The International Financial Services Centres Authority (IFSCA) has recently introduced a significant initiative to enhance liquidity in the bullion market through the Liquidity Enhancement Scheme (LES). This decision is aimed at boosting market efficiency and providing better opportunities for investors and market participants. The scheme focuses on improving the liquidity of illiquid commodity derivatives contracts, a crucial development for the Bullion Exchange in the International Financial Services Centre (IFSC).
What is the Liquidity Enhancement Scheme (LES)?
The LES is a mechanism designed to increase the liquidity of commodity derivatives contracts, specifically those related to bullion. The scheme allows the Bullion Exchange to offer incentives to market makers, liquidity providers, and other participants who contribute to enhancing liquidity in the market. By improving liquidity, the scheme helps ensure smoother market operations, more efficient price discovery, and better risk management.
Key Features of the Liquidity Enhancement Scheme
Approval and Monitoring:
The Bullion Exchange must get prior approval from its Governing Board before implementing the LES. This approval will be valid for one year, and the effectiveness of the scheme will be monitored quarterly by the Governing Board. The Bullion Exchange must also submit reports to the IFSCA, including the Governing Board’s comments, on a half-yearly basis.
Objective and Transparent Incentives:
One of the core principles of the LES is that it should be objective, transparent, non-discretionary, and non-discriminatory. The Bullion Exchange is required to specify the types of incentives available to market makers and liquidity providers, such as discounts on fees, cash payments, or shares and warrants.
Market Integrity:
The scheme is designed to maintain the integrity of the market. There are safeguards in place to prevent manipulation and ensure that incentives are not misused. For instance, trades made solely to earn incentives or trades involving the same client on both sides of a transaction will not be eligible for incentives.
Incentive Limits:
To maintain the financial health of the Bullion Exchange, the total incentives granted under the scheme are capped. The incentives for a given financial year cannot exceed 25% of the net profits or free reserves of the Bullion Exchange, whichever is higher, based on audited financial statements from the previous year. During the first five years of its operation, the Bullion Exchange can earmark up to 25% of its net worth to fund LES incentives.
Disclosures and Monitoring:
The Bullion Exchange is required to disclose any modifications or discontinuations of the LES at least 15 days in advance to ensure that market participants are well-informed. Additionally, the outcomes of the scheme, including the volume and incentives granted to market makers, will be published monthly on the Bullion Exchange’s website.
Eligible Securities:
The Bullion Exchange will determine the criteria for selecting the securities eligible for the LES. These will generally be illiquid securities, and the scheme can be re-introduced for the same securities once it is discontinued. The exchange must also publish the list of eligible securities for transparency.
Why is the LES Important for the Bullion Market?
The bullion market, particularly in emerging financial hubs like the IFSC, faces challenges in ensuring consistent liquidity in commodity derivatives contracts. The introduction of the LES is a significant step to address this issue. By offering targeted incentives, the scheme encourages market participants to engage more actively, thereby improving trading volumes and price efficiency. This is particularly vital for illiquid commodities, where market participation can sometimes be low, leading to wider bid-ask spreads and less accurate pricing.
Moreover, the LES will help bolster investor confidence in the market by ensuring transparency and fairness in the allocation of incentives. The checks and balances incorporated into the scheme, such as monitoring for potential market manipulation and misuse of incentives, further support market integrity.
