SEBI has issued a proposal to allow Foreign Portfolio Investors (FPIs) to trade in physically settled, non-agricultural commodity derivatives. The move aims to boost market liquidity and better align Indian prices with global benchmarks. To avoid tax and delivery complications, the regulator has introduced a mandatory exit rule for investors before the contract expires.
The Securities and Exchange Board of India (SEBI) has released a consultation paper proposing a significant expansion in the scope of trading for Foreign Portfolio Investors (FPIs) in the commodity derivatives market. The proposal seeks to allow FPIs to participate in physically settled, non-agricultural commodity contracts. This update could change how international investors interact with Indian markets, covering key assets such as crude oil, natural gas, gold, silver, and various base metals.
Currently, FPIs are largely restricted to trading in cash-settled contracts. In a cash-settled system, the investor only receives or pays the difference in price; they do not actually receive the physical commodity. By opening access to physically settled contracts, SEBI aims to deepen market liquidity and help Indian commodity prices move more closely in line with international standards.
Safeguards Against Physical Delivery Issues
A central challenge with physically settled contracts is the actual delivery of goods. Taking delivery of items like crude oil or bulk metals requires local business infrastructure, including Goods and Services Tax (GST) registrations, which most FPIs do not possess. To navigate this, SEBI has proposed a mandatory exit mechanism.
Under the new plan, FPIs would be required to square off or roll over their positions at least three days before the delivery period starts, referred to as the T-3 deadline. This rule is designed to ensure that FPIs exit the trade before the contract enters the physical delivery phase. If an FPI fails to meet this deadline, the clearing member—the financial institution that manages the trade settlement—would be responsible for taking over the position. This mechanism is intended to insulate the FPI from the operational and tax complexities associated with owning physical commodities.
Potential Impact and Risks
For the Indian market, this proposal is aimed at bringing in more participants and increasing trading volumes, which is generally viewed as a positive for exchange operators and market efficiency. However, the introduction of international participants into physically settled contracts brings new considerations. Increased participation may improve liquidity, but it also creates the possibility of higher price volatility, especially as contracts approach their expiration dates and investors move to close their positions.
There are also operational risks to watch. While the proposed exit rule protects FPIs from physical delivery, it places a higher monitoring responsibility on clearing members to ensure all positions are managed correctly. Investors should keep an eye on how these final regulations are structured, particularly regarding the risk management framework for clearing houses. The implementation of these rules will depend on feedback from the current consultation process, which will determine how effectively the market can balance broader global participation with the unique requirements of the Indian commodity trade.