India as a country still considers “gold” as the traditional and safest means for investment. To harness the said potential, Securities and Exchange Board India (SEBI) via a press released bearing No. 19/2021 issued a consultation paper on ‘Proposed framework for Gold Exchange in India and draft SEBI (Vault Managers) Regulations, 2021’ (“Paper”). SEBI currently seeks public comments on the Paper.
While gold can be traded as a commodity on various exchanges and can also be invested upon viz. sovereign bonds, The said Paper brings a new perspective of “physical” trading and delivery. Physical delivery of gold, that conversion of a mutual fund or sovereign fund bond to gold is currently not permissible.
This article looks at some of the important aspects relating to the said paper and how trading on a ‘gold exchange’ might look like.
How the exchange will function
According to SEBI, the exchange will work in three (3) tranches. In the first tranche, any entity which wants to deliver gold (either locally manufactured or imported) on the Exchange will first have to approach a SEBI regulated vault manager and deposit physical gold meeting the requisite quality and quantity parameters. Against this deposit, in the second stage, the vault manager will issue an Electronic Gold Receipt (“EGR”), which will be tradeable on the exchanges, in the second tranche. Finally, in the third tranche, a beneficial owner will surrender the EGR to a vault manager and take delivery of the gold in the third tranche. The aforesaid EGRs will act as a replica of shares on an exchange. Those desirous of buying EGRs, will pay the beneficial owner in cash and get those the same in their Demat account.
Like in all other exchange transactions, SEBI under the proposed exchange plans to develop an interface between vault managers, depositories, clearing corporations and stock exchanges to enable seamless execution of the aforesaid three (3) tranches. Further, the proposed denominations as provided in the Paper, reflecting underlying physical gold – of EGRs are denominations – (i) 1 kilogram; (ii) 100 grams; (iii) 50 grams. Subject to conditions, can also be for 10 grams and 5 grams. In the third tranche, the beneficial owner wants to obtain the physical possession of the gold as proposed in the EGR, he/she will have to surrender the EGR.
SEBI to be the regulator – EGR as securities
The Paper clearly envisages that SEBI will treat EGR as a security, under the aegis of Securities Contracts (Regulation) Act, 1956. Further, 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 to be involved in the process of EGR trading. These regulations amongst others will require the vault managers to submit necessary details and comply with SEBI (Intermediaries) Regulations, 2008.
The aforementioned steps may delay the actual investment process and trading of EGRs as the idea will be to have a strong regulation with strict and high levels of integrities for intermediaries involved. Keeping in mind the volatility, it is in interest that SEBI take appropriate time for security of such exchanges.
Single exchange or multiple ‘stock exchange’?
Through the changes brought about in 2018, SEBI allowed for trading of equities and commodities on a single stock exchange. However, ‘gold trading’ on exchange is different from simple commodity trading of gold. The underlying ‘gold trading through EGR’ will require a different dimension to trading. Hence, it might be a better idea to develop a different exchange for gold trading, regulated by SEBI.
The exercise of opening a different exchange for ‘gold EGR trading’ maybe tedious, but keeping in mind the activity involved, the enhancement and creation of a new market for trading a valuable & retaining the importance of the asset in function (with regards to its liquidity, trading, and delivery), i.e., gold. A reference to the same can be drawn from the fact that after announcement of setting up of the gold exchange-traded funds in China in 2010, the demand for gold in that country for the first quarter of 2011 doubled that of India (surpassing India as the largest market for gold coins and bars).
Fungibility and deliveries
The Paper aims to provide fungibility to vault manager/s wherein gold deposited through one EGR can be delivered against surrender through the other EGR (of-course, relating the same contract specifications). Hence, this ‘inter-operability between vault managers’ would facilitate physical gold deposited at one location and with one ‘vault manager’, and withdrawal from a different location of same or different vault manager. The margins, withdrawal commissions etc. are something SEBI will have to decipher.
Interestingly, the fungibility will also have to take into consideration relative volumes of trading and practicality of the amounts to be delivered. It would be pragmatic for SEBI to lay out certain minimum quantity for delivery/withdrawal. SEBI may consider accrual of up to at-least 20 grams to 50 grams of gold for any withdrawal for delivery to take place. This is important because in case SEBI is considering setting up a different framework for this gold exchange, it would be advisable to have high security for its base delivery centre and additional delivery centre/s.
While the said paper deals with a lot of interesting aspects about gold, the main highlights will follow when the EGRs actually start trading. One feels that apart from the regulatory requirements, discussed above, the quality, standard and purity of gold will have an impact of the success/failure of the trading.
For the retail investor it may present a unique opportunity wherein the old lockers where gold lies as a security gaining no investment, may turn the tide around and be traded on a stock exchange.
The transactions contemplated under the aegis of this new exchange will of course be subject to securities tax and GST. However, for certain small investors, it may be a fruitful notion that government to have good volumes of trading, gives exemptions in GST.
Image Credit - Unsplash.com