Will the entry of mutual funds and banks to commodity futures increase the price volatility in India?
The decision of the US regulator not to allow financial institutions any further increase in their exposure to commodity futures leaves a question mark on the proposal to allow MFs and banks to trade in commodity futures in India.
On Tuesday in Washington, Walter Lukken, acting chairman of the Commodity Futures Trading Commission, announced at a packed hearing that the proposals to increase the exposure of pension funds, hedge funds in commodity futures have been put on hold.
However, the US commodity futures turned volatile because of excessive exposure to certain sectors, according to D K Agarwal, Chairman and Managing Director, SMC Comtrade Ltd. "What happened there was that some hedge funds had invested heavily in metals," he said.
In India if mutual funds, banks, NRI's and Foreign Institutional Investors (FIIs) are allowed there should be limits fixed by the regulator regarding exposure to commodities, he added.
The price discovery function can happen only if there is liquidity in the market and that can be ensured with regulated entry of MFs and banks, Agarwal said.
It would be wrong to cite the US experience for not allowing banks and mutual funds to participate in Indian futures, Ashok Jain, Director, Contact India Commodities told Commodity Online.
Jain said that initially mutual funds and banks can be allowed to trade in some commodities such as bullion and avoid agri-commodities. Later on when the markets attain depth, FII participation can be allowed with the regulator ensuring checks and balances regarding over-exposure.
He said MFs and banks are likely to bring discipline in the market and ensure that market is not manipulated. Right now the unorganised players can form a cartel and manipulate prices in some commodities. They don't declare their positions.
In the US hedge funds have to declare their open interest positions and similar stipulations can be worked out in India bringing transparency to the market, Jain added. Right now present regulations are enough to curb volatility even if more financial institutions enter the fray, he said.
In the US, faced with widespread complaints from the agricultural industry, regulators are backing away from two proposals that would have allowed institutional investors to expand their stake in the turbulent commodity futures markets.
With the explosive increase in crop prices, US markets are attracting a flood of capital from hedge funds, pension funds and commodity index funds. Those index funds have become a popular way for individual investors to speculate on the soaring prices in food, fibers and fuel markets.
"Given current market conditions and the uncertainty surrounding additional speculative money in these markets, I will be very cautious about moving forward with such initiatives at this time," Lukken said.
Even the Chicago Board of Trade which supported the proposal initially backed out as they didn't want to be accused of making the price volatility worse, Charlie Carey, CME Group Vice Chairman said.
It was the pressure from the wheat farmers, cotton growers, shippers, rice producers that forced the regulator to rule out increased exposure of financial institutions in the commodity futures in the US.
