Applicability of Commodity Laws on Crypto Exchanges in India

If the Cryptocurrencies are classified as ‘commodities,’ the exchanges which facilitate the trading of cryptocurrencies might be governed as the ‘commodity’ exchanges, which can have implications under various regulations such as foreign direct investment (FDI)[1]– Consolidated FDI Policy Circular of 2017, and Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations, 2019[2] (TISPROI).

There are two kinds of commodity exchanges, commodity spot exchange- which facilitate purchase and sale of specified commodities, including agricultural commodities, metals and bullion by providing spot delivery contracts in these commodities, and commodity derivative exchanges, which deals with the derivative contracts.

As per the guidelines issued by Government of India Ministry of Commerce & Industry Department of Industrial Policy & Promotion SIA(FC Section), a composite ceiling for foreign investment of 49% was allowed with prior Government approval, subject to the condition that investment under the Portfolio Investment Scheme will be limited to 23% and that under the FDI Scheme will be limited to 26%. Further, no foreign investor/entity including persons acting in concert will hold more than 5% of the equity in these companies.[3]

An exhaustive list of commodities was notified under SCRA[4], and this list does not include the cryptocurrencies. This notification has to be read with clause (bc) of section 2 of the Securities Contracts (Regulation) Act, 1956 (amended), (42 of 1956).[5] The said notification can hence be concluded to only deal with derivative trading market and not with the spot/ ready delivery market.

In IMAI vs RBI[6], the Supreme Court of India opined that, “The argument that other stakeholders such as the Enforcement Directorate which is concerned with money laundering, the Department of Economic Affairs which is concerned with the economic policies of the State, SEBI which is concerned with security contracts and CBDT which is concerned with the tax regime relating to goods and services, did not see any grave threat and that therefore RBI’s reaction is knee-jerk, is not acceptable. Enforcement Directorate can step in only when actual money laundering takes place, since the statutory scheme of Prevention of Money Laundering Act deals with a procedure which is quasi-criminal. SEBI can step in only when the transactions involve securities within the meaning of Section 2(h) of the Securities Contracts (Regulation) Act, 1956. CBDT will come into the picture only when the transaction related to the sale and purchase of taxable goods/commodities. Every one of these stakeholders has a different function to perform and are entitled to have an approach depending upon the prism through which they are obliged to look at the issue. Therefore, RBI cannot be faulted for not adopting the very same approach as that of others. ….”

This judgment has given ample of power to the SCRA to classify the cryptocurrencies as commodities in the future and they are classified as commodities in USA. In 2015, the Commodity Futures Trading Commission or CFTC settled charges against online facility Derivabit and its founder for offering Bitcoin options contracts without complying with the commodity exchange act or CFTC regulations. The provisions of CFTC regulations were applied retrospectively to the cryptocurrencies and the cryptocurrency exchange was held liable with respect to infringement of CFTC guidelines.

The SCRA notification, in all probability should serve as the benchmark with respect to the list, and if the cryptocurrencies are classified as commodity, it would only have prospective effect. However, the central government may at any time choose to notify virtual currencies (in general, or any class of them) as commodities under the above notification. This would bring derivatives contracts in virtual currencies within the SCRA (and hence, SEBI’s jurisdiction). For spot trading, foreign direct investment would then be restricted to 49 per cent of the capital. There is currently no separate licensing regime for commodities spot exchanges. But it should be kept in mind that the central government might issue such notification retrospectively, and the liabilities might be retrospective in nature as was the case in USA with respect to Derivabit.