Business Standard has another editorial on a financial architecture question: on the organisation of commodity futures regulation. At first blush, it's an obvious problem - look around the world, and all the important exchanges of the world trade futures on all kinds of underlyings under a single roof. But in India, we're headed for a messy separation of the exchange-traded equity derivatives ecosystem from the exchange-traded commodity derivatives ecosystem.
If you are an exchange trading equity index futures, you won't be able to launch a gold futures product, and vice versa. If you are a securities firm, you will need to setup two distinct subsidiaries: one trading equity futures and another trading commodity futures. If you are a customer, you will need to have two trading accounts when one would have sufficed. This will induce three kinds of difficulties:
- Costs will go up. India will fail to harness economies of scale and economies of scope.
- There will be adverse effect on competition owing to walling off subsets of the industry from each other. In the best of times, it's hard to get active competition into the exchange industry, given the network effects associated with market liquidity. We make it worse by walling off exchanges from competing with each other.
- It will take many years, and possibly many a disaster, before FMC replicates the learning that has already taken place at SEBI in terms of building an adequate regulatory capacity.
It looks like the UPA Cabinet has decided to support an amendment to the Forward Contracts (Regulation) Act. I haven't yet seen the amendment; it's unlikely to become public until it gets tabled in Parliament. Even if the amendment drafting is perfect, we'd get a bad policy (separation of commodity futures into a separate industry with a separate regulator).
In practice, it could easily get worse than that, if weak human capital is put into the drafting of the law. I have closely watched the evolution of SC(R)A and the SEBI Act over the last 15 years, and I know how hard it is to get the drafting right. There isn't much knowledge of finance in the Department of Consumer Affairs, where the drafting is being done, and I don't know that they are outsourcing the work to people who know. So we could easily get a flawed implementation of a bad idea.