SEBI opens wider commodity derivatives market to foreign investors with T-3 exit safeguard

The Securities and Exchange Board of India (SEBI) Thursday widened access to India’s exchange-traded commodity derivatives market for foreign portfolio investors (FPIs), allowing them to participate in a broader range of non-agricultural commodity contracts while putting safeguards in place to prevent them from entering the physical delivery process.

The SEBI Board approved FPI participation in non-agricultural commodity index derivatives irrespective of whether their underlying contracts are cash-settled, while also opening non-cash-settled non-agricultural commodity derivatives to foreign investors. The change marks an expansion from the existing framework, under which FPIs were primarily permitted to participate in cash-settled non-agricultural commodity derivatives and indices comprising such commodities.

T-3 safeguard for delivery contracts

The regulator has built an exit mechanism into the expanded framework to ensure that foreign investors do not acquire physical delivery obligations. FPIs trading non-cash-settled contracts will have to exit their positions before the beginning of the tender or staggered delivery period and will not be permitted to increase their positions from the T-3 day.

The tender period begins three days before the expiry of a contract, making T-3 a critical cut-off under the revised framework. The restrictions are intended to allow FPIs to gain exposure to a wider universe of commodity derivatives while keeping them outside the process through which the underlying physical commodity is ultimately delivered.

Before being enabled to trade on an exchange, an FPI will also have to enter into an agreement with its trading member or trading-cum-clearing member. The agreement will specify arrangements for handling the investor’s positions, including the mechanism through which they will be squared off before any delivery obligation can arise.

Fallback for residual positions

SEBI has also provided a mechanism for dealing with positions that remain open before the tender period despite the exit requirements. Such residual positions can be devolved to the FPI’s trading member or trading-cum-clearing member at the closing price or daily settlement price declared by the exchange on the day of devolution.

Once transferred, the position will be treated as a trade and will attract the applicable statutory levies. The mechanism effectively shifts any remaining exposure away from the foreign investor before the contract reaches the physical-delivery stage, while giving exchanges and intermediaries a defined procedure for dealing with positions that have not been voluntarily closed.

The safeguards address one of the central issues surrounding broader FPI participation in commodity derivatives — the possibility that a financial investor could inadvertently become responsible for taking or making delivery of the underlying commodity. By establishing a mandatory exit point and a fallback mechanism, SEBI has sought to separate foreign portfolio investment from physical commodity settlement.

Push to deepen liquidity

The decision followed an August consultation paper in which SEBI proposed widening FPI participation after receiving representations from market participants. The regulator has been seeking to increase institutional participation in commodity derivatives, where greater trading activity can improve liquidity and facilitate more efficient price discovery and risk management.

Foreign portfolio investors have been allowed to participate in Indian exchange-traded commodity derivatives under a regulatory framework introduced in 2022. Their access, however, was initially restricted largely to cash-settled non-agricultural contracts, with the latest decision substantially broadening the range of products available to them.

The change could bring additional institutional participation into contracts linked to non-agricultural commodities while retaining restrictions around physical settlement. Exchanges and intermediaries will now have to operationalise the T-3 controls and arrangements for transferring residual positions before FPIs can take advantage of the expanded framework.

SEBI’s move reflects its attempt to deepen India’s commodity derivatives market without exposing foreign portfolio investors to the operational complexities associated with taking delivery of physical commodities. The success of the expanded framework will depend on whether the wider product access translates into greater FPI participation and improved liquidity across eligible contracts.