commodity derivative markets essentially serve as messengers to not only commodity trade and industry to enable them to frame and revise from time to time their business plans, but also to the government authorities to draw their policies and plans time and time again under changing commodity supply and demand situations. To ensure that commodity markets truly discover equilibrium prices, reflecting the present and prospective supply and demand, regulators need to carry out intelligent exercises in price analyses continually for different commodities. Without expert price analysts well-bred in price theory economics, such exercises are not easy to undertake. Not

consumer class in different markets must grow, too. Such growth calls for specialized regulatory-cum-development agencies for different markets, and not a nebulous UFA. Whats perhaps quite weird is that at a time when the FSLRC announced its Approach Paper, the Union cabinet also approved the Forward Contract Regulation Act (Amendment) Bill that seeks to provide more teeth to the FMC, and enlarges the scope of commodity derivative trading to include options, as also to allow the entry of institutional players into such trading; the Insurance Laws (Amendment) Bill allows FDI investment in insurance

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companies to 49% from 26% at present; and the Pension Fund Regulatory and Development Authority Bill, 2011, on which the Standing Committee on Finance recommended that certain amendments should be added to the Bill to permit up to 26% FDI in private pension funds. With the Cabinet approval to all these bills that only aim at strengthening their respective regulatory authorities and empowering them with more reins, the FSLRCs recommendation for a UFA looks superfluous. The best course for the Commission is to abandon its concept of a UFA.

madhoo.pavaskar@ftindia.com Endnotes 1. Madhoo Pavaskar, Death Trap for Commodity Futures, Chapter 10 in Readings in Commodity Derivative Markets, Takshashila Academia of Economic Research, 2010, pp. 144-160. 2. Madhoo Pavaskar, Commodity Exchanges are not Stock Exchanges, Chapter 9 in Readings in Commodity Derivative Markets, op.cit. pp. 133143 3. Securities Market in India: An Overview, NSE, Indian Securities Market: A Review (ISMR), 2012, p. 3 4. Holbrook Working, Futures Trading and Hedging, in Selected Writings of Holbrook Working, Book I, Readings in Futures Markets, Chicago Board of Trade, p.142. 5. Ibid 6. Draft Report of the Inter-Ministerial Task Force on the Convergence of the Securities and Commodity Derivatives Markets, Union Ministry of Consumer Affairs, as posted on the website of the Forward Markets Commission. The Task Force never finalized its draft report. 7. Ibid 8. Ibid 9. Ibid 10. Ibid 11. Madhoo Pavaskar, Death Trap for Commodity Futures, Economic and Political Weekly, Jan 1, 2005, pp. 14-19.