Forward Markets in India and the Saga of Electricity

Rahul Jajoo, Advocate, Supreme Court of India

Introduction

Forward markets pertaining to commodities in India have been recognized as a way to deal in derivative markets ^[1] since independence. It was however only in 1952 that the government of India decided to regulate the regime of forward markets and hence, the Forward Contracts Regulation Act, 1952 (“FCRA”) was enacted. The object and purpose of the FCRA was “An Act to provide for the regulation of certain matters relating to forward contracts, the prohibition of options in goods and for matters connected therewith.”

It is pertinent to state that in 2015 the Forward Contracts Regulations Act (‘FCRA’) was repealed and replaced by the Securities Contracts (Regulation) Act, 1956 (“SCRA”) and as a consequence thereof, the Forwards Market Commission was also merged while transferring all the powers of the commission to the Securities and Exchange Board of India (‘SEBI’)

The object and purpose of the FCRA made the legislation wide and open-ended which later resulted in one of the biggest disputes in two central ministries (in terms of longevity). The dispute over forwards market contracts in the market of electricity became a cause of disagreement between two regulators viz. the erstwhile Forward Market Commission (FMC) now merged with SEBI as stated hereinabove and Central Electricity Regulatory Commission (“CERC”) under the Electricity Act, 2003.

Note: The article seeks to summarize the position of forward markets qua electricity and the status of the existing regulatory dispute between two instrumentalities of the state.

What are Forwards Contracts?

Forwards contracts essentially mean a contract between two parties. One party agrees to buy a commodity or financial asset on a date in the future at a fixed price, while the other agrees to deliver that commodity or asset at the predetermined price. These are not traded on exchanges because they are negotiated directly between two parties.^[2]

Insofar as regulation of forward trading is concerned, the same is governed by a three tier regulatory regime consisting of (a) the Central Government, (b) the Forward Markets Commission / now SEBI and (c) the Recognized Commodity Exchanges / Associations.^[3]

Role of Government qua Forwards Contracts can be summarized as under :

The Government of the India has the powers to legislate on the subject of forward trading in commodities by the virtue of Entry 48 of List of the VII Schedule of the Constitution of India. Prior to 2015, the subject was dealt with by the Ministry of Consumer Affairs, Food and Public Distribution in the Central Government,.

The Dispute over the regulation of Forward Contracts of Electricity

The two regulatory authorities functioning under two different enactments viz. Central Electricity Regulatory Authority (CERC) under The Electricity Act, 2003 and the Forwards Markets Commission under the FCRA, 1952/SEBI under SCRA, 1956 were at loggerheads qua the sole right in the matter of forward contracts in electricity in the first decade of the 21^st century.

The dispute began in 2009 when CERC did not allow MCX India to introduce futures trading in power, saying its approval was needed and not that of the erstwhile Forwards Market Commission. The commission said it was empowered to regulate all futures contracts. In 2015, the FMC was absorbed by SEBI. Currently, the dispute between the CERC and the FMC is sub–judice before the Hon’ble Supreme Court of India in the case of the Securities and Exchange Board of India vs. Central Electricity Regulatory Commission, SLP (C) 17300 of 2011 wherein the parties had approached the Supreme Court in 2011 against a Bombay High Court order that said that none of the regulators had an exclusive jurisdiction over power futures contracts.

Arguments raised by both the Parties

The CERC argued that the Electricity Act of 2003 gives it the sole right to regulate electricity futures. Section 14 (c)^[4] of the Electricity Act of 2003 authorizes CERC to grant a license to any person to undertake trading in electricity as an electricity trader. It further argued that the Electricity Act was brought in with the purpose to consolidate the laws relating to generation, transmission, distribution, trading, and use of electricity and generally for taking measures conducive to the development of the electricity industry, promoting competition therein, protecting the interest of consumers and supply of electricity to all areas, rationalization of electricity tariff, ensuring transparent policies regarding subsidies, promotion of efficient and environmentally benign policies, the constitution of Central Electricity Authority, Regulatory Commissions and establishment of Appellate Tribunal and for matters connected therewith or incidental thereto. Therefore, it is a self-contained code to regulate future market in electricity as commodity, and in case of forward/future markets, delivery of electricity as commodity is possible only at the behest of CERC.

The FMC argued that according to Section 15 of the FCRA, forward contracts could be entered into only in respect of goods notified by the Central government.  That on 9th January 2006, the Central government had issued a notification and specified electricity as goods in respect of which forward contracts could be entered into. Relying upon this notification, the FMC allowed the Multi Commodity Exchange to start trading future contracts in electricity.

Observation(s)/Conclusion

In Indian political setup, it is correct to say that various departments of the Government are its limbs and, therefore, they must act in coordination and not in confrontation. Further, it is trite law that in every case where a dispute is between government departments and/or between a Government department and a public sector undertaking, the matter should be referred to the High Power Committee established by the Government and that it is the duty of every court or tribunal to demand clearance from the Committee and that in the absence of clearance, the proceedings must not be proceeded with. As on date, the ball is in the Government’s Court, they must resolve the interse dispute without bringing any disrepute to the ministries and must quickly mitigate the loss suffered by the industry. Both the regulator must join the hands in regulating market, since both play a vital role in regulating the market. The general development of the electricity market vests with CERC, while the speculative trading horizon is rested with SEBI owing to better and immaculate understanding of the financial market.

Legally, the Hon’ble Apex Court may attempt to resolve the inter-department dispute with the help of tools of construction viz. doctrine of purposive interpretation or by harmoniously constructing the two conflicting legislations. The Court may crease out the regulatory regime of both, the CERC and the SEBI upon construing the object and purpose of the respective legislations. SEBI has wide power to regulate the financial aspects of commodity and to ensure the investor protection, whereas CERC is a body that can facilitates the physical delivery of the commodity. Therefore, a cohesive and concordant approach is appealed for reaching solution.

As on date, some news articles suggest that the ministries have resolved their issues but the decision taken by the executives is yet to be in public domain. It is however suggested that in the light of the existing legal structure, none of the regulators shall be deprived of regulating over the forward contracts of electricity and the demarcations can be made between who may govern the Ready Delivery Contracts^[5] and Non-Transferable Specific Delivery Contracts^[6] and who may take care of the remaining forward contracts.  Further, a distinction between physical and financial aspects of electricity future market must be made, allowing the SEBI to hold and govern the financial aspects whereas physical aspects may be dealt by CERC. The same can be deduced from the best global practice.

A reformative approach will boost a investor friendly environment where consumers and power generators may enter into future contract, and may use it as hedging tool to mitigate price volatility risk. That apart, dealings via an exchange would be safe as its clearinghouse provides a system of guarantee that mitigates counter party credit risk.

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^[1] The term “Derivative” indicates that it has no independent value, i.e. its value is entirely “derived” from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities

^[2] Rajshree Sugars and Chemicals Limited and Ors. v. AXIS Bank Limited and Ors., AIR 2011 Mad 144.

^[3] A commodity exchange is an organized, regulated market that facilitates the purchase and sale of contracts whose values are tied to the price of commodities (e.g., corn, crude oil and gold). Typically, the buyers of these contracts agree to accept delivery of a commodity, and the sellers agree to deliver the commodity. Eg: Multi Commodity Exchange

^[4] Power to grant license for transmission, distribution and trading of electricity

^[5] “ready delivery contract” means a contract which provides for the delivery of goods and the payment of a price therefor, either immediately or within such period not exceeding eleven days after the date of the contract and subject to such conditions as the Central Government may, by notification in the Official Gazette, specify in respect of any goods, the period under such contract not being capable of extension by the mutual consent of the parties thereto or otherwise.

^[6] non-transferable specific delivery contract” means a specific delivery contract, the rights or liabilities under which or under any delivery order, railway receipt, bill of lading, warehouse receipt or any other document of title relating thereto are not transferable.