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Commodity Futures and Regulation

A Vibrant Market Looking for a Powerful Regulator

K G SAHADEVAN

Introduction
The Forward Contracts (Regulation) Amendment Bill,
2010 is critical to commodity futures markets and the
farm sector in India forthree reasons. One, it is risky for
Commodity
Commodity nificantIndia
India lifted
liftedgrowth nificant
the futures the prohibition
prohibition ingrowth
on futures the lastin
marketstrading in the
decade. lastfuturesdecade.
in on India
com- TheGovernment
The have trading Government
witnessed in com- sig-ofof
an agrarian country to liberalise internal modities
trade in
in April 2003 with the objective of liberalising do-
commodities without a powerful regulatormestic trading
in inplace.commodities, asTwo,
envisaged in the National
lending institutions do not consider commodities as a policy shift, coupled
Agricultural Policy, 2000. This major
with the government's decision to allow national online
standard asset class because they lack back-end
futures exchanges the same year, triggered the growth of
infrastructure and well-regulated liquid markets.
trade in commodity futures Three,
on an unprecedented scale.
foreign direct investment can be attractedRegulation
to is critical
build for the orderly growth of the emerging

infrastructure in the commodities supplycommodity
chain ecosystem, particularly spot
only ifand futures trade in
commodities. While spot trade is a state subject, which is regu-
there is a powerful regulator that ensures integrity and
lated by state-level Agriculture Produce Market Committee
investor confidence in the mar ketplace. (apmc) Acts, the organised exchanges that deal with, among
other things, futures is under the regulatory control of the Union
government. It is widely known that the performance of many
apmcs has been abysmal, particularly in liberating farmers from
middlemen by providing them with direct market access. As far
as benefits to the farming community are concerned, the per-
formance of futures markets has been no better. This is because
there is very little direct participation by farmers in futures trad-
ing and they lack indirect access to it through aggregators who
serve their collective interests (Sahadevan 2007).
This paper seeks to critically examine the existing legisla-
tion for regulation of commodity futures markets in India, parti-
cularly its architecture, which suffers from a built-in principal-
agent dichotomy. It attempts to identify the dangers arising
from the non-synchronised motives of the "principal" (the gov-
ernment and the government regulator) and the "agent" (com-
modity exchanges), which may lead to serious moral hazards
for the principal and a degeneration of market integrity and
investor confidence, threatening the growth of futures mar-
kets and preventing its potential benefits from reaching genu-
ine stakeholders. Finally, it presents a strong case for the pro-
posed Forward Contracts (Regulation) Amendment Bill, 2010
and examines how a powerful regulator as the principal can
motivate agents and achieve a prudent balance between the
former's public regulatory obligation and the latter's commer-
cial aspirations.

Current Status and Emerging Issues
I thank an anonymous referee of this journal for insightful comments.
There are now five online national exchanges and 16 regional
K G Sahadevan (devan@iimlac.iri) is with the Indian Institute
ones that are permitted to offer futures in 113 commodities, in-
of Management, Lucknow.
cluding agriculture, metals, energy and plastics.1 To increase

1°6 DECEMBER 29, 2012 vol XLVii no 52 ÛEZS3 Economic & Political weekly

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their market share and stay ahead of rivals, the national ex- Agricultural commodities have lost their prominent position
changes have been trying to penetrate into semi-urban and in futures markets to bullion and other metals and, lately, to
rural agricultural areas in many parts of the country by in- energy. While the share of agricultural commodities in total
stalling trading terminals there. A leading exchange report- value of trade declined sharply from 55% in 2005-06 to 23% in
edly has more than 2,170 members and 3.46 lakh terminals 2007-08 and further to 12% in 2010-11, the share of bullion
spread over 1,577 cities and towns.2 The annual turnover of and other metals rose from 36% to 65% and further to 68% in
trade in organised exchanges exceeded the nominal gross the corresponding years. The share of energy products more
domestic product (gdp) figure of the country by March 2010. It than doubled during this period from less than 10% to 20%.
rose from Rs 1.29 lakh crore in 2003-04 to Rs 119 lakh crore in The prices of most of these non-agricultural commodities are
2010-11 and further to Rs 181 lakh core in 2011-12. 3 heavily influenced by their rates in international spot markets
and the exchange rate of the rupee.
Market Infrastructure Institutions
Second, the composition of the portfolio of agricultural com-
modities
Encouraged by the growing market potential, a number of is of crucial relevance to the benefits of futures. Al-
commodity market infrastructure institutions (miis) have futures are permitted in as many as 90 agricultural
though
commodities,
come up in the recent past. After the launch of futures trade in leading exchanges offer contracts in only 32 of
them.
national online commodity exchanges in 2003, 4 spot trade inMost of these commodities, however, have failed to gen-
commodities in independent online spot exchanges began
erate in
a significant volume of trade. The two leading agricul-
2008.5 Although no progress has been made on amending
turalthe
commodity exchanges together had less than 13% (includ-
archaic Forward Contracts (Regulation) Act (fcra), 1952
ingthat
metals and energy) of the total value of trade in the country
in the last three years. More importantly, the data (see Appen-
regulates futures trade, there has been legislation for strength-
dix) and
ening miis. This includes the Warehousing (Development shows that major commodities with larger production,
marketable surpluses and nationwide spot markets are not
Regulation) Act (wdra), 2007 and the Warehousing Develop-
ment and Regulatory Authority (Electronic Warehouse Re-all that much in these exchanges. In the case of wheat,
traded
ceipt) Regulation, 2009. Following this, the Warehousemaize,
Devel-potatoes, chillies, cardamom and rubber, the futures
opment and Regulatory Authority came into being in 2010 for
multipliers7 are in fractions, while commodities like mentha oil,
developing and regulating warehouses and warehouse re-seed, and guar gum generate much larger trade volumes
guar
compared to their total production. For instance, the total vol-
ceipts (wrs) . Parallel to the existing network of public-sector
warehouses, there are a number of new initiatives in the ume of futures trade in wheat in 2010-11 was 26.8 lakh tonnes
pri-
vate sector6 to promote organised supply chain management
with a multiplier of 0.03, though its production was 859 lakh
tonnes. The world market benchmark multiplier is 28. At the
and warehousing, which facilitate the delivery of contracts
traded in exchanges and provide collateral management ser-
same time, the volume of trade in guar seed was more than 200
vices to various stakeholders. times its annual production. If a futures multiplier is too high,
Despite fast-growing markets and miis, concerns have been as the Abhijit Sen Committee (goi 2008) pointed out, the di-
raised about the extent to which futures has played the role itvergence between spot and futures widens, exposing futures
was intended to. Answering this critical question requires a markets to the charge of being driven by speculators.
deeper analysis of certain key issues. Though the focus of this Third, a more fundamental question is to what extent the
analysis is market regulation, it is worthwhile throwing some markets have helped farmers and other stakeholders in reduc-
light on them as they are as important as regulation. ing the price risk of agricultural commodities and ensuring
First, it is important to ensure a healthy balance between better prices. Though there is a growing literature offering
the basket of commodities in which futures trading is permit- empirical evidence on futures markets in India,8 it mainly cov-
ted and what is relevant to the economy. The choice is crucial ers their behaviour with regard to the efficacy of price dis-
to the benefits that the economy derives from futures trading.covery and spot price stability. Empirical studies, particularly
The current basket comprises three commodity groups - bul- on agricultural commodity futures, include Naik and Jain
lion and other metals, agricultural commodities, and energy. (2002), Karande (2006), Sahi (2006), iimb (2008) and Nath
The major reason the .government allowed a futures market and Lingareddy (2008). These studies do not offer any uni-
was to develop a market-driven mechanism for hedging the form evidence on market efficiency and price stability. The
price risk of farmers and improving awareness about the value Abhijit Sen Committee also did not find any evidence of either
of their marketable surplus through better price discovery and reduced or increased volatility in spot prices because of futures
its dissemination. With these objectives, the Dantwala Com-trading. It observed that futures markets have not succeeded as
mittee (1966) and Khusro Committee (1980) recommended an effective instrument of risk management in India.
steps to revive futures trading in more agricultural commodi- Finally, there are certain structural constraints that limit
ties. Later, the Kabra Committee (1994) excluded certain com- the access of farmers to futures markets. Unless institutional
modities of mass consumption but reiterated the usefulness ofparticipation is permitted, futures markets will remain inac-
futures to the farm sector. However, the fast-changing composi- cessible to more than 80% of farmers, who are small and mar-
tion of the market and the interest in imported commodities has ginal with landholdings of less than one hectare. Institutional
now tilted futures markets more towards metals and energy. participants who operate as aggregators could take positions

Economic & Political weekly December 29, 2012 vol xlvii no 52 107

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in futures markets on behalf of farmers. This model not only in place an equally powerful statutory regulator for commod-
offers a profitable business opportunity to many potential ity markets, especially because the scale of its impact is signifi-
players like banks, farmers' cooperatives, commodity boards, cantly larger than that of the capital market. Misconduct in
and marketing federations, but also saves farmers from un- commodity markets can have economy-wide effects in terms
scrupulous middlemen in the agricultural supply chain. An of prices in the spot markets, stock positions, farm invest-
organised supply chain obviously requires back-end infra- ments, and cropping pattern, but a variation in stock prices
structure for storage, grading, insurance, wrs, and a liquid due to market manipulation directly affects only a group of
secondary markets for wrs. All these changes, which would stakeholders and the market value of their assets.
ensure adequate asset-backed institutional credit to the farm There are a number of inadequacies in the fcra, 1952 and
sector and its overall development, call for amendments to the most of them have been adequately addressed by the Forward
legislations governing banks, and the spot and futures mar- Contract (Regulation) Amendment Bill, 2010. Though the
kets. The WDRA, 2007 and the setting up of the Warehouse stated objective of the fcra, 1952 is the regulation of "certain
Development and Regulatory Authority in 2010 were the first matters" relating to forward contracts, there is neither a defi-
steps towards this. nition of a forward contract nor the manner in which it differs
from a futures contract. It defines a forward contract as a con-
FCRA, 1952 and the Regulatory Structure tract for the delivery of goods that is not a ready-delivery con-
Schedule vu of the Indian Constitution includes forward and tract.11 The Act is silent about the distinction between over-
futures trading and stock and commodity exchanges involved the-counter (otc) and exchange-traded contracts and there is
in such trading in the Union list, bringing them into the regu- a lack of clarity on the regulation of the former, while the lat-
latory ambit of the central government. The fcra was passed ter is regulated by the commission through registered associa-
in 1952 for regulating all types of forward contracts in com- tions (exchanges). This uneven treatment of exchange-traded
modities. Its preamble states that it is to provide for "regulation and otc derivatives leads to regulatory arbitrage and market
of certain matters relating to forward contracts, the prohibition abuse. Since otc contracts are not permitted, illegal off-
of options in goods and for matters connected therewith". market transactions ( dabba trading) reportedly flourish in the
The act provides for a three-tier regulatory structure - (a) the surroundings of many regional commodity exchanges.12
central government with all powers of policymaking and regu- The fcra, 1952 defines goods as any movable property other
lation; (b) the Forward Markets Commission, established under than actionable claims, currency and securities. This defini-
Section 3 of the Act, for exercising the functions and discharg-tion forbids exchanges from introducing innovative and tailor-
ing the duties that may be assigned to it by the Act; and (c) as- made futures contracts in intangibles and services such as the
sociations (exchanges), which are bodies of individuals recog-commodity price index, weather index, freight index, and so
nised by the central government on the recommendation of theon.13 More importantly, the commission is an intermediary
commission, and constituted for the purpose of regulating and between the central government and exchanges14 and its func-
controlling the business of sale and purchase of commodity tions outlined in Section 4 of the Act are limited to that of an
derivatives. For the central government, the department of con- advisor and supervisor to the government, an observer of the
sumer affairs under the Ministry of Consumer Affairs, Food and markets, and an agency to collect and publish market data. It is
Public Distribution (mca) discharges all the regulatory respon- not empowered to frame subordinate legislation for regulating
sibilities outlined in the Act. The mca, in turn, has delegatedmarket intermediaries and miis. As per Sections 5 through 17
many of its powers to the commission. The commission in its and 28 of the Act, the government enjoys all regulatory pow-
present form is not a statutory body endowed with the full ers, including granting and withdrawing recognition to ex-
responsibility of market regulation and the powers to do it. It changes, approving by-laws of exchanges, permitting/prohib-
rather operates as a subordinate office under the mca. iting futures contracts in commodities, and suspending the
A similar regulatory structure prevailed in the capital mar- business of recognised exchanges. The commission is only a
ket with the Controller of Capital Issues under the department consultative and recommendatory body of the government
of company affairs regulating stock exchanges till the Securi- with its powers limited to inspecting accounts and documents
ties and Exchange Board of India (sebi) was set up by a com- of exchanges and their members, receiving annual reports of
prehensive Act in 1992. The need for an autonomous regulator exchanges, suspending persons from exchanges, prohibiting
for commodity futures markets was not felt till futures trade members of exchanges from entering into any contracts, and
was allowed in 2003. 9 Concerns over the limited powers of the granting certificates of registration to exchanges.
The fcra, 1952 provides for the appointment of four mem-
regulator and its lack of competence to deal with the complexi-
ties of markets with modern trading systems and practices bers of the commission, which is headquartered in Mumbai
have been growing, particularly after electronic trading began and has a regional office in Kolkata. The office of the commis-
in national multi-commodity exchanges. Many expert com- sion has a sanctioned strength of 135 (including a chairman
mittee reports have highlighted the need for a more powerful and two members), of which 54 professionals are to constitute
regulator in commodity futures markets.10 Moreover, publicits core strength. The remaining 81 general staff are to help in
perception about the steady growth of capital markets underits day-to-day administration. The staff strength continues to
the regulatory control of sebi has strengthened the need to put be at the same level as it was before national online commodity

IO8 December 29, 2012 vol XLVii no 52 GEES Economic & Political WEEKLY

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REVIEW OF RURAL AFFAIRS

exchanges came into existence.15 Moreover, the distribution of needs to have a proactive strategy to keep itself updated about
manpower is skewed towards general and secretarial acti- the behaviour of market participants so that quick remedial
vities, not to the core, technical, research and analytical wing. actions can be taken against indiscipline before it dents inves-
Frontline officers, including economic advisors, directors, dep- tor confidence and market integrity. Therefore, the challenge
uty and assistant directors, and enforcement officers, are only before the regulator is ensuring a continuous flow of informa-
54, and surprisingly more than 40% of these important posi- tion between itself and the market and making certain that
tions are vacant.16 With increasing complexities in the func- exchanges discharge their responsibilities as sros by safe-
tioning of the market, the regulator needs to be equipped to guarding the integrity of all dealings and protecting the confi-
deal with more complex regulatory obligations. However, the dence of investors.

present structure, composition and staff allocation of the Exchanges are accountable for violations of norms and
commission raise serious doubts about its capability to handle guidelines by its members (brokers), who are governed by the
market regulation.17 by-laws approved by the commission. Members have to file
The most pressing reason for seeking a paradigm shift in annual compliance reports in their respective exchange to en-
commodity futures regulation is the agency problem that orig- sure that they comply with all provisions of the by-laws, rules
inates from the current regulatory architecture. It is difficult and regulations of the exchange as well as the directives and
to fully weed out the agency problem'and its threat to market circulars of the commission. In spite of these provisions, the
integrity and client confidence as long as marketplaces are conduct of exchanges has raised concerns about their failure
sponsored and run by private corporate bodies with commer- to maintain a balance between private commercial aspirations
cial aspirations. It is, however, possible to minimise the threat and public regulatory obligations. For example, a national
to market integrity by modifying agents' behaviour in the mar- exchange amended the settlement rules of live contracts in
kets. This would be possible only if there is a powerful regula- chana and urad, which could have potentially favoured one
tory agency that can bring in checks and balances to serve the party or the other in the market (Nair 2011: 91). There are in-
public interest in a marketplace apparently dominated by the stances in which exchanges have failed to adhere to quality
private interests of agents. specifications at the time of delivery. The commission has re-
ported that exchanges carry out a large volume of trade with-
Principal-Agent Dichotomy and Moral Hazards out payment of margin money.20 The practice of proprietary
The principal-agent problem has to do with the difficulties that trade is not only in violation of rules and by-laws, but also puts
arise from incomplete and asymmetric information when a exchanges under systemic risk as the margin payable is
principal delegates work to an agent. The relationship bet- avoided by netting of the positions at the members' end as all
ween the government regulator and exchanges now is akin to trade is done in a single account (only proprietary account).21
a principal-agent relationship. As policymakers, the govern- The exchanges, which are predominantly driven by profit
ment and the commission (which is in a way an agent of the motives, tend to resort to certain practices that inflate their
government) are in the position of a principal, and exchanges, individual trading volumes to help them maintain their stand-
which are private entities with commercial interests, are ing in the market. They turn a blind eye to market abuse by
agents. The market regulatory powers of exchanges derive prominent members who contribute substantial business. The
from their status of being self-regulatory organisations commission examined the penalties imposed by the national
(sros).18 As sros, exchanges enjoy legislative, executive and exchanges on their members for various irregularities and in
enforcement powers. They make rules that govern trading, March 2010 notified a uniform penalty structure to discourage
margins, clearing, settlement, and delivery of contracts exe- market malpractices. To deal with erring members, the ex-
cuted on their platform. changes are directed, in addition to imposing financial penal-
The agency problem arises when (a) the desires or goals of ties, to initiate disciplinary proceedings that may culminate in
the principal and agent are in conflict, and (b) it is difficult or suspension of their membership.22 There are cases where the
expensive for the principal to verify what the agent is actually commission has restrained a national exchange from deliber-
doing. The problem here is that the principal cannot verify ately attempting to increase its market share by charging dis-
that the agent has behaved appropriately (Eisenhardt 1989). In proportionately low transaction charges.23 The commission
spite of various incentives and penal provisions19 in the Act and treats this as an anti-competitive and unfair trade practice as
the by-laws of exchanges to synchronise the interests of the variations in transaction charges across exchanges can lead to
principal and the agent, the innate commercial interest of the regulatory arbitrage.
latter often poses a threat to the market and the principal. In In its annual reports, the commission has disclosed cases in
the present situation, moral hazards occur to the government which it inspected and audited the books of accounts of mem-
and the commission as they have incomplete information on bers of exchanges, particularly of national multi-commodity
markets. As market monitoring, surveillance and risk control exchanges, and suspended them from trading when irregular-
are primarily the responsibilities of exchanges, which are on- ities were found. In 2010-11, it inspected the books of accounts
site market regulators, information about happenings in the of a national exchange and a regional exchange in addition to
market may not reach the government and the commission in conducting surprise checks on two regional exchanges. In the
real time. With this information asymmetry, the commission same period, it carried out a similar exercise against four

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members of exchanges.24 In 2009-10, surprise checks were margins, clearing, settlement, and delivery of contracts and
carried out on two regional exchanges and the books of ac- even penalties are laid down in the by-laws of exchanges.29
counts of nine members were inspected.25 At the micro level, The exchanges seem to leverage these legislative powers to
exchanges verify their members' compliance with by-laws and fulfil their commercial aspirations, leading to a serious agency
rules by auditing books of accounts. Such audits have revealed problem. This is a major handicap for the commission when
major deficiencies/deviations with regard to many mandatory compared to sebi, its capital market counterpart, which has
requirements, including opening of trade accounts before ini- independent powers to regulate all market intermediaries.
tiating trade, margin deposits, required net worth, and fulfill- The fcra, 1952 does not have any specific provisions for
ing know-your-customer (kyc) norms (Nair 2011: 126). ensuring market integrity and investor confidence, and the
uniform penalty imposed by the commission has not proved to
Amendment Bill and Way Forward be an effective deterrent. As stated in the parliamentary stand-
The MCA has made attempts in the past to amend the fcra, ing committee's report on the Forward Contracts (Amend-
1952. The Forward Contracts (Regulation) Amendment Bill, ment) Bill, 2010, "The powerful traders who indulge in mal-
1998 lapsed after it was not passed by the Lok Sabha before it practices have no fear of the authority conferred on the Com-
was dissolved in 2003. After the liberalisation of commodity mission under the fcra, 1952 nor are they bothered about the
futures markets at the beginning of 2003, the need for a com- fine that can be imposed on them". The commission has re-
prehensive amendment to the Act came up with the establish- ported that during 2010-11 it assigned the books of accounts of
ment of three national online exchanges and a host of complex three national exchanges, 16 regional exchanges and 280
trading systems and practices, which showed the existing reg- members of national exchanges for audit.30 It is worth noting
ulatory capacity was insufficient to cater to the need of expo- that in the us, the replacement of the Commodity Exchange
nentially growing markets. The total value of commodity Act, 1936 by the Commodity Futures Modernisation Act
futures traded rose from Rs 1.29 lakh crore in 2003-04 to (cfma), 2000 made the Commodity Futures Trading Commis-
Rs 21.34 lakh crore in 2005-06.26 The annual turnover figure sion (cftc) more powerful than before, while strengthening
touched an all-time high of Rs 119.49 lakh crore in 2010-11 self-regulation by exchanges to reduce systemic risk. To ensure
against Rs 77.65 lakh crore the preceding year.27 The mca fair play in the market, the cfma prescribes seven criteria to be
came up with the Forward Contracts (Regulation) Amendment adhered to by exchanges for getting their recognition from
Bill, 2006, but this too failed to sail through before the dissolu- cftc.31 In addition, to promote transparency and integrity
tion of the Lok Sabha. This was replaced by the Forward Con- in the market, the cfma lays down 17 core principles that
tracts (Regulation) Amendment Bill, 2010, which is now pend- exchanges have to comply with on a continuing basis.32
ing with Parliament. Other than all the above reasons for strengthening market
The bill proposes to, among other things, empower the com- regulation, the government and policymakers have to heed
mission and transform it to a powerful independent regulator the lessons of the global financial crisis that began in 2008.
like sebi. This is critical to commodity futures markets in gen- Years without accountability and transparency in markets for
eral and the farm sector in particular for many reasons. It is a wide range of assets culminated in a massive failure of busi-
risky for a country with a dominant farm sector to liberalise nesses, a drop in housing prices and a wipeout of the savings
internal trade in commodities without a powerful regulator in of wealthy as well as low-income households. The message
place. Inadequately developed spot markets and spurious price was loud and clear - markets require strong regulation to
discovery in excessively speculative futures markets28 can dis- strengthen responsibility and accountability and to give inves-
tort the market prices of commodities and jeopardise invest- tors confidence that there is a system in place that works for
ments in agriculture. A major obstacle to growth of agriculture and protects them. In the us, this led to the passage of a com-
is inadequate formal institutional credit, particularly to the prehensive piece of legislation known as the Dodd-Frank Wall
rural farm sector. Lending institutions in India do not consider Street Reform and Consumer Protection Act (The Dodd-Frank
commodities as a standard asset class because of the lack of Act) in 2010. In addition to bringing transparency and
back-end infrastructure and well-regulated liquid markets.accountability to the derivatives markets, a strong consumer
More importantly, the proposed opening up of multi-brand financial protection watchdog, reforming the Federal Reserve,
retail can attract foreign direct investment (fdi) to build infra-and ending "too big to fail" bailouts, the Dodd-Frank Act
structure in the commodities supply chain, especially in stor-envisages the establishment of a Financial Stability Oversight
age and collateral management, only if there is a powerful Council to address systemic risks. Similar reforms are being
initiated in the uk in the form of the Financial Services Bill,
regulator that ensures integrity and investor confidence in the
marketplace. which proposes to replace the existing umbrella regulator by
It is difficult to modify the behaviour of agents in the market two separate agencies, the Prudential Regulatory Authority
if the government regulator is not empowered to frame subor- and the Financial Conduct Authority.
dinate legislation to exercise regulatory control over them and No such regulatory superstructure is being created in India,
all Mils. In the absence of such regulatory supervision, their though a number of subordinate laws have been passed by the
conduct in the market will not conform to what is expected relevant market regulators for micro regulations. The Finan-
from ethical sros. Currently, all rules relating to trading, cial Sector Legislative Reform Commission constituted in 2011

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is in the process of reviewing the architecture of the legislative India. Given the relevance of futures, particularly agriculture
and regulatory system governing the financial sector, includ- commodity futures, to the national economy, there is an ur-
ing commodity futures markets in India. It is also mandated to gent need to pass the Forward Contracts (Regulation) Amend-
examine the need for restatement of the law and immediate ment Bill, 2010 that proposes to transform the existing com-
repeal of any outdated legislation, and to examine the issue ofmission to a powerful independent regulator. The conflicting
consumer protection in financial markets. It is therefore im-motives of exchanges and the inability of the commission to
portant that the Forward Contracts (Regulation) Amendment
modify the behaviour of these private agents are detrimental
Bill, 2010 is passed so that the commission becomes an auto-
to market integrity and client confidence. An independent reg-
ulator with statutory powers to make subordinate legislation
nomous statutory regulator with powers to frame subordinate
legislation for better control over the exchanges and miis. It
can improve the on-site regulation of the agents and save the
is also important that all stakeholders in the governmentgovernment and the commission from moral hazards. An ac-
are convinced about the economic benefits of futures markets. tive regulator is indispensable in the formative stage of mar-
Policy certainty is important for the growth of markets. Wekets, particularly to ensure they have the best practices and
do not have to wait for a disastrous market crisis to pass thisprocedures for trading, margining, clearing, market monitor-
ing and surveillance, risk control, settlement, and delivery.
legislation and ensure the government's commitment to the
development of futures markets. Prevention is always better
Thereafter, the regulator can operate as an enabler of markets
than cure. and has to only actively intervene at the time of approval of
exchanges and other miis and their by-laws and contract speci-
Conclusions
fications. If the contracts are well formulated, and the delivery
The following points emerge from this analysis. The modalities
existing provide an effective line of defence against manip-
legal and institutional framework is inadequate for effective
ulation, the regulator has to only act as an off-site watchdog
(Sahadevan
regulation of the fast-growing commodity futures markets in 2002).

NOTES
Impact of Futures Trading on Agricultural organisations recognised by the government
Commodity Prices (Abhijit Sen Committee re- on the recommendation of the FMC .
1 Though the Forward Markets Commission
(FMC) has notified 113 commodities underport, Sec-
Gol 2008). 15 "Comments on the Terms of Reference of the
tion 15 of the FCRA, 1952, exchanges 9 After
have independence,
not futures trade flourished in Working Group on Securities Set Up by the
many commodities
offered futures in all of them. For example, the until it was banned in the FSLRC", MCX, Mumbai, July 2012.
Multi Commodity Exchange of India,mid-1960s,
which except for pepper and turmeric.16 Annual Report 2010-11, FMC, Government of
had 82% of the total value of tradeLater,
duringtrading was permitted selectively in India, Mumbai, October 2011.
2010-11, trades only in 52 commodities.potatoes, castor seeds and gur in the 1980s,
17 "Report of the Inter-ministerial Task Force on
and in hessian and edible oils and oilseeds in
2 "About Us", Multi Commodity Exchange of India, Convergence of Securities and Commodity
the 1990s, followed by sugar futures in 2001 Derivative Markets", Ministry of Consumer
http://www.mcxindia.com/aboutus/aboutus.
before the ban was lifted in 2003. Affairs, Food and Public Distribution, Govern-
htm, accessed on 17 August 2012.
10 The reports of the Inter-ministerial Task Force ment of India, New Delhi, 2003.
3 Monthly Market Review, March 2011 and March
on Convergence of Securities and Commodity 18 As per FCRA, 1952 the recognised exchanges/
2012, FMC, Government of India, Mumbai.
Derivatives Markets 2003, the Parliamentary associations provide the framework of rules
4 The FMC initially granted recognition to four
Standing Committee on the Forward Contracts and regulations for conduct of trading, indicate
exchanges as national exchanges - National
(Regulation) Amendment Bill 2006, the Parlia- the place where the trading can be conducted,
Multi Commodity Exchange of India (NMCE),mentary Standing Committee on the Forward report, record, execute and settle contracts,
Ahmedabad; Multi Commodity Exchange Contractsof (Regulation) Amendment Bill 2010
and provide a forum for exchange of docu-
India (MCX), Mumbai; National Commodity (in 2011 and 2012) and internal studies of the ments and payments.
and Derivatives Exchange (NCDEX), Mumbai;commission.
and National Board of Trade (NBOT), Indore - 19 For example, the government on the recom-
11 The ready-delivery contract as defined by the mendation of the commission can cancel the
in 2003. While the first three commenced trad-
Act is one which provides for the delivery of recognition of exchanges, and earlier, the ex-
ing with the launch of gold and silver futures in
goods and payment of a price either immedi- changes were made to sign a memorandum of
October, November and December, respectively,
ately or within a period not exceeding 11 days understanding (MoU) with the commission.
the same year NBOT continued with soybean/
after the date of the contract. All such contracts
The commission prescribes certain regulatory
oil futures and was later derecognisedwhere by the
the delivery of goods and/or payment measures, including limit on open position and
FMC in 2007. Two more exchanges came in, is not completed within 11 days from
for goods daily price fluctuation, additional and special
Indian Commodity Exchange, New
theDelhi,
date of the contract are treated as forward
margins, skipping trading, closing the markets
which commenced in 2009, and an existing re-
contracts.
and closing out the contracts to deal with cer-
gional exchange in Ahmedabad with a change
12 These contracts are not routed through the tain for-emergency situations.
in ownership and rechristened ACE Derivatives
mal trading channels of registered exchanges.20 Clients reportedly route their trade through
and Commodity Exchange, Mumbai in 2010.
In spite of extensive counterparty risk involvedthe proprietary accounts of brokers to escape
5 Two exchanges, NCDEX Spot Exchange (NS-
in these illegal markets, traders find it conven-
from depositing margin money with the
POT), promoted by NCDEX, and Nationalient Spot
as they do not have to comply with manda- exchanges.
Exchange, promoted by MCX, offer spottorytrade
margin deposits and physical delivery21 Memo, FMC, Mumbai, 19 May 2006.
in a variety of commodities. requirements. It is estimated that the size of
22 Annual Report 2009-10, FMC, Mumbai, Janu-
6 They include National Collateral Management
this illegal market in commodities is twice the
ary 2011.
Services promoted by NCDEX and National
size of the formal exchange-traded contract
Bulk Handling Corporation promoted by markets.
MCX. 23 Annual Report 2010-11, FMC, Mumbai, October
2011.
7 This is the ratio of futures trade volume 13 The Securities Contract (Regulation) Act
to total
production of any commodity. Internationally, (SCRA), 1956 has already been amended 24 Annual
to Report 2010-11, p 21, 43, FMC, Mumbai,
October 2011.
the benchmark trade multiplier varies from take care
15 of derivatives trading in securities.
upward for agricultural commodities though The term it"securities" has now been redefined 25 Annual Report 2009-10, FMC, Mumbai, Janu-
depends on their respective spot markets. to includeAderivatives. The derivatives, in turn, ary 2011
larger ratio indicates, inter alia, a higher haveinten-
been defined to include a contract which 26 Safeguarding Futures, FMC, Mumbai, 2005.
sity of speculation. derives its value from the index of prices of un- 27 Annual Report 2010-11, FMC, Mumbai, October
8 A review of these studies is available in the derlying securities. 2011.

Report of the Expert Committee to Study the14 Commodity exchanges are self-regulatory28 Commodities in which open positions are

Economic & Political weekly EE259 December 29, 2012 vol xlvii no 52 m

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All use subject to https://about.jstor.org/terms
excessively larger than their actual production - (2010): "Forward Contracts (Regulation) Interface between State and the Market",
figures are considered to be speculative. For Amendment Bill", Ministry of Consumer Af- PhD thesis, Jawaharlal Nehru University, New
example, open positions in mentha oil, guar fairs, Food and Public Distribution, New Delhi. Delhi.
gum and guar seed futures are sometimes IIMB (2008): "Impact of Futures Trading in Wheat, Nath, Golaka C and Tulsi Lingareddy (2008):
more than 40 times their actual production. Sugar, Pulses and Guar Seed on Farmers", "Impact of Futures Trading on Commodity
29 As per the FCRA, 1952, the by-laws prepared by Study commissioned by the Forward Markets Prices", Economic & Political Weekly, 43(3):
the respective exchanges are approved by the Commission and conducted by the Indian Insti- 18-23.
commission, which has powers to modify the tute of Management Bangalore. Sahadevan, K G (2002): "Sagging Agricultural
rules of trade and penalty structure contained
Karande, K (2006): "A Study of Castorseed Futures Commodity Exchanges - Growth Constraints
in the by-laws. Market in India", doctoral dissertation, Indira and Revival Policy Options", Economic & Politi-
30 Annual Report 2010-11 , FMC, Mumbai, October Gandhi Institute of Development Research, Mum- cal Weekly, 37(30): 3153-60.
2011. bai, at Social Science Research Network (SSRN), - (2007): "Advantages of Commodity Futures
31 These criteria laid down in section 110 (b) http://www.ssrn.com/abstract=
of 983342 Trading through Electronic Trading Platform
the CFMA are prevention of market manipula- Naik, G and Sudhir Jain (2002): "Indian Agricul- for Farmers of Uttar Pradesh - A Study of Pota-
tion, fair and equitable trading, trade execu- tural Commodity Futures Markets - A Perform- to and Mentha", Report submitted to Multi
ance Survey", Economic & Political Weekly,
tion facility, financial integrity of transactions, Commodity Exchange of India, Mumbai.
• disciplinary procedures, public access and abil-37(30): 3161-73. Sahi, Gurpreet S (2006): "Influence of Commodity
ity to obtain information. Nair, C K G (2011): "Regulatory Reforms in Indian Derivatives on Volatility of Underlying", at So-
Commodity Futures Market - An Analysis of
32 Section 110 (d) of the CFMA lists 17 principles cial Science Research Network (SSRN), http://
such as compliance with rules, contracts not Commodity Futures Exchange as Regulatory ssrn.com/abstract= 953594
readily subject to manipulation, monitoring of
Appendix:
trading, position limitations or accountability, Futures Trade Multiples of Various Agricultural Commodities (Production and trade
volume in lakh MT)
emergency authority, availability of general in-
formation, daily publication of trading infor-
mation, execution of transactions, trade infor-
mation, financial integrity of contracts, protec-
tion of market participants, dispute resolution, Chana/gram

governance fitness standards, conflicts of inter- Wheat

est, composition of boards of mutually owned
contract markets, record keeping, and antitrust
Maize

considerations. Soy oil

Mentha oil

REFERENCES Guar seed

Eisenhardt, M Guargum K (1989): "Agenc
sessment and Review", Academ
Potatoes

ment Review, 14 (1): 57-74.
Government Chillies
of India (1952): "F
(Regulation) Jeera Act,
(cuminseed) 1952", Ministry
Affairs, Food and Public Dist
Delhi.
Cardamom

- (2008): "Report
Pepper COOP MT)

of the Exper
Study the Impact of Futures Tra Rubber (MT)

cultural Commodity
Source: Prices", Min
An
sumer Affairs, Food
National and Publi
H
New Delhi. Vol 33, Ru

112 December 29, 2012 vol XLVii no 52 EEC3 Economic & Political WEEKLY

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