The International Financial Services Centres Authority (IFSCA) has recently issued a circular on Liquidity Enhancement Scheme for Bullion Exchange on February 04, 2025 allowing the introduction of a Liquidity Enhancement Scheme (LES) for the Bullion Exchange in the International Financial Services Centre (IFSC). This move aims to boost the trading of commodity derivatives contracts, particularly those that may be considered illiquid. Simply put, the LES is designed to encourage more active participation in the market, making it easier for traders to buy and sell bullion-related financial products.
What is the Liquidity Enhancement Scheme (LES)?
The LES is essentially a set of incentives and guidelines that the Bullion Exchange can implement to boost the liquidity of specific commodity derivative contracts. Liquidity, in this context, refers to the ease with which an asset can be bought or sold without significantly affecting its price. Illiquid contracts can be challenging to trade, potentially discouraging participation and hindering market efficiency.
Key highlights of the IFSCA Circular:
- Flexibility for Bullion Exchange: The circular grants Bullion Exchange the autonomy to introduce one or more LES tailored to their specific needs and market conditions.
- Governance and Oversights: The Governing Board of the Bullion Exchange must approve any LES before implementation. The validity of the scheme is set for one year (or less, as decided by the Board), with quarterly reviews to assess its effectiveness.
- Transparency and Fairness: The scheme must be objective, transparent, non-discretionary, and non-discriminatory. This means that the rules and incentives should be clear, accessible to all participants, and applied consistently.
- Incentives Structure: The LES may offer various incentives to market makers, liquidity providers, and related participants.
- Market Integrity Assurance: The scheme should not compromise market integrity or risk management. This is a critical aspect, as the goal is to enhance liquidity without creating opportunities for manipulation or unfair practices.
- Periodic Reviews and Public Disclosure: The Governing Board must review the scheme’s effectiveness quarterly, while half-yearly reports must be submitted to the IFSCA. Additionally, market participants must be informed at least 15 days in advance of any modifications or discontinuation.
- Monthly Reporting: The outcomes of the scheme, such as incentives granted and volumes achieved (market maker-wise and security-wise), must be published on the Bullion Exchange’s website every month.
Which Securities are Eligible under the LES?
The Bullion Exchange has the authority to formulate its own benchmarks for selecting securities for liquidity enhancement, with the primary goal of enhancing liquidity in illiquid securities. Once discontinued, the scheme can be reintroduced on the same security. Furthermore, the list of securities eligible shall be disclosed to the market.
Incentives under LES
The incentives under the LES should be transparent and measurable and can take the following forms:
- Discount in fees, adjustment in fees in other segments, or cash payment
The incentives during a financial year shall not exceed 25% of the net profits or 25% of the free reserves of the Bullion Exchange, whichever is higher, as per the audited financial statements of the preceding financial year.
- However, during the first five years of its operation, the Bullion Exchange can earmark up to 25% of its audited net worth as on the last day of the previous financial year, as the yearly incentives for the LES.
- The Bullion Exchange will create a reserve specifically to meet its LES incentives/expenses and transfer funds to such reserve accordingly, which shall be approved by its Governing Board. Such reserve shall not be included in the calculation of its net worth.
- Shares, including options and warrants, of the Bullion Exchange
The shares that may accrue on exercise of warrants or options, given as incentives under all LES, during a financial year, shall not exceed 25% of the issued and outstanding shares of the Bullion Exchange as on the last day of the preceding financial year. Further, the Bullion Exchange must ensure that this follows the IFSCA (Bullion Market) Regulations, 2025 at all times.
Bullion Exchange to ensure market integrity
Market integrity is a cornerstone of the LES framework. To uphold it, the Bullion Exchange is required implement the following measures:
- Monitor Trading Activity: Strict systems and procedures must be in place to prevent manipulative trades aimed solely at gaining incentives.
- Incentive Restrictions: No incentives will be granted for trades where the counterparty is the same entity (i.e., where the same Unique Client Code (UCC) appears on both sides of a transaction).
- Avoiding Liquidity Drain: The scheme should add liquidity to the market rather than shifting it from other areas, preventing any mis-selling of products.
Role of Market Makers and Liquidity Providers
Market makers and liquidity providers play a crucial role in ensuring continuous trading activity. The Bullion Exchange has to:
- Define and monitor the obligations of market makers/liquidity enhancers.
- Ensure that all orders and trades by liquidity enhancers are identifiable.
- Establish a conflict-of-interest framework, mandating disclosure by liquidity providers participating in the scheme.
- Make these disclosures publicly available on its website.
Implementation and Compliance Requirements
The Bullion Exchange is required to:
- Establish the necessary systems and processes to implement the circular’s provisions.
- Amend relevant byelaws, rules, and regulations to align with the circular.
- Notify its members and publish the circular’s provisions on its website.
- Report the status of implementation to IFSCA.
The introduction of Liquidity Enhancement Schemes (LES) in the Bullion Exchange is a significant step toward fostering a vibrant and liquid bullion market in IFSC.
Disclaimer: The information published in the above newsletter is collected from various sources in electronic medium and analyzed by the firm. The reader is advised to consult the attorney qualified in their jurisdiction, before acting on any information contained in this newsletter. India Juris excepts no liability what so ever in this regard.
