SEBI Panel Prefers Common Custodians For Equities And Commodities
Allowing custodians of securities to also track and store commodities will be a cost-effective way to boost participation of institutional investors in the commodity market, according to a working group set up by the regulator.
This option, called the universal model, is more cost effective, less complex and preferred by institutions, according to the group’s report—BloombergQuint has reviewed a copy. Custodians are responsible for safeguarding and storing securities and other assets.
The group also proposed a second model of allowing warehousing firms to become custodians. But this option, according to the report, is complex, cost ineffective and is not favoured by institutional investors.
The working group submitted the report and the regulator is considering it, Mrugank Paranjape, managing director and chief executive officer at Multi Commodity Exchange, had said at a recent event. Two people aware of the matter separately confirmed that to BloombergQuint requesting anonymity.
The Securities and Exchange Board of India is likely to take a call in its Sept. 18 board meeting, said the second person quoted above.
Poor institutional investments mean commodity derivatives market couldn’t grow because of low liquidity and price inefficiencies. SEBI’s move to build custodian infrastructure is aimed at promoting participation by investors like mutual funds, pension funds and insurers in the commodity markets. More so after exchanges will be allowed to offer both equity and commodity trading starting Oct. 1.
Asset classes currently supported by the custodian industry are limited to government bonds, stocks, fixed income and hybrid instruments, said the working group report. Institutional investors such as alternate investment funds and mutual funds appoint SEBI-registered custodians.
For commodity derivatives, the ecosystem to enable physical delivery comprises exchanges, warehouse service providers, approved warehouses or vaults. All deliveries happen by transfer of electronic credit balances or warehouse receipts.
“A new framework that integrates the existing commodity market ecosystem with registered custodians is desired so that asset managers, regulators and investors are comfortable and the laid-down norms and procedures for enabling physical delivery in commodity derivatives markets are continued,” said the report.
In April last year, SEBI had allowed hedge funds in the commodity market but so far only two have registered with MCX due to lack of clarity. SEBI issued a discussion paper in December to allow mutual funds and portfolio management services to participate in commodities. The norms couldn’t be finalised due to lack of amendments to custodian regulations.
The regulator then set up the working group to make suggestions. Here’s what it proposed:
- Existing custodians will be permitted to add commodities as an asset class and provide physical delivery of both securities and commodities.
- Custodians will aid in delivery for only those investors who are already availing their services.
- Limited to only SEBI-registered derivatives exchanges and commodities.
- Custodians will rely on clearing corporations and exchange for delivery based on their warehousing system. So, the onus of physical delivery would be on the clearing system of exchanges.
- Physical commodities as assets carry inherent risks such as perishability, quality issues, pilferage, inadequacies or frauds in storage infrastructure. This will be termed as “markets risk” and would devolve to investors or asset managers.
- In case of commodity loss, custodian would need to support the recovery process—through exchange-administered mechanism or through insurance claims.
- The custodian would need to ensure that adequate insurance cover is in place when title of receipts are transferred to it.
Warehousing Firms As Custodians
- Warehousing services providers will register have to register with SEBI as custodians.
- The ones that take on the custodian responsibilities need to have a net worth of Rs 50 crore.
- Custody for commodities requires different expertise, skill and infrastructure which is not supported by the existing players in their respective business verticals.
- The warehousing services providers have been ensuring safekeeping of underlying physical commodities and have developed necessary expertise in dealing with physical commodities.
- The issue is that there are no universal warehouses that deal with all commodities; and hence the asset manager may have to deal with multiple warehouse custodian for different commodities.
- Though a sub-custodian approach can be looked at for a single commodity like gold where it’s feasible to operate with single warehousing firm or vaulting agent for safekeeping of such assets.