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The Implications of SEBI & FMC Merger on Financial Services Sector: A Case of Daruwala Broking Pvt Ltd.*

CASE STUDY, FINANCIAL MANAGEMENT
ET Cases - FLAME, 8 Pages
AUTHOR(S) : Dr. Sharon K Jose- Faculty, Dr. Manisha Singh- Faculty - IBS, Bangalore

Case Preview

The Implications of SEBI & FMC Merger on Financial Services Sector: A Case of Daruwala Broking Pvt Ltd.

 

Srijan Daruwala (Srijan) was in a dilemma. He had to make a tough decision of cost-cutting at his brokerage firm, “Daruwala Brokign Pvt Ltd.” which involved downsizing of employees at its commodities trading department. He couldn’t blame Finance minister or SEBI for his predicament as merger of the Forward Market Commission (FMC) with the Securities and Exchange Board of India (SEBI) has been for a good reason which, he hoped, would bring the commodities market back on the growth trajectory.

Daruwala Broking Pvt Ltd.

Founded by Srijan in 2003, Ahmedabad-based Daruwala Broking Pvt Ltd. traded both in equity and commodity markets. The business was doing good with commission margin ranging from 0.10% to 0.50% from equity and various derivative instruments. Initially, the broking firm began trading at NMCE (National Multi-Commodity Exchange of India) and soon explored trading at MCX and NCDEX as well which together brought in lot of business in terms of volume as well as returns. Srijan developed many successful trading strategies for his clients and for his trading friends, and as a result, majority of trader of Mandis of Ahmedabad were his customers.................

1.1Commodity trading regulatory environment

The regulatory body for commodity trading business was Forward Market Commission (FMC). It was attached to the Ministry of Consumer Affairs, Food & Public Distribution under the regulation of Forward Contracts (Regulation) Act (FC(R) A), 1952, which practically meant two regulators. The problem with having two regulators was that FMC did not have a free hand in handling the commodities market.............

1.2 Commodities Market Manipulations

Another issue was manipulation of commodities futures’ market. As against commodities like rice, cotton, wheat etc. which were largely traded in spot (physical) market, the popular commodities in future trades were commodities like Guar seeds, Guargum, spices (e.g. turmeric) which did not have a very strong physical presence...........

1.3 Need for strong Regulation

Unlike better-regulated stock market, Indian commodities market was in dire straits due to the absence of a powerful regulator, The commodities market had been prone to many illegal activities like circular trading, wash trading, dabba trading (where a stockbroker executes a customer’s trade done through his local books, but not reflecting at the exchange, with the hope of making some gains at a future date).............

1.4 National Spot Exchange Limited

The next major occurrence in the commodities market was establishment of NSEL. National Spot Exchange Limited (NSEL) was the national-level online spot exchange which commenced its operation on October 15th 2008............

1.4.1 NSEL Scam

Srijan was quite happy with these changes as he felt they brought in lot of transparency in the system and helped build the trust factor which was necessary for more business. He hoped that these changes would attract more retail investors to commodities trading resulting in better business for him..............

....................................

1.5 Reactions

1.5.1 Response of the Government

After the scam, the oversight of FMC was transferred from Department of Consumer Affairs under Ministry of consumer affairs, Food and Public distribution to Department of Economic Affairs under the Ministry of Finance in September 2013. According to the policy makers, the move was aimed at improving “coordination among regulators.”.............

1.5.2 Committees’ Recommendations

This was the time when the need for a single and a powerful regulator was felt. In fact, as far as Srijan could remember, such merger was first mooted in 2003 by Waijahat Habibullah Committee, and continued in next few years before the Rajan committee reiterated consolidation of all financial sector regulators under one umbrella in 2009.............

1.5.3 Merger Announcement

Finance Minister, Arun Jaitley, announced the merger of FMC with SEBI in February 2015. The amalgamation of the two financial giants came into effect on September 29th 2015. It was a historical event, a first of its kind in the world where a 60-year-oldcommodities regulator FMC was merging with a 27-year-old SEBI...............

1.5.4 Nitty-gritties of the Merger

1.5.4.1 Repealing of FCRA, 1952

With this union, Government repealed Forward Contracts (Regulation) Act, 1952 w.e.f. September 29th 2015. In an attempt to make the merger effective, SEBI amended Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations................

1.5.4.2 Member’s eligibility criteria

There were lots of speculations on the status of MCX & NCDEX after the amalgamation. SEBI in order to clear the uncertainty, announced that they would be given status of ‘deemed exchange’ on fulfilling the eligibility criteria of (i) having a net worth of INR100 crore and.............

1.5.4.3 Formation of CDMR Department

SEBI also created a separate Commodity Derivatives Market Regulation (CDMR) Department for the regulation of commodity derivatives including exchange administration, market policies............

1.5.4.4 Separate Clearing Corporation

The SEBI stipulated a separate clearing corporation post-merger with a minimum net worth of INR300 crore. Thus far, commodities exchanges were having their clearing and settlement function in-house. Post-merger, they were given a time period of 3 years.................

1.6 Reactions from the Broker’s community

Srijan was happy. Like him, the reaction of his broker’s community was also unparalleled. As per Girish Dev, Chief Executive Officer and Managing Director at Geofin Comtrade, a commodities trading firm, “Never before have had market participants so eagerly awaited a regulator; generally, regulations are met with skepticism......

2. Present Scenario

2.1 Issues and Challenges

2.1.1 Downsizing

However, not everything spelt well for Srijan’s business because of this merger. There were some issues which were a direct outcome of the merger. For example, now that there would be a universal exchange dealing with equity............

2.1.2 Changes in Product mix

Secondly, with the consolidation, many products were believed to become redundant. For example, there would be no reason for an investor to prefer Gold Futures over Gold Exchange Traded Funds (ETFs) since both would now be traded on the same platform.............

2.1.3 Stringency in broker’s margin

Thirdly, in case the banks or mutual funds were to be allowed to trade in the commodities market, the trading dynamics would change.............

2.1.4 Broker’s Anxiety

Srijan, although happy, was also anxious. He wanted some directions on how the future would unfold for his business. He had a lot of confidence on SEBI as a regulator for electronic settlement but commodity market also demanded physical settlement..................

3. Future Perspective

Srijan knew that synchronization of spot and futures market was very important for price discovery, but was unsure about the operational aspect..........

Assignment Questions

I. How do you see SEBI as a regulator of Equity & Commodities Market? Do an impact analysis for all the stake holders.
II. Why Mr.SrijanDaruwala is in dilemma? Cite Reasons.
III. How according to you, SEBI as a independent regulator would deal with commodity market manipulations such as Dabba trading, paired trading, circular trading or wash trading? Discuss.
IV. ...........

Exhibits

Exhibit: I: Sequence of Developments

Exhibit II: The Roadmap

Teaching Note Preview

The Implications of SEBI & FMC Merger on Financial Services Sector: A Case of Daruwala Broking Pvt Ltd.

 

Synopsis

The case describes the various circumstances which led to the SEBI- FMC merger. It also talks about the implications of this merger on different market players especially on the broker’s community in terms of warehousing aspects, physical settlement of the underlying assets, product redundancy as well as introduction of new & exotic instruments, increased competition due to entry of new market players etc.

The case begins with a small dilemma faced by the protagonist on downsizing in his firm as a result of SEBI-FMC merger and proceeds with brief history of the commodities market. It describes warehousing aspects and also about the cash as well as physical settlement of the trade. It highlights various developments which have occurred in the commodities market in chronological order and and also the reasons of such developments. A brief mention of few trading manipulation like dabba trading or circular trading has been added to improve the student’s understanding of the same. The culmination of all such manipulations in to the NSEL scam in 2013 has been discussed in the case to help the students understand the causes of merger in a better manner. The case towards the end talks about with few more dilemmas faced by Srijan on account of this merger, which are basically the issues which have been raised as well as the implications of this SEBI-FMC union for brokers. It ends with lots of scope to discuss the road ahead......................

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Abstract

**ET Cases – FLAME Young Case Writer Award - 2016

Award Winning Case Study

In India, commodity futures’ trading is quite old. It has been in existence since late 19th century with the kick-starting of organized trading in cotton through the establishment of Cotton Trade Association in 1875. Since then, over a period of time, many other commodities have been allowed to be traded in futures exchanges till six decades of 20th century. In fact, in 1952, Forward Contracts (Regulation) Act FCRA), 1952 had been enacted to regulate the commodities market. However, later on, regulatory constraints in 1960s had resulted in virtual dismantling of the commodity futures market. It was only in the first decade of the new millennium that commodity futures exchanges have been actively encouraged. However, so far the markets have seen only slim participation with poor liquidity and have not developed to any substantial level. Also the exploitation of the commodities market by few traders through various malpractices and manipulations has kept the small investors at bay. Lack of effective regulatory powers of FMC has also added to the investors’ woes.

In the given backdrop, the case describes the various circumstances which led to the SEBI-FMC merger. It also talks about the implications of this merger on various market players especially on the brokers’ community in terms of warehousing aspects, physical settlement of the underlying assets, product redundancy, introduction of new and exotic instruments as well as increased competition due to entry of new market players etc.

The case begins with a small dilemma faced by the protagonist, Srijan Daruwala (Srijan) regarding downsizing of staff in his firm, Daruwala Broking, as a result of SEBI-FMC merger. The case proceeds with brief history of the commodities market, then talks about warehousing aspects and also about the cash as well as physical settlement of the trade. It encapsulates various developments of the commodities market as well as the factors which led to their evolution. A brief mention of few trading manipulations like dabba trading or circular trading has been added to improve the student’s understanding of the same. The culmination of all such manipulations into the NSEL scam in 2013 has been discussed in the case to help the students understand the causes of merger in a better manner. The case also highlights few more dilemmas faced by Srijan which underlines the implications of SEBI-FMC merger for brokers. It concludes with lots of scope to discuss the road ahead.............


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