Gold is one of the best asset classes that can help you diversify your investment portfolio and beat inflation. Last week, we had prepared a detailed article on five popular methods through which one can invest in gold in India. To recap, you can buy physical gold (in the form of jewellery, coins), invest in digital gold, gold ETFs & mutual funds, and sovereign gold bonds (SGBs). 

Interestingly, the Securities and Exchange Board of India (SEBI) has come out with an exciting proposal for an exchange where people can buy and sell gold in electronic form. Let us learn more about this proposal and learn how a gold exchange would work.

SEBI’s Proposal

India is the second-largest consumer of gold after China, with an annual demand of 800-900 tonnes. We are net importers of the commodity as our gold mining industry is very small or insignificant. Buying gold is considered to be a good omen amongst most Indians, and it does have its own set of benefits. Due to the risks associated with owning physical gold, many are now buying or investing in digital gold and gold ETFs. However, despite securing an important position in global markets, there is no concrete system in India to discover or influence the price of gold.

This is the issue that SEBI wants to address. Through a consultation paper titled “Gold Exchange in India and Draft SEBI (for Vault Managers) Regulations 2021”, the market regulator has proposed to set up a trading exchange for gold in India. Similar to the stock market, where you buy and sell shares of listed companies, a gold exchange will allow you to trade electronic receipts that will have physical gold backing them. When a large number of people buy and sell gold and negotiate on its price, it could provide a better estimate of the true value of gold at a point in time. This can be compared with prices at international gold exchanges or forums and could help us discover the true price of gold.

Retail investors, banks, foreign portfolio investors (FPIs), jewellers, and bullion dealers would be allowed to trade on the gold exchange.

How Will it Work?

When authorized institutions or people import gold into India, the deposits are stored in secure vaults. The owners of these deposits could choose to convert their physical gold into Electronic Gold Receipts (EGRs). For this, the gold has to meet certain standards, and the owner (or vault manager) has to record all relevant information regarding it. They will have to forward and save this data in a common digital interface. Thus, physical gold is converted into digital receipts and is documented on a secure network. Then, a unique code has to be assigned to EGRs so that they can be traded. This unique code is termed as International Securities Identification Number or ISIN.

In India, we have two main depositories that are responsible for maintaining information about tradable financial instruments (such as stocks and bonds). It is the National Securities Depository Ltd (NSDL) and Central Depository Services Ltd (CDSL). It is these depositories that assign a unique code to the EGRs. Finally, you will be able to trade these EGRs on the exchange. At the end of each trading day, the important stakeholders will make sure that all gold is accounted for.

According to the consultation paper, SEBI will be the sole regulator of the gold exchange. There will be three important operations performed at the exchange: 

  1. Conversion of physical gold to Electronic Gold Receipts (EGRs) 
  2. Trading of EGRs, and 
  3. Conversion of EGRs to physical gold.

What is the proposed unit of each EGR?

In the consultation paper, SEBI states that the gold exchange should have EGRs of 1 kilogram, 100 grams, and 50 grams. They might also allow EGRs of smaller denominations, including 10 grams and 5 grams, in the future.

SEBI had already formed working groups to test the transaction flow from physical gold to EGRs and vice versa. They have studied the role of different entities in the flow, such as vault managers and depositories. These groups have also suggested means of verifying the purity of gold and other safety and security measures.

Key Issues/Drawbacks

As mentioned in SEBI’s consultation paper, there are certain drawbacks with respect to this concept. Gold is a commodity and one should ideally be able to exchange the EGR for physical gold. However, this is only possible if a trader has a substantial amount of receipts (or EGRs).

Suppose you are holding 50-gram EGRs and wish to exchange them for physical gold. The vault manager (who holds and manages the physical gold) has to terminate the receipts, request the depository to cancel the entry from their database, and then send 50 grams of gold to you. This has to be done every time a person wishes to convert their EGRs to physical gold. It is a rather long and time-consuming process.

Taxation is another key issue. When EGRs are traded on an exchange, a Securities Transaction Tax (STT) will be levied. Also, GST will be applicable when EGRs are converted into physical gold. However, if the buyer and seller are from different states, the application of state GST will be very complicated. SEBI has suggested that levying Integrated GST (IGST) could resolve this issue.

You can read SEBI’s consultation paper here. Since the proposal is in the consultation phase, you can even mail them your views and ideas on the gold exchange. Let us look forward to seeing how SEBI implements its plans. We will soon be able to trade gold!

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