The participation of mutual funds and portfolio managers in the 15-year-old commodity derivatives market will be a gradual process, not without challenges, two MF officials, a custodian and a former commodity exchange head told ET after market regulator Sebi said on Friday that MFs and PMSes could now participate on exchange-traded derivatives subject to certain safeguards. The safeguards haven’t been spelled out.
Lack of adequate understanding of commodity markets, taxation treatment of commodity derivatives, absence of adequate institutional custodial services in the commodity market and the NSEL fiasco would make institutional participation a slowmoving process, was the consensus view of the officials who asked not to be named.
“Dealing with shares and actual commodities is a world of difference,” said one of them. “You can specialise in sector analysis and know the nitty-gritty of company balance sheets, etc, but dealing in actual underlying commodities has its own challenges,” said the commodity market expert.
The custodian official added that Sebi had to spell out the “safeguards”, based on which institutions would be allowed to participate. “We’d have to wait and see what the safeguards are and whether MFs and PMSes will be comfortable taking or giving delivery, location of warehouses, which commodities will be initially opened to MFs for trading, etc.”
The MF official said that gains made in CDS (commodity derivatives segment) are treated as business income, which means they will fall in the 30 per cent tax slab, unlike short and long-term capital gains which attracts 15 per cent and 10 per cent tax respectively. “Tax treatment of gains made in shares is advantageous over that in CDS,” he said. The other fund manager said that apart from the treatment of profit there was the “issue” of GST on commodities that one would have to contend with. For example, if a commodity is traded and each time the warehouse receipt (invoice) conferring title over goods changes hands, GST is applicable at the relevant rate. This would raise the cost of trading and reduce the return compared to any of the equity or debt schemes run by the MF, he added. He said there were hardly any custodial services for institutions in the commodity markets to “generate” confidence among MFs in the quality and quantity backing the contracts traded in exchanges.
In the current dispensation, custodians will have to figure out location of the warehouses housing the goods. The onus of quality and quantity parameters will be with the warehouse managers who are regulated by a separate regulator — WDRA. The exchange would have to make good any defect in quality and quantity to the counterparty.
The other contention of a few of these stakeholders was that the Rs 5,600-crore NSEL scam was still fresh in their memory. The main reason for the scam that broke out in July 2013 was that goods backing contracts offered on the exchange were near absent.