[Arunimaa Jaiswal is a fourth-year student at Gujarat National Law University, Gandhinagar]
Through the Union Budget 2021-22, the Government of India notified the Securities and Exchange Board of India (“SEBI”) as the regulator for gold exchanges in India. Upon such notification and in pursuance of the Government’s intention of establishing regulated gold exchanges in the country, SEBI released a consultation paper on 17 May 2021. The paper presents the proposed framework for a Gold Exchange in India and annexed to it is a draft of the SEBI (Vault Managers) Regulations, 2021.
India is the second largest consumer of gold globally with an annual gold demand of approximately 800-900 tonnes. Presently, however, the Indian gold market is characterised by a high degree of fragmentation. There also exists lack of quality assurance and weak price transparency. To overcome these challenges, the World Gold Council suggests the establishment of a gold spot exchange. An integrated, uniform and transparent mechanism for gold trading will help India unlock the potential its gold market holds towards driving the economy to higher levels of growth. On the international front, India’s consolidated gold market will acquire a position from where it will be better capable of influencing global prices.
Accordingly, SEBI has identified the creation of a vibrant gold ecosystem incorporating the trading and physical delivery of the metal as a necessity in India. In its paper, SEBI suggests a mechanism to facilitate trading of gold in the form of electronic gold receipts (“EGR”) on a Gold Exchange. Since the advantages of an exchange are manifold, the paper posits that the proposed framework will lead to efficient and transparent spot price discovery, assurance in the quality of gold and augmented recycling of gold in India.
The Framework
Addressing various aspects that require attention, SEBI in its paper has covered a lot of ground in the proposed scheme for a Gold Exchange in India.
With respect to the transactions, SEBI proposes their division into three tranches. The first being the conversion of physical gold into EGR. The second being the trading of EGRs on the exchange and the third, conversion of EGR to physical gold. SEBI recommends that existing stock exchanges be allowed to deal in EGRs as opposed to setting up a new stock exchange exclusively for EGRs. The latter poses a less attractive option owing to cumbersome regulatory processes, investment requirements and delays associated with it.
Recognising the importance of appropriate and adequate market infrastructure institutions (“MII”), SEBI will develop a common interface among vault managers, depositories, stock exchanges and clearing corporations to facilitate these transactions. This would mean that, upon delivery of gold to the vault manager, depositors will be able to convert physical gold into EGRs tradeable on the exchange. EGRs will reflect in the depositor’s demat account maintained with the depository participant. Stock exchanges on receipt of information from the depository will list the EGR and permit trading. The clearing corporation will settle the trades executed on stock exchanges and will also notify changes in beneficial ownership of EGRs. Beneficial owners will be able to obtain physical gold against the EGR by surrendering it. Accordingly, the vault manager will extinguish such EGRs and request the depository to cancel the corresponding entry from the beneficial owner’s demat account.
Over the years, these MIIs have harmonised their functions to promote seamless trading of stocks, bonds and commodities. Therefore, it is reasonable for SEBI to propose that aspects such as the settlement cycle, clearing, risk management, the grievance redressal mechanism, know your client and know your depositor requirements along with participants in the Gold Exchange framework will be akin to the practices currently being followed in the securities market.
Moreover, SEBI’s proposal of fungibility of EGRs and their inter-operability between vault managers will translate into reduced costs making the trade process more robust. An efficient mechanism for collection of storage and delivery charges levied by vault managers has also been propounded. This would imply that requests of beneficial owners will be entertained only upon payment of these charges to the depository for onward payment to the vault managers.
Many Indians regard gold as an auspicious metal. Given the fondness of Indians, both rural and urban towards gold, it serves as a preferred opportunity for investment. However, the options presently available for such investment such as over-the-counter purchase of physical gold requires the buyer to find a trusted dealer and then haggle over prices. Sovereign gold bonds possess low liquidity for trade in the secondary market. Gold exchange traded funds have floor limits. Digital gold suffers from the lack of government regulation. Gold futures contracts and mutual funds cannot be converted into physical gold. Tackling these issues, it can be said that SEBI’s proposed framework will set the stage for unified and standardized gold trading procedures common to all buyers and sellers. This will eliminate regional price disparity, provide quality assurance and bolster transparent price discovery of gold.
Gold Exchanges in other Jurisdictions
China, Dubai, London, Turkey and the United States are certain jurisdictions which are already home to fully functional gold exchanges. Most noteworthy is the Shanghai Gold Exchange (“SGE”) which was established in October 2002. Today, it has successfully achieved its goal of becoming the central hub of the Chinese gold market. The consumption of gold in China is 1000 tonnes per year. This level of consumption is similar to India’s. Remarkably, the SGE trades in 49,000 tonnes per year. Therefore, the exchange is likely to have a significant impact on India’s gold market. That the government is conscious of the importance of this trade and is taking these steps to regularise the trading in gold is admirable.
In 2018, the NITI Aayog in its committee report acknowledged that gold exchanges in these jurisdictions played a pivotal role in the development of an efficient market for gold by way of channelling demand-supply information into a central mechanism, assuring standards in the quality of gold, acting as a channel for gold recycling by working through accredited refineries and prompting active retail participation and use of gold bars and coins for investment instead of jewellery. In its consultation paper, SEBI has taken cognizance of these factors and has meticulously devised a framework that may lead to actualization of a centralised gold trading platform in India as well.
SEBI as the Appropriate Regulator
For the burgeoning of the proposed electronic gold market, it is important to garner the trust of individual investors and institutions alike. SEBI’s designation as regulator of the Gold Exchange will create the necessary market integrity and maintain stability to allure investors to trade in EGRs. Since its inception, SEBI has operated on the philosophy of protection of the interests of investors in the securities market as has been enshrined in the Preamble to the SEBI Act, 1992.
In its paper, SEBI has advanced the treatment of EGRs as “securities”. It follows from this that EGRs will be assigned a meaning under the Securities Contracts (Regulation) Act, 1956. All features applicable to other securities would be made applicable to EGRs as well. This essentially means that SEBI’s extensive regulatory framework already in place to act as a check on securities market transactions will become applicable to transactions in EGRs as well.
Further, by way of the SEBI (Vault Managers) Regulations, 2021, SEBI proposes regulation of vault managers as intermediaries in the gold ecosystem. Vault managers and recognized vaults will be permitted to commence operations upon grant of a certificate of registration by SEBI. Thereafter, they will be required to conform with all the requirements specified by SEBI for the purpose of providing vaulting services including the “fit and proper” criteria as specified by SEBI in Schedule II of the SEBI (Intermediaries) Regulations, 2008.
It might be the case that retail investors will take a while before they acclimatize themselves with the EGR mechanism and develop faith in the electronic gold market. This reinforces requirement of maintaining high standards of integrity, credibility and accountability in the market – a job well fitted for the market watchdog. Regulation of the proposed Gold Exchange by SEBI will ensure transparency, symmetry of information and timely interception of undesirable practices that may act against the interest of investors.
Conclusion
The proposed framework will revolutionize trading in gold by giving rise to a national regulated gold market in India. An integrated whole, this national market will assimilate all fragments of the gold market currently dispersed across the country. In this regard, SEBI’s consultation paper can be lauded as a sincere attempt towards creation of a Gold Exchange. Consistent trading procedures coupled with sound SEBI regulations, the Gold Exchange and EGRs may in fact open an easier, safer and regulated avenue for gold investment. In the event that the Gold Exchange is brought into existence, whether it gains traction is something interesting that will invite keen observation in the future.
– Arunimaa Jaiswal
