Sucheta Dalal :Merger of commodities and bullion market regulation
Sucheta Dalal

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Merger of commodities and bullion market regulation  

Nov 1, 2004

Positive step, but first strengthen Sebi and sort out work overlap with RBI 

In Mumbai on Friday, finance minister P Chidambaram reiterated his Budget announcement that commodities market regulation would be merged with the Securities and Exchange Board of India (Sebi) in the near future. This will bring the commodities markets under the finance minister instead of being accountable to the consumer affairs ministry and partly to the agriculture ministry.

Bringing commodities trading under an economic ministry is a positive and necessary move. I understand that there is political consensus on this issue and the Union Cabinet will soon approve the move. Clearly, our politicians are savvy enough to realise the explosive consequences of weak market regulation allowing runaway speculation in key commodities that affect the lives of ordinary people. After all, elections have been lost in India because of inflated onion prices.

However, the issue of merging commodities regulation with the capital market regulator is trickier. The argument in favour of merging the two regulators is very persuasive. First, that the Forward Markets Commission (FMC), which currently regulates the market, is not adequately equipped to deal with derivative trading. The FMC needs to be upgraded urgently; in fact, the process of creating a powerful regulator ought to have happened at the same time that the government cleared four new multi-commodity exchanges.

Although the underlying commodity are vastly different from equity, commodity derivatives (or futures contracts) are ultimately financial products. Those in favour of a common regulator argue that derivative products, whether in stock or commodities are thus homogenous and require a similar regulatory framework. Hence, it is quicker and more sensible to merge the regulatory functions rather than the slow process of setting up a separate regulator, drafting new regulation and building a new cadre of people who can understand and regulate this market.

If the consensus is to merge commodity and capital market regulation, then Sebi will first need to be strengthened considerably. It will have to set up new departments, probably double its staff strength, train its officials in commodities markets, set up some form of coordination with agriculture produce boards in order to understand the commodity trading and learn to deal with a new class of investors, such as grain and bullion traders and farmers, who will rapidly enter the system. Many of these players will bring a different quality of inside information on price trends based on demand-supply cycles or the impact of climatic conditions and will need to have rules framed to deal with them. Is Sebi equipped to do so? After all, it has systematically botched up its insider trading rules in three important cases — Hindustan Lever, Reliance (L&T case) and Samir Arora.

While it seems simple to expand Sebi to deal with commodities trading, the government may find the process more difficult. The staff attrition rate at Sebi as well as the National Stock Exchange (NSE) is already extremely high. In fact, every time Sebi registers a new foreign institutional investor (FII) or a sub-account; and when foreign a financial major sets up a back office in India, they immediately poach on officials from these institutions. By offering to double the income, they manage to hire trained employees with a sound understanding of regulatory issues.

The problem is far more acute at Sebi. Several executives who have opted to move out have sound reasons for leaving. Having opted to work at a government regulator after management school, usually at lower salaries than they would have got in the public sector, the more idealistic among them are appalled at the sloth, corruption and lack of understanding among seniors. The shocking lack of knowledge about regulatory issues, among the senior most Sebi officials, who come on deputation from other government agencies, is cited as the single most frustrating factor.

What makes it worse is that these executive directors are unfazed about their lack of knowledge or wrongly view capital market regulation through the prism of their past experience in banking, income tax or the enforcement directorates. Coming from these agencies, notorious for pathetic record of investigations, they are usually unconcerned at the loss of credibility when the Securities Appellate Tribunal throws out important cases. On the other hand, Sebi’s legal department alone has lost several good employees at lower levels, in the last few weeks.

So acute is the problem, that a very senior Sebi functionary reportedly remarked that barring some exceptions “half the staff is corrupt and the other half incompetent”.

This is hardly the ideal situation in which to expand its reach and regulatory ambit without tackling core human resources issues at Sebi.

Moreover, while the government is on its way to merge commodities and capital market regulation, it has still not sorted out issues of regulatory overlap between the Reserve Bank of India (RBI) and Sebi over debt market regulation.

The RBI was all set to launch its screen-based, order-matched Negotiated Dealing System (NDS) for banks to trade in government debt on September 1. This was stalled by the finance ministry since the RBI would have become both regulator and operator of an exchange. Moreover, the implications of a closed club membership, open only to banks and a few financial entities for exclusively trading in government securities needed closer examination; especially since it also planned to eliminate brokers.

The government must make sure that it takes into account these issues while working on a framework for converging commodities and capital market regulation.

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-- Sucheta Dalal