Big Leap: SEBI Opens Up Physical Commodity Derivatives to FPI, Mandating Stringent Safeguard Mechanism

Big Leap: SEBI Opens Up Physical Commodity Derivatives to FPI, Mandating Stringent Safeguard Mechanism​

SEBI Expands FPI Scope to Include Physical Commodity Derivatives​

The Securities and Exchange Board of India (SEBI) has released a consultation paper proposing a significant expansion of Foreign Portfolio Investor (FPI) participation within the commodity derivatives market. The move aims to deepen institutional engagement by allowing FPIs access to physically settled non-agricultural commodity derivatives, alongside opportunities in non-agricultural index contracts.

Currently, FPIs are restricted to cash-settled derivative contracts and indices. SEBI’s proposal seeks stakeholder input on enabling participation in both non-agri indices and physically settled ETCDs (Exchange Traded Commodity Derivatives). The decision follows a period of consultations and representations from market participants seeking broader access.

The rationale behind allowing FPIs to trade physically settled commodities, such as crude oil, natural gas, gold, silver, and base metals, is manifold. Granting this access is intended to enhance market depth, improve price discovery, and strengthen the convergence between derivatives markets and physical commodity flows in India.

Globally, foreign investors are already active in these segments within major exchanges like CME (USA) and ICE (Europe). While international markets have established mechanisms for clearing members to assess delivery capability, domestic regulation must account for FPIs' lack of a permanent establishment in India.

Safeguard Mechanisms for Non-Cash Settled Contracts​

The proposal introduces robust safeguards designed to prevent FPIs from assuming an obligation of physical delivery on contracts they are trading in. The core mechanism relies on a layered structure combining voluntary exit with mandatory backstop provisions run by the exchange and designated Trading Member (TM).

FPIs retain the primary option to voluntarily square off or roll over their open positions at any time up to the close of market hours on the day preceding the start of the tender period (T-1). This voluntary action remains the preferred method of exit.

Should an FPI fail to execute a voluntary exit by the close of market hours on T-3, the mandatory Safeguard Mechanism is triggered. The FPI’s open position will then be automatically transferred at the Closing Price/Daily Settlement Price to the proprietary account of the designated TM or Trading-cum-Clearing Member (TCM).

To ensure proper margin arrangement, the Professional Clearing Member (PCM) must inform the designated TM by end-of-day on T-2 about the FPI’s position that is liable to devolve. This transfer operates in a post-closure window before EOD activities of the clearing corporation.

Operational Framework and Compliance Details​

The operational process for this mechanism is meticulously defined across several stages, ensuring regulatory compliance and market integrity. The framework mandates specific actions by various participants—the FPI, the TM, and the Clearing Corporation.

Crucially, no Clearing Member is permitted to accept or clear any fresh trade that increases an FPI’s open position in the near-month deliverable contract on T-1 (the day before the tender period starts). This restriction forces the market participants toward resolution.

The designated TM/TCM absorbs the transferred risk into its own proprietary account, treating the transaction as a Normal Market trade and subjecting it to all applicable statutory levies, including Commodity Transaction Tax (CTT) and GST on turnover charges. The transfer mechanism is designed as a closing-price based window rather than continuous market execution.

To incentivize voluntary square-off or rollover, the consultation paper proposes incorporating a "Proprietary Risk Absorption Charge." This pre-agreed charge is payable by the FPI to the TM/TCM if the position is involuntarily transferred due to failure to execute a voluntary exit.

The consultative process also extends to index derivatives (Proposal 1), seeking input on whether FPIs should be allowed to trade non-agricultural index contracts irrespective of their underlying assets being cash settled, as suggested by the Commodity Derivatives Advisory Committee (CDAC).

Timeline for Safeguard Mechanism Triggering​

The timeline governing the involuntary transfer of positions is structured across multiple trading days leading up to the Tender Period (T).

On T-3, the compulsory square-off or rollover window opens, and FPIs are expected to exit voluntarily. By T-2 EOD, the PCM informs the designated TM regarding the liable position for safeguard triggering. On T-1, no fresh positions that increase an existing contract exposure are allowed for the FPI. If voluntary action is lacking by the T-1 EOD cut-off, the unsquared FPI position is automatically transferred to the designated TM’s proprietary account at the closing price of the day. The residual position then falls under the general tender/delivery provisions applicable to trading members at the start of the Tender Period (T).

Stakeholders are invited to provide feedback on these proposals and the detailed framework by September 01, 2026, through the online platform provided by SEBI.