Cash versus physical settlement in commodity derivatives
In both the cases, the concern raised by the affected parties was regarding the unreliability of futures prices in reflecting underlying fundamental forces. Given that price discovery is one of the primary functions of a commodities exchange, such concerns of stakeholders have to be taken seriously.
There have been discussions in academics, among regulators and even market participants (including commodities exchanges) about ways and means to ensure proper price discovery on the exchanges. Since commodity exchanges take cues and also borrow best practices from the capital market, the recent move by Securities Exchange Board of India (Sebi) to allow physical settlement in equity derivatives and the reported subsequent move by the Bombay Stock Exchange (BSE) to move towards physical settlement (in equity derivatives) should probably offer some food for thought on physical settlement as a mechanism for better price discovery (through convergence of spot prices with the futures).
The Sebiís nod for physical settlement could be a regulatory response
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