[Darshana Gaggar is an associate at Mindspright Legal]
The Securities and Exchange Board of India (SEBI) proposed a legal framework for the formation of a spot exchange for trading gold, hoping to use India’s disproportionate physical market power to allow gold to be traded in the financial market as well. Trading of gold in the financial market would be considered as another way of persuading people to stop hoarding gold and build an exchange with clear pricing and liquidity, in addition to directly influencing the gold price (to cash or back to gold). India currently has been trading only in gold derivatives and Gold ETFs, unlike several other countries which have spot exchanges for physical trade in gold.
Gold has an ambivalent relationship with India. Gold is an appreciated asset among consumers, valued as an adornment as well as an investment. Perhaps, due to this relationship, gold is a significant contributor to the government’s current account deficit, which was needed to be addressed.
In order to provide a comprehensive analysis of the market, the World Gold Council commissioned the Federation of Indian Chambers of Commerce and Industry (FICCI), which in turn commissioned the Bureau of Research on Industry & Economic Fundamentals (BRIEF) to conduct a nationwide survey of Indian consumers and assess policies in other countries facing [similar issues] such as consumer behavior in respect to purchase, consumption, logistic and hoarding of gold. According to the poll, it was determined that whatever may be the macroeconomic, budgetary, or political situations, gold demand remains strong and durable. The vast majority of respondents stated they would buy gold in both good and bad times. Over 60% of those polled stated they would consider depositing gold in a financial institution in exchange for interest.
SEBI Circulars on Implementation of EGR
The Ministry of Finance declared electronic gold receipts (EGR) as “securities” for the purpose of section 2 of the Securities Contracts (Regulation) Act, 1956. This paved the way for SEBI to exercise its jurisdiction, as the regulator of the Indian securities market.
In January 2022, SEBI published a framework for operationalizing a spot exchange where the yellow metal will be traded in the form of electronic gold receipts and it is anticipated that the bourse will facilitate a price discovery mechanism for spot trading in gold. EGRs will have trading, clearing and settlement features akin to other securities that are currently available in India. Also, SEBI notified the SEBI (Vault Managers) Regulations, where the vault manager will be registered and regulated as SEBI intermediary, for providing vaulting services meant for gold deposited to create EGRs.
In February 2022, SEBI in continuation with the circular pertaining to framework operationalizing the gold exchange in India published a circular on the trading features of the electronic gold receipts segment, such as trade timings, process for conducting call auctions, and so on. Further, to ensure the ease of compliance for the market participants in the EGR ecosystem as well as effective implementation of the Regulations, Standard Operating Guidelines under regulation 28 of SEBI (Vault Managers) Regulations, 2021 read with regulation 97 of SEBI (Depositories and Participants) Regulations, 2018 were issued.
SEBI, vide its circular dated 28 March 2022, published a framework stating that the entire transaction in EGR segment has been divided into three tranches. Physical gold will be turned into EGR in the first tranche; EGR will be traded on stock markets in the second tranche; and EGR can be converted into physical gold in the third tranche. The framework further stipulates that stock exchanges may create contracts with different denominations for trading and/or conversion of EGR into gold, as long as they follow all of SEBI’s standards.
Recently, SEBI vide circular dated 11 April 2022 has issued a comprehensive risk management framework for the EGR segment which requires the stock exchanges and clearing corporations, in all segments, in consultation with one another, to devise a standard framework for the imposition of fines on the trading member/clearing members for false reporting of margins collected from the clients, found during inspection.
Gold Exchange in India
India is the world’s second-largest gold importer, accounting for over half of all global gold consumption, with China, having an annual gold demand of over 800-900 tons which plays a significant role in global markets. The domestic market, on the other hand is beset by issues such as a lack of quality certification, a lack of price transparency, and a high level of market fragmentation. A gold spot exchange can address these issues and minimize market inefficiencies as a result and is expected to create a vibrant gold ecosystem commensurate with India’s large share of gold consumption.
Given the certainty in the regulatory framework brought about by SEBI’ circulars as described above, the India Bullion and Jewelers Association (IBJA), a Mumbai-based bullion association, has announced its intention to set up the first regulated spot exchange for gold trading in India. IBJA is a national organization of gold dealers, merchants, and jewelers that are looking forward to a physical exchange that will result in improved pricing. The National Stock Exchange (NSE) has proposed to set up a new domestic spot gold exchange that would bring more efficiency and transparency to bullion pricing. NSE has proposed to create the exchange together with the IBJA, which represents the industry members in the sector of gold distribution and retailing. SEBI has also given the BSE an in-principle approval to begin trading in EGR subject to the submission of additional material in order to obtain final permission for the implementation of the EGR segment. The advantages of a dedicated Physical Gold Exchange include the ability to deal in gold and bring a sense of transparency to the market, as well as the possibility of large cash transactions. It also allows jewelers, traders, banks, and consumers to deal in gold and bring a sense of transparency to the market.
Global Gold Exchanges
The London OTC market, the US futures market, and the Shanghai Gold Exchange (SGE) are the three most prominent gold trading centers. These marketplaces account for over 90% of worldwide trading volume, and they are supplemented by smaller secondary market centers all throughout the world (both OTC and exchange-traded).
The London OTC Market
The London OTC market has long been the heart of the gold trade, accounting for over 70% of global notional trading volume. The London market attracts traders from all over the world and sets the LBMA Gold Price, a twice-daily global reference benchmark for gold. The London market is unique in that, it trades 400 ounce ‘Good Delivery’ bars that are stored in the London Precious Metals Clearing Limited (LPMCL) and Bank of England member vaults. London is sometimes referred to as the ‘terminal market’ because of its unique vaulting infrastructure, which includes a stringent chain of custody and large gold inventories.
The US Futures Market (COMEX)
Despite London’s dominant position in the physical market, CME Group’s COMEX derivatives exchange has become an increasingly important venue for price discovery. The ‘active month’ (nearest dated) contract, which functions as a proxy for the spot price, sees the most trading activity on COMEX. Although only a small percentage of contracts physically settle into delivery of bars into COMEX vaults, the market is nevertheless strongly linked to physical markets via the Exchange for Physical (EFP) market, which is quite active.
The Chinese Market (SGE)
The Shanghai Gold Exchange (SGE), which was founded in 2002 under the supervision of the People’s Bank of China, has risen to prominence quickly, mirroring China’s growing importance in the gold market. SGE has become the world’s largest physical gold exchange less than 20 years after launching. China mines 11 percent of the world’s gold, making it the world’s largest gold producer.
Secondary Market Centers
Dubai, India, Japan, Singapore, and Hong Kong are all key markets. All of these markets have exchanges that offer a variety of spot trading facilities or listed contracts, although these have not garnered the same level of liquidity as the market’s principal venues.
Pursuant to the implementation of the EGR and Gold Stock Exchange in India, India can play a critical role in gold price making. With sufficient liquidity, the EGR system will aid in the creation of a consistent and transparent domestic gold spot price discovery price structure.
– Darshana Gaggar