Professional Documents
Culture Documents
1
Introduction
To
Commodity Market
SYNOPSIS
buy agricultural products at Minimum Support Price (MSP) to ensure that the farmer benefited.
The government also managed storage, transportation, and distribution of agriculture products.
These measures weakened the agricultural commodity markets in India.
The government appointed four different committees (Shroff Committee in 1950, Dantwala
Committee in 1966, Khusro Committee in 1979, and Kabra Committee in 1993) to go into the
regulatory aspects of forward and futures trading in India. In 1996, the World Bank in association
with United Nations Conference on Trade and Development (UNCTAD) conducted a study of
Indian commodities markets. In the post-liberalization era of the Indian economy, it was the Kabra
Committee and the World Bank–UNCTAD study that finally assessed the scope for forward and
futures trading in commodities markets in India and recommended steps to revitalize futures
trading.
There are four national-level commodity exchanges and 22 regional commodity exchanges in
India. The national-level exchanges are Multi Commodity Exchange of India Limited (MCX),
National Commodity and Derivatives Exchange Limited (NCDEX), National Multi Commodity
Exchange of India Limited (NMCE), and Indian Commodity Exchange (ICEX).
2. Relevance and Potential of Commodity Markets in India
Majority of commodities traded on global commodity exchanges are agri-based. Commodity
markets therefore are of great importance and hold a great potential in case of economies like
India, where more than 65 percent of the people are dependent on agriculture.
There is a huge domestic market for commodities in India since India consumes a major
portion of its agricultural produce locally. Indian commodities market has an excellent growth
potential and has created good opportunities for market players. India is the world’s leading
producer of more than 15 agricultural commodities and is also the world’s largest consumer of
edible oils and gold. It has major markets in regions of urban conglomeration (cities and towns)
and nearly 7,500+ Agricultural Produce Marketing Cooperative (APMC) mandis. To add to this,
there is a network of over 27,000+ haats (rural bazaars) that are seasonal marketplaces of various
commodities. These marketplaces play host to a variety of commodities everyday. The commodity
trade segment employs more than five million traders. The potential of the sector has been well
identified by the Central government and the state governments and they have invested
substantial resources to boost production of agricultural commodities. Many of these
commodities would be traded in the futures markets as the food-processing industry grows at a
phenomenal pace. Trends indicate that the volume in futures trading tends to be 5-7 times the
size of spot trading in the country (internationally, it is much higher at 15 to 20 times).
Many nationalized and private sector banks have announced plans to disburse substantial
amounts to finance businesses related to commodity trading. The Government of India has
initiated several measures to stimulate active trading interest in commodities. Steps like lifting the
ban on futures trading in commodities, approving new exchanges, developing exchanges with
modern infrastructure and systems such as online trading, and removing legal hurdles to attract
more participants have increased the scope of commodities derivatives trading in India. This has
boosted both the spot market and the futures market in India. The trading volumes are increasing
as the list of commodities traded on national commodity exchanges also continues to expand. The
volumes are likely to surge further as a result of the increased interest from the international
participants in Indian commodity markets. If these international participants are allowed to
participate in commodity markets (like in the case of capital markets), the growth in commodity
futures can be expected to be phenomenal. It is expected that foreign institutional investors (FIIs),
mutual funds, and banks may be able to participate in commodity derivatives markets in the near
future. The launch of options trading in commodity exchanges is also expected after the
Introduction to Commodity Market 5
amendments to the Forward Contract Regulation Act (1952). Commodity trading and commodity
financing are going to be rapidly growing businesses in the coming years in India.
With the liberalization of the Indian economy in 1991, the commodity prices (especially
international commodities such as base metals and energy) have been subject to price volatility in
international markets, since India is largely a net importer of such commodities. Commodity
derivatives exchanges have been established with a view to minimize risks associated with such
price volatility.
3. What do you mean by commodity?
A commodity is anything for which there is demand, but which is supplied without
qualitative differentiation across markets.
They are things of value, of uniform quality, that are produced in large quantities by
many different producers; the items from each
different producer are considered equivalent.
Unlike brand name products, commodities
are goods that have a universal price around the
world. Gold, for example, has the same price per
ounce in Brazil and Bombay, whereas the price of a
toaster oven or even a T-shirt varies depending on
the brand and the place in which it is sold.
Commodities are not strictly limited to so-
called ‘pure’ elements like gold. A commodity can
be refined from a raw element, as oil is refined from
petroleum. A commodity can also be mined directly
from the Earth, such as a metal, or it can also be an
agricultural product, like eggs. In some cases, a
commodity can be an abstract financial tool that is
universal, such as the fluctuations in interest rates.
Because commodities can take so many different physical forms, the financial market
classifies them as a group based on their universal value and how they are traded. However,
commodities trading is not limited to simple exchanges. An entire set of complex trading rules,
including speculation on so-called “futures,” keeps the market active.
Additionally, the expansion of the category of commodities to include more abstract
objects like interest rates is a relatively recent addition. Historically, commodities were based on
ordinary, tangible goods that could be easily visualized by the layperson. The expansion into this
new territory reflects the growth and ambition of the increasingly globally integrated financial
markets. Because there are now more participants in the global markets, the desire for ‘new’
financial territory has encouraged the expansion of the commodities market.
her risk of suffering a major financial wipe-out, as every sector of the financial market would have
to completely collapse to destroy their investment portfolio, a scenario that would undoubtedly
be the end of society as it is currently known.
In the 2008 financial collapse, for example, several major institutions went bankrupt due
to faulty business practices. Stockholders in these institutions lost money. However, the
commodities market is largely immune to collapses of this type. By its very nature, a commodity is
not ‘owned’ by any one entity. Commodities can therefore provide a reliable source of income for
an investor who has spent time carefully considering what commodity he is buying, when he is
buying it, and at what price he plans to sell it.
For those investors who are unfamiliar with commodities, or who are buying into the
market in order to differentiate their portfolio, there are several different ways to invest in the
commodities market. There are commodities indexes, commodities exchanges, and numerous
types of contracts and buying options which allow a savvy financial investor to make considerable
amounts of money based on the expected performance of a given commodity. As with any
financial venture, extensive research is a definite pre-requisite to investment.
5. Are commodities risky?
Despite their inherent durability, there are different risks involved with investing in
commodities, especially when one considers the different aspects of the initial investment, the
type of loan or margin at which the commodity is purchased, and in some cases, the nature of the
commodity itself.
Although market forces do not impact commodities in the same way they impact stocks, they
do play a role. If an investor has allocated a significant portion of his portfolio into eggs, for
example, and a biological blight renders an entire month’s supply of eggs unusable on one
continent, the difference between the expected performance of the commodity and the dismal
reality will cause that investor to lose substantial amounts of money, depending on the types of
contracts that investor has secured.
However, this is not an automatic loss for the investor. Consider the following scenario. If the
biological egg blight occurred in Europe, but the investor had invested in unusually high demand
futures in the United States, the investor would actually reap enormous profits from his
investment when Europe’s lack of supply forced the continent to import eggs from other
countries. Europe’s significant demand would bolster egg prices in the United States, thereby
dramatically increasing egg performance over standard industry expectations.
Of course, this scenario requires unusual acuity and luck on the part of the investor. Consider
the reverse scenario, which is just as likely. This same investor has invested in high egg supply
futures in Europe. When the blight occurs, the supply drops astronomically. Should the investor
have purchased futures, as opposed to options on this commodity, he will be required to sell his
futures at a pre-appointed date for an agreed value. When he attempts to sell his high European
egg supply futures in a climate of enormous demand, he will lose a tremendous amount of money
because the market simply does not match the anticipated futures.
In each case, there is really no way for the investor to know whether eggs will experience
high supply or high demand in Europe when he buys the initial future or option contract. In this
way, commodities can be a risky investment, because they are prone to natural disasters and
other events that no ordinary human can predict.
However, there are always ways to mitigate risk. In each version of this scenario, the investor
chose futures which required the market to behave in unusual ways. It should be noted that
investors can choose to invest in commodities with a high volatility ranking to increase their
Introduction to Commodity Market 7
chance of windfalls, but that this strategy can also backfire and result in tremendous losses. Many
commodities have low volatility rankings, and will therefore perform in a fairly predictable way.
Additionally, there are so many ways to invest in commodities—including a yield curve
approach, where an investor buys the same type of commodity with different future maturity
dates—that an experienced investor will probably be able to balance any high volatility
commodities with steadier performers.
An investor must also consider the benefits of the specific financial tools he uses to acquire
the commodities, such as “futures” versus “options.” Each poses its own risks, from the amount of
the initial investment to the agreed sell date. Depending on what financial institution the future or
option is purchased from, an investor may be subject to variable margin fees. While each of these
topics will be explored in-depth in subsequent sections of this guide, an investor should know this:
while risk is certainly a factor in investing in commodities, the nature of the investor and the
amount of information he is willing to gather will largely determine how successful his
investments are. In other words, commodities can be a wonderful investment, but a certain
degree of risk is always part of every transaction. Nothing, unfortunately, is ever fully guaranteed.
6. Global Classification of Commodities.
Precious Metals: Gold, Silver, Platinum, etc.
Other Metals : Nickel, Aluminum, Copper, Zinc, etc.
Agro-Based Commodities : Wheat, Rice, Corn, Cotton, Oils, Oilseeds, etc.
Soft Commodities : Coffee, Cocoa, Sugar, etc.
Petrochemicals : High Density Polyethylene, Polypropylene.
Energy : Crude Oil, Natural Gas, Gasoline, etc.
7. Commodities that are not traded in the commodity market.
Rare metals :
The following metals are not, at present (2008), traded on any exchange, such as the London
Metal Exchange (LME), and, therefore, no spot or futures market, where producers, consumers
and traders can fix an official or settlement price exists for these metals. The only price
information that is available globally is published by, among others, the London Metal Bulletin and
is based on information from producers, consumers and traders. Germanium, Cadmium, Cobalt,
Chromium, Magnesium, Manganese, Molybdenum, Silicon, Rhodium, Selenium, Titanium,
Vanadium, Wolframite, Niobium, Lithium, Indium, Gallium, Tantalum, Tellurium, and Beryllium.
Agricultural products
The following Agricultural Products are not, at present (2008), traded on any exchange,
and, therefore, no spot or futures market where producers, consumers and traders can
fix an official or settlement price exists for these minerals. Generally the only price
information that is available is based on information from producers, consumers and
traders.
Fresh Flowers, Cut Flowers, Melons, Lemons, Tung Oil, Gum Arabic, Pine Oil, Xanthan,
Milk, Tomatoes, Grapes, Eggs, Potatoes, and Figs.
8. The Top ways to Invest in Commodities
As this guide has rather exhaustively demonstrated, commodities are as complex as the
people who trade in them. Because of this, the top ways to invest in commodities are as follows:
i) Pick a commodity or commodities that are interesting : No successful commodity trader
gets there purely because of his understanding of abstract mathematical formulas. Commodities
are impacted by real life events. Even the steadiest commodities will experience fluctuations. The
8 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
only way to have some notion of what is around the bend is to be a full participant in the process.
By choosing a commodity that is interesting, a trader or investor will be able to stay motivated to
keep track of developments that are affecting that particular commodity.
ii) Register with a licensed and affiliated broker : No matter how well informed any trader
is, no one will be able to interact meaningfully unless that trader is registered with a licensed
broker. Each exchange house requires that all traders are members, or are affiliated with
members of the Commodity Futures Trading Commission.
iii) Be prepared to lose initial investments : For those who are attempting to trade and
invest in commodities for the first time, being prepared to lose money while learning how quickly
the market can change and shift will save potential heartbreak and help individual investors avoid
a personal financial crisis. Using trailing stop losses can help lock in gains and protect investors
from some of the downside risks. It is far more important to be profitable than it is to be right all
the time.
iv) After experience has been gained, invest in indexes : After an individual investor or
trader has learned the ropes of commodities trading, investing in larger financial institutions, such
as indexes, can yield surprisingly profitable results. However, this should only be attempted after
significant experience has been gained by the individual investor.
9. What do you mean by commodity market?
Commodity market is a place where trading in commodities takes place. These are the
markets where raw and primary products are exchanged.
These raw commodities are traded on regulated commodity exchanges, in which they are
bought and sold in standardized contracts. It is similar to an equity market, but instead of
buying or selling shares one buys or sells commodities.
Commodity markets are markets where raw or primary products are exchanged. These
raw commodities are traded on regulated commodities
exchanges, in which they are bought and sold in
standardized contracts. It focuses on the history and
current debates regarding global commodity markets. It
covers physical product (food, metals, electricity)
markets but not the ways that services, including those
of governments, nor investment, nor debt, can be seen
as a commodity. Articles on reinsurance markets, stock
markets, bond markets and currency markets cover
those concerns separately and in more depth. One
focus of this article is the relationship between simple
commodity money and the more complex instruments
offered in the commodity markets.
10. Commodity Bull Cycles & Bear Cycles
Although any individual commodity can experience different rates of growth, taken as a
whole commodities can also be described as experiencing bull cycles and bear cycles. These cycles
are brought about not only by the market forces of supply and demand, but also certain policy
decisions by major governments, especially when it comes to tangible specie standards in relation
to national currency fluctuations and valuations.
Because so many governments base the value of their currency against the value of the
currency of other nations, as opposed to a tangible specie standard, both gold and silver do not
play the same kind of pivotal role in international economics that they did forty years ago. Despite
this, the fluctuating value of some major commodities, like gold and silver, can influence how
Introduction to Commodity Market 9
other investors perceive the overall commodities market. If gold has an exceptionally high price
per ounce in a given year, the commodities market can be said to be flourishing, whereas if the
price drops for several years in a row, financial analysts can sometimes use this to point to the
emergence of a bear market.
The difficulty with describing the performance of so many different commodities as
experiencing an overall growth or retraction is that there are always exceptions to the rule. The
best predictor of a predominantly bull or bear commodity cycle tends to be the size of the
population relative to the amount of production. The period of the 1980’s to roughly 2000 has
been described as a bear market for commodities because demand growth was not very high.
Starting in about 1999/2000, several nations that previously had virtually no measurable
interest in metals began aggressive manufacturing operations, dramatically increasing the
demand for previously unremarkably valued metals such as zinc and copper. This sudden interest
in metals correspondingly drove up the demand for gold and silver, as investors interpreted the
demand for zinc and copper as the beginning of a bull commodities market. Additionally, as the
manufacturing operations continued to expand, the increased economic prosperity brought about
a new group of consumers, who began to buy other commodities like eggs in much greater
numbers. The increased investment activity, combined with actual tangible demand by new
populations, subsequently resulted in an actual bull commodities market.
Therefore, the quantity of certain commodities is frequently a predictor, or at least an
indicator, of these bull and bear cycles. Oil, for example, can frequently swing the commodities
market one way or the other based on how much of it is produced, simply because so many other
industries depend on the energy that oil inadvertently produces. As an example, a steep drop in
oil production which results in higher gasoline prices can affect the transportation of agricultural
commodities. This produces artificial constraints in supply and demand, and can impact the
overall prices of other commodities. However, because oil frequently experiences fluctuations in
its supply, many experienced commodities investors and traders anticipate certain seasonal
fluctuations, and may build these anticipated supply / demand shifts in to their investments.
These secondary effects are therefore a somewhat predictable part of the overall market.
However, it should be noted that since many commodities indexes make their money based
on expectations of performance, an extreme shift in the production of the amount of oil or
another high profile commodity can correspondingly cause the futures market to either perform
up to or below expectations. A completely unexpected rigorous drop in the production of oil may
trigger a bullish market, whereas oversupply tends to saturate the marketplace, creating a bear
market. However, although certain high profile commodities can influence these cycles, the
commodities market is varied enough so that only truly major global events can significantly
impact demand. Even in the case of a major global event, such as a tsunami, one sector of the
commodities market may fall, while another may rise.
Some economists have argued that the economy itself generates these cycles, based not only
on major global events and supply and demand, but the very nature of investing itself. Certain
economic theories, such as the theory of Kondratieff cycles, have attempted to describe the
complex nature of the global economy as experiencing longer-form cycles that can be interpreted
as a series of booms and busts, triggered by certain behaviors.
11. How to trade in commodity market?
10 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
in a clay vessel, then clay writing tablets to represent the amount—for example, the number of
goats, to be delivered. These promises of time and date of delivery resemble futures contract.
Early civilizations variously used pigs, rare seashells, or other items as commodity money.
Since that time traders have sought ways to simplify and standardize trade contracts.
Gold and silver markets evolved in classical civilizations. At first the precious metals were
valued for their beauty and intrinsic worth and were associated with royalty. In time, they were
used for trading and were exchanged for other goods and commodities, or for payments of
labor. Gold, measured out, then became money. Gold's scarcity, unique density and the way it
could be easily melted, shaped, and measured made it a natural trading asset.
good at a certain date in the future. These contracts are traded (bought and sold) between
producers, dealers or speculators (i.e. traders seeking a profit from price movement).
Commodities market, commodities trading, commodity futures. These terms are not very
commonly understood by many. However, commodity markets offer as much an opportunity to
investors as does the stock market.
Markets for futures trading were developed initially to help agricultural producers and
consumers manage the price risks they faced harvesting, marketing and processing food crops
each year. Today, futures exist not only on agricultural products, but also a wide array of
financial, stock and forex markets.
The world’s oldest established futures exchange, the Chicago Board of Trade, was founded
in 1848 by 82 Chicago merchants. The first of what were then called “to arrive” contracts were
flour, timothy seed and hay, which came into use in 1849. “Forward” contracts on corn came
into use in 1851 and gained popularity among merchants and food processors.
Meanwhile, what is now the nation’s largest futures exchange, the Chicago Mercantile
Exchange, was founded as the Chicago Butter and Egg Board in 1898. At that time, trading was
offered in – you guessed it – butter and eggs.
In 2007, CME and CBOT officially merged, and are now collectively known as CME Group Inc.,
the world’s largest and most diverse derivatives exchange.
Other prominent U.S. commodities exchanges were formed before or just after the turn of
the century, and also had their roots in agriculture. At one time, you could trade on the National
Metal Exchange, the Rubber Exchange of New York, the National Raw Silk Exchange, and the New
York Hide Exchange. Small exchanges like these ultimately merged to become the exchanges we
have today.
In the 21st century, online commodity trading has become increasingly popular, and
commodity brokers offer front-end interfaces to trade these electronic-based markets. A
commodities broker may also continue to offer access to the traditional pit-traded, or open-
outcry, markets that established the commodity exchanges.
out of an investment without having to face the difficulty of trying to find a buyer or seller for your
securities.
A commodity may be defined as an article, a product or material that is bought and sold. It
can be classified as every kind of movable property, except Actionable Claims, Money &
Securities.
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 efficient portfolio diversification option.
In fact, the size of the commodities markets in India is also quite significant. Of the country's
GDP of ` 13, 20,730 crore (` 13,207.3 billion), commodities related (and dependent) industries
constitute about 58 per cent.
Currently, the various commodities across the country clock an annual turnover of ` 1, 40,000
crore (` 1,400 billion). With the introduction of futures trading, the size of the commodities market
grows many folds here on.
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 develop a 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.
Bombay Cotton Trade Association Ltd., set up in 1875, was the first organized futures market.
Bombay Cotton Exchange Ltd. was established in 1893 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 existent at several places in Punjab and Uttar Pradesh. But the most notable
futures exchange for 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
1927 with the establishment of East Indian Jute Association Ltd. These two associations
amalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct organized trading in
both Raw Jute and Jute goods. Forward Contracts (Regulation) Act was enacted in 1952 and the
Forwards 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.
serious problem. The CBOT took shape to provide a centralized location, where buyers and sellers
can meet to negotiate and formalize forward contracts.
In 1864, the CBOT listed the first ever standardized "exchange traded" forward contracts,
which were called futures contracts. In 1919, the Chicago Butter and Egg Board, a spin-off of the
CBOT, was reorganized to enable member traders to allow future trading, and its name was
changed to Chicago Mercantile Exchange (CME).
On October 19, 2005, the initial public offering (IPO) of 3,191,489 CBOT shares was priced at
$54.00 (USD) per share. On its first day of trading the stock closed up +49% at $80.50 (USD) on the
NYSE.
In 2007, the CBOT and the CME merged to form the CME Group.
In 2012, the CBOT expanded electronic trading hours to 22 hours per day to become more
competitive in the industry. The open outcry hours remained the same.
Chicago Board of Trade
The CBOT originally traded corn, wheat, oats and soybeans, but has grown to offer over 25
products. Its first financial product – a Guaranteed National Mortgage Association ("Ginnie Mae")-
backed certificate – was added in 1975. The exchange continued its broadening in 1982 by
introducing a new category for trading called an option, which gives a buyer the right to acquire or
sell a contract within a limited period of time. This innovation became so popular that the Board
later opened a second exchange – the Chicago Board Options Exchange.
The Board started an electronic trading system in 1994 to facilitate a more fluid transaction
process; however, the original trading method of an open auction held on the exchange floor is
still used today for some commodities. There are more than 3600 members of the CBOT who
traded nearly 35 million in January 2009. The exchange merged with the Chicago Mercantile
Exchange in 2007, becoming part of the CME Group.
Chicago Mercantile Exchange
The CME began as the Chicago Butter and Egg Board in 1898 and evolved into the Mercantile
Exchange in 1919. It has led the way in many futures trading initiatives. Starting as an agricultural
exchange, the CME added livestock in 1961 with the first frozen pork belly contract. It introduced
the world's first financial products in 1972, dealing contracts on seven foreign currencies. The first
international link was established, with the CME and the Singapore Exchange Derivatives Trading
Ltd. connecting in 1984. In addition, the Exchange introduced the world to the Globex system in
1992.
In 2007, the CME merged with the CBOT to become the CME Group. The group expanded
further as it acquired the New York Mercantile Exchange in 2008.Today the group of exchanges
manages trade volume of around six million contracts on a daily basis.
New York Mercantile Exchange
The NYMEX was founded in 1882, beginning as the New York Butter, Cheese and Egg
Exchange. It is the world's largest physical futures exchange, and includes the Commodity
Exchange (COMEX), established in 1933 when a collection of smaller trading groups merged.
NYMEX pioneered energy futures in 1978 and continues to be one of the most recognized
exchanges for energy-related trading. In addition to energy products, contracts include metals,
coffee, cocoa, sugar and environmental products. The exchange traded an average of 1.3 million
contracts per day in 2008.
Kansas City Board of Trade
The KCBOT was founded in 1856 as a clearinghouse for grain merchants. It continues to exist
primarily as a grain exchange, bringing together merchants worldwide. It trades over 10,000
Introduction to Commodity Market 15
contracts per day on average, mostly wheat products. The Board did introduce an influential
and popular innovation during the 1980s: the stock index future.
New York Board of Trade
The NYBOT is New York City's oldest exchange, dating back to 1870 when it began as the New
York Cotton Exchange (NYCE). Since then it has undergone several growth phases. In 1882 the
Coffee Exchange joined the NYCE then formed the Coffee and Sugar Exchange in 1916 after issuing
its first sugar contracts. The Cocoa Exchange later merged with the CSE creating the Coffee, Sugar
and Cocoa Exchange (CSCE). The NYCE and CSCE officially became the NYBOT in 2004. It now
operates under the Intercontinental Exchange® (ICE) which acquired the NYBOT in 2007. In
October 2008, the exchange traded just under 8.2 million contracts for the month.
Minneapolis Grain Exchange (MGEX)
The MGEX began as the Minneapolis Chamber of Commerce in 1881 issuing its first futures
contract on hard red spring wheat. It operated as the Chamber until 1947 when it became the
MGEX because the term "chamber of commerce" had become recognized as a social/civic
organization. The exchange remains primarily a grain futures clearinghouse, trading both the
commodities contracts and agricultural index futures. Since 1997, the MGEX has averaged over
one million contract trades per year.
Intercontinental Exchange (ICE)
Born out of the electronic trading systems that evolved throughout the 1990s, the ICE began
trading in 2000 using a technology infrastructure that linked markets together. The exchange
began using its electronic platform to trade energy futures. In 2001, it acquired the International
Petroleum Exchange (IPE), following that with a purchase of the NYBOT in 2007. The ICE has
helped expand the market for over-the-counter (OTC) futures, which are typically too small to be
listed on major exchanges. Over 219 million shares traded over the ICE networks in 2008.
OBJECTIVE QUESTIONS
I. Fill-in-the-blanks
1. ________ market function on immediate delivery.
[Electricity, oil, wheat]
2. ETF began to feature commodities in __________.
[2002, 2003, 2004]
3. In _________ CBOT and CNE Merged.
[2006, 2007, 2008]
4. There are _________ national level commodity exchange.
[2, 3, 4]
5. _________ is soft commodity.
[CoCoa, Rice, Gold]
[Ans.: 1) Electricity ; 2) 2003; 3) 2007; 4) 4 ; 5) CoCoa]
2
Different types
Of
Commodities
SYNOPSIS
2.2 Energy
2.3 Metals
Wheat
Rough Rice
Oats
2.2 ENERGY
Fueling and heating the country, the energy commodities allow you to take advantage of
everything from rising gas prices to supply disruptions in the Gulf of Mexico. Crude oil is one of the
most political commodities. Over 50% of the world’s reserves are in the Middle East, and OPEC is
the oil cartel that has influenced price for decades. Heating oil and gasoline are oil products
processed in refineries around the world. Consumers do not buy raw crude oil; they purchase oil
products. Natural gas is a commodity that is domestic in nature as it has been difficult to transport
by means other than pipelines. New technology is making it possible to turn the gas into liquid
form for shipment to other consumers around the world.
Crude Oil
Heating Oil
Unleaded Gas
Natural Gas
2.3 METALS
The metal commodities allow you to speculate on the price of precious metals or fluctuations
in the prices of industrial metals. Precious metals are rare and lustrous commodities that are
popular for investing and jewelry. Gold, silver, platinum and palladium all have certain industrial
applications. Nonferrous metals like copper, aluminum, nickel, lead and zinc are all building blocks
of infrastructure. Copper trades on the COMEX division of the CME while the other metals trade
on the London Metals Exchange.
Gold
Silver
Copper
Softs
The softs markets cover many of the food and fiber commodities. They are exotic as many of
these commodities are predominately grown in other regions of the world. Soft commodities are
also luxury commodities. Cotton, cocoa, coffee, sugar, lumber and frozen concentrated orange
juice all require specific climates. These commodities are often highly volatile since production
occurs in very specific areas of the world.
Cotton
Cocoa
Coffee
Sugar
Lumber
Orange Juice
20 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Livestock
Pork bellies are probably the most recognized among the livestock commodities. Beef and
pork are staples in most diets and these commodities offer some of the most reliable trending
patterns. Carnivores around the world can watch the wholesale prices of beef and pork that trade
on futures markets. Animal protein consumption has increased with population growth over
recent years as Asian nations have seen people shift from rice-based diets to more complex
proteins.
Live Cattle
Lean Hogs
What are the different types of commodities that are traded in these markets?
World-over one will find that a market exists for almost all the commodities known to us.
These commodities can be broadly classified into the following:
Precious Metals : Gold, Silver, Platinum, etc.
Other Metals : Nickel, Aluminum, Copper, etc.
Agro-Based Commodities : Wheat, Corn, Cotton, Oils, Oilseeds, etc.
Soft Commodities : Coffee, Cocoa, Sugar, etc.
Live-Stock : Live Cattle, Pork Bellies, etc.
Energy : Crude Oil, Natural Gas, Gasoline, etc.
Since commodity trading got into India, the volumes of commodity bourses are closely
inching towards the capital markets. Indians are new to commodities. But introducing Futures and
Options in capital markets reduced the knowledge barrier and slowly and steadily many investors
are moving to commodities from equities. Commodity Online has evaluated the following top five
commodities in Indian in terms of popularity, value and volume.
production of photovoltaic cells, the most common type of solar cells and even in Jet engines. The
once famous model, Zen from Maruti stable, used a silver engine – that gave more efficiency than
any other engines. Silver is suddenly the darling of investors.
3. Copper
The first metal man extracted from earth was more used in utensils in ancient era before
ceramic and stainless steel plates were introduced. Due to its wide variety of usage, it is one of the
most versatile and volatile commodities traded in the commodity exchanges. Copper is more
traded by the business community to hedge their positions. More than 16 per cent of total Copper
available is used for building wire followed by plumbing and heating. It is also used in automative
industry, electrical, air conditioning & commercial refrigeration, electronics and various other
uses. The copper usage has increased to such an extent that thirty years ago a car used about 35
pounds of copper as against 50 to 80 pounds of copper now. Imagine even a Boeing 727 airplane
uses 9,000 pounds of copper.
4. Crude
One of the most essential commodities in today’s world. Crude ditched thousands of
investors when the prices nosedived from over $147 a barrel in July 2008 to less than 34 in Jan
2009. Many investors went bankrupt and in India, many are said to have taken the extreme step
of killing themselves after seeing their wealth melt like ice. Why this happened is something that
OPEC, the Crude price controlling authority should answer. But the fact that speculators in
tandem with OPEC made the price extraordinary and unrealistically high, was one major reason.
Prices just exploded in a natural progression of demand and supply. Some earned while a majority
lost their trust in Crude. Thereafter, many in India turned to Gold as a safe investment haven. But
being a commodity without which the world cant move, Crude is still in the top five.
5. Zinc
Not everyone knows that Zinc is found everywhere in daily life, in every cell of the human
body, in the earth, in the food we eat and in products we use daily whether it is vehicles
appliances, or food we eat. For industry it is a corrosion resistant metal. But for a trader, it is yet
another commodity used to gain wealth. According to Portugal-based International Lead and Zinc
study group Zinc production declined by 44% to 166,000 tonnes in the first eight months of 2010.
But its inventories piled up resulting in more than 11% drop in prices at MCX.
Trading in derivatives first started to protect farmers from the risk of the value of their crop
going below the cost price of their produce. Derivative contracts were offered on various
agricultural products like cotton, rice, coffee, wheat, pepper, et cetera.
It is only in the last decade that commodity derivatives exchanges have been actively
encouraged. But, the markets have suffered from poor liquidity and have not grown to any
significant level, till recently.
However, in the year 2003, four national commodity exchanges became operational;
National Multi-Commodity Exchange of India (NMCE), National Board of Trade (NBOT), National
Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX).
The onset of these exchanges and the introduction of futures contracts on new commodities
by the Forwards Market Commission have triggered significant levels of trade. Now the
commodities futures trading in India is all set to match the volumes on the capital markets.
If the investor wants, instead of taking the delivery of the commodity upon maturity of the
contract, an option to settle the contract in cash also exists. Cash settlement comprises exchange
of the difference in the spot price of the commodity and the exercise price as per the futures
contract.
At present, the option of cash settlement lies only with the seller of the contract. If the seller
decides to make or take delivery upon maturity, the buyer of the contract has to fulfil his
obligation by either taking or making delivery of the commodity, depending on the specifications
of the contract.
In the above example, if the seller decides to go for cash settlement, the contract can be
settled by the seller paying ` 300 to the buyer, which is the difference in the spot price of the
commodity and the exercise price. Once again, the return on the investment of ` 870 is 34.5%.
The above example shows that with very little investment, the commodity futures market
offers scope to make big bucks. However, trading in derivatives is highly risky because just as
there are high returns to be earned if prices move in favour of the investors, an unfavourable
move results in huge losses.
The most critical function in a commodity derivatives exchange is the settlement and clearing
of trades. Commodity derivatives can involve the exchange of funds and goods. The exchanges
have a separate body to handle all the settlements, known as the clearing house.
In spite of the surge in the turnover of the commodity exchanges in recent years, a lot of
work in terms of policy liberalisation, setting up the right legal system, creating the necessary
infrastructure, large-scale training programs, et cetera still needs to be done in order to catch up
with the developed commodity derivative markets.
Also, trading in commodity options is prohibited in India. The regulators should look towards
introducing new contracts in the Indian market in order to provide the investors with choice, plus
provide the farmers and commodity traders with more tools to hedge their risks.
What is a Warehouse Receipt? Warehouse receipts are title documents issued by the
warehouse to the depositors against commodities deposited in warehouses. These receipts are
transferable by endorsement and delivery. Either the original depositor or the holder in due
course (transferee) can claim the commodities from the warehouse. According to Sec.32 of the
Bombay Warehouse Act, 1959, a receipt issued by a warehouseman shall, unless otherwise
specified on the receipt, be transferable by endorsement, and shall entitle its lawful holder to
receive the goods specified in it on the same terms and conditions on which the person who
originally deposited the goods would have been entitles to receive them. The physical
warehouse receipt suffers from the following deficiencies being the paper form of title
documents. Need for splitting the warehouse receipt in case the depositor has an obligation to
transfer only a part of the commodities. A single warehouse receipt is generally issued to the
depositor for the goods deposited by him at one time hence he faces this difficulty in case of
part transfer. Need to physically move the warehouse receipt from one place to another with
the risk of theft, mutilation, loss in transit etc. if the transferor and the transferee are at two
different locations. Risk of fake / forged warehouse receipt with the introduction of
dematerialization of warehouse receipt the above deficiencies are taken care of.
Entities involved in the demat process Issuer: The issuer is an entity, which floats the physical
paper document. It would be a company in case of the share certificate or warehouse in case of
warehouse receipt. The Registrar and Transfer Agents : It acts on behalf of the issuer as an
interface between the issuer and the depository for converting the physical warehouse receipt in
the demat form. The Depository : The Depository maintains the records of the beneficial owner in
its books. Presently there are two depositories in India i.e. National Securities Depository Limited
(NSDL) and Central Depository Services Limited (CDSL). Types of Demat Account Beneficiary
Owner Account is used to hold and transact in commodity balances. The depositor is required to
quote this account number at the time of depositing commodity in the warehouse. The
commodity balances are credited in this type of account. All the investors trading in the
commodity markets are required to separately open beneficiary owner account for commodity.
The existing demat account for securities cannot be used for the purpose of holding and
transacting in the commodity. Unlike the securities demat account, the investors need to open the
commodity demat account with both the depositories i.e. NSDL and CDSL.
The basic reason behind opening the account in both the depositories is that the
Depositories have not yet started Inter-Depository transfer in case of commodities. Clearing
Member Pool Account is used for the purpose of settlement of delivery obligation. The account
is used by the member for giving or receiving delivery of commodity to or from the Clearing
House of the Exchange. In short the pay-in and pay-out of the exchange is settled through this
account. All the members of the exchange are required to open the CM Pool Account with both
the depositories. This cannot be used for holding the commodity. Process of Demat Commodity
The depositor at the time of deposit of commodity contacts the Exchange approved Quality
Certifying Agency (QCA) to get the quality of goods assayed in order to ascertain whether the
goods confirms to the quality specification norms of the Exchange. After receipt of the quality
certificate from the QCA the depositor is required to fill Commodity Deposit Form (CDF) which
contains the details of the quality, quantity, validity dates of both for a commodity, demat
account number of the depositor, etc. The depositor is required to ensure that all these details
are properly filled in the form to avoid any kind of delays or errors. The depositor submits the
CDF, quality certificate and warehouse receipt to the warehouse and receives acknowledgement
of the same. The warehouse management then initiates the process of demat credit in co-
ordination with the Exchange, Registrar and Transfer Agent and the Depository. The depositor is
required to check the holding statement (which can be obtained from his depository
Introduction to Commodity Market 25
participant) after a day or two to see whether the commodity deposited has been credited to
his account under proper Commodities Identifier – ICIN.
Concept of International Commodity Identification Number (ICIN) ICIN refers to
International Commodity Identification Number. Commodities that have been dematerialized
are identified by its unique code (i.e. ICIN) allotted by depository. ICIN is generated on the
uniqueness of the following 4 parameters: Commodity. Warehouse Location. Grade / Fineness
of the commodity. Validity date of the commodity. Change in any of the above parameters will
result in the generation of new ICIN.
Rematerialization / Withdrawal / Revalidation of Commodities The depositor approaches the
DP and makes request for withdrawal of commodity in the prescribed form called Remat Request
Form (RRF). The acknowledgement copy of RRF is given to the depositor. The depositor will
approach the vault / warehouse along with the following documents for withdrawal of
commodity. Original copy of acknowledgment issued by DP on which RRN is written Authority
letter from the depositor (in case agent) Proof of identification of the agent person. All agricultural
commodities have a shelf life and cannot be stored indefinitely. The “final expiry” of commodity
refers to the maximum time period for which the particular commodity has shelf-life. “Validity /
Revalidity Duration” refers to the number of times and the corresponding duration for which the
quality certification is valid. After the validity date, ICIN is considered to have expired and the
same would not be acceptable as good delivery at the exchange. The depositor has two options
after the validity date: The depositor can withdraw the goods from the warehouse. The depositor
can go for re-validation of the commodity.
Dematerialisation and Settlement of Warehouse Receipts
NSDL, the first depository in the country was established in the year 1996 to remove the
difficulties arising out of use of physical (paper) certificates for settlement of trades on stock
exchanges and improving settlement efficiency. The depository system has successfully met its
objectives. On the basis of the success of demat, rolling settlements were introduced and today,
India is one among the few countries that have T + 2 rolling settlement system.
With the increase in activity in the commodities futures market and establishment of
national level screen-based multi-commodities exchanges, need for an efficient settlement system
in that market is felt. Broadly, a commodity futures contract may be settled either by cash or by
delivery of commodity depending upon the terms of the trade, demand of the buyer and rules of
the exchange. If the trade is expected to be settled by way of delivery of commodity, the clearing
house of the commodity exchange will receive warehouse receipts from the seller instead of
actual commodities and pass such warehouse receipts over to the buyer. In case of national
commodity exchanges, buyers and sellers could operate from different parts of the country and if
warehouse receipts are in physical form, the warehouse receipts have to be delivered across the
country from the seller to the buyer which could lead to systemic inefficiencies.
Warehouse receipts are title documents issued by warehouses to depositors against the
commodities deposited in the warehouses. These documents are transferred by endorsement and
delivery. Either the original depositor or the holder in due course (transferee) can claim the
commodities from the warehouse. Warehouse receipts in physical form suffer all the
disadvantages of the paper form of title documents. Some of these limitations are as follows
Need for splitting the warehouse receipt in case the depositor has an obligation to
transfer only a part of the commodities;
Need to move the warehouse receipt from one place to another with risk of
theft/mutilation, etc. if the transferor and transferee are at two different locations;
26 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
OBJECTIVE QUESTIONS
I. Fill-in-the-blanks
1. ________ is primary commodities.
[Corn, Egg, Butter]
2. United state is the World’s largest producer of _________ .
[Wheat, Rice, Corn]
3. Asia is major producer of _________ .
[Corn, Soyabean, Rice]
4. India is the largest consumer of _________ .
[Rice, Corn, Gold]
[Ans.: 1) Corn ; 2) Corn; 3) Rice; 4) Gold]
3
Derivatives
SYNOPSIS
3.4 Future
CategoryExamples of Underlying
A : Financial
30 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
1. Equity Based:
a) Individual Stock a) Infosys, Tata Motors, etc.
b) Indices b) Sensex, Nifty, NSE Volatility Index, etc.
2. Debt Based:
a) Interest Rates a) LIBOR, T-bill Rates, etc.
b) Credit b) Bonds (Cash Flows), Loan Receivable.
3. Others:
a) Currency a) US Dollar, GBP, Euro, etc.
b) Weather b) Temperature, Rainfall, Index, etc.
c) Emissions c) Carbon credits
B. Physical/ Non-Financial: Cereals and Pulses, Fruits, Vegetables, etc.
1. Agricultural
2. Non-Agricultural:
a) Metals a) Gold, Silver, Copper, Zinc, etc.
b) Dairy Products b) Butter, Margarine, etc.
c) Animal Products c) Egg, Lamb, etc.
d) Energy Products d) Crude Oil, Gases (Methane, Butane, etc.)
Introduction
It is believed in financial world that the most significant milestone in financial innovation is
achieved with the issuance and trading of derivatives. Along with this positive element, the
proponents of derivatives also admit that this term arouses more controversies and most people
look at them with suspicion and few would believe that they do contribute to the society’s
welfare. But the matter of fact is that derivatives are a standard risk management tool that
enables risk-sharing and facilitates the efficient allocation of capital to productive investment
activities. In this study, we will try and examine the veracity of a few misconceptions that
surround derivatives along with their economic benefits.
Historical development of derivative market in India
Derivative markets in India have been in existence in one form or the other for a long time. In
the area of commodities, the Bombay Cotton Trade Association started future trading way back in
1875. This was the fist organized futures market. Then Bombay Cotton Exchange Ltd. In 1893,
Gujarat Vyapari Mandall in 1900, Calcutta Hesstan Exchange Ltd. In 1919 had started future
market. After the country attained independence, derivative market came through a full circle
from prohibition of all sorts of derivative trades to their recent reintroduction. In 1952, the
governcment of India banned cash settlement and options trading, derivatives trading shifted to
informal forwards markets. In recent years government policy has shifted in favour of an
increased role at market based pricing and less suspicious derivatives trading. The first step
towards introduction of financial derivatives trading in India was the promulgation at the
securities laws (Amendment) ordinance 1995. It provided for withdrawal at prohibition on options
in securities. The last decade, beginning the year 2000, saw lifting of ban of futures trading in
detail about evolution of derivatives are shown in table with the help of the chronology of the
events. This table is presenting complete historical developments.
A Chronology of event in Financial Derivatives in India
Introduction to Commodity Market 31
Regulatory Objectives
A. Investor Protection : Attention needs to be given to the following four aspects:
i) Fairness and Transparency : The trading rules should ensure that trading is conducted in
a fair and transparent manner. Experience in other countries shows that in many cases,
derivatives-brokers / dealers failed to disclose potential risk to the clients. In this context, sales
practices adopted by dealers for derivatives would require specific regulation. In some of the most
widely reported mishaps in the derivatives market elsewhere, the underlying reason was
inadequate internal control system at the user-firm itself so that overall exposure was not
controlled and the use of derivatives was for speculation rather than for risk hedging.
ii) Safeguard for clients' money : Money and securities deposited by clients with the
trading members should not only be kept in a separate clients' account but should also not be
attachable for meeting the broker's own debts. It should be ensured that trading by dealers on
own account is totally segregated from that for clients.
iii) Competent and honest service : The eligibility criteria for trading members should be
designed to encourage competent and qualified personnel so that investors/clients are served
well. This makes it necessary to prescribe qualification for derivatives brokers/dealers and the
sales persons appointed by them in terms of a knowledge base.
iv) Market integrity : The trading system should ensure that the market's integrity is
safeguarded by minimizing the possibility of defaults. This requires framing appropriate rules
about capital adequacy, margins, clearing corporation, etc.
B. Quality of markets
The concept of "Quality of Markets" goes well beyond market integrity and aims at
enhancing important market qualities, such as cost-efficiency, price-continuity, and price-
discovery. This is a much broader objective than market integrity.
C. Innovation
While curbing any undesirable tendencies, the regulatory framework should not stifle
innovation which is the source of all economic progress, more so because financial derivatives
represent a new rapidly developing area, aided by advancements in information technology."
1. Futures/ Options contracts in both index as well as stocks can be bought and sold through
the trading members of National Stock Exchange, or the BSE Mumbai Stock Exchange. Some
of the trading members also provide the internet facility to trade in the futures and options
market.
2. The investor is required to open an account with one of the trading members and complete
the related formalities which include signing of member-constituent agreement, constituent
registration form and risk disclosure document.
3. The trading member will allot the investor an unique client identification number.
4. To begin trading, the investor must deposit cash and/or other collaterals with his trading
member as may be stipulated by him. SEBI has issued detailed guideline for the benefit of
the investor trading in the derivatives exchanges. These may be viewed and studied.
5. Margins are computed and collected on-line, real time on a portfolio basis at the client level.
Members are required to collect the margin upfront from the client & report the same to the
Exchange.
6. All the Futures and Options contracts are settled in cash at the expiry or exercise of the
respective contracts as the case may, be. Members are not required to hold any stock of the
underlying for dealing in the Futures / Options market.
Important Eligibility/Regulatory Conditions Specified by SEBI
Derivative trading to take place through an on-line screen based Trading System.
The Derivatives Exchange/Segment shall have on-line surveillance capability to monitor
positions, prices, and volumes on a real time basis so as to deter market manipulation.
The Derivatives Exchange/ Segment should have arrangements for dissemination of
information about trades, quantities and quotes on a real time basis through at least two
information vending networks, which are easily accessible to investors across the country.
The Derivatives Exchange/Segment should have arbitration and investor grievances redresses
mechanism operative from all the four areas / regions of the country.
The Derivatives Exchange/Segment should have satisfactory system of monitoring investor
complaints and preventing irregularities in trading.
The Derivative Segment of the Exchange would have a separate Investor Protection Fund.
The Clearing Corporation/House shall perform full innovation, i.e., the Clearing
Corporation/House shall interpose itself between both legs of every trade, becoming the
legal counterparty to both or alternatively should provide an unconditional guarantee for
settlement of all trades
The Clearing Corporation/House shall have the capacity to monitor the overall position of
Members across both derivatives market and the underlying securities market for those
Members who are participating in both.
The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the
position. The concept of value-at-risk shall be used in calculating required level of initial
margins. The initial margins should be large enough to cover the one-day loss that can be
encountered on the position on 99% of the days.
The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for
swift movement of margin payments.
In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House
shall transfer client positions and assets to another solvent Member or close-out all open
positions.
Introduction to Commodity Market 35
the stock market. Some of the common exchange traded derivative instruments are futures and
options.
Over the counter (popularly known as OTC) derivatives are not traded through the
exchanges. They are not standardized and have varied features. Some of the popular OTC
instruments are forwards, swaps, swaptions etc.
3.4 FUTURES
A 'Future' is a contract to buy or sell the underlying asset for a specific price at a pre-
determined time. If you buy a futures contract, it means that you promise to pay the price of the
asset at a specified time. If you sell a future, you effectively make a promise to transfer the asset
to the buyer of the future at a specified price at a particular time. Every futures contract has the
following features:
Buyer
Seller
Price
Expiry
Some of the most popular assets on which futures contracts are available are equity stocks,
indices, commodities and currency.
The difference between the price of the underlying asset in the spot market and the futures
market is called 'Basis'. (As 'spot market' is a market for immediate delivery) The basis is usually
negative, which means that the price of the asset in the futures market is more than the price in
the spot market. This is because of the interest cost, storage cost, insurance premium etc., That is,
if you buy the asset in the spot market, you will be incurring all these expenses, which are not
needed if you buy a futures contract. This condition of basis being negative is called as 'Contango'.
Sometimes it is more profitable to hold the asset in physical form than in the form of futures.
For eg: if you hold equity shares in your account you will receive dividends, whereas if you hold
equity futures you will not be eligible for any dividend.
When these benefits overshadow the expenses associated with the holding of the asset, the
basis becomes positive (i.e., the price of the asset in the spot market is more than in the futures
market). This condition is called 'Backwardation'. Backwardation generally happens if the price of
the asset is expected to fall.
It is common that, as the futures contract approaches maturity, the futures price and the
spot price tend to close in the gap between them ie., the basis slowly becomes zero.
Options
Options contracts are instruments that give the holder of the instrument the right to buy or
sell the underlying asset at a predetermined price. An option can be a 'call' option or a 'put'
option.
A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is
called 'strike price'. It should be noted that while the holder of the call option has a right to
demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if
the buyer wants to buy the asset, the seller has to sell it. He does not have a right.
Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the
buyer. Here the buyer has the right to sell and the seller has the obligation to buy.
So in any options contract, the right to exercise the option is vested with the buyer of the
contract. The seller of the contract has only the obligation and no right. As the seller of the
Introduction to Commodity Market 37
contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is
paid for buying an option contract is called as premium.
The buyer of a call option will not exercise his option (to buy) if, on expiry, the price of the
asset in the spot market is less than the strike price of the call. For eg: A bought a call at a strike
price of ` 500. On expiry the price of the asset is ` 450. A will not exercise his call. Because he can
buy the same asset from the market at ` 450, rather than paying ` 500 to the seller of the option.
The buyer of a put option will not exercise his option (to sell) if, on expiry, the price of the
asset in the spot market is more than the strike price of the call. For eg: B bought a put at a strike
price of ` 600. On expiry the price of the asset is ` 619. A will not exercise his put option. Because
he can sell the same asset in the market at ` 619, rather than giving it to the seller of the put
option for ` 600.
Futures contracts are derivatives that obtain their value from an underlying cash commodity.
A corn futures contract represents 5,000 bushels of corn, while a crude oil futures contract
represents 1,000 barrels of oil. There are commodity contracts on assets as diverse as currencies
to weather.
A swap is a financial agreement among parties to exchange a sequence of cash flows for a
defined amount of time. Interest rate swaps and currency swaps are common types of
agreements. Swaps are generally traded over the counter but are slowly moving to being traded
on centralized exchanges. The financial crisis of 2008 led to new financial regulations such as the
Dodd-Frank Act, which created new swaps exchanges to encourage centralized trading.
A forward contract is an agreement to trade an asset, often currencies, at a future time and
date for a specified price. Forward contracts are traded over the counter since they are custom
agreements between the parties. Since they are traded over the counter, there is a higher risk of
counterparty default.
To give an idea of the size of the derivative market, The Economist has reported that as of
June 2011, the over-the-counter (OTC) derivatives market amounted to approximately $700
trillion, and the size of the market traded on exchanges totaled an additional $83 trillion.
However, these are "notional" values, and some economists say that this value greatly
exaggerates the market value and the true credit risk faced by the parties involved. For example,
in 2010, while the aggregate of OTC derivatives exceeded $600 trillion, the value of the market
was estimated much lower, at $21 trillion. The credit risk equivalent of the derivative contracts
was estimated at $3.3 trillion.
Still, even these scaled down figures represent huge amounts of money. For perspective, the
budget for total expenditure of the United States government during 2012 was $3.5 trillion, and
the total current value of the U.S. stock market is an estimated $23 trillion. The world annual
Gross Domestic Product is about $65 trillion.
And for one type of derivative at least, Credit Default Swaps (CDS), for which the inherent risk
is considered high, the higher, nominal value, remains relevant. It was this type of derivative that
investment magnate Warren Buffett referred to in his famous 2002 speech in which he warned
against "weapons of financial mass destruction." CDS notional value in early 2012 amounted to
$25.5 trillion, down from $55 trillion in 2008.
Forward Commitments
A forward commitment is a contract between two (or more) parties who agree to engage in a
transaction at a later date and at a specific price, which is given at the start of the contract. It is a
customized, privately negotiated agreement to exchange an asset or cash flows at a specified
future date at a price agreed on at the trade date. In its simplest form, it is a trade that is agreed
to at one point in time but will take place at some later time. For example, two parties might
38 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
agree today to exchange 500,000 barrels of crude oil for $42.08 a barrel three months from today.
Entering a forward contract typically does not require the payment of a fee.
There are two major types of forward commitments
Forward contracts, or forwards, are OTC-traded derivatives with customized terms and
features.
Futures contract, or futures, are exchange-traded derivatives with standardized terms.
Futures and forwards share some common characteristics:
Both futures and forwards are firm and binding agreements to act at a later date. In most
cases this means exchanging an asset at a specific price sometime in the future.
Both types of derivatives obligate the parties to make a contract to complete the
transaction or offset the transaction by engaging in anther transaction that settles each
party's obligation to the other. Physical settlement occurs when the actual underlying
asset is delivered in exchange for the agreed-upon price. In cases where the contracts are
entered into for purely financial reasons (i.e. the engaged parties have no interest in
taking possession of the underlying asset), the derivative may be cash settled with a
single payment equal to the market value of the derivative at its maturity or expiration.
Both types of derivatives are considered leveraged instruments because for little or no
cash outlay, an investor can profit from price movements in the underlying asset without
having to immediately pay for, hold or warehouse that asset.
They offer a convenient means of hedging or speculating. For example, a rancher can
conveniently hedge his grain costs by purchasing corn several months forward. The
hedge eliminates price exposure, and it doesn't require an initial outlay of funds to
purchase the grain. The rancher is hedged without having to take delivery of or store the
grain until it is needed. The rancher doesn't even have to enter into the forward with the
ultimate supplier of the grain and there is little or no initial cash outlay.
Both physical settlement and cash settlement options can be keyed to a wide variety of
underlying assets including commodities, short-term debt, Eurodollar deposits, gold,
foreign exchange, the S&P 500 stock index, etc.
Commodity futures markets allow commercial producers and commercial consumers to
offset the risk of adverse future price movements in the commodities that they are
selling or buying.
In order to work a futures contract must be standardised. They must have a standard size
and grade, expire on a certain date and have a preset tick size. For example, corn futures
trading at the Chicago Board of Trade are for 5000 bushels with a minimum tick size of
1/4cent/bushel ($12.50/contract).
A farmer may have a field of corn and in order to hedge against the possibility of corn
prices dropping before the harvest he might sell corn futures. He has locked in the
current price, if corn prices fall he makes a profit from the futures contracts to offset the
loss on the actual corn. On the other hand, a consumer such as Kellogg may buy corn
futures in order to protect against a rise in the cost of corn.
In order to facilitate a liquid market so that producers and consumers can freely buy and
sell contracts , exchanges encourage speculators. The speculators objective is to make a
profit from taking on the risk of price fluctuation that the commercial users do not want.
The rewards for speculators can be very large precisely because there is a substantial risk
of loss.
Advantages of commodity trading
Introduction to Commodity Market 39
Leverage. Commodity futures operate on margin, meaning that to take a position only a
fraction of the total value needs to be available in cash in the trading account.
Commission Costs. It is a lot cheaper to buy/sell one futures contract than to buy/sell the
underlying instrument. For example, one full size S&P500 contract is currently worth in
excess off $250,000 and could be bought/sold for as little as $20. The expense of
buying/selling $250,000 could be $2,500+.
Liquidity. The involvement of speculators means that futures contracts are reasonably
liquid. However, how liquid depends on the actual contract being traded. Electronically
traded contracts, such as the e-minis tend to be the most liquid whereas the pit traded
commodities like corn, orange juice etc are not so readily available to the retail trader
and are more expensive to trade in terms of commission and spread.
Ability to go short. Futures contracts can be sold as easily as they are bought enabling a
speculator to profit from falling markets as well as rising ones. There is no uptick rule for
example like there is with stocks.
No Time Decay. Options suffer from time decay because the closer they come to expiry
the less time there is for the option to come into the money. Commodity futures do not
suffer from this as they are not anticipating a particular strike price at expiry.
Disadvantages of commodity trading
Leverage : Can be a double edged sword. Low margin requirements can encourage poor
money management, leading to excessive risk taking. Not only are profits enhanced but
so are losses!
Speed of trading : Traditionally commodities are pit traded and in order to trade a
speculator would need to contact a broker by telephone to place the order who then
transmits that order to the pit to be executed. Once the trade is filled the pit trader
informs the broker who then informs his client. This can take some take and the risk of
slippage occurring can be high. Online futures trading can help to reduce this time by
providing the client with a direct link to an electronic exchange.
payment of price after 11 days. These contracts are essentially party-to-party contracts, and are
fulfilled by the seller giving delivery of goods of a specified variety of a commodity as agreed to
between the parties. Rarely are these contracts for the actual or physical delivery allowed to be
settled otherwise than by issuing or giving deliveries. Such situations may arise when unforeseen
and uncontrolled circumstances prevent the buyers and sellers from receiving or taking deliveries.
The contracts may then be settled mutually.
Unlike the physical markets, futures markets trade in futures contracts which are primarily
used for risk management (hedging) on commodity stocks or forward (physical market) purchases
and sales. Futures contracts are mostly offset before their maturity and, therefore, scarcely end in
deliveries. Speculators also use these futures contracts to benefit from changes in prices and are
hardly interested in either taking or receiving deliveries of goods.
What is price risk management? How does a commodity futures market perform this economic
function?
The two major economic functions of a commodity futures market are price risk
management and price discovery. Among these, the price risk management is by far the most
important, and is the backbone of a commodity futures market. The need for price risk
management, through what is commonly called "hedging", arises from price risks in most
commodities. The larger, the more frequent and the more unforeseen is the price variability in a
commodity, the greater is the price risk in it. Whereas insurance companies offer suitable policies
to cover the risks of physical commodity losses due to fire, pilferage, transport mishaps, etc., they
do not cover similarly the risks of value losses resulting from adverse price variations. The reason
for this is obvious. The value losses emerging from price risks are much larger and the probability
of the recurrence is far more frequent than the physical losses in both the quantity and quality of
goods caused by accidental fires and mishaps, or occasional thefts.
Derivatives as a tool for managing risk first originated in the Commodities markets. They
were then found useful as a hedging tool in financial markets as well. The basic concept of a
derivative contract remains the same whether the 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.
* 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.
* Provide trading limit finance to Traders in commodities Exchanges.
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 restrictions 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 need for wheat or rice. In all these aspects the futures market 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 market. I can sell my wheat at a price, which
is fixed today, which eliminates my risk from price fluctuations. These days, agriculture requires
investments -- farmers spend money on fertilizers, high yielding varieties, etc. They are worried
when making these investments that by the time the crop comes out prices might have dropped,
resulting in losses. Thus a farmer would like to lock in his future price and not be exposed to
fluctuations in prices.
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 "optimal" 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 Indian 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.
Commodities have become an established asset class in the Indian markets in the past few
years. While futures trading is relatively new to the Indian commodity markets, the global
commodity futures exchanges have been functioning for several decades.
What has attracted investors to trading in commodity futures is the transparency in the price
mechanism, low margins, risk management, benefits to farmers by way of price clarity and an
organised marketplace. Other than these, commodities also offer a different investment avenue,
are less volatile when compared with equities and bonds, are a highly liquid asset class and offer
investors an opportunity to gain from the price movements in the commodity space.
A "Futures Contract" is a highly standardized contract with certain distinct features. Some
of the important features are as under :
42 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
is driven totally by market fundamentals and the risk factor associated with manipulation is
effectively negated.
The price discovery happens when the seller enters the quantity and the price at which he is
willing to sell and the buyer enters the quantity and the price at which he wishes to buy. When a
sell and buy order match and there is a buyer for the exact quantity and price offered by the
seller, a trade gets generated. All this takes place on the electronic exchange platform where the
buyer and seller remain anonymous thereby enabling a very transparent price discovery with
absolutely no scope for manipulation.
Small traders find the lower margins in commodity futures particularly enticing. The high
leverage allows them to invest in a larger number of lots, thereby increasing their exposure
despite their limited funds.
5. Managing the risk
Risk management is a major benefit for commodity traders in India. Exchanges have well
structured settlement procedures and prudent risk management practices, which reassures an
investor. The absence of counter party risk also stands as an advantage to commodity traders.
Clearing houses stands as a legal counter party between the buyer and the seller; thus the
clearing house becomes buyer to every seller and seller to every buyer. Due to this, there is no
need to examine the credit-worthiness of each counter party, which makes the entire process of
trading easier.
6. Helping farmers as well
Even the agricultural sector benefits from the commodities futures trading. India is
traditionally an agricultural economy and fluctuation in prices during the harvesting period has
always been a major concern for the farming community. Futures trading have emerged as a
viable option for providing a greater degree of assurance on the price front. For instance, a farmer
growing soybean is exposed to risk of fall in prices when his harvest comes out. Using futures
market, he can sell the soybean contract today at the futures platform and lock in the price which
could eliminate his risk from price fluctuations.
Further, farmers sometimes go for distress selling during the harvest time due to lack of
storage facilities. Using the futures platform, farmers can store their produce in the exchange
designated warehouse till the time their produce fetches reasonable returns.
Future contracts, because of the way they are structured and traded, have many inherent
advantages over trading stocks.
1. Futures are Highly Leveraged Investments
An investor has to put in a margin—a fraction of the total amount (typically 10% of the
contract value)—to be invested in futures. The margin is a security that the investor has to keep
with the exchange in case the market moves opposite to the position he has taken and he incurs
loses. This may be more than the margin amount, in which case the investor has to pay more to
bring the margin to a maintenance level.
What trading futures essentially means for the investor is that he can expose himself to a
much greater value of stocks than he could when buying the original socks. And thus his profits
also multiply if the market moves in his direction (10 times if margin requirement is 10%).
For example, if the investor wants to invest $1250 into Apple Inc. stock (APPL) priced at $125,
he can either buy 10 stocks or a future contract holding 100 Apple stocks (10% margin for 100
44 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
stocks: $1250). Now assuming a $10 increase in price of Apple, if the investor would have invested
in the stock, he would earn a profit of $100, whereas if he took a position in an Apple future
contract his profit would be $1000.
2. Future Markets are Very Liquid
Future contracts are traded in huge numbers every day and hence futures are very liquid. The
constant presence of buyers and sellers in the future markets ensures market orders can be
placed quickly. Also, this entails that the prices do not fluctuate drastically, especially for contracts
that are near maturity. Thus, a large position may also be cleared out quite easily without any
adverse impact on price.
3. Commissions and Execution Costs are Low
Commissions on future trades are very low and are charged when the position is closed. The
total brokerage or commission is usually as low as 0.5% of the contract value. However, it depends
on the level of service provided by the broker. An online trading commission may be as low as $5
per side, whereas full-service brokers may charge $50 per trade.
4. Speculators Can Make Fast Money
An investor with good judgment can make quick money in futures because essentially he is
trading with 10 times as much exposure than with normal stocks. Also, prices in the future
markets tend to move faster than in the cash or spot markets. Similarly, there is also the risk of
losing money. However, it could be minimized by using stop-loss orders.
5. Futures are Great for Diversification or Hedging
Futures are very important vehicles for hedging or managing different kinds of risk.
Companies engaged in foreign trade use futures to manage foreign exchange risk, interest rate
risk by locking in a interest rate in anticipation of a drop in rates if they have a sizeable investment
to make, and price risk to lock in prices of commodities such as oil, crops, and metals that serve as
inputs. Futures and derivatives help increase the efficiency of the underlying market because they
lower unforeseen costs of purchasing an asset outright. For example, it is much cheaper and more
efficient to go long in S&P 500 futures than to replicate the index by purchasing every stock.
6. Future Markets are More Efficient and Fair
It is difficult to trade on inside information in future markets. For example, who can predict
for certain the next Federal Reserve's policy action, or the weather for that matter?
Commodity Futures trading is done on margins. The investor only deposits a fraction of the
value of the futures contract with the broker to cover the exchange specified margin
requirements. This gives the investor greater leverage and thus the ability to generate higher
returns.
2. Liquidity
Unlike investment vehicles like real estate, investments in commodity futures offer high
liquidity. It is equally easy to both buy and sell futures and an investor can easily liquidate his
position whenever required. There is also another advantage of being able to use the profits from
a trade elsewhere, without having to close the position.
3. Diversification
Investments in commodities markets are an excellent means of portfolio diversification. For
example, gold prices have historically shown a low correlation with most other asset prices (such
as equities) and thus offer an excellent means for portfolio diversification.
4. Inflation Hedge
As the commodity prices determine price levels and consequently inflation, investing in
commodity futures can act as a hedge against inflation.
5. Total Transparency
To start with, an electronic trading platform helps in creating a transparent price discovery
mechanism on the commodities futures exchanges without any intervention by sellers or buyers.
It is driven totally by market fundamentals and the risk factor associated with manipulation is
effectively negated.
6. Managing the risk
Risk management is a major benefit for commodities traders in India. Exchanges have well
structured settlement procedures and prudent risk management practices, which reassures an
investor. The absence of counter party risk also stands as an advantage to commodities traders.
7. Helping farmers as well
Even the agricultural sector benefits from the commodities futures trading. India is
traditionally an agricultural economy and fluctuation in prices during the harvesting period has
always been a major concern for the farming community. Futures trading has emerged as a viable
option for providing a greater degree of assurance on the price front. For instance, a farmer
growing soybean is exposed to the risk of fall in prices when his harvest comes out. Using futures
market, he can sell the soybean contract today at the futures platform and lock in the price which
could eliminate his risk of price fluctuations.
The primary objectives of any futures exchange are authentic price discovery and an
efficient price risk management. The beneficiaries include those who trade in the commodities
being offered in the exchange as well as those who have nothing to do with futures trading. It is
because of price discovery and risk management through the existence of futures exchanges
that a lot of businesses and services are able to function smoothly.
1. Price Discovery
Based on inputs regarding specific market information, the demand and supply equilibrium,
weather forecasts, expert views and comments, inflation rates, Government policies, market
dynamics, hopes and fears, buyers and sellers conduct trading at futures exchanges. This
transforms in to continuous price discovery mechanism. The execution of trade between buyers
and sellers leads to assessment of fair value of a particular commodity that is immediately
disseminated on the trading terminal.
46 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
The existence of warehouses for facilitating delivery with grading facilities along with other
related benefits provides a very strong reason to upgrade and enhance the quality of the
commodity to grade that is acceptable by the exchange.
It ensures uniform standardization of commodity trade, including the terms of quality
standard: the quality certificates that are issued by the exchange-certified warehouses have the
potential to become the norm for physical trade.
Selling Options benefits
Selling (also known as writing) options can offer benefits to investors in both equities and
commodities. However, there are substantial differences between writing stock options and
writing options on futures. What it generally boils down to is leverage. Futures options offer more
leverage and, therefore, can deliver greater potential rewards (in addition to greater risk).
In selling equity options, you do not have to guess short-term market direction to profit. The
same remains true in futures, with a few key differences:
1. Lower margin requirement (that is, a higher return on investment). This is a key factor that
attracts many stock option traders to futures. Margins posted to hold short stock options can
be 10 to 20 times the premium collected for the option. With the futures industry’s margin
calculation system, however, options can be sold with out-of-pocket margin requirements for
as little as one to one-and-a-half times premium collected. For instance, you might sell an
option for $600 and post a margin of only $700 (total margin requirement minus premium
collected). This can translate into substantially higher return on your working capital.
2. Attractive premiums can be collected for deep out-of-the-money strikes. Unlike equities —
where to collect any worthwhile premium, options must be sold one to three strike prices
out of the money — futures options often can be sold at strike prices far out of the money.
At such distant levels, short-term market moves typically will not have a big impact on your
option’s value; therefore, time value erosion may be allowed to work less impeded by short-
term volatility.
3. Liquidity. Many equity option traders complain of poor liquidity hampering efforts to enter
or exit positions. While some futures contracts have higher open interest than others, most
of the major contracts, such as financials, sugar, grains, gold, natural gas and crude oil, have
substantial volume and open interest, offering several thousand open contracts per strike
price.
4. Diversification. In the current state of financial markets, many investors are seeking precious
diversification away from equities. By expanding into commodity options, you not only gain
an investment that is not correlated to equities, option positions also can be uncorrelated to
each other. In stocks, most individual stocks, and their options, will move at the mercy of the
index as a whole. If Microsoft is falling, chances are your Exxon and Coca Cola holdings are
falling as well. In commodities, the price of natural gas has little to do with the price of wheat
or silver. This can be a major benefit in diluting risk.
5. Fundamental bias. When selling a stock option, the price of that stock is dependent on many
factors, not the least of which are corporate earnings, comments by the CEO or board
members, legal actions, regulatory decisions or broader market direction. Soybeans,
however, can’t cook their books, and copper can’t be declared too big to fail.
OBJECTIVE QUESTIONS
I. Fill-in-the-blanks
1. The first organized future market came up in ________ .
48 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
[1873, 1874,1875]
2. In ________ SEBI prohibits forward transaction.
[1992, 1993, 1994]
3. In ________ Equity derivatives introduced at BSE.
[2000, 2001, 2008]
4. Currency derivatives introduced at ________.
[2006, 2007, 2008]
[Ans.: 1) 1875; 2) 1993; 3) 2000; 4) 2008]
V. Short Notes
1. Investing commodity derivatives.
2. Futures
3. Options
4. Liquidity
5. Selling option benefits
Introduction to Commodity Market 49
4
Institutions
Of
Commodity market in India
SYNOPSIS
speculation, particularly in the conditions of scarcity, prompted the Government to continue the
prohibition well into the 1980s.
This left the India with a large number of small and isolated regional futures markets. The
futures markets are dispersed and fragmented, with separate trading communities in different
regions with little contact with one another. The exchanges generally have yet to embrace
modern technology or modern business practices.
The Commodity Future Markets are regulated according to the provisions of Forward
Contract (Regulation) Act 1952. The Act broadly divides commodities into 3 categories, i.e.
commodities in which forward trading is prohibited, commodities in which forward trading is
regulated and residuary commodities. Under Section 17 of the F.C(R) Act, 1952, the Government
has powers to notify commodities, forward trading in which is prohibited in whole or part of India.
Any forward trading in such commodities in the notified area is illegal and liable to penal action.
Under Section 15, Government has powers to notify commodities in which forward trading is
regulated as also the area in which such regulation will be in force. Once a commodity is notified
under section 15, the forward trading in such contracts (other than Non-transferable Specific
Delivery Contracts) has to be necessarily between members of the recognized association or
through or with any such member. Contracts other than these are illegal.
Section 6 of the Act provides for powers to the Central Government to grant recognition to
an association for organizing forward contracts in the commodity which is notified under Section
15. Such recognition may be for a specified period or may remain in force till revoked under
Section 7 of the Act. Section 18(1) exempts the Non-Transferable Specific Delivery Contracts from
the purview of regulation.
However, under Section 18(3) of the Act, the Government has powers to prohibit or regulate
the non-transferable specific delivery contracts in commodities also by issue of a notification. Such
notifications may apply for the whole of the country or the specified part of the country. Trading
in commodities where non-transferable specific delivery contracts are prohibited is illegal and
liable to penal action. Trading in non-transferable specific delivery contracts in respect of
regulated commodities has to be through recognized associations just as in the case of other
forward contracts. The commodities that are notified neither under section 15 nor under section
17 of the Act is in common parlance referred to as free commodities. For organized forward
trading in such commodities, the concerned Association or Exchange has to get a certificate of
registration under Section 14B of the Act from the Forward Markets Commission.
The Act defines three types of contracts i.e. ready delivery contracts, forward contracts and
options in goods.
Ready delivery contracts are contracts for supply of goods and payment thereof where both
the delivery and payment is completed within 11 days from the date of the contract. Such
contracts are outside the purview of the Act.
Forward Contracts, on the other hand, are contracts for supply of goods and payment, where
supplies of goods or payment or both take place after 11 days from the date of contract or where
delivery of goods is totally dispensed with.
The forward contracts are further of two types, viz., specific delivery contracts and 'other
than specific delivery contracts'. The specific delivery contracts are those where delivery of
goods is mandatory though delivery takes place after a period longer than 11 days. Specific
delivery contracts are essentially merchandising contracts entered into by the parties for actual
transactions in the commodity and terms of contract may be drawn to meet specific needs of
parties as against standardized terms in futures contracts.
52 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Forward contracts other than specific delivery contracts are what are generally known as
'futures contracts' though the Act does not specifically define the futures contracts. Such
contracts can be performed either by delivery of goods and payment thereof or by entering into
offsetting contracts and payment or receipt of amount based on the difference between the rate
of entering into contract and the rate of offsetting contract. Futures contracts are usually
standardized contracts where the quantity, quality, date of maturity, place of delivery are all
standardized and the parties to the contract only decide on the price and the number of units to
be traded. Futures contracts are entered into through the Commodity Exchanges.
‘Options’ in goods means an agreement, by whatever name called, for the purchase or sale of
a right to buy or sell, or a right to buy and sell, goods in future and includes a put, a call, or a put
and call in goods. Options in goods are prohibited under the present Act. An option contract is the
right (but not the obligation) to purchase or sell a certain commodity at a pre-arranged price (the
"strike price") on or before a specified date. For this contract, the buyer or seller of the option has
to pay a price to his counterpart at the time of contracting, which is called the "premium; if the
option is not used, the premium is the maximum cost involved. When prices move favorably, this
right will not be exercised, and therefore, the purchase of options provides protection against
unfavourable price movements, while permitting to profit from favourable ones. Option can give
the right to buy or sell a certain amount of physical commodity, or, more commonly, they can give
the right to buy or sell a futures contract.
Forward Markets Commission
The Forward Markets Commission is a commodities market regulatory authority overseen by
the Ministry of Consumer Affairs and Public Distribution of the government of India.
The commodities overseen include
Fibres and Manufacturers
Spices
Edible Oilseeds and Oil
Pulses
Energy Products
Vegetables
Metals
Others
Functions of FMC
Forward Markets Commission is a statutory body set up under Forward Contracts
(Regulation) Act, 1952. The Commission functions under the administrative control of the
Ministry of Consumer Affairs, Food & Public Distribution, Department of Consumer Affairs,
Government of India. The functions of the FMC are dealt with in section 4 of the Forward
Contracts (Regulation) Act, 1952 [F.C(R) Act, 1952] which is given below :
i) to advise the Central Government in respect of the recognition of, or the withdrawal of
recognition from any association or in respect of any other matter arising out of the
administration of the FC(R) Act, 1952.
ii) 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
FC(R) Act, 1952.
iii) to collect and whenever the Commission thinks it necessary, publish information
regarding the trading conditions in respect of goods to which any of the provisions of this
Introduction to Commodity Market 53
Act is made applicable, including information regarding supply, demand and prices and to
submit to the Central Government periodical reports on the operation of the Act, and the
working of forward markets relating to such goods.
iv) to make recommendations generally, with a view to improving the organization and the
working of forward markets.
v) 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
considers it necessary and
vi) to perform such other duties and exercise such other powers as may be assigned to the
Commission by or under the FC(R) Act, 1952 or as may be prescribed.
Section 4A of the FC (R) Act, 1952 deals with the powers of the Commission which are as
follows:
The Commission have all the powers of a civil court under the Code of Civil Procedure
1908 (5 of 1908) while trying a suit in respect of the following matters:
Summoning and enforcing the attendance of any person and examining him on oath;
Requiring the discovery and production of any documents;
Receiving evidence on affidavits;
Requisitioning any public record or copy thereof from any office;
Any other matter which may be prescribed.
The Commission, thus, is a statutory authority entrusted with regulatory functions under the
Act. The Commission consists of a Chairman and two members. Presently, Shri. B.C. Khatua, IAS is
the Chairman of the Commission. The other members of the Commission are Shri. Rajeev Kumar
Agarwal, IRS and Shri. D. S. Kolamkar, IES. It has its headquarters at Mumbai and a Regional Office
at Kolkata. Forward Markets Commission has 5 Divisions to carry out various tasks. These Divisions
were formed on 1st August 2005 in order to streamline the work on a functional basis.
i) Markets, Trading and Development (Market Division)
ii) Market Intelligence, Monitoring & Surveillance ( M & S Division )
iii) Awareness, Training and Intermediary Registration and IT (IR Division)
iv) Investigation, Vigilance and Legal Affairs Division (Legal Affairs Division)
v) Commission Secretariat including HR, Administration and Finance, Grievances
(Administration Division)
Each Division is headed by a Director, assisted by Deputy Directors, Assistant Directors,
Economic Officers and Junior Research Assistants.
54 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
COMMISSION
Division – II Division V
Division – I Market Division – III Division-IV Commission
Division of Intelligence, Investigation,
Awareness, Secretariat
Markets, Monitoring Vigilance and
Training and including HR,
Trading and Administration
& Intermediary Legal Affairs
Development Surveillance Division & Finance
Registration
(Market (M& S (Legal Affairs Grievances
and IT
Division ) (ADM
Division) Division)
Division)
“The uniform pricing can only ensure the fair spot price. The new mechanism would resolve
the issue of agri commodities market space, which is poorly managed as traders quote different
prices,” said a Sebi source who is familiar with the meeting agenda.
Adding : “Transparency is lacking in the current system, as there are participants with vested
interest. For any derivative contract, it is necessary to have a linkage between the derivative price
and underlying spot prices.”
The panel is also likely to give finishing touches to a proposal for introduction of new
commodity derivatives products on the exchanges, especially options and index futures, to
deepen and improve the market’s liquidity. Presently, only futures contracts are allowed in the
commodity derivatives space. The introduction of such new derivatives can make the market
more attractive and efficient, feels an expert.
The committee will also discuss reforms suggested for the utilisation and impact of
commodity derivatives, and ways to strengthen hedging activity in this market. “A more pro-active
role is required by all classes to expand hedging in India. Deficiency of awareness in both rural and
urban India, coupled with almost negligible participation by corporates are among the key reason
why hedging activities are yet to gain momentum, especially in agri commodities,” said Ajay Kedia,
managing director of Kedia Commodities.
Weather derivatives are one product idea the Sebi panel will deliberate on. This is a financial
instrument for managing this risk in the agricultural sector.
“Some conclusion will be likely at the meeting,” said a source. The committee will also look
into the proposal of minimum support prices for all commodities.
This will be the second meeting of Sebi’s commodities panel after the Forward Markets
Commission was merged with market regulator in September 2015.
A little over two years after Jignesh Shah and Financial Technologies promoted National Spot
Exchange Limited (NSEL) suspended trading of all its contracts, resulting in a payments crisis
amounting to over ` 5,600 crore that still remains unresolved, the Forwards Market Commission,
the commodities market regulator, was merged with the Securities and Exchange Board of India
on Monday. Finance Minister Arun Jaitley, who had proposed the merger in his Budget speech in
February, said, “Markets thrive on confidence and integrity. These are crucial times for India, we
can’t afford throwing away the opportunity presented by the advantages.” This is what the
merger means for investors and market participants.
While foreign institutional investors are allowed to invest in Indian equities and debt
markets, they are currently restricted from participating in commodities trading at exchanges.
According to sources, Sebi may allow FII participation in commodities trading going forward,
which would provide more depth to the markets, and increase liquidity, investor participation and
better price discovery. Brokers also feel Sebi may introduce option contracts (call and put options)
in commodities trading, thereby providing better hedging tools to investors. Sebi has said that it
will oversee price determination of commodities. “Price discovery has been a major issue in
commodities trading, and if the regulator addresses that concern, it will be a big confidence-
booster for participants,” said Sugandha Sachdev of Religare Commodities.
Who proposed the merger?
The NSEL episode underlined the need for a better and stronger regulator to safeguard
investor interest and restore confidence. The Financial Sector Legislative Reforms Commission
(FSLRC) had earlier stressed on the need to move away from sector-wise regulation. It proposed a
system in which RBI would regulate the banking and payments system, and a Unified Financial
Agency (UFA) would subsume all other financial sector regulators such as SEBI, IRDA, PFRDA and
FMC, to regulate the rest of the financial markets.
What challenges could Sebi face?
Sebi has all necessary infrastructure to regulate the commodities market, but some feel it
lacks knowledge of the commodities market. However, since several FMC officials will move to
Sebi in line with the merger, such issues are likely to be sorted out.
The capital markets regulator said the major norms the commodities derivatives market will
need to comply with post the merger of Sebi with Forward Market Commission (FMC) include
those related to net worth, shareholding structure, composition of board, corporatization and
demutualization, setting up of various committees, turnover, infrastructure and so on.
Sebi decided to give three years for corporatization and demutualization of regional
commodity derivatives exchanges from the date of merger, which is likely to happen by the end of
September. This is similar to Sebi’s existing norms for the country’s stock exchanges.
Corporatization means converting an entity from being controlled and managed by a group
of individuals to one being a company incorporated as per the existing laws for companies.
Demutualization is the process through which a member-owned organization becomes a
shareholder-owned company. An entity is required to split the membership into two parts —
trading rights and ownership rights to demutualize itself.
After three years of the merger and demutualization, a commodity derivatives exchange will
be required to avail of the services of a clearing corporation for trade clearing and settlement,
Sebi said.
Till then, clearing may continue through the current arrangement, Sebi said. However, all
commodity exchanges will need to ensure a guarantee for the settlement of trades including good
delivery, Sebi ordered.
Also, all national commodity derivative exchanges such as MCX and NCDEX, will need to
attain a net worth of ` 100 crore before 5 May 2017. Regional exchanges, however, have been
given three years to do so. Similarly, to comply with the shareholding structure, national
exchanges will have time till 5 May 2019, while regional commodities derivatives exchanges will
have three years from the date of merger to do so.
Suresh Nair, director, ADMISI Commodities Pvt. Ltd, said Sebi has adopted a non-disruptive
approach for regulating commodity market participants and one can expect more uniformity in
the functioning of the two segments.
Introduction to Commodity Market 57
“Sebi will bring in more uniformity in the regulation of commodity and equity markets. The
first set of norms signal that there will be a lesser amount of regulatory confirmations for market
intermediaries. Both, participants and investors will have more faith as Sebi has an excellent track
record in regulating equity markets. The challenge for Sebi now will be to understand the physical
commodity market and address its settlement issues,” said Nair.
The proposed norms for commodity derivatives market, which will be notified on 28
September, also emphasized on strengthening of risk management and investor protection norms
for commodity derivatives exchanges.
The Sebi board also approved amendments to Sebi’s stock broker and sub-broker regulations
to allow registration of members of the commodity exchanges. The existing members of these
exchanges will be required to make an application for registration with Sebi within three months.
“These regulations will enable functioning of the commodities derivatives market and its
brokers under Sebi norms and integration of commodities derivatives and securities trading in an
orderly manner,” Sebi said.
P.K. Singhal, joint managing director of Multi Commodity Exchange of India Ltd (MCX), said
“the norms announced by Sebi are largely in line with the discussions it had with exchanges and
other stakeholders. It is a welcome move and the integrity of the commodity market will go up”.
A section of market participants, however, said that Sebi has failed to address the issue of
corporates, jewellers or even co-operative societies that act as members of commodity exchanges
to manage their exposure to specific commodities. Such entities do not function in the equity
market and so Sebi would need to look at a separate category of membership for such entities,
they say.
In a separate move, the Sebi board relaxed a primary market norm and removed the current
restriction on the maximum number of anchor investors (currently 25) for allocation of above `
250 crore in a public issue.
According to the existing norms, an anchor investor in a public issue has to make an
application for at least ` 10 crore worth of shares. Further, a minimum of two and a maximum of
15 such investors are allowed for allocation of above ` 10 crore and upto ` 250 crore. For
allocation of above ` 250 crore worth of shares to anchor investors, the present rules say there has
to be a minimum of five and a maximum of 25 such investors, with the minimum allotment being `
5 crore per such investor.
Sebi relaxed this rule on Monday and said that in a public issue, in case of allocation of shares
worth above ` 250 crore there can be 10 additional investors for every additional allocation of `
250 crore. In such cases, however, the minimum allotment will remain to be ` 5 crore per
additional anchor investor, Sebi said in a release.
Sebi said it will put out a discussion paper for public comments on a proposal to exempt
those cases from the mandatory open offer obligations in which an increase in voting rights has
happened due to the expiry of call notice period and forfeiture of shares in a listed company.
Further, Sebi said an expert committee on clearing corporations, headed by K.V. Kamath, has
submitted its proposals to Sebi in July and recommended allowing interoperability between
clearing corporations. The committee has also made proposals related to investment by a clearing
corporation, a review of the norm on transfer of 25% profit every year by stock exchanges to
clearing corporations; review of norms on transfer of 25% profits every year by depositories to
their Investor Protection Fund; and the existing norms on liquid assets for the purpose of
calculation of net worth of a clearing corporation.
58 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
4.3 NABOT
National Board of Trade Limited (NBOT) was incorporated on July 30,1999 to offer
integrated, state-of-the-art commodity futures exchange. It was incorporated to offer transparent
and efficient trading platform to various market intermediaries in the commodity futures trade.
Today NBOT is one of the fastest growing commodity exchanges recognized by the Government of
India under the aegis of the Forward Markets Commission. Within a short span of seven years,
NBOT has carved out a niche for itself in the commodities market. It has implemented the state-
of-the-art technology and system for efficient handling of Trading, Margining, Clearing and
Settlement in respect of all the transactions confirmed by the Exchange. The Board of directors,
adorned by a galaxy of the most respectful personalities drawn from different categories of trade
and commerce has been giving necessary impetus and thrust for setting up of the exchange and
provide guidance for its proper functioning.
NBOT has been constantly endeavoring to strengthen professionalism in the commodities
futures market and to provide credible nation-wide trading facilities to market players in tune
with the international standards.
Corporate Philosophy
NBOT Will be a catalyst for the development of the Indian Oilseeds growers, trade and
industry by providing the cost effective and efficient services. In being so, NBOT's sphere of action
will synergies and naturally identify with the interests of NBOT members, the investors, the
industry and above all, the country. In all that we do, we will be fair, professional and pre-
eminent.
Mission
To achieve high distinction in integrity for pricing, risk management and investment to build
an internationally acclaimed innovative Commodity Exchange in India.
Object
Futures Exchange helps to achieve dual economic purposes : Price Discovery & Risk-
Management.
The introduction of futures trading with the ability to buy and sell commodities for future
delivery helps make the price less volatile and, of course, realistic in comparison to the cash
market prices. Futures contract is a contract of a specific quantity and quality of a given
commodity at a predetermined place and time in future with all terms of contracts standardized
excepting the price which is determined by the market forces. At the time of expiration of the
contract, the open position is either squared-off or resulting in delivery.
Volatile trend in the price movement of oilseeds and their derivatives often has a telling
effect on the performance of the processors, growers and other intermediaries. Futures Exchange
tends to achieve a rational for price discovery and data dissemination on real-time basis which
improves hedging by minimizing speculative risk.
Management
The day to day affairs of the Exchange are managed by professionals who have a deep
domain knowledge and understanding of the commodity futures markets. The IT team is led by
competent people who strive to make the system as contemporary as possible without
compromising on the quality.
The rates quoted on the Exchange serve as a benchmark rates in the edible oil sector. The
settlement rates arrived at by the Exchange are widely acclaimed by the trade and industry as the
genuine settlement rates.
Introduction to Commodity Market 59
NBOT has conceived and developed the trading, clearing and settlement system which is user
friendly and functional under the fully computerized environment. The trading takes place in the
Ring Hall with an outcry system which will be replaced in gradual phases through computerized
environment. All trades confirmed by the exchange are guaranteed for performance.
Trading takes place from Monday to Friday between 10:00 a.m. to 5:00 p.m. and on
Saturdays between 10:00 a.m. to 2:00 p.m. Trade shall have priority strictly in the order of price,
time, non-member client account and own account. Trading limit for trading is fixed by clearing
member, which is subject to over-all limits fixed by the Exchange.
In order to ensure adequate safety for trades executed through the Exchange, ceiling on
trading by each member is fixed. There will be daily clearing based on mark to market system ;
failure to clear the dues will result in automatic closing out of open positions. Pre-margin
requirements in case a member exceeds free trading limits.
On the last trading day, deliveries can be tendered at the option of the short members, and
the same will be apportioned to the long members on pro-rata basis. In case of delivery default,
the Exchange will resort to buying in and selling out as a first step before invoking squaring
off/closing out open position.
4.4 CWC
A premier Warehousing Agency in India, established during 1957 providing logistics support
to the agricultural sector, is one of the biggest public warehouse operators in the country offering
logistics services to a diverse group of clients.
CWC is operating 445 Warehouses across the country with a storage capacity of 10.43 million
tonnes providing warehousing services for a wide range of products ranging from agricultural
produce to sophisticated industrial products.
Warehousing activities of CWC include foodgrain warehouses, industrial warehousing,
custom bonded warehouses, container freight stations, inland clearance depots and aircargo
complexes.
Apart from storage and handling, CWC also offers services in the area of clearing &
forwarding, handling & transporation, procurement & distribution, disinfestation services,
fumigation services and other ancillary activities.
CWC also offers consultancy services/ training for the construction of warehousing
infrastructure to different agencies.
CWC operations include scientific storage and handling services for more than 400
commodities include Agricultural produce, Industrial raw-materials, finished goods and variety of
hygroscopic and perishable items.
Scientific Storage Facilities for commodities including hygroscopic and perishable items
through network of 476 warehouses in India with its 5,658 trained personnel.
Import and Export Warehousing facilities at its 36 Container Freight Stations in ports and
inland stations.
Bonded Warehousing facilities .
Disinfestations services.
Handling, Transportation & Storage of ISO Containers
CWC enables the movement of imported and exportable goods to and from the port towns
and has developed infrastructure of Container Freight Stations & Inland Clearance Depots
throughout the country. It operates 36 CFSs/ ICDs where composite services for containerised
60 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
4.6 APMC
An agricultural produce market committee (APMC) is a marketing board established by a
state government in India.
APMC operate on two principles
Ensure that farmers are not exploited by intermediaries (or money lenders) who compel
farmers to sell their produce at the farm gate for an extremely low price.
All food produce should first be brought to a market yard and then sold through auction.
Features
Each state which operates APMC markets geographically divide the state and markets
(mandis) are established at different places within the state. Farmers are required to sell their
produce via auction at the mandi in their region. Traders require a license to operate within a
mandi. Wholesale and retail traders (e.g. shopping mall owners) and food processing companies
cannot buy produce directly from a farmer.
Some of the salient features of the APMC Model Act 2003 are as follows 1) Facilitates
Contract farming model 2) Special market for perishables 3) Farmers, private persons can setup
own market 4) Licensing norms relaxed 5) Single market fee 6) APMC Revenue to be used for
improving market infrastructure
However, not all States have passed the bill. Some States have passed but neither framed
rules nor notified it. Thus, inter-state barriers continue. Further, Union Budget 2015 proposed to
create United National Agriculture Market with the help of State Government and NITI Ayog.
Karnataka
The state government of Karnataka has created APMCs in many towns to enable farmers to
sell their produce at reasonable prices. Most APMCs have a market where traders and other
marketing agents are provided stalls and shops to purchase agriculture produce from farmers.
Farmers can sell their produce to agents or traders under the supervision of the APMC.
Farmers cannot sell produce outside the APMC mechanism. However, the government is now
encouraging direct selling through 'Rautu Bazar' or to supermarkets directly. The present APMC
system makes farmers vulnerable to traders' and marketing agents' price manipulations. The
Government of India is considering improving the APMC Act to benefit all parties involved.
Maharashtra
The Maharashtra State Agricultural Marketing Board runs 295 APMCs in Maharashtra, under
the APMC Act enacted by the Government of India. In July, 2016, the Maharashtra State
Government removed fruits and vegetables from the purview of the APMCs.
Although the decision is limited to fruits and vegetables, it will cause of a loss of around
` 5,000 crore to the ` 50,000 crore annual turnover of APMC markets across the state, admitted
state (agricultural) marketing minister Chandrakant Patil. The government will soon promulgate
an ordinance for its implementation after finalising modalities, he said.
“With the historic move, the farmers will now be able to sell their produce to anyone who
gives them a good price, which will ultimately help them earn more,” said Patil.
62 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Currently, farmers are required to sell their produce in an auction at the APMC markets in
their region, according to the Maharashtra Agricultural Produce Marketing (Regulation) Act,
passed in 1963. Traders require a licence to operate within a market. The decision will also help
farmers sell their produce directly to wholesale and retail traders — retail chains and food
processing companies.
The state has 295 APMC markets that are running under the Maharashtra State Agricultural
Marketing Board.
The objective of the APMC Act was to ensure farmers were not exploited by intermediaries,
who would compel them to sell their produce at an extremely low price. But instead, traders
exploited the farmers by making them pay a commission to buy their produce, forcing them to pay
carrier charges, entry taxes, among other expenses. With this move, the monopoly of traders
ends, said a senior official from the state marketing department.
Tamil Nadu
In Tamil Nadu, the Tamil Nadu State Agricultural Marketing Board is the regulatory board for
agricultural markets which is successfully running since 1977. 21 Market committees are
established for every notified area and 277 Regulated Markets are functioning under these
committees for better regulation of buying and selling of agricultural produce.
There are many problems faced by farmers due to the restrictions imposed by the APMC Act.
Even after receiving the produce, some traders delay payment to farmers for weeks or months. If
payment is made at the time of sale, then the trader may arbitrarily deduct some amount, on the
excuse that he has not received payments from the other parties. To avoid tax, some traders do
not give sale slips to farmers. As a result, it is difficult for the farmer to prove his income to get
loans from banks. On average, the farmer is able to receive barely 25% to 33% of the final retail
price. Middlemen receive double commission (both from seller and buyer), thus making
consumers pay for this spread. Also middlemen do not pass the benefit to either side. During peak
seasons, when they buy from farmers at low prices, they do not drastically reduce the prices to
final consumers. Conversely, during lean seasons, when consumer prices are high, the farmers do
not get higher returns on their produce.
Agriculture Produce Market Committee
Agriculture produce means all produce (whether processed or not) of agriculture,
horticulture, animal husbandry, pisciculture and forests as specified in the schedule.
The APMCs were established by the State Govt. for regulating the marketing of different
kinds of agriculture and pisciculture produce for the same market area or any part thereof.
The Maharashtra Agricultural Produce Marketing (Development & Regulation) Act was
passed in the year 1963, with a view to regulate the marketing of agricultural and pisciculture
produce in market areas. After giving due consideration to various committee's recommendations
and study groups, some important changes have been made in this Act in the year 1987 and
thereafter.
Constitution
Every market shall consist of
Agriculturists residing in the market area and being 21 years of age on the date specified
from time to time by the Collector in this behalf.
Traders and commission agents holding license to operate in the market area.
Chairman of the co-operative society doing business of processing and marketing of
agriculture produce in the market area.
Introduction to Commodity Market 63
Chairman of the Panchayat Samiti within the jurisdiction in which the market area is situated,
President or Sarpanch of the local authority within the juridiction of which the principal market is
situated. Deputy Registrar of Co-operative Society of the district, the Assistant Cotton Extn. Officer
or where there is no such officer the district Agriculture Officer of the Department of Agriculture.
Objectives
It shall be the duty of the Market Commitee to implement the provisions of the Maharashtra
Agricultural Produce Marketing (Regulation) Act 1963, the rules and bye-laws made there under in
the market area to provide such facilities for marketing of agricultural produce therein as the
Director may from time to time, direct do such other acts as may be required in relation to the
superintendence, direction and control of markets or for relating marketing of agricultural
produce in any place in the market area and for purpose connected with the matters aforesaid,
and for that purpose may exercise such powers and perform such duties and discharge such
functions as may be provided by or under this Act.
The Act provides for establishment of Market Committees in the State. These Market
Committees are engaged in development of market yards for the benefit of agriculturists and the
buyers. Various agricultural produce commodities are regulated under the Act. At present there
are 305 APMCs with main markets and 603 sub markets.
Divisionwise break-up of APMCs are as follows:
1 Konkan 20 42
2 Nasik 38 89
3 Pune 38 103
4 Aurangabad 29 63
5 Latur 56 85
6 Amravati 55 93
7 Nagpur 48 71
8 Kolhapur 21 57
Total 305
64 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
In order to augment the reach of bank credit and increase the production of commercial
crops as also for creation of marketing avenues for the farmers, all contract farming arrangements
(within and outside AEZs) are made eligible for availing special refinance package from NABARD.
The various initiatives undertaken by NABARD in this direction are:
Financial Interventions
Special Refinance package for financing farmers for contract farming in AEZs
100% refinance to disbursements made by CBs, SCBs, RRBs and select SCARDBs (having
net NPA less than 5%)
Term facility for repayments (3 years)
Fixation of higher scale of finance for crops under contract farming.
Extension of refinance scheme for financing farmers for contract farming in AEZs to
contract farming outside AEZs besides coverage of medicinal and aromatic plants.
Extension of Refinance scheme for contract farming under Automatic Refinance Facility.
Preparation of banking plan for financing Diesel Gensets to Gherkin farmers in Karnataka
with TFO – 1.71 crore
Area Development Project for grapes in Nashik District, Maharashtra with TFO – 402
crore.
Refinance support extended for contract farming within AEZs and outside to various
financing agencies during 2004-05 and 2005-06 was to the tune of ` 774 crore and
` 268 crore respectively.
Developmental interventions
Conducting workshops and exposure visits for better interface among farmers and
entrepreneurs and popularization of contract farming concept.
Conducting crop specific studies in (Ex. Gherkins in Karnataka, Grapes in Maharashtra
and Mango in AP) to understand the gamut of contractual arrangements.
Sensitisation of stake holders through State and District level meets and consultations.
Sensitisation of Bankers through tailor-made training programme at Bankers Institute for
Rural Development (BIRD) Lucknow.
Follow-up with National Agricultural Insurance Corporation for insurance of crops grown
under contractual arrangements in AEZs.
Initiatives for expansion of scope of contract farming for medicinal plants through
corporate initiatives.
MCX offers MCX Certified Commodity Professional (MCCP) programme for those who want
to be acquainted with the commodity derivatives market. The programme focuses on the
modalities of trading in commodity markets, its operations and practices, clearing, settlement and
delivery procedures, and its regulatory and legal framework. On successful completion of the
programme, the candidates will earn ‘MCCP’ or ‘MCX Certified Commodity Professional’
certificate.
2. Taking into account international experience and the needs of the Indian financial markets,
with a view for protecting interests of investors in financial markets and more importantly,
for minimizing risks of losses arising out of deficient understanding of markets and
instruments, National Stock Exchange introduced in 1998 a facility for testing and
certification by launching NSE's Certification in Financial Market (NCFM). It is an on-line
testing system, a revolutionary concept in administration of examinations and the only one
of its kind today in the country. It tests the practical knowledge and skills required to operate
in the financial markets in a secure and unbiased manner and awards certificates based on
relative merits thus ensuring that the caliber of persons entering this field is kept high in the
best interests of a mature and vibrant market.
The entire process of testing, assessing, scores reporting and invigilation in the NCFM is fully
automated. The system is operated through an intranet facility by using a central World Wide
Web server with terminals located at each of the designated test centers to be used as an
examination front end. Communication between the central server and the test centers is
achieved through VSAT/leased line network. The Test is also offered through the Internet to
enable candidates outside the designated test centers to take tests at their convenience. This
allows flexibility in terms of testing centers, dates and timing and provides easy accessibility and
convenience to candidates. The easy accessibility as well as flexibility involved in the NCFM
programme has resulted in its wider acceptance among market intermediaries, students and
regulators.
Why NCFM ?
The financial markets are going to be the turf of certified professionals very soon due to
regulatory compulsions and/or initiatives of the industry. By imparting comprehensive knowledge
and skill in the chosen field, NCFM enhances career opportunities for NCFM certified persons.
Some of these modules have regulatory sanctity. For example, It has been specified by SEBI
that all brokers/dealers and sales persons in the derivatives market have to mandatory obtain
certification. In order to improve the level of knowledge of market participants, only persons who
have passed Capital Market (Dealers) Module of the NCFM are authorized to use the trading
system of the National Stock Exchange. The National Securities Depository Limited has similarly
prescribed that all the branches of the depository participants must have at least one person who
has qualified the NCFM module on Depository Operations. SEBI recommends Surveillance Module
for the officers working in surveillance departments of stock exchanges. SEBI has made it
mandatory for all mutual funds to appoint agents/distributors who have obtained certification in
AMFI - Mutual Funds Modules. The existing and new employees of mutual funds, particularly
those who are involved in sales and marketing, are encouraged to pass the certification in AMFI -
Mutual Funds Modules.
Insurance Regulatory and Development Authority requires that a person desiring to obtain or
renew a license to act as an Insurance agent or a composite agent shall pass Pre recruitment
Examination for Life Insurance Agents and / or pre-recruitment examination for General Insurance
Agents as the case may be.
Capital Market (Dealers) Module
Introduction to Commodity Market 67
This module equips the candidates with the knowledge and skills required for dealers in the
capital market operations.
Derivatives Market (Dealers) Module
SEB1 Committee on Regulatory Framework for Financial Derivatives in India' had
recommended that all brokers-members and sales persons/dealers in the derivatives market must
pass a certification Programme. Based on the Committee's recommendations, SEBI issued
guidelines for the conduct of the certification examination. The Derivatives Market (Dealers)
Module certifies brokers-members and sales persons/dealers in the derivatives market.
Commodities Market Module
The module equips the candidates with the knowledge and skills required for dealers in
Commodities Market Module.
OBJECTIVE QUESTIONS
I. Fill-in-the-blanks
1. FMC was established in ________ .
[1952, 1953, 1954]
2. NABOT incorporated in ________ .
[1997, 1998, 1999]
3. CWC is operating ________ warehouses across the country.
[443, 444, 445]
4. APMC model act ________.
[2001, 2002, 2003]
5. Maharashtra state has ________ APMC.
[295, 296, 297]
[Ans.: 1) 1953; 2) 1999; 3) 445; 4) 2003; 5) 295]
V. Short Notes
1) Contract farming.
2) Forward market contract
3) State warehousing corporation
4) NCFM
Introduction to Commodity Market 69
5
Commodity Exchange
SYNOPSIS
1. Homogeneity
The commodity must be homogeneous i.e., all units of a particular commodity must be
perfectly identical so that all dealers may mean the same commodity when they mention it in
their dealings.
2. Durability
It must be durable so as to last for a period of a future contract (ordinarily more than one
year). If it perishes rather quickly, contracts for its purchase and sale will be frustrated.
3. Gradability
The commodity should be such as will lend itself to grading. If the commodity cannot be
classified into well-known grades, trading will be difficult for every time the quality will have to be
ascertained.
4. Price Fluctuation
There must be frequent fluctuations in the price of the commodity. If there were no price
fluctuations, the speculators would have no intention to speculate in it at the exchange.
5. Open Supply
The supply of the commodity should be open and free and should not be monopolized by
one or a few persons. Again, the supply of the commodity or its price must not be controlled by
the Govt.
Objectives of Commodity Exchanges
The organised market represents a public organisation consisting of buyers, sellers,
producers, traders and dealers dealing in one or more commodities which constitute the articles
of trade in the market. The exchange for commodity is a private association of dealers and is not
for making money or profit or for fixing prices.
Its objectives are to provide an open platform for the interaction of free play of the forces of
demand and supply. It only registers the prices reflecting the forces of demand and supply. Buying
and selling, trading practices and actual working of the organised market are governed by a code
of rules and regulations and these can ensure fair dealings, fair prices and equity.
Nature of Commodity Exchanges
Organised market has the following features
1. Best facilities available for close and continuous contact between total demand and total
supply both present and potential.
2. All businesses are governed by rules and regulations and these rules are strictly enforced by
the exchange authorities.
3. Usually the exchange enjoys internal autonomy and it is self-regulated, self-administered and
self-disciplined autonomous body. At present, almost in all organised markets there are
special legislations to control the activities of these organised markets.
4. There is free competition of buyers and sellers. The forward markets for commodities and
securities are also known as two-way auction markets. Open public outcry gives offers and
bids by sellers and buyers. They also use finger signals to declare their prices and amounts.
5. Every forward market has a clearing house organisation to facilitate clearing of all dealings
and their settlement. The clearing house guarantees payment of dues and taking and giving
of delivery of commodities or securities during the settlement period.
6. An organised market acts as a clearing house of market information, i.e., collection of all facts
and figures and regular publicity of all relevant statistical information which helps the traders
72 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
to estimate and forecast price trends, changes in demand and supply. Constant price
quotation services enable people to make their purchases and sales with certainty and
confidence.
7. The speculative trader is a necessary and vital part of any broad and stable commodity or
securities market. Speculation is an integral part of market mechanism whether in stock
exchange or in commodity exchange.
8. It is a convenient central market place.
Availability of warehousing system certainly mitigates the compulsion of the farmer to have their
products sold as soon as possible at any minimum price in order to escape product loss. The
elimination of this problem can put the farmers at the advantage side. By becoming able to
control the storage function, they can charge the products as per the co-ordination of efficient
market demand and supply. Furthermore, warehousing system also assists the farmers to certify
their production as collateral via the warehouse receipts that are provided against the products
stored in the warehouse, which can be in turn used against bank loan. Technically, a warehouse
receipt is a kind of document which contains the standard quantity and valuation of the stored
commodity and also can be used as money instrument. The bottom line is that, the availability of
the finance through the warehouse receipt for the farmers who were always in short of it can take
advantage of it for further investment in productivity and quality of their farm.
Similarly, distribution part of commodity market mechanism can also play a vital role in agro-
economy development. When the commodities are being traded in the future contract, there is a
stipulated delivery date that needs to be maintained. Hence, this market needs efficient
distribution mechanism to meet the required standard, which in turn, emphasizes for proper
transportation infrastructure development. However, this part of the infrastructure requires a
massive investment; so, excess effort is expected from the market for the purpose to develop this
field. Therefore, being involved in this sector enables the farmers to take advantage of such
distribution mechanism, which is the major hurdle of current agro-economy.
In this way, the various other feature of Commodity market can help establish the agriculture
sector, into a potential investment sector, securing more and more investment and
entrepreneurship. Furthermore, Commodity market mechanism enables the farmers (the
currently disadvantaged ones) to take a winning side in the whole market process thereby turning
traditional agriculture into commercial one, which instead shall boost the agro-economy, thereby
enhancing the national economy or GDP.
The relationship between the broker and the client is long-term. Thus there must be a strong
rapport, and mutual trust between the client and the broker. Further, the client must
communicate clearly to the broker his needs and objectives for trading in commodities, whether
they are for the purpose of hedging, investment, etc. Further, your objectives for entering the
market provide you with a valuable parameter to judge whether a broker fits your needs.
In order to keep your investment decisions and objectives in check, it is important to choose
the right certified Commodities Broker, it is important to learn about the process of depositing
margin for commodity trading and why it is necessary to deposit margin with the broker.
2. Depositing the Margin
To begin trading, the investor needs to deposit a margin with his broker. Margin
requirements are of two types, the initial margin and the maintenance margin. These margin
requirements vary across commodities and exchanges but typically, the initial margin ranges from
5-10% of the contract value.
The maintenance margin is usually lower than the initial margin. The investor's position is
marked to market daily and any profit or loss is adjusted to his margin account. The investor has
the option to withdraw any extra funds from his margin account if his position generates a gain.
Also, if the account falls below the maintenance margin, a margin call is generated from the
broker and the investor needs to replenish his account to the initial level.
3. Trading plan and access to information
As commodity futures are not long-term investments, their performance needs to be
monitored. The investor should have access to the prevailing prices on the exchanges as well as
market information that can help predict price movements. Brokers provide research and analysis
to their clients. Other information sources are financial dailies, specialized magazines on
commodities and the internet. Further, an investor requires a trading plan. Such a trading plan can
be developed in consultation with the broker. In any case, the investor has to remember to ride
his profits and cut his losses by using stop loss orders.
4. Flow chart
After the process of opening account is done the investor may want to trade in commodity.
IT is important to understand the process after the trade is placed.
An investor places a trade order with the broker (at the dealing desk) on phone. The dealer
puts the order in exchange trading system. At the initiation of the trade, a price is set and initial
margin money is deposited in the account. At the end of the day, a settlement price is determined
by the clearing house (Exchange). Depending on if the markets have moved in favor or against the
76 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
investors' position the funds are either being drawn from or added to the client's account. The
amount is the difference in the traded price and the settlement price. On next day, the settlement
price is used as the base price. As the spot market prices changes every day, a new settlement
price is determined at the end of every day. Again, the account will be adjusted by the difference
in the new settlement price and the previous night's price in the appropriate manner.
5. Dematerialisation
Some basics for giving and taking delivery of commodities in the Indian commodity futures
markets.
Dematerialization is the process of recording physical holdings (warehouse receipts) in
electronic form. It facilitates the easy transfer of holdings through electronic mode. The investor
opens an account with a depository participant (DP) of NSDL, gets the goods to the warehouse
and makes a request for Demat credit. The warehouse accepts goods for storage and delivery. The
goods are assayed and the information is given to the NSDL via the Registrar and Transfer Agent
(R&TA). The R&TA is the link between the warehouse and the depository. NSDL, upon
confirmation from the R&TA, credits the ICIN (a unique number allotted by NSDL for identification
purposes) balance into the Demat account of the client.
Reforms in the commodities derivatives market regarding clearing activities are facing many
challenges as they are being examined by the ministry of finance before they are implemented.
The reforms were proposed by the market regulator, Forward Markets Commission.
The department of economic affairs had proposed setting up of a Common Clearing
Corporation for all national commodity exchanges. An industry official said, “There are inherent
risks in the one common clearing corporation for all exchanges because any problem that occurs
in the clearing of one of the member exchange could affect the industry as a whole and
potentially cause systemic risk.”
It is also argued that physical clearing and settlement is integral to efficient price discovery
on the commodity exchanges and therefore cannot be removed from complete control of an
exchange.
NCDEX, a major agri-centric commodity exchange, is the only National Commodity Exchange
in the country to have a vertically integrated architecture and capability to support the growth of
the commodity derivatives market. The exchange said, “In our view, for the development of
integrated commodity market in India, there is also a need for a common clearing across market
segments from mandis (APMC), forwards and futures as well as state government and central
government procurement and sale activities.”
Even other exchanges have not fully supported the idea of common clearing. One of them
said even multiple common clearing corporations could be a better option where market can
make a choice and so the exchanges.
Market players see better arbitrage opportunities if clearing activity along with trading is
under one roof for multi segments especially futures and forwards. If there is common clearing for
various segments across exchanges then the arbitrage opportunity will be wider. However, costs
shall increase to market participants.
Clearing method
There are many types of commodity traded in the world and the same goes for places where
these commodities are traded. There are a lot of different exchanges or markets in the world that
are often specialized in one or more specific commodites. On these exchanges, futures contracts,
which give access to underlying commodities, are traded. These futures are traded by traders on
Introduction to Commodity Market 77
the floor. An exchange arranges for a centralized area in which to trade in a responsible manner
and are usually regulated by a national regulatory agency. An exchange has a number of tools at
its disposal to control trading.
Trading Methods
When trading is on an exchange there are two ways to buy or sell a contract. The first way is
by using open out-cry in a trading pit. A trading pit is usually a raised octagonal platform, where
traders trade contracts. This trading is done by using hand signals and shouting between traders.
This form of trading is however being used less frequently and many exchanges are now only
using electronic trading. This form of trading excludes the need for traders to physically meet for
completing a trade. This way, traders can easily trade on a number of different exchanges from a
single location. Electronic trading uses specialized software, which can differ per exchange. The
advantage of electronic trading is the possibility to trade around the clock. With open out-cry
trading, traders are bound to the designated trading hours.
Clearing Houses
Each exchange has its own clearing house. A clearing house is an institution which clears
transactions between two trading parties with the intention of providing a form of security
between traders. Every member trading on an exchange is required to clear all of their trades at
the end of a trading session. This means that all transactions, both bought and sold, are offset.
Based on this result a margin is required to cover potential losses because of price fluctuations. A
margin is a percentage of the total price of the trade. Therefore a part of the risk is covered by the
clearing house itself. In the case prices of futures contract rise or drop the initial margin can be
adjusted to match the current price, this type of margin is called maintenance margin. Clearing
houses use this margin to maintain a sufficient deposit. Along with margining and maintaining
enough margin per trader, clearing houses fulfill other services for traders at an exchange. In the
case of a failure of one of the parties to honor its obligations, a clearing house will handle the
further completion of a contract. To exclude this risk it is important for clearing houses to monitor
the credit worthiness of traders or firms.
OBJECTIVE QUESTIONS
I. Fill-in-the-blanks
1. Commodity exchange is ________ organisation.
[Public Sector, Profit, Non-profit]
2. ________ is manufactured products
[Zinc, Jute, hides]
3. ________ is mineeral product
[Jute, hides, lead]
4. ________ divide the commodity on quality
[Homogeneity, grading, durable]
[Ans.: 1) Non-Profit; 2) hides; 3) lead; 4) grading ]
II. True or False
1) Sophisticated product includes interest rates
2) Commodity futures face a substantial risk
3) Initially margin range 3 to 4 % in commodity exchange
4) Trading in future has 7 steps
[Ans. : True : 1, 2,
78 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
False : 3, 4]
V. Short Notes
1) Commodity Exchange
2) Aims or Commodity Exchange
3) Basic functions of Commodity exchange
4) Dematierialisation
Introduction to Commodity Market 79
6
Commodity Exchange
In
India
SYNOPSIS
Forward Markets Commission (FMC) : It is statutory institution set up in 1953 under Forward
Contracts (Regulation) Act, 1952. Commission consists of minimum two and maximum four
members appointed by central government.
Who Uses Commodity Exchanges?
The main users of commodity exchanges are hedgers and speculators. A hedger is someone
who is taking a risk based on the price of a commodity. For example, a power plant might produce
power using coal, and sell this power at a fixed price. If coal rose in price, they could be forced to
sell at a loss. This producer might buy coal futures in order to profit from those futures if coal
prices rose. When a financial transaction leads to a profit that offsets a business loss (or a loss that
offsets a business profit), it is known as a hedge. A speculator is simply betting on the direction of
prices, without having an underlying business interest.
Commodity Exchange Benefits
Commodity exchange benefits of can be given in the following :
Agricultural products produced by farmers in terms of real value and reach of the market
available to the extent of the state support policies in the agricultural sector due to
reduced financial burden to undertake.
Agricultural products and animal products registered with the Stock Exchange traded off
the record to be recorded is provided to the economy so the state withholding tax in
these products, VAT and tax losses and leakages are prevented.
Commodity exchanges, pre-estimate the possible fluctuations will stabilize.
Exchanges of producers, their products in large quantities in the face of the receiver can
not supply, so that in that day´s conditions, can sell with confidence and real prices is a
market.
Exchanges of producers, their products in large quantities in the face of the receiver can
not supply, so that in that day´s conditions, can sell with confidence and real prices is a
market.
Only registered members of the Commodity Exchange may enter the stock market and
trading can make. The only exception to this limitation are agricultural producers.
Therefore, an important part of every trader in the stock market creates agricultural
producers.
What is the commodity market?
Commodity market is a place where trading in commodities takes place. It is similar
to an equity market, but instead of buying or selling shares one buys or sells commodities.
How old are the commodities market?
The commodities markets are one of the oldest prevailing markets in the human
history. In fact, derivatives trading started off in commodities with the earliest records
being traced back to the 17th century when rice futures were traded in Japan.
What are the different types of commodities that are traded in these markets?
World-over one will find that a market exists for almost all the commodities known to
us. These commodities can be broadly classified into the following:
Precious Metals : Gold, Silver, Platinum, etc.
Other Metals : Nickel, Aluminum, Copper, etc.
Agro-Based Commodities : Wheat, Corn, Cotton, Oils, Oilseeds, etc.
Soft Commodities : Coffee, Cocoa, Sugar, etc.
82 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
may be available in the local market. These and other factors deter a person from giving /
receiving delivery through the exchanges.
What is the size of the commodities market as compared to the equity market?
In the developed markets the volumes on the exchange-based commodity derivates
markets are about five times more than that of the equity markets.
What is the history of commodities markets in India?
India, being an agro-based economy, has markets for most of the agro-based
commodities. India is the largest consumer of gold in the world, which implies a huge
market for the yellow metal. India has huge spot markets for all these commodities. For
instance,. Indore has a huge market for soya, Ahmedabad for castor seeds and
Surendranagar for cotton, etc.
During the pre-Independence era, India also had a thriving futures market for
commodities such as gold, silver, cotton, edible oils, etc. In mid-1960s, due to wars,
natural calamities and the consequent shortages, futures trading in most commodities
was banned.
Currently, the futures markets that exist in India are localised for specific
commodities. For example, Kerala has an exchange for pepper; Ahmedabad for castor
seeds, and Mumbai is the major center for gold, etc. These exchanges, however, have
only a regional presence and are dominated by people who are involved with the physical
trade of that commodity.
What are the current developments in this market?
The government has now allowed national commodity exchanges, similar to the
Bombay Stock Exchange and the National Stock Exchange, to come up and let them deal
in commodity derivatives in an electronic trading environment. These exchanges are
expected to offer a nation-wide anonymous, order-driven, screen-based trading system
for trading. The Forward Markets Commission (FMC) will regulate these exchanges.
Consequently four commodity exchanges have been approved to commence
business in this regard. They are:
Multi Commodity Exchange of India Ltd (MCX), located at Mumbai
National Commodity and Derivatives Exchange Ltd (NCDEX), located at Mumbai
National Board of Trade (NBOT), located at Indore
National Multi Commodity Exchange (NMCE), located at Ahmedabad.
What is the need for the exchange-traded commodity derivatives market?
The biggest advantage of having an exchange-based platform is reach. A wider reach
ensures greater participation, which results into a more efficient price discovery
mechanism. In fact, it comes to a stage where the derivative market guides the spot
market in terms of pricing.
This can be well understood by looking at the following example:
Imagine a soy wholesaler in Madhya Pradesh, who -- having bought the crop from the
farmer -- wishes to sell it to the oil refiners. To sell his crop he has to go to the local
market at Indore.
The price that he will get for his crop would be solely dependent upon the demand
supply condition prevailing at that point of time at that market place. Also as the number
84 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
of players is less there are chances of the prices being biased. In contrast the prices in the
futures market are determined not only by the local demand supply conditions but also by
the global scenario.
Add to that the view taken on a commodity by various sets of people depending upon
different parameters such as technical analysis, political news, exchange rates, etc. The
price that is thus quoted can be safely regarded as the most efficient price.
Thus, looking at the futures price the trader can price his crop appropriately.
What opportunities do the commodity derivatives provide for investors?
Futures contract in the commodities market, similar to equity derivatives segment,
will facilitate the activities of speculation, hedging and arbitrage to all class of investors.
Speculation
It facilitates speculation by providing opportunity to people, although not involved
with the commodity, to trade on the views in the movement of commodity prices. The
speculative position is taken with a small margin amount that is paid to the exchange, and
the contract can be squared-off anytime during the trading hours.
Hedging
For the people associated with the commodities the futures market can provide an
effective hedging mechanism against price movements.
For example an oil-seed farmer may go short in oil-seed futures, thus 'locking' his sale
price and in the process hedging against any adverse price movements.
On the other hand a processor of oil seeds may buy oil-seed futures and thus assure
him a supply of oil-seeds at a pre-determined price. Similarly the oil-seed processor may
go short in oil futures, which may be bought by a wholesaler of oil.
Also, there is a saying that 'gold shines when everything fails.' Thus, gold can be used
as a hedging tool against other investments.
Arbitrage
Traders may exploit arbitrage opportunities that arise on account of different prices
between the two exchanges or between different maturities in the same underlying.
There are 24 commodity exchanges in India. There are three national level commodity
exchanges to trade in all permitted commodities. They are:
Multi Commodity Exchange of India Ltd, Mumbai (MCX)
MCX is an independent and de-mutualised multi commodity exchange. MCX features
amongst the world's top three bullion exchanges and top four energy exchanges. Its key
shareholders are Financial Technologies (I) Ltd., State Bank of India and it's associates, National
Bank for Agriculture and Rural Development (NABARD), National Stock Exchange of India Ltd.
(NSE), Fid Fund (Mauritius) Ltd. - an affiliate of Fidelity International, Corporation Bank, Union
Bank of India, Canara Bank, Bank of India, Bank of Baroda, HDFC Bank and SBI Life Insurance Co.
Ltd.
National Commodity and Derivative Exchange, Mumbai (NCDEX)
A consortium of institutions promotes NCDEX. These include the 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).
National Multi Commodity Exchange of India Ltd, Ahmedabad (NMCE)
Introduction to Commodity Market 85
It is the first de-mutualised electronic multi-commodity Exchange of India. Some of its key
promoters are Central Warehousing Corporation (CWC), National Agricultural Co Operative
Marketing Federation of India Limited (NAFED), Gujarat Agro Industries Corporation Limited
(GAIC) and Punjab National Bank (PNB).
COMMODITY EXCHANGE BENEFITS
Commodity exchange benefits of can be given in the following :
Agricultural products produced by farmers in terms of real value and reach of the market
available to the extent of the state support policies in the agricultural sector due to
reduced financial burden to undertake.
Agricultural products and animal products registered with the Stock Exchange traded off
the record to be recorded is provided to the economy so the state withholding tax in
these products, VAT and tax losses and leakages are prevented.
Commodity exchanges, pre-estimate the possible fluctuations will stabilize.
Exchanges of producers, their products in large quantities in the face of the receiver can
not supply, so that in that day´s conditions, can sell with confidence and real prices is a
market.
Exchanges of producers, their products in large quantities in the face of the receiver can
not supply, so that in that day´s conditions, can sell with confidence and real prices is a
market.
Only registered members of the Commodity Exchange may enter the stock market and
trading can make. The only exception to this limitation are agricultural producers.
Therefore, an important part of every trader in the stock market creates agricultural
producers.
To ease participation, the Exchange offers facilities such as calendar-spread facility, as also
EFP (Exchange of Futures for Physical) transactions which enables participants to swap their
positions in the futures/ physical markets. The exchange’s flagship index, the MCXCOMDEX, is a
real-time composite commodity futures price index which gives information on market
movements in key commodities. Other commodity indices developed by the exchange include
MCXAgri, MCXEnergy, and MCXMetal. MCX has been certified to three ISO standards including ISO
9001:2000 quality management standard, ISO 27001:2005 information security management
standard and ISO 14001:2004 environment management standard.
With an aim to seamlessly integrate with the global commodities ecosystem, MCX has forged
strategic alliances with leading international exchanges such as CME Group, London Metal
Exchange (LME), Shanghai Futures Exchange (SHFE) and Taiwan Futures Exchange (TAIFEX). The
Exchange has also tied-up with various trade bodies, corporates, educational institutions and R&D
centres across the country. These alliances enable the Exchange in improving trade practices,
increasing awareness, and facilitating overall improvement of commodity futures market.
MCX’s ability to use and apply technology efficiently is a key factor in the development of its
business. The exchange’s technology framework is designed to provide high availability for all
critical components, which guarantees continuous availability of trading facilities. The robust
technology infrastructure of the exchange, along with its with rapid customisation and
deployment capabilities enables it to operate efficiently with fast order routing, immediate trade
execution, trade reporting, real-time risk management, market surveillance and market data
dissemination.
The Exchange is committed to nurturing communities that are vital for the development of
its business. To achieve our goal of inclusive growth, we collaborate with diversified partners.
Gramin Suvidha Kendra, our social inclusion programme in partnership with India Post, seeks to
enhance farmers’ value realisation from agricultural activities.
MCX has been continuously raising the bar through effective research and product
development, intelligent use of information and technology, innovation, thought leadership and
ethical business conduct.
The Exchange commenced its operations in the Currency Derivatives (CD) Segment on
October 7, 2008, under the regulatory framework of SEBI and Reserve Bank of India (RBI). MCX-SX
launched Capital Market Segment, Futures and Options Segment and flagship index ‘SX40’ on
February 9, 2013 and commenced trading from February 11, 2013. Trading in the ‘SX40’ index
derivatives began from May 15, 2013. ‘SX40’, is a free-float based index consisting of 40 large-cap,
liquid stocks representing diverse sectors of the economy. Its base value is 10,000 with the base
date of March 31, 2010.
The Debt Market Segment of MCX-SX, was launched on June 7, 2013, and trading
commenced from June 10, 2013.
Commitment to Financial Literacy and Inclusion ‘Information, Innovation, Education and
Research’ are the four cornerstones of the unique market development philosophy adopted by
MCX-SX and supports its mission of Financial-literacy-for-Financial Inclusion, as is envisaged by the
Government of India.
As part of this mission, MCX-SX conducts large-scale investor education and awareness
programmes, averaging at least programme one per working day, across the length and breadth
of the country. The Exchange has collaborated with academic institutions of repute, media, trade
bodies, international organisations and industry experts for organising literacy and awareness
drives.
Introduction to Commodity Market 87
MCX-SX has come out with a ‘Manifesto of Change’, which is a roadmap of what the
Exchange intends to achieve in terms of driving market development and inclusive growth over
the next 10 years.
Multi Commodity Exchange
MCX
Merchant Customer Exchange, see Merchant Customer
Exchange. “MCX” is also the Roman numeral for 1110.
Multi Commodity Exchange of India Ltd. (MCX) (BSE :
534091) is an independent commodity exchange based in
India. It was established in 2003 and is based in Mumbai. The
turnover of the exchange for the fiscal year 2009 was US$ India’s No. 1 Commodity Exchange
1.24 trillion, and in terms of contracts traded, it was in 2009
the world’s sixth largest commodity exchange. MCX offers futures trading in bullion, ferrous and
non-ferrous metals, energy, and a number of agricultural commodities (metha oil, cardamom,
potatoes, palm oil and others).
In 2012, MCX has taken the third spot among the global commodity bourses in terms of the
number of futures contracts traded. Based on the latest data from Futures Industry Association
(FIA), during the period between January and June this year, about 127.8 million futures contracts
were traded on MCX.
MCX has also set up in joint venture the MCX Stock Exchange. Earlier spin-offs from the
company include the National Spot Exchange, an electronic spot exchange for bullion and
agricultural commodities, and National Bulk Handling Corporation (NBHC) India’s largest collateral
management company which provides bulk storage and handling of agricultural products.
In February 2012, MCX has come out with a public issue of 6,427,378 Equity Shares of ` 10
face value in price band of 860-1032 ` per equity share to raise around $ 134 million. It is the first
ever IPO by an Indian exchange.
It is regulated by the Forward Markets Commossion.
MCX is India’s No. 1 commodity exchange with 83% market share in 2009.
The exchange’s main competitor is National Commodity and Derivatives Exchange Ltd.
Globally, MCX ranks no. 1 in silver,
no. 2 in natural gas, no. 3 crude oil and gold in
futures trading (But actual volume is far
behind CME group volume as Silver is traded
in 30 kg lots on MCX whereas CME traded in
Approx 155 kg Lot size same in Gold 1 kg : 3
kg Approx and Crude 100 Barrels : 1000
Barrels on CME) and major volume in
manipulated as there in no strict regulation in
India markets just to escalate the prices of
Shares of company. Also the major volume comes from Arbitration of CME and MCX which is also
not legal to do.
The highest traded item is gold.
MCX has several strategic alliances with leading exchanges across the globe.
As of early 2010, the normal daily turnover of MCX was about US$ 6 to 8 billion.
MCX now reaches out to about 800 cities and towns in India with the help of about
126,000 trading terminals
MCX COMDEX is India’s first and only composite commodity futures price index.
88 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Polypropylene
Linear Low Density Polyethylene
Polyvinyl Chloride.
Aluminum Ingot,
Copper Cathode
Nickel Ingot
Zinc Cathode
National Commodity and Derivatives Exchange is set to launch gold futures contract from
January16, a senior official of the exchange said today.
The exchange has received tremendous response to its newly-launched cotton seed futures
contract and now it is proposing to launch gold futures contract from January 16.
The co-relation between India and international gold prices has been affected duo to recent
government policies of heavy import duty and financing restrictions which has caused changes in
gold ecosystem and gold futures prices Keeping this in mind the exchange is launching a futures
contract to provide an option of investment-hedging to its participants.
The exchange has started settlement of the futures contract through COMTRAC, a special
platform. The exchange has developed the programme to offer better services to its value chain
participants.
NCDEX IN THE NEWS FOR THE WRONG REASONS
Traders are facing destruction of black pepper or kalimirchi stock, worth about ` 300 crore
traded on NCDEX that was found to contain carcinogenicmineral oils
Pepper traders have welcomed commodity market regulator Forward Markets Commission
decision instructing commodity exchanges to bear the responsibility of delivering quality goods.
The traders were up in arms against National Commodity & Derivatives Exchange over the
Exchange’s disowning responsibility for destroying adulterated stocks in the Exchange accredited
warehouses.
As per Forward Contract Regulation Act 1952, forward contracts in commodity markets entail
that all the contracts must eventually result in delivery of the commodities.
The Madhya Pradesh High Court has been moved to seek urgent justice as the traders’
money of over ` 300 crore has been stuck and that they are losing heavily on all fronts.
specialises in bullions and precious metals like gold and silver, NCDEX is highly trusted for the
trading of agri-based products like oil and oil seeds, cereals, etc.
In fact it is a fact well-known among the investor community that MCX is the best platform
for trading gold and silver and other globally traded metals and NCDEX provides the best returns
in trading of agri-based products.
MCX deals in the trading of 40 commodities which include bullions, precious metals,
plantations and more; and NCDEX offers 34 commodities of which 23 are agri-based and the rest
include precious metals, energy, polymer, etc. To increase the convenience of trading for its
members and promote fair-trade, both MCX and NCDEX have several nationalised as well as
private sector banks that take care of the clearings and transactions for its members. NCDEX has
fifteen and MCX sixteen banks empanelled as its clearing banks.
nature of the global markets at present, trading should be distributed among various commodities
and therefore, among various commodity trading exchanges.
MCX /NCDEX DIFFERENCES , SIMILARITIES AND PRODUCTS WITH HIGH LIQUIDITY
Sr. Description MCX NCDEX
No.
1 Commodities Traded Aluminium, ATF, Barley, Aluminium_New, Almond, Barley,
Cardamom, CER, CFI, Chanadel, Brent_Crude_Oil, Castor Seed New,
Copper, Coriander, CPO, Crudeoil, Chana, Red_Chilli, ThermalCoal,
Flakementh, Gasoline, Gold, Cotton seed oil Cake, Akola, Copper,
Goldguinea, GoldM, Guarseed, Indian Cotton 28.5Mm,
Heatingoil, Kapas, Kapaskhali, Crude_Palm_Oil, Crude oil ,
Lead, LeadMini, Maize etc Coriander, Guar_Gum, Guar_ Seed,
Gasoline, Gold_ Ahmedabad, Gold_
International, Gold 100 Grams
Ahmedabad etc
6 Date of
Nov 03 November 10, 2003
Commencement
Shares of Mumbai-based Multi Commodity Exchange of India (MCX) rose nearly 3 per cent in
early trade on Bombay Stock Exchange (BSE) after Blackstone bought 2.79 per cent stake in
company, increasing holding in the commodity bourse to 4.99 per cent.
Multi Commodity Exchange of India (MCX), an independent commodity exchange based in
India, has declined media report that UCX is eyeing FTIL's stake buying, which led company’s
shares soaring over 20 per cent on Friday.
MCX appoints ManojVaish as Managing Director & CEO
Spread benefit on Copper-CopperM& Nickel-NickelM contracts
Gold Mini April 2014 contract will be available for futures trading with effect from Monday,
January 6, 2014
The Exchange has decided to de-accredit cold storages at some of the delivery centers.
Following sixteen new contracts will be available for futures trading with effect from
Wednesday, January 1, 2014. Contract specifications, trading parameters, delivery and
settlement procedures of the said contracts as have been specified in the respective circulars
issued earlier by the Exchange as mentioned below, shall be binding on all the Members of
the Exchange and constituents trading through them.
NCDEX
NCDEX re-launched crude palm oil future contract
NCDEX re-launched steel long future. NCDEX is the only exchange which offered Steel
Long Futures, which had become a benchmark price reference for the long products
segment in the Indian steel industry.
96 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
trade, and while it does have certain guidelines that must be followed by its members, the
exchange itself does not advocate one particular trade over another. The principal purpose of
commodities exchanges is to develop these regulations, and keep the market from becoming too
chaotic. Those who trade on the exchange floor must be members. All major decisions that affect
the running and regulation of the exchange are generally made by a vote of the member body.
The exchange itself is divided into administration, which is operated by a paid staff, and the
actual trading floor itself, which is populated by traders. The traders proceed to make bids and
offers on trading cards. Bids are made by buyers, and are comprised of a specific sum for a specific
quantity of a particular commodity. Offers are made by sellers, and list a price for a specific
quantity of a commodity. Both bids and offers are announced in the open air of the central trading
ring. When a bid and offer match, a trade is officially made and recorded by the pit recorder. This
information is posted on a large board; in the modern electronic era, this information is
immediately sent out to all affiliated online traders as well. All trades must be resolved before the
start of the next trading day. All of the information related to the trade, including the parties
involved, the price of the trade, and the time period in which the trade was made, are recorded
on the card.
Most commodity exchanges work by allowing traders to exchange futures contracts, or cash
forward contracts, as they were initially known. The procedure is the same for a futures contract
as for a commodity. In this case, the futures bid and offer must incorporate sell dates and the
price at which the trade will be made in the future. Certain commodities can only be exchanged in
certain exchanges.
The top two U.S. commodities exchanges are the Chicago Board of Trade and the Chicago
Mercantile Exchange, which together comprise roughly 80 percent of all U.S. trading volume. The
second largest exchange in the world is the London International Financial Futures and Options
Exchange, or LIFFE. Most exchanges in the U.S. are regulated by the Commodity Exchange Act of
1974.
2. Beginners Guide to Commodities Futures Trading in India.
Indian markets have recently thrown open a new avenue for retail investors and traders to
participate : commodity derivatives. For those who want to diversify their portfolios beyond
shares, bonds and real estate, commodities is the best option.
Till some months ago, this wouldn't have made sense. For retail investors could have done
very little to actually invest in commodities such as gold and silver -- or oilseeds in the futures
market. This was nearly impossible in commodities except for gold and silver as there was
practically no retail avenue for punting in commodities.
However, with the setting up of three multi-commodity exchanges in the country, retail
investors can now trade in commodity futures without having physical stocks!
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 efficient portfolio diversification option.
In fact, the size of the commodities markets in India is also quite significant. Of the country's
GDP of ` 13,20,730 crore (` 13,207.3 billion), commodities related (and dependent) industries
constitute about 58 per cent.
98 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Currently, the various commodities across the country clock an annual turnover of
` 1,40,000 crore (` 1,400 billion). With the introduction of futures trading, the size of the
commodities market grow many folds here on.
Like any other market, the one for commodity futures plays a valuable role in information
pooling and risk sharing. The market mediates between buyers and sellers of commodities, and
facilitates decisions related to storage and consumption of commodities. In the process, they
make the underlying market more liquid.
Here's how a retail investor can get started:
Where do one need to go to trade in commodity futures?
You have three options - the National Commodity and Derivative Exchange, the Multi
Commodity Exchange of India Ltd and the National Multi Commodity Exchange of India Ltd. All
three have electronic trading and settlement systems and a national presence.
How do one choose my broker?
Several already-established equity brokers have sought membership with NCDEX and MCX.
The likes of Refco Sify Securities, SSKI (Sharekhan) and ICICI commtrade (ICICIdirect), ISJ Comdesk
(ISJ Securities) and Sunidhi Consultancy are already offering commodity futures services. Some of
them also offer trading through Internet just like the way they offer equities. You can also get a
list of more members from the respective exchanges and decide upon the broker you want to
choose from.
What is the minimum investment needed?
You can have an amount as low as ` 5,000. All you need is money for margins payable upfront
to exchanges through brokers. The margins range from 5-10 per cent of the value of the
commodity contract. While you can start off trading at ` 5,000 with ISJ Commtrade other brokers
have different packages for clients.
For trading in bullion, that is, gold and silver, the minimum amount required is ` 650 and `
950 for on the current price of approximately ` 65,00 for gold for one trading unit (10 gm) and
about ` 9,500 for silver (one kg).
The prices and trading lots in agricultural commodities vary from exchange to exchange (in
kg, quintals or tonnes), but again the minimum funds required to begin will be approximately `
5,000.
Do a person have to give delivery or settle in cash?
You can do both. All the exchanges have both systems - cash and delivery mechanisms. The
choice is yours. If you want your contract to be cash settled, you have to indicate at the time of
placing the order that you don't intend to deliver the item.
If you plan to take or make delivery, you need to have the required warehouse receipts. The
option to settle in cash or through delivery can be changed as many times as one wants till the last
day of the expiry of the contract.
What do one need to start trading in commodity futures?
As of now you will need only one bank account. You will need a separate commodity demat
account from the National Securities Depository Ltd to trade on the NCDEX just like in stocks.
What are the other requirements at broker level?
You will have to enter into a normal account agreements with the broker. These include the
procedure of the Know Your Client format that exist in equity trading and terms of conditions of
the exchanges and broker. Besides you will need to give you details such as PAN no., bank account
no, etc.
Introduction to Commodity Market 99
The sales tax is applicable at the place of delivery. Those who are willing to opt for physical
delivery need to have sales tax registration number.
What happens if there is any default?
Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds. The exchanges
have a penalty clause in case of any default by any member. There is also a separate arbitration
panel of exchanges.
Is stamp duty levied in commodity contracts? What are the stamp duty rates?
As of now, there is no stamp duty applicable for commodity futures that have contract notes
generated in electronic form. However, in case of delivery, the stamp duty will be applicable
according to the prescribed laws of the state the investor trades in. This is applicable in similar
fashion as in stock market.
How much margin is applicable in the commodities market?
As in stocks, in commodities also the margin is calculated by (value at risk) VaR system.
Normally it is between 5 per cent and 10 per cent of the contract value.
The margin is different for each commodity. Just like in equities, in commodities also there is
a system of initial margin and mark-to-market margin. The margin keeps changing depending on
the change in price and volatility.
3. What do you mean by commodity exchange?
An entity, usually an incorporated non-profit association that determines and enforces
rules and procedures for the trading of commodities and related investments, such as
commodity futures.
Commodities exchange also refers to the physical center where trading takes place
18 existing commodity exchanges in India offering domestic contracts in 8 commodities
and 2 exchanges that have permission to conduct trading in international (USD
denominated) contracts.
The two most important commodity exchanges in India are;
i) Multi-Commodity Exchange of India Limited (MCX),
ii) National Multi-Commodity & Derivatives Exchange of India Limited (NCDEX).
4. National Commodity and Derivatives Exchange Limited – NCDEX
This is an online multi-commodity exchange that is promoted in 2003 and professionally
managed by the following:
ICICI Bank Limited - ICICI Bank
Life Insurance Corporation of India – LIC
NABARD
National Stock Exchange of India Limited – NSE
Punjab National Bank – PNB
CRISIL Limited
Indian Farmers Fertilizer Cooperative Limited.
Unique Features
Online Commodity Prices
Long Term Continuous Charts
Intraday Charts
Introduction to Commodity Market 101
Seasonal Charts
Spread Charts
Comparison Charts
Technical Indicators
Depth of the Market
Various Filter Views
5. Multi Commodity Exchange of India Ltd – MCX
MCX is an independent multi commodity exchange, headquartered in Mumbai, 2003.
MCX is promoted by Financial Technologies.
It is recognized by the government for conducting the following in the area of
commodities futures and options:
Facilitating online trading
Clearing
Settlement operations.
National Level Online Multi Commodity Futures Exchange
Key Promoters –
Financial Technologies (India) Ltd, State Bank of India, Union Bank
Corporation Bank, Bank of India, Canara Bank,
State Bank of Indore ,Bank of Baroda
Operations from 300 cities with over 775 members & 3000 TWS
First Indian Exchange to enter into an agreement with an International Exchange
(TOCOM)
Facilitating Cost effective and economic technology.
Real-time price & information dissemination through website and info vendors.
Salient Futures of MCX:
On-line monitoring at members and contract level - exposure, price, open interest,
quantity, client, etc.
On-line margin adjustment - Business in relation to deposit System driven control and
action.
Electronic fund transfer
Daily clearing – marked to market
Pay-in and pay-out: T+1 working day
Exchange approved depositories
Seller to submit proof of delivery with proper quality certification to MCX
MCX offers connects to the following:
Producers and Processors
Traders
Corporate house
Regional trading centers
Importers
102 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Exporters
Co-operatives
Industry Associations and institutions.
Product at MCX: For Example;
Bullion
Spices
Fiber
Cereals
Plantations
Pulses
Oil & Oil Seeds
Energy
Petrochemicals
Metals
6. Commodity eco-system
Introduction to Commodity Market 103
6. An option for high networth investors : With the rapid spread of derivatives trading in
commodities, the commodities route too has become an option for high networth investors.
7. Useful to the producer : Commodity trade is useful to the producer because he can get an
idea of the price likely to prevail on a future date and therefore can decide between various
competing commodities, the best that suits him. Farmers, for instance, can get assured
prices, thereby enabling them to decide on the crop that they want to grow. Since there is
transparency in prices, the farmer can decide when and where to sell, so as to maximize his
profits.
8. Useful for the consumer : Commodity trade is useful for the consumer because he gets an
idea of the price at which the commodity would be available at a future point of time. He can
do proper costing/financial planning and also cover his purchases by making forward
contracts. Predictable pricing and transparency is an added advantage.
9. Corporate entities can benefit by hedging their risks if they are using some of the
commodities as their raw materials. They can hedge the risk even if the commodity traded
does not meet their requirements of exact quality/technical specifications.
10. Useful to exporters : Futures trading is very useful to the exporters as it provides an advance
indication of the price likely to prevail and thereby help the exporter in quoting a realistic
price and thereby secure export contract in a competitive market.
11. Improved product quality : Since the contracts for commodities are standardized, it becomes
essential for the producers/sellers to ensure that the quality of the commodity is as specified
in the contract. The advent of commodities futures markets has also enabled defining quality
standards of different commodities.
12. Credit accessibility : Buyers and sellers can avail of the bank finances for trading in
commodities. Nationalized banks and private sector banks have come forward to offer credit
facilities for commodity trading.
Benefits to Indian Economy
As the constituents of the commodity market ecosystem get benefited, the Indian economy
is also benefited. Growth in the organized commodity markets and their constituents implies that
there would be tremendous advantages and benefits accrued to the Indian economy in terms of
business generation and growth in employment opportunities. As India imports bulk of raw
material (especially in base metals and energy), there is scope for minimizing price risk for
international commodities. With the consumption of commodities increasing rapidly, especially in
developing countries such as China and India, the prices of commodities are volatile, emphasizing
the need for organized commodity derivatives exchanges.
7. Commodity Markets – Overview
Indian commodity market – set for paradigm shift
Four licenses recently issued by Govt. of India to set-up National Online Multi Commodity
Exchanges – to ensure a transparent price discovery and risk management mechanism
List of commodities for futures trade – increased from 11 in 1990 to over 100 in 2003
Reforms with regard to sale, storage and movement of commodities initiated
Shift from administered pricing to free market pricing – WTO regime
Overseas hedging has been allowed in metals
Petro-products marketing companies have been allowed to hedge prices
Institutionalization of agriculture.
8. India’s Place in World Market
106 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
substantial price changes. The Fund could incur significant losses on its commodity investments.
Unlike other Nuveen-sponsored funds, the Fund is a commodity pool. It is not a mutual fund,
a closed-end fund or any other type of “investment company” within the meaning of the
Investment Company Act of 1940 (the “1940 Act”), and therefore is not subject to regulation there
under nor afforded the protections of the 1940 Act. As such, the Fund’s board does not have the
scope of authority mandated to a board under the 1940 Act.
Shareholders have no rights to participate in the Fund’s management other than the right in
certain circumstances to remove or replace Nuveen Commodies Asset Management, LLC, the
Fund’s manager. The Fund’s board has very limited powers (specifically, to serve as the audit and
nominating committees, and to terminate the manager for cause under specified circumstances).
The board therefore does not have the control of the management and operation of the Fund that
would be typical of the board of directors of a corporation.
Therefore, Fund shareholders will have to rely on the judgment of
the manager to manage the Fund.
After almost two years that commodity trading is finding favor
with Indian investors and is been seen as a separate asset class with
good growth opportunities. For diversification of portfolio beyond
shares, fixed deposits and mutual funds, commodity trading offers a
good option for long-term investors and arbitrageurs and
speculators. And, now, with daily global volumes in commodity
trading touching three times that of equities, trading in commodities
cannot be ignored by Indian investors.
Online commodity exchanges need to revamp certain laws
governing futures in commodities to make the markets more
attractive. The national multi-commodity exchanges have unitedly
proposed to the government that in view of the growth of the
commodities market, foreign institutional investors, too, should be
given the go-ahead to invest in commodity futures in India. Their
entry will deepen and broad base the commodity futures market. As a matter of fact, derivative
instruments, such as futures, can help India become a global trading hub for select commodities.
Commodity trading in India is poised for a big take-off in India on the back of factors like
global economic recovery and increasing demand from China for commodities. Considering the
huge volatility witnessed in the equity markets recently with the Sensex touching 6900 level
commodities could add the required zing to investors' portfolio. Therefore, it won't be long
before the market sees the emergence of a completely redefined set of retail investors.
MCX is an independent and de-mutualised multi commodity exchange. MCX features
amongst the world's top three bullion exchanges and top four energy exchanges. Its key
shareholders are Financial Technologies (I) Ltd., State Bank of India and it's associates, National
Bank for Agriculture and Rural Development (NABARD), National Stock Exchange of India Ltd.
(NSE), Fid Fund (Mauritius) Ltd. - an affiliate of Fidelity International, Corporation Bank, Union
Bank of India, Canara Bank, Bank of India, Bank of Baroda, HDFC Bank and SBI Life Insurance Co.
Ltd.
systems and structures. Faced with the grudging reluctance to modernize and slow pace of
introduction of fair and transparent structures by the existing Exchanges, Government allowed
setting up of new modern, demutualised Nation-wide Multi-commodity Exchanges with
investment support by public and private institutions. National Multi Commodity Exchange of
India Ltd. (NMCE) was the first such exchange to be granted permanent recognition by the
Government
National Multi-Commodity Exchange of India Limited is committed to provide world class
services of on-line screen based Futures Trading of permitted commodities and efficient Clearing
and guaranteed settlement, while complying with Statutory / Regulatory requirements.
Our Mission
Improving efficiency of marketing through on-line trading in Dematerialization form.
Minimization of settlement risks.
improving efficiency of operations by providing best infrastructure and latest technology.
Rationalizing the transaction fees to optimum level.
Implementing best quality standards of warehousing, grading and testing in tune with
trade practices.
Improving facilities for structured finance.
improving quality of services rendered by suppliers.
Promoting awareness about on-line features trading services of NMCE across the length
and breadth of the country.
Mr. Anil Mishra, has about 30 years of commodity trading supply chain management
experience both in National and International Markets, has worked towards strengthening
NMCE’s relationships and brand image with customers, regulators, key investors and other
business partners. Under his leadership, new commodities like coffee and cotton were introduced,
20 commodities were activated, and evening session was started.
Prior to joining NMCE he started and led the Indian Operations of Ecom Gill Coffee Trading
Pvt. Ltd as the Country Manager. He was also Country Head for Coffee Cargill India Pvt. Ltd, He
was in-charge of Agri Exports in Grasim Industries Ltd. In National Market, he worked for IndoGulf
Fertilizers & Shriram Fertilizers (DCM Group). He was also a recipient of Bhartiya Udyog Ratna
award in 2003.
The Department of Economic Affairs in the Ministry of Finance - Government of India, is the
apex regulatory body governing all commodity exchanges. Various powers to provide regulatory
supervision, besides the powers to grant or withdraw recognition of any exchange rests with this
Department of the Government of India. The Forward Markets Commission (FMC) was set up in
1953 to provide regulatory advice to the Government and have closer regulatory interaction with
the commodity exchanges. Most of the regulatory powers of the Central Government have been
delegated to the FMC. For example, FMC has powers to approve the Memorandum and Articles of
Associations as well as Byelaws of the Exchange. It has also powers to conduct inspection of
accounts of the exchanges/their members, inquire into the affairs of the exchange. In an
emergency, it can even suspend trading. All contracts for futures trade have to be approved by
the FMC before they can be launched on the exchange. As a self-regulatory organization, NMCE
also plays an important role by ensuring that the provisions in the Articles of Association, and
Byelaws etc. are followed in letter and spirit. The regulation by the Exchange is rule-based and
incorporated in the software itself. Regulation involving human intervention and of discretionary
nature is implemented through various committees of professional and experts. Special care is
taken while constituting these committees to ensure that there is no conflict of interest.
110 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Legal Hierarchy
The Multi Commodity Exchange of India Limited
(MCX), India’s first listed exchange, is a state-of-the-art,
commodity futures exchange that facilitates online
trading, and clearing and settlement of commodity futures
transactions, thereby providing a platform for risk
management. The Exchange, which started operations in
November 2003, operates within the regulatory
framework of the Forward Contracts (Regulation) Act,
1952.
MCX offers trading in varied commodity futures
contracts across segments including bullion, ferrous and
non-ferrous metals, energy and agricultural commodities.
The Exchange focuses on providing commodity value chain
participants with neutral, secure and transparent trade
mechanisms, and formulating quality parameters and
trade regulations, in conformity with the regulatory
framework. The Exchange has an extensive national reach, with over 2000 members, operations
through more than 468,000 trading terminals (including CTCL), spanning over 1900 cities and
towns across India. MCX is India’s leading commodity futures exchange with a market share of
about 81 per cent in terms of the value of commodity futures contracts traded in Q1 FY2014-15.
To ease participation, the Exchange offers facilities such as calendar-spread facility, as also
EFP (Exchange of Futures for Physical) transactions which enables participants to swap their
positions in the futures/ physical markets. The Exchange’s flagship index, the MCXCOMDEX, is a
real-time composite commodity futures price index which gives information on market
movements in key commodities. Other commodity indices developed by the exchange include
MCXAgri, MCXEnergy, and MCXMetal. MCX has been certified to three ISO standards including ISO
9001:2008 quality management standard, ISO 27001:2005 information security management
standard and ISO 14001:2004 environment management standard.
With an aim to seamlessly integrate with the global commodities ecosystem, MCX has forged
strategic alliances with leading international exchanges such as CME Group, London Metal
Exchange (LME), The Baltic Exchange, Dalian Commodity Exchange (DCE) and Taiwan Futures
Exchange (TAIFEX). The Exchange has also tied-up with various trade bodies, corporates,
educational institutions and R&D centres across the country. These alliances enable the Exchange
in improving trade practices, increasing awareness, and facilitating overall improvement of
commodity futures market.
MCX’s ability to use and apply technology efficiently is a key factor in the development of its
business. The exchange’s technology framework is designed to provide high availability for all
critical components, which guarantees continuous availability of trading facilities. The robust
technology infrastructure of the exchange, along with its with rapid customisation and
deployment capabilities enables it to operate efficiently with fast order routing, immediate trade
execution, trade reporting, real-time risk management, market surveillance and market data
dissemination.
The Exchange is committed to nurturing communities that are vital for the development of
its business. To achieve our goal of inclusive growth, we collaborate with diversified partners.
Gramin Suvidha Kendra, our social inclusion programme in partnership with India Post, seeks to
enhance farmers’ value realisation from agricultural activities.
Introduction to Commodity Market 111
MCX has been continuously raising the bar through effective research and product
development, intelligent use of information and technology, innovation, thought leadership and
ethical business conduct.
National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed
online multi commodity exchangebased in India. It is a national level, technology driven de-
mutualised on-line 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 participants to trade in a wide
spectrum of commodity derivatives driven by best global practices, professionalism and
transparency. It is a public limited company incorporated on 23 April 2003 under the Companies
Act, 1956. It obtained its Certificate for Commencement of Business on 9 May 2003. It has
commenced its operations on 15 December 2003. NCDEX is the only commodity exchange in the
country promoted by national institutions. The institutional promoters and shareholders of NCDEX
bring institutional experience, national contacts, technology, and risk management experience.
NCDEX is regulated by the Forward Markets Commission (FMC). NCDEX is also subject to the
Companies Act 2013, Stamp Act, Contracts Act, Forward Commission (Regulation) Act, and various
other laws.
National Multi Commodity Exchange
In response to the Press Note issued by the
Government of India during May 19999, fist stat-of-the –
art demutualised multi-commodity Exchange, National
Multi Commodity exchange of India Ltd. (NMCE) was
promoted by commodity-relevant public institutions, viz.,
Central Warehousing Corporation (CWC), National
Agricultural Cooperative Marketing Federation of India (NAFED), Gujarat Agro-Industries
Coropration Limited (GAICL), Gujarat State Agricultural Marketing Board (GSAMB), 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. Pubjab 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 suppoirt from the commodity relevatn 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.
NMCE is unique in many other respects. It is a zero-debt company; following widely accepted
prudent accopunting 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 on its delivery provisions to attract speculative volume. Public interest rather than
commercial inters guide the Exchange. It has also established fair and transparent rule-based
procedures and demostrated total commitment towards eliminating any conflicts of interest.
NMCE commenced futures trading in 24 commodities on 26th Novermber, 2002 on a
national scake and the basket of commodities has growth substantially since then to include cash
crops, food gains, plantations, spices, oil seeds, metals and bullion among others. Research Desk
of NMCE is constantly in the process of indetifying the hedging needs of the commodity economy
112 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
and the basket of products is likely to grow even further. NMCE was the first Exchange to take up
the issue of differential treatment of speculative loss. It was also the first Exchange to enroll
participation of high net-worth corporate securities 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.
A Close Look at NMCE
NMCE’s Exchange solution is a mission critical application which it had then selected in 2002
off the shelf market and then it worked around and built a heavy structure with multiple features
and functionalities including its integration with delivery and settlement system and to bring user
friendliness and regulatory changes from time to time. Now this is completely different then the
original basic apoplication. DTSS is built on C, C++, VC, Power Builder Languages with Sybase as
database. This is message based architecture.
When an order is placed on the exchange, the server at BMCE scans through the orders
posted on it from al 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 kthe first commodity exchange to provide trading facility through internet,
through Virtual Private Network (VPN).
NMCE follows best international risk management practices. The contracts are marked to
market on daily basis. The system of upfront margining based on Value at Risk is followed to
ensure financial security of the market. In the event of high volatility in theprices, special intra-day
clearing and settlement is held. NMCE has also set up a Trade Guarantee Fund. Well-capitalized in
–house clearinghouse assumes counter-party risk of settlement. BMCE was the first to initiate
process of dematerialization and electronic trasnfer of warehoused commodity stocks. The unique
strength of NMCE is its settlements via a Delivery Backed System, an imperative in the commodity
trading business. These deliveries are executed through a sound and reliable Warehouse Receipt
System, leading to guaranteed cleagin and settlement.
Size of the Market
The trading of commodities includes physical trading of food items, Energy and Metals,
etc. and trading of derivatives.
In the fiver years up to 20078, the value of flobal physical exports of commodities
increased by 17% while the notional value outstanding of commodity OTC derivatives
increased more than 500% and commodity derivative trading on exchanges more than
200%.
Agricultural contracts trading grew by 32% in 2007, enery 29% and industrial metals by
30%.
Precious metals trading grew by 3%, with higher volume in New York being partially
offset by declining volume in Tokyo.
OTC trading accounts for the majority of trading in gold and silver.
ICEX
only about 3 times the size of physical market,
whereas it is more than10 times the size of physical
market in other developed countries. Therefore, the
A CUTTING EDGE PLATFORM
Indian Commodity Exchange Limited
Introduction to Commodity Market 113
current state of commodities market in India leaves lot of scope for growth in terms of depth and
reach of the market as well as attracting new players who are utilizing the services of overseas
commodities market due to various reasons like lack of depth in product category they wish to
trade in; inadequate warehousing facilities at strategic locations, etc.
Indian Commodity Exchange Limited is a screen based on-line derivatives exchange for
commodities and has established a reliable, time tested, and a transparent trading platform. It is
also in the process of putting in place robust assaying and warehousing facilities in order to
facilitate deliveries. It is jointly promoted by Reliance Ex-change Next Infrastructure Limited and
MMTC Limited, Indiabulls Financial Services Ltd., KRIBHCO, Indian Potash Ltd., and IDFC among
others, as its partners.
This exchange is ideally positioned to tap the huge scope for increasing the depth and size of
commodities’ market and fill in the structural gaps existing in the Indian market. We have head
office located in Mumbai and have regional offices spread across the country which covers agri
belt, with a vision to encourage participation of farmers, traders and actual users to hedge their
positions against the wide price fluctuations.
Corporate Vision
ICEX would strive to achieve the following :
Provide fair, transparent and efficient trading platform to all participants.
Meet the international benchmarks for the Indian commodity market.
Provide equal opportunity and access to investors all Over the country through the
modern communication modes.
Attract a wide array of end users, financial intermediaries and hedgers.
Become a major trading hub for most of the commodities.
To provide product portfolio to suit the trading Community needs in an efficient manner.
Commodities traded
ICEX will provide the widest range of benchmark future products available on any exchange,
covering all major commodities. Their collective vision is global grwoth, innovative product
development, continually enhanced technology and the highest level of service available on any
exchange. They offer future trading in
Agricultural commodities
Bullions
Base Metals
Energy
Key Differentiators
Impeccable lineage :
Joint venture between Public/Private entities
Well capitalized ` 100 Cr. initial capital.
Reputation of partners and pan India presence.
Key stake holders having rich experience in the do-main viz. commodities, warehousing,
financial markets.
Professionally driven exchange with an entrepreneurial mindset.
Aim to remove discrepancy in the commodities market by building transparency in the
exchange.
114 Commodities Markets – (S.Y.B.F.M)-(Sem. III)
Minerals and Metals Trading Corporation of India Limited, a Government of India enterprise
and the largest international trading company of India. It is the largest exporter of Minerals and
single largest importer/supplier of Bullion and Non-Ferrous Metals in India. MMTC also leads in
trading of agro products, fertilizers, coal, hydrocarbons, textiles,
Indiabulls Financial Services Limited is a part of Indiabulls Crop, one of the top business
houses in the country with business interests in Real Estate, Infrastructure, Financial Services,
Retail, Multiplex and Power sector. Indiabulls Financial Services is one of India’s leading and
fastest growing private sector financial services companies. It is an integrated financial services
powerhouse ranking among the top private sector financial services and baning groups (in terms
of net worth).
KrishakBharti Cooperative Limited, a world premier fertilizer producing cooperative society,
registered under Multi-State cooperative Societies Act-1985, promoted by Govt. of India, IFFCO,
NCDC and other agricultural cooperative societies spread all over the country.
Indian Potash Limited, the biggest canalizing agency (State Trading Enterprise) for import of
Urea and other fertilizers on behalf of Government of India, is a major player in Indian Fertilizer
Industry with offices and dealers network across the country.
Infrastructure, Development Finance company Limited, a specialized financial intermediary
for infra-structure development has funded integrated transportation, urban infrastructure,
health care, food and agri-business infrastructure, education infrastructure, tourism, energy
telecommunication and infrastructure technology projects. It has taken key initiatives in providing
leadership rationalizing policy and regulatory.
In order to attract volumes, the exchange will charge a fee of Re 1 for every transaction
totalling ` 1 lakh for the first three months. However, it has fixed a four-slab fee structure based
on the turnover.
As an inaugrual offer, trading and clearing member are charged a concession membership
fee of ` 2.5 lakh against ` 5 lakh, while a trading member have to shell out ` 1 lakh against regular
charge of ` 1.5 lakh. The exchange will also be available on the commonly used ODIN trading
platform. It has already got ready delivery centres for metals and agriculture commodities in
major markets. Praveen pillai, Chief Executive Officer of UCX, said that the exchange will focus on
all the segments of commodity initially and work on specialisation after gauging the market
response.
“Being the latest exchange, we may not have the first mover advantage, but we definitely
know what we should not do. We have the option to learn from others mistake,” he said.
Commex Technology will be the anchor investor with 43 per cent stake, REC and Nabard
owns 16 per cent each, IFFCo will hold 15 per cent and IDBI Bank 10 per cent. Commex has to
progressively reduce its stake to 26 per cent.
Ramesh Abhishek, Chairman, Forward Markets Commission, siad that the new exchange has
to do something different from others to gain market share, particularly when there is a fall in
overall turnover on commodity exchanges, low commodity prices, tight regulation and tough
economic condition.
“Having said that, there is a tremendous scope in this market as there are several
commodities which have huge demand and are unrepresented in the futures platform. UCX has its
work already cut out,” he said.
Benefits of commodity Future Markets
Price Discovery : Based on inputs regarding specific market information the demand and
supply equilibrium, weather forecasts, expert views and comments, inflation rates, government
policies, market dynamics, hopes and fears, buyers and sellers conduct trading at futures
exchanges. This transforms in to continuous price discovery mechanism.
Price Risk Management : Hedging is the most common method of price risk
management. It is strategy of offering price risk that is inherent in spot market by taking an equal
but opposite position in the futures market. Futures markets are used as a mode by hedgers to
protect their business from adverse price change. This coulde dent the profitability of their
business. Hedging benefits who are involved in trading of commodities like farmers, processors,
merchandisers, manufacturers, exporters, importers etc.
Import-export competitiveness : The exporters can hedge their price risk and improve
their competitiveness by making use of futures market. A majority of traders which are involved in
physical trade internationally intend to buy forwards. The purchases made from the physical
market might expose them to the risk of price risk resulting to losses.
Benefits for farmers / Agriculturalists : Price instability has a direct bearing on farmers in
the absence of futures market. There would be no need to have large reserves to cover against
unfavorable price fluctuations. This would reduce the risk premiums associated with the
marketing or processing margins enabling more returns on produce. Storing more and being more
active in the markets. The price infromation accessible to the farmers determines the extent to
which traders/processors increase price to them. Since one of the objectives of futures exchange
is to make available these prices as far as possible, it is very likely to benefit the farmers.
OBJECTIVE QUESTIONS
I. Fill-in-the-blanks
1) Futures markets in bullion began in ________.
Introduction to Commodity Market 117
V. Short Notes
1) ACE derivative exchange
2) UCX
3) Spot trading
4) ICEX
5) TOCOM
118 Commodities Markets – (S.Y.B.F.M)-(Sem. III)