1.

COMMODITY AND COMMODITIES MARKET

1.1 Introduction:India, a commodity based economy where two-third of the one billion population depends on agricultural commodities, surprisingly has an under

developed commodity market. Unlike the physical market, futures markets trades in commodity are largely used as risk management (hedging) mechanism on either physical commodity itself or open positions in commodity stock.

Even today, framing is essentially a way of living for rural population. There are many issues related to framing such as excess rains or short fall in rains; pests and diseases; impact of global commodity price fluctuations due to over supply on the domestics market etc., which are known to inflict huge losses but beyond the control of framers. Amongst them, it is the weather-related issues that are

particularly beyond the control of framers and they have a devastating effect on farming and farmers in general.

However, certain risks such those emanating from price fluctuations can be managed by trading in commodities futures exchanges. And this is wDehat Indian farmers need to realize and put to effective practice. Time has arrived for them to no longer treat farming as a vocation, but as a business.

Although trading in futures started in India as early as in 1875 with the establishment of Bombay Cotton Trade Association, and flourished well up to 1960s, it almost came to a halt subsequently owing to various restrictions imposed on commodity futures trading by the Government during 1960s and 1970s. However, with the advent of economic liberalization and opening up of markets to foreign players, the government all intervention in every activity associated with marketing of agricultural commodities such as transportation in every activity associated with
1

marketing of agricultural commodities such

as transportation, storage, credit supply, price determination, and exports, has slowly come down. This process has further been speeded up with the implementation of agreement on agriculture under the World Trade Organization. As a result,

agricultural commodities are facing high price risk. This necessitated development of commodity futures trading in country.

The Kabra committee, set up in 1993 to examine the need for commodity futures trading, recommended its launching and thus futures trading again came existence. commodities. Currently a futures trading is permitted into in all

1.2 COMMODITY DEFINITION

Definition of a commodity Any product that can be used for commerce or an article of commerce which is traded on an authorized commodity exchange is known as commodity. The article should be movable of value, something which is bought or sold and which is produced or used as the subject or barter or sale. In short commodity includes all kinds of goods. Forward Contracts (Regulation) Act (FCRA), 1952 defines goods as every kind of movable property other than actionable claims, money and securities. In current situation, all goods and products of agricultural (including plantation), mineral and fossil origin are allowed for commodity trading recognized under the FCRA. The national commodity exchanges, recognized by Central Government, permits commodities which include precious (gold and silver) and non-ferrous; raw jute and jute goods; sugar and gur; potatoes and onions; Coffee and tea; rubber and spices, Etc. Commodities are an integral part of our life. They form a part of the: Food eat (Pulses, Food grains, Oil & Oil seeds) Clothes we wear (Cotton, Silk) Precious Metals (Gold & Silver)

Different dictionary defines commodity as under: A commodity may be defines as an article, a product or material that is bought and sold. It can be classified as every kind movable property, except Actionable Claims, Money & Securities. Any item can be bought and sold. Taken to refer Exchangetraded item including sugar, wheat, Soya beans, coffee, and tin. That which affords convenience, advantage, or profit, especially in commerce, including

everything movable that is bought and sold (except animals), -- goods, wares, merchandise, produce of land and manufactures, etc. In the world of business, a commodity is an undifferentiated product whose market value arises from the owners right to sell rather to use. Example commodities from the financial would include oil (sold by the barrel), wheat, bulk chemicals such as sulfuric acid and even pork-bellies. Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitrageurs and speculators. Retail

investors, who claim to understand the equity markets, may find commodities an unfathomable market. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically,

pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an portfolio diversification option.

1.3

COMMODITY MARKET AND ITS EVOLUTION IN INDIA

Bombay Cotton Trade Association Ltd., was established in 1893 following organized futures market. Bombay Cotton Exchange Ltd. Was established in1893 following the widespread discontent amongst leading cotton mill owners and merchants over functioning of Bombay Cotton trade Association, The futures trading in oilseeds started in 1900 with the establishment of the Gujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and cotton. Futures trading in wheat was chamber of commerce at Hapur set up in 1913. Futures trading in bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and jute goods. But organized futures trading in raw jute began only in Mumbai in 1920.Calcuta Hessian Exchange Ltd. These two associations

amalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct organized trading in both Raw Jute goods. Forward Contract Regulation Act was enacted 19532 and the Forward Markets Commission(FMC) was established in 1953 under the Ministry of Consumer Affairs and public Distribution . In due course, several other exchanges were created in the country to trade in diverse commodities.

Commodity market is an important constituent of the financial markets of any country. It is the market where a wide range of products, viz., precious metals, base metals, crude oil, energy and soft commodities like palm oil, coffee etc. are traded. It is important to development vibrant, active and liquid commodity market. This would help

investors hedge their commodity risk, take speculative positions in commodities and exploit arbitrage opportunities in the market.

1.4 LATEST INTRODUCTIONS IN THE COMMODITIES MARKET

According to the latest circular, demat account facilities have been opened for the members of MCX. The members were informed about the facility of converting the physical warehouse receipt into the electronic (demate) formed and also the

requirements of opening the demate accounts both by the members and their clients. The Exchange has advised the members to open the Clearing member (CM Pool) accounts with both the depositories.

The government

has changed the regulations in the commodity exchange. Form

earlier policies of allowing corporate to hedge only a fraction of their physical market exposure, corporate can now almost double their participation in commodity exchanges. Extra limit on hedging will apply to domestic as international traders, who are trading from India. Apart from corporate this will also encourage participation from

speculation thanks to a possible deepening of the market in the coming days. Speculators will get more flexibility to cover up their open positions. Corporate until now could only trade within an upper ceiling fixed by the regulator and exchanges. Under the new system a corporate can now trade twice its earlier permissible limit if it can substantiate that the extra trading is used to hedge the price risk.

Another development is that the APMC market at New Mumbai has become the first agri-commodity market to go live with the electronic price & information

dissemination system. On June 14,2005, National Spot Exchange for Agriculture Produce (NSEAP) and Multi Commodity Exchange of India Ltd. (MCX) launched Indias first ever Commodity Suchana Kendra a knowledge centre of commodities from spot and futures market price & information on fundamentals. The aim is to link the markets electronically in phases to create a Common Indian Market as being envisioned by the

Union Government. The Commodity Suchana Kendra will display spot and futures commodity prices and also Indias first composite Commodity Futures Index MCX COMOEX. Computed & displayed on a real time basis. NSEAP plans to set up commodity Suchana Kendra at all APMC markets which would link all the agriculture physical market players over a period of time. It would also help in linking the support infrastructure from a single point access, thereby enabling to get all the assistance normally required for buying, ``selling, storing, transporting and payment of commodities. This is the first phase of implementation where NSEAP is interlinking all key APMC market electronically. In the second stage, the network established by NSEAP & MCX will be used by farmers, co-operative and intermediaries in the APMC for trading in commodities. Commodity specific grades, quality standards and delivery & settlement mechanism shall be laid down by NSEAP. The initiative by NSEAP will integrate the fragmented markets, create a new distribution channel for procurement & sale and enhance

consumer-producer interaction with minimum intermediation, thereby truly integrating the rural India The Next Green Revolution. Electronically networking the producers & consumers of agriculture commodities will help in creating a common nationwide market. In the long run it will enable and empower the farmers to sell their producer at

The future for commodity market is bright. It is noteworthy that the commodity and equity markets have been moving in tandem, bucking the global market trend. The growth of a sizeable section of the middle class with increasing disposable incomes has led to a hike in consumer spend in consumer spend in India, Markets due to a slowdown in flows from foreign funds and high crude prices, the trend for commodities still appears healthy. Since the commodity cycle is normally for 10-15 years, the consensus is that Strong demand for commodities will comfortably continue for another 10 years. The strong local demand for metals is expected to grow the commodities market and industry by about 7 to 8 per cent, while high purchasing power will boost consumer spending, whereas with crude price nearing record levels, there are fears that the equity market could crack in the near term.

1.5 STRUCTURE OF COMMODITY MARKET

Ministry of Consumer Affairs FM C

Commodity Exchanges

National Exchange

Regional Exchanges

NCDE

MCX

NMCE

NBOT

28 other Regional

10

2 Forward Markets Commission (FMC):Forward Markets Commission (FMC) headquartered at Mumbai is a

regulatory authority, which is overseen by the Ministry of consumer Affairs and Public Distribution, Govt. of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952.

The act Provides that Commission shall consist of not less then two but not exceeding four members appointed by the Central Government out of them being nominated by the Central Government to be the Chairman thereof. Currently Commission comprises three members among whom Dr. Kewal ram, IES, is Acting as chairman and Smt. Padma Swaminathan, CSS and Dr. (Smt.) Jayashree Gupta, CSS, are the Members of the Commission.

The functions of Forward Markets Commission are as follows: (a) To advise the Central Government in respect of the recognition or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of the Forward Contracts

(Recognition) Act 1952.

(b)

To keep forward markets under observation and to take such action in relation to them, as it may consider necessary, in exercise of the powers assigned to it by or under the Act.

(c)

To collect and whenever the commission thinks it necessary, to publish information regarding the trading conditions in respect if goods to which any of the provisions of the act is made applicable, including information regarding supply, demand and prices, and to submit to the Central Government, periodical reports on the working of forward markets relating
11

to such goods.

12

(d)

To

make

recommendations

generally

with

view

to

improving

the

organization and working of forward markets.

(e)

To undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considerers it necessary.

13

3 DIFFERENT SEGMENTS IN COMMODITIES MARKET

The commodities market exits in two distinct forms namely the 1.Over the Counter (OTC) market 2. Exchange based market:Also, as in equities, there exists the spot and the derivatives segment. The spot markets are essentially over the counter markets and the participation is restricted to people who are involved with that commodity say the farmer, processor, wholesaler etc. Derivative trading takes place through exchange- based markets with standardized contracts, settlements etc.

14

3.1 DIFFERENT TYPES OF COMMODITIES TRADED

Commodity Markets

Precious Metals

Other Metals

Agriculture

Energy

World- over one will find that a market exits for almost all the commodities known to us. These commodities can be broadly classified into the following:

15

Commodities Segment Wise:-

COMMODITIES

Metals

Edible Oils

Softs

Agri. Comm.

Gold Siler Steel

Crude Palm Oil Soy Oil Mustard Oil

Cotton Sugar Silk Gur

Wheat Guar Seed Soy Beans Castor Mustard Urad Rice

Chana Etc.

16

Precious Metals Other Metals Agro- Based Commodities Soft Commodities Live-Stock Energy

Gold, Silver, Platinum etc Nickel, Aluminum, Copper etc Wheat, Corn, Cotton, Oils, Oilseeds. Coffee, Cocoa, Sugar etc Live Cattle, Pork Bellies etc Crude Oil, Natural Gas, Gasoline etc

17

4 .LEADING COMMODITY MARKETS OF WORLD

What are commodities exchanges? Commodity exchanges are institutions which provide a platform for trading in commodity futures just as how stock markets provide space for trading in equities and their derivatives. They thus play a critical role in robust price discovery where several buyers and sellers interact and determine the most efficient price for the product. Indian commodity exchanges offer trading in commodity futures in a number of commodities. Presently, the regulator, Forward Markets Commission allows futures trading in over 120

commodities. There are two types of commodity exchanges in the country-3 national level and 21 regional.

Some of the leading exchanges of the world are New York Mercantile Exchange (NYMEX), the London Metal Exchange (LME) and the Chicago Board of Trade (CBOT).

18

4.1 LEADING COMMODITY MARKETS OF INDIA

The government has now allowed national commodity exchanges, similar to the BSE & NSE, to come up and let them deal in commodity derivatives in an electronic trading environment, these exchanges are expected for trading. The Forward Markets Commission (FMC) will regulate these exchanges.

The number of commodity exchanges (comexes) in the country and their current state of affairs:-

There are as many as 25 exchanges functioning across the country where futures trading are taking place in about 78 commodities. These exchanges operate

independently under the direction, guidance and control of their respective board of directors. Essentially a commodity exchange is responsible for facilitating trading in futures, fixing of ours of trade, recording trading prices, clearing services, collecting margins, assigning delivery orders and providing arbitration support, wherever required. Trading in futures contracts is carried out through open outcry system and positions are settled daily. Online trading facilities are of late being offered by major exchanges. Some commodity exchanges have also initiated warehouses receipt system-based deliveries. These exchanges function under the watchful eyes of the Forward Markets Commission that performs the functions of advisory, monetary supervision and regulation of fitures and forward trading.

There is a general feeling that the commodity exchanges are not functioning properly. Also, there is general ignorance about their working. The feeling is not entirely unfounded.

19

There are some exchanges which are working well, but some do need to improve their working. But the fact that there has been a prolonged prohibition on futures trading in a majority of agricultural commodities cannot be overlooked. The prohibition of futures trading in most of the agricultural commodities has both been the cause

and the effect of the current state of affairs the commodity exchanges.

Also, this prohibition led to reduced volumes of trading on these commodity exchanges. Consequently, this resulted in the poor financial position of these exchanges and poor service to members. It is has also led to arguments that as the exchanges are not strong and self-supporting, futures trading should not be resumed in more commodities.

But it is important that this deadlock be broken. The lead, however, has to be taken by both commodity exchanges (in improving their working conditions) and by the government (by liberalizing its policy regarding permitting futures trading in additional commodities).

The government has, in the last two years, already taken some steps in the area of permitting futures trading in additional commodities. The exchanges are also making attempts to improve their working. Both these steps should lead to greater confidence about the role of futures trading and the capabilities of commodity exchanges to conduct such trading.

20

4.2 Why Trade in Commodity Exchanges

No counter party risks. Higher Leverage: Get high exposures for the margin provided. Prices are pegged to international markets of NYMEX, CBOT, CME, LME etc., Portfolio diversification: An investor can now diversify his portfolio by investing in commodities markets. Arbitrage opportunities: Take the advantage of price spreads, calendar spreads and Inter exchange spreads.

21

4.3 What needs to be done to improve comexes.

FMC has been emphasizing upon the commodity exchanges the need to improve their working. We have been working in this direction jointly with the authorities of the commodity exchanges for the last two years. With this, the crucial areas in the working of exchanges are:

1) 2) 3) 4) 5)

improving the trading condition ensuring security of contracts, improving the financial position of the exchange, strengthening the administrative structure and Reactivating arbitration and quality assurance mechanisms so that the exchanges become vibrant self-regulatory organizations.

Also the comexes are taking their own steps, though the pace may differ from one exchange to the other. Improved working would be the best way to promote business and create increased and wider awareness about futures trading. One area development would be to have a common set of by laws for all the exchanges so that a member of one exchange can trade on other exchanges. It may be worthwhile for commodity exchange to take up trading in more than one commodity and develop themselves as institutions for future trading in several commodities. This will be possible when futures trading in additional commodities are permitted and after the exchange have improved their working. However, for this they need to first improve their functioning.

22

Whether comexes face closure with non-renewal of their registration, if the functioning is not improved.

There may not be an occasion to close down any exchange, though in the normal course it is likely that some exchanges may not be able to improve their working and may become inoperative or close down on their own. Apart from periodic reviews of the working of exchanges, at the time of renewal of recognition, the performance of commodity exchanges is reviewed and this practice will continue. If it is found that any exchange has not performed properly, its recognition may not be renewed.

The current market turnover of Indias commodity exchanges.

Even though there are 25 comexes in the country, futures trading is permitted trading (since 1980) for only six commodities. These six commodities are: pepper, turmeric, castor seed, gur (jiggery), potato, and Hessian . The total annual volume of trading in these six commodities is about Rs 27000crore, while the annual of production of the six commodities is about Rs 12500 crore per annum. Thus the volume of trading is slightly more than twice the annual production. However there are variations from commodity to commodity in the case of Hessian the volume of trading is 14 times the production whereas in the case of potatoes the volume of trading is insignificant compared to the production of more than Rs 5,000 crore.

Various types of contracts permitted on the comexes,

Of the

25

commodity

exchanges,

eight

are

dealing

exclusively

with

non-

transferable specific delivery contracts in cotton. The largest numbers of exchanges 10 are organizing futures trading in gur. Three of these exchanges are also recognized for conducting futures trading in potato. Three
23

exchanges are organizing futures trading in castor seed (Ahmedabad, Rajkot and Mumbai).

There is only one exchange (each) for trading in futures contracts in pepper (Kochi), turmeric (Sangli) and Hessian (Calcutta). The exchange organizing futures trading in Hessian is also organizing trading in transferable and non- transferable specific delivery contracts in raw jute and jute goods.

Till

the

early

1960s,

futures

trading

were

permitted

in

number

of

commodities, including edible as well as non-edible oilseeds/oils/oilcakes, raw jute, jute goods, cotton, spices, etc.

From

the mid-1960s onwards futures trading in a number of commodities came to be

prohibited, leading ultimately to a situation where futures were permitted in only two commoditiespepper and turmeric.

In addition, non-transferable specific delivery (NTSD) contracts are allowed in cotton; and transferable specific delivery contracts and also NTSD contracts are allowed in raw jute, jute goods.

24

5 .MCX (Multi Commodity Exchange) MCX :Headquartered in the financial capital of India, Mumbai, Multi Commodity Exchange of India Ltd (www.mcxindia.com) is a demutualised nationwide electronic commodity futures exchange set up by Financial Technologies (India) Ltd. with permanent recognition from Government of India for facilitating online trading, clearing &

settlement operations for futures market across the country. The exchange started operations in November 2003.

MCX has achieved three ISO certifications including ISO 9001:2000 for quality management, ISO 27001:2005 - for information security management systems and ISO 14001:2004 for environment management systems. MCX offers futures trading in more than 40 commodities from various market segments including bullion, energy, ferrous and non-ferrous metals, oil and oil seeds, cereal, pulses, plantation, spices, plastic and fibre. The exchange strives to be at the forefront of developments in the commodities futures industry and has forged strategic alliances with various leading International Exchanges, including Tokyo Commodity Exchange, Chicago Climate Exchange, London Metal Exchange, New York Mercantile Exchange, Bursa Malaysia

Derivatives, Berhad and others.

25

MCX deals in following Commodities.

Commodities

Bullion Oil &

Gold, Gold HNI, I-Gold, Silver, Silver HNI, Silver M Caster Oil, Caster Seeds, Caster Seeds (Disa), Cottonseed, Crude Palm Oil, Groundnut Oil, Kapasia Khalli (Cottonseed Oilcake), Mustard Seed (Hapur), Mustard seed (Jaipur),

Oilseeds

Mustard/Rapeseed Oil, Mustard Seed (Sirsa), RBD Palmolein, Refined Soy Oil, Sesame Seed, Soy meal, Soy Seeds. Spices Metals Cardamom, Jeera, Pepper, Red Chilli, Turmeric Aluminum, Copper, Nickel, Sponge Iron, Steel Flat, Steel Long ((Bhavnagar), Steel Long (Gobingarh), Tin Pulses Cereals Energy Plants Chemicals Others Chana, Masur, Tur, Urad, Yellow Peas, Basmati Rice, Mize, Rice, Sarbati Brent Crude Oil, Crude Oil, Furnace Oil Cashew Kernel, Rubber High Density Polyethylene (HDPE), Polypropylene (PP), Guar Seed, Guar gum, Gurchaku, Mentha Oil, Sugar M-30, Sugar S-30,

26

6.
NCDEX:-

National

Commodity

&

Derivatives

Exchange

Limited

(NCDEX)

is

professionally managed online multi commodity exchange promoted by ICICI Bank Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India Limited (NSE). Punjab National Bank (PNB), CRICIL Limited (formerly the Credit Rating Information Services of India Limited), Indian Farmers Fertilizer Cooperative Limited (IFFCO) and Canara Bank by subscribing to the equity shares have joined the initial promoters as shareholders of the Exchange. NCDEX is the only commodity exchange in the country promoted by national level institutions. This unique parentage enbles it to offer a bouquet of benefits, which are currently in short supply in the commodity markets. The institutional promoters of NCDEX are prominent players in their respective fields and bring with them institutional building experience, trust, nationwide reach, technology and risk management skills.

NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of

Business on May 9, 2003. It commenced its operations on December 15, 2003.

NCDEX

is

nation-level,

technology

driven

de-mutualised

on-line
27

commodity exchange with an independent Board of Directors and professional management - both not having any vested interest in commodity markets. It is committed to provide a world-class commodity exchange platform for market

28

participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency.

NCDEX is regulated by Forward Markets Commission. NCDEX is subjected to various laws of the land like the Forward Contracts (Regulation) Act, Companies Act, Stamp Act, Contract Act and various other legislations.

NCDEX is located in Mumbai and offers facilities to its members about 550 centers throughout India. The reach will gradually be expanded to more centers.

NCDEX currently facilitates trading of

57 commodities -

29

6.1

NCDEX deals in following Commodities.

NCDEX Futures Contract Specifications:AgroProducts: Cashew Chana Coffee Arabica Common Raw Rice Crude Palm Oil Expeller Mustard Oil Grade A Raw Rice Groundnut Expeller Oil Guar Seeds Jeera Lemon Tur Indian Raw Rice Indian 31 mm Cotton Masoor Grain Bold Mentha Oil Mulberry Raw Silk Pepper Rapessed-Muatrd Seed Oilcake Refined Soy Oil Sesame Seeds Sugar Turmeric V-797 Kapas Yellow Peas Castor Seed Chilli Coffee Robusta Common Parboiled Rice Cottonseed Oilcake Grade A Parboiled Rice Groundnut (in Shell) Guar gum Gur Jute sacking bags Indian Parboiled Rice Indian 28 mm Cotton Maharashtra Lal Tur Medium Staple Cotton Mulberry Green Cocoons Mustard Seed Raw Jute RBD Palmolein Rubber Soya bean Yellow Soybean Meal Urad Wheat Yellow Red Maize
30

Base Metals: Electrolytic Copper Cathode Mild Steel Ingots Sponge Iron

Precious Metals: Gold Silver

NCDEX Energy: Brent Crude Oil Furnace Oil

31

7.
NMCE :In response to the Press Note issued by the Government of India during May1999 first state-of-the art demutualised multi-commodity Exchange, National Multi Commodity Exchange of India Ltd. (NMCE) was promoted by commodityrelevant public intuitions, viz., Central Warehousing Corporation (CWC), National Agricultural Cooperative Marketing Federation of India (NAFED), Gujarat AgroIndustries Corporation Limited (GAICL), Gujarat State Marketing Board (GSAMB), Agricultural National Institute of

Agricultural Marketing (NIAM), and Neptune Overseas Limited (NOL). While various integral aspects of commodity economy, viz., warehousing, cooperatives, private and public sector marketing of agricultural commodities, research and training were adequately addressed in structuring the Exchange, finance was still a vital missing link. Punjab National Bank (PNB) took equity of the Exchange to establish that linkage. Even today, NMCE is the only Exchange in India to have such investment and technical support from the commodity relevant institutions. These institutions are represented on the Board of directors of the Exchange and also on various committees set up by the Exchange to ensure good corporate governance. Some of them have also lent their personnel to provide technical support to the Exchange management. The day-to-day operations of the Exchange are managed by the experienced and qualified professionals with impeccable integrity and expertise. None of them have any trading interest. The structure of NMCE is impossible to replicate in India.

32

NMCE is unique in many other respects. It is a zero-debt company; following widely accepted prudent accounting and auditing practices. It has robust delivery

mechanism making it the most suitable for the participants in the physical commodity markets. The exchange does not compromise interest guide the functioning of the Exchange. It has also established fair and transparent rule-based procedures and demonstrated total commitment towards eliminating any conflicts of interest. It is the only Commodity Exchange in the world to have received ISO 9001:2000 certification from British Standard Institutions (BSI).

NMCE commenced futures trading in 24 commodities on 26th November, 2002 on a national \scale and the basket of commodities has grown substantially since then to include cash crops, food grains, plantations, spices, oil seeds, metals & bullion among others. Research Desk of NMCE is constantly in the process of identifying the hedging needs of the also made immense contribution awareness about and in raising

catalyzing implementation of

policy reforms in the commodity sector. NMCE was the first Exchange to take up the, issue of differential treatment of speculative brokers in commodity derivatives market. It was the Exchange, which showed a way to introduce warehouse receipt system within existing legal and regulatory framework. It was the first Exchange to complete the contractual groundwork for dematerialization of the warehouse receipts. Innovation is the way of life at NMCE.

33

A CLOSE LOOK AT NMCE:

NMCE facilities electronic derivatives trading through robust and tested trading platform, Derivatives Trading Settlement System (DTSS), provided by NMCE.

When an order is placed on the exchange, the server at NMCE scans through the orders posted on it from all its trading terminals. It then locates and matches the best counter-offers/bids by maintaining anonymity of the counter- parties. Anonymity helps is eliminating formation of cartels and other unfair practices, thereby protecting the efficiency of price-discovery at the Exchange. NMCE was the first commodity exchange to provide trading facility through internet, through Virtual Private Network (VPN).

34

8. COMMODITY FUTURES TRADING IN INDIA

8.1 INTRODUCTION
Derivatives as a tool for managing risk first originated in the Commodities markets. They were then fo und useful as a hedging tool in financial market as well. The basic concept of a derivative contract remains the whether underlying happens to be a commodity or a financial asset. However there are some features, which are very peculiar to

commodity derivative markets. In the case of financial derivatives, most of these contracts are cash settled. Even in the case of physical settlement, financial assets are not bulky and do not need special facility for storage. Due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates the need for warehousing. Similarly, the concept of varying quality of asset does not really exist as far as financial underlying are concerned. However in the case of commodities, the quality of the asset underlying a contract can vary largely. This becomes an important issue to be managed.

The weakness of the commodity, futures market, in India impact on the farmers income and interest. For instance, though India is the largest producer of castor seeds, accounting for 70% of the global production, the country has an insignificant role in determining prices, which are decided in the futures markets at Rotterdam. Similarly in the case of gold, where India is the largest consumer, the ability to influence global prices of the product is limited because of lack of efficient market mechanisms in the country.

35

8.2 . The role of futures trading in commodities.

Futures trading perform two important economic functions, namely, price discovery and price risk management. Also, futures trading reduce the amplitude of

fluctuation in the prices of the concerned commodity though variations in prices continue. It is useful for segments of the economy, directly or indirectly.

For the producer, the exporter, the importer and the processor it is directly useful. They can take decisions based on prevailing futures prices and, thereafter, cover their risks by hedging in the futures markets. For a small grower/producer, even if he does not wish to hedge his risks, the futures markets give an idea of the price likely to prevail and he can make his decisions accordingly. This is borne out by the experience of small cultivators enquiring about futures and ready prices of trading in recognized exchanges when they bring their produce for marketing to the agricultural markets.

8.3. Characteristics of Commodity Futures Contracts

Futures contracts are an improved variant of forward contracts. They are agreements to purchase or sell a given quantity of a commodity at a predetermined price, with settlement expected to take place at a future date. The futures contracts as against forwards are standardized in terms of quantity, and quantity, and place and of delivery of the commodity.

36

The commodity futures contracts in India as defined by the FMC has

the following features (Forward Markets Commission, 2000):

(a)

Trading in futures is necessarily organized under the auspices of a recognized

association so that such trading is confined to or conducted through members of the association in accordance with the procedure laid down in the Rules and bye-laws of the association.

(b)

It is invariably entered into for a standard variety known as the basis variety

with permission to deliver other identified varieties known as tender able varieties.

(c)

The units of price quotation and trading are fixed in these contracts, parties to

the contracts not being capable of altering these units.

(d)

The delivery periods are specified.

(e)

The seller in a futures market has the choice to decide whether to deliver

goods against outstanding sale contracts. In case he decides to deliver goods, he can do so not only at the location of the Association through which trading is organized but also at a number of other pre-specified delivery centers.

(f)

In futures market actual delivery of goods takes place only in a very cases.

37

Transactions are mostly squared up before the due date of the contract and contracts are settled by payment of differences without any physical delivery taking place. The terms and specifications of futures contracts however vary depending on the commodity and the exchange in which it is traded. These terms are standardized and applicable across the trading community in the respective exchanges and are framed to promote trade in the respective commodity. for example, the contract size is important money better management of risk by the customer. It has implications for amount of money that can be gained or lost relative to a given change price levels. It alos affects the margins required and the commission charged.

38

8.4 Regulation of Commodity Futures

Merchandising and stockholding of many commodities in India have always been regulated through various legislations like FCRA, 1952; ECA, 1955 and Prevention of Black-marketing and Maintains of Supplies of commodities Act, (PBMSCA) 1980.The ECA, 1955 gives powers to control production, supply, distribution, etc. of essential commodities for maintaining or increasing supplies and for securing their equitable distribution and availability at fair prices. Using the powers under the ECA, 1955 various Ministries/Departments of the Central Government have issued control orders

for regulating production/distribution/quality

aspects/movement etc.

pertaining to the commodities which are essential and administered by them. Currently, 29 commodity groups have been declared essential under the hoarding and black- marketing etc., in essential commodities. It is being implemented by state government to detain persons who obstruct the supplies of essential

commodities. The FCRA, 1952 provided for 3 tier regulatory system for commodity futures trading in India: (a) an association recognized by the Government of India on the recommendation of FMC, (b) the FMC and (c) the Central Government (Deportment of Consumer Affairs).

Stock Exchanges and futures markets being a part the union list their regulation is the responsibility of the central government. All types of forward contracts in India are governed by the previsions of the FCRA, 1952. The Act divides commodities into

three categories with reference to extent of regulation, viz., (a) the commodities in which futures trading can be organized under the auspices of recognized association, (b) the commodities in which futures trading is prohibited and (c) the free commodities which are neither regulated nor prohibited. While options in goods are prohibited by the FCRA, 1952, the ready delivery contracts remain outside its purview. The ready delivery contract as defined by the Act is the one which provides for the delivery of goods and payment of a price thereof, either immediately or within a period not exceeding eleven
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days after the date of the contract.

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8.5

BENEFITS TO INDUSTRY FROM FUTURES TRADING

Hedging the price risk associated with futures contractual commodities. Spaced out purchases possible rather than cash purchases and its storage. Efficient price discovery prevents seasonal price volatility. Greater flexibility, certainty and transparency in procuring commodities would aid lending. Facilitate informed lending. Hedged positions of producers and processors would reduce the risk of default faced by banks. Lending for agricultural sector would go up with greater transparency in pricing and storage. Commodity Exchanges to act as distribution network to retail agri- finance from Banks to rural households. Provides trading limit finance to Traders in Commodities Exchanges.

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8.6

BENEFITS TO EXCHANGE MEMBER

Access to a huge potential market much greater than the securities and cash market in commodities. Robust, scalable, state-of-art technology development. Member can trade in multiple commodities from a single point, on real time basis. Traders would be trained to be rural Advisors and Commodity Specialists and through them multiple rural needs would be met, like bank credit,

information dissemination, etc.

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8.7

WHY COMMODITY FUTURES?

One answer that is heard in the financial sector is we need commodity futures markets are that we will have volumes, brokerage fees, and something to trade. I think that is missing the point. We have to look at futures markets in a bigger perspective what is the role for commodity futures in Indias economy? In India agriculture has traditionally been an area with heavy government intervention. Government intervenes by trying to maintain buffer stocks, they try to fix prices, and they have import-export restriction and a host of other interventions. Many economists think that we could have major benefits from liberalization of the agricultural sector. In this case, the question arises about who will maintain the buffer stock, how will we smoothen the price fluctuations, how will farmers not be vulnerable that tomorrow the price will crash when the crop comes out, how will farmers get signals that in the future there will be a great for wheat or rice. In all these aspects the futures markets has a very big role to play. If you think there will be a shortage of wheat tomorrow, the futures prices will go up today, and it will carry signals back to the farmer making sowing decisions today. In this fashion, a system of futures markets will improve cropping patterns. Next, if I am growing wheat and am worried that by the time the harvest comes out prices will go down, then I can sell my wheat on the futures markets. I can sell my wheat at a price, which is fixed today, which eliminates my fluctuations. These days, agriculture risk requires from price investments

farmers spend money on fertilizers, high yielding varieties, etc. they are worried when making these investments that by the time the crop comes prices might have dropped, resulting in losses. Thus farmer would like to lock in his future price and not be exposed to fluctuations in prices.

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The third is the role about storage. Today we have the Food Corporation of India, which is doing a huge job of storage, and it is a system, which in my opinion does not work. Futures market will produce their own kind of smoothing between the present and the future. If the future price is high and the present price is low, an arbitrager will buy today and sell in the future. The converse is also true, thus if the future price is low the arbitrageur will buy in the futures market. These activities produce their own optional buffer stocks, smooth prices. They also work very effectively when there is trade in agricultural commodities; arbitrageurs on the futures market will use imports and exports to smooth India prices using foreign spot markets. In totality, commodity futures markets are a part and parcel of a program for agricultural liberalization. Many agriculture economists understand the need of

liberalization in the sector. Futures markets are an instrument for achieving that liberalization. Price-uncertainty is the age-old liberalization has further problem faced by farmers. The ongoing transmission of

accentuated

the problem by

international commodities price volatility into domestic market. Trading in commodity futures comes handy for farmers to lock-in a price well in advance of harvesting. The volumes in derivatives market are pretty low today.

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9 . The following table indicates the total volume and value of trade during the quarter (January to March 2012) in the major commodity exchanges.
Volume Of Trade Value (` in Name of Exchange (In lakh Crore) tons) Multi Commodity Exchange of1927.92 3616406.37 India Ltd., Mumbai National Commodity Derivatives Exchange Ltd., Mumbai &1164.82 522656.53 % share (In value terms) 82.13

11.87

National Multi Commodity 196.47 Exchange of India Ltd., Ahmedabad Indian Commodity Exchange Ltd., 80.65 Mumbai ACE Derivatives & Commodity Exchange Ltd., Mumbai Total of top 5 exchanges others Grand total 83.94

147717.97

3.35

60364.74 39526.43

1.37 0.90

3453.80 31.41 3485.21

4386672.05 16577.04 4403249.09

99.62 0.38 100

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10. Volume & Value of Trading in Various Commodities for the year 2012-13(April-March)

Volume & Value of Trading in Various Commodities for the year 2012-13(April-March) (Volume of Trading in Lakh Tonnes & Value in ` Crore) Sl.No I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 (A) 22 23 24 25 26 27 28 29 30 31 32 Name of the Commodity Agricultural Commodities Food Items Chana/Gram Refined Soya oil Pepper Jeera (Cumin seed) Red Chilli Soya bean/seed Rape/Mustard Seed Wheat Potato Turmeric Sugar Gur Cardamom Maize Feed Barly Coffee Rep Bulk Coriander/Dhaniya Crude Palm Oil Copra Coconut oil RBD palmolein Total of Above Non Food Items Mentha Oil Castor seed Kapas Rubber Raw jute Cotton seed Oilcake / Kapasia Khali Sacking Isabgul Seed Cotton Almond Soymeal 7.04 253.72 102.36 5.17 61.85 433.95 22.92 22.14 22.69 0.001 27.01 96189.51 97559.41 49972.61 9190.15 16444.35 60826.37 12585.66 12225.24 22735.43 2.67 7854.88 367.76 922.91 8.21 43.20 17.57 646.45 476.40 36.33 50.01 54.95 58.77 21.10 2.04 74.81 38.21 12.77 90.77 202.72 8.21 0.01 4.76 3137.96 192797.61 5237.38 5037.96 28320.90 19298.42 6178.36 22410.53 10499.61 5430.05 17375.18 47388.51 101530.72 3515.67 5.49 2488.50 1634777.67 32644.67 62988.75 10136.75 227850.82 157720.75 675921.03 2012-13(Upto Feb'13) Volume Value

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(B) (A+ B) II 1 2 3 III IV V VI

Total of Above Total Agri-Commodities Bullion Gold Silver Platinum Total of Above Metals Energy Plastics Other Grant Total (I to VI)

958.84 4096.80 0.11 6.68 0.00 6.80 1547.62 7783.84 0.00 0.01 13435.06 0.00 1.28 0.00

385586.26 2020363.93 3470339.85 3855870.92 7326210.77 2995168.46 3441095.70

15782840.14

Note: Natural Gas & Gasoline volumes are not included in the Total Volume.

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