The Securities and Exchange Board of India (Sebi) has proposed a phased framework allowing select agricultural commodity derivatives to initially trade as cash-settled contracts before transitioning to mandatory physical delivery. According to the consultation paper released Tuesday, these contracts would initially operate as financially settled products, with mandatory physical settlement required once they meet predefined thresholds including average daily traded volume, open interest levels, or a maximum period of two years, whichever is earlier. The proposal retains compulsory physical settlement as the eventual outcome, with contracts required to transition once sufficient market depth is achieved. The framework would allow exchanges to revive illiquid contracts or launch new delivery-based contracts that initially do not require physical delivery, with contract specifications relating to quality standards, delivery centres, and settlement mechanisms defined upfront. Sebi has clarified that this proposal does not mark a shift away from physical settlement as a regulatory principle but introduces temporary flexibility for select contracts.
Sebi cited structural issues in India's agricultural derivatives market as the primary driver for these changes. The regulator noted that while the existing framework has improved market discipline and strengthened the link between futures and spot prices, it has also led to weak volumes, low open interest, and limited participation from genuine hedgers. According to Sebi, compulsory physical settlement from inception may limit participation to entities capable of taking or giving delivery, while allowing contracts to operate temporarily in a financially settled format could broaden participation and improve market depth before delivery obligations are introduced. The regulator highlighted that despite expansion of accredited warehouses and assaying mechanisms, their utilization remains limited in certain commodities, making it difficult for new or revived contracts to sustain liquidity. Sebi emphasized that commodity derivatives markets play a vital role in agricultural value chains by facilitating price discovery, risk management, and market transparency, with physical settlement historically viewed as key mechanism for ensuring convergence between futures and spot prices.
Sebi has proposed significant changes to position limits in agricultural commodity derivatives, with client-level limits being doubled to 2%, 1%, and 0.5% for broad, narrow, and sensitive commodities respectively. The current limits stand at 1% for broad commodities, 0.5% for narrow commodities, and 0.25% for sensitive commodities, based on deliverable supply calculations. According to Sebi, the proposal is aimed at improving liquidity, deepening market activity and strengthening price discovery in commodity futures trading. The regulator has also proposed relaxing the definition of a 'broad commodity', allowing commodities to qualify if they meet either quantitative or monetary thresholds instead of both criteria. To manage risk during transition, Sebi suggests a phased approach for commodities migrating from narrow to broad category, with such commodities initially maintaining 1% limits for one year before exchanges can raise them to 2% after review. The framework also introduces stricter operational actions against repeated violations, with trading members breaching limits more than three times in a month facing square-off mode for one trading day if violations are linked to the same client.
Under the revised framework, Sebi has proposed capping penalties for violations exceeding 2% of position limits at ₹2 lakh, whichever is lower between the formula-based calculation and the cap. For smaller breaches of up to 2%, the existing ₹10,000 ceiling would continue. The consultation paper also proposes stricter operational actions against repeated violations, with trading members breaching limits more than three times in a month facing square-off mode for one trading day if violations are linked to the same client. Additional penalties may also be imposed for habitual breaches. Narinder Wadhwa from SKI Capital Services noted that the current limits were too small for the market size and that the penalties were previously very harsh, making the proposal beneficial for players who might accidentally breach position limits.
Sebi has suggested that commodities such as maize, chilli, and groundnut could be considered under a pilot programme for the proposed cash-settlement framework. The framework would initially be implemented on a pilot basis for a limited set of commodities, with Sebi inviting public comments on the suitability of the phased approach, safeguards during the financially settled phase, and the choice of commodities for the pilot. These agricultural commodities have historically suffered from low liquidity or repeated discontinuation, making them suitable candidates for the initial phase of the phased approach. The framework aims to allow these contracts to build trading activity and market participation through cash settlement before transitioning to physical delivery requirements. Stakeholders have been asked to submit comments by June 2, 2026 on the proposed pilot framework.
Market participants anticipate that the proposal could improve liquidity and participation in agricultural derivatives, though not dramatically. The framework is expected to attract more traders, arbitrageurs, and smaller participants who currently avoid agricultural derivatives due to delivery risk. According to Sebi, the transition would be governed by objective and transparent triggers to ensure the flexibility remains time-bound, with the framework seeking to address liquidity constraints in agricultural derivatives, particularly during the initial stages of a contract's launch. However, industry experts note that settlement reform alone may not be enough to fully revive India's agri-derivatives market, as frequent policy interventions including export restrictions, stock limits, and trading bans continue to create uncertainty for traders and hedgers. The proposal could also facilitate greater foreign investor participation in select internationally traded agricultural commodities where cash settlements are available.
