Sagging Agricultural Commodity Exchanges

Growth Constraints and Revival Policy Options

Commodity derivatives have a crucial role to play in managing price risk
especially in agriculture dominated economies. However, as long as prices of
many commodities are restrained to a certain extent by government
intervention in production, supply and distribution, forward and futures markets
for hedging price risk in those commodities have only limited practical
relevance. A review of the nature of institutional and policy level constraints
facing this segment calls for more focused and pragmatic approach from the
government, the regulator and the exchanges for making the agricultural
futures market a vibrant segment for risk management.
K G Sahadevan
Instability of commodity prices has always been a major concern of the producers as well as the consumers
in an agriculture dominated country like India. Farmers’ direct exposure to price fluctuations, for instance,
makes it too risky for them to invest in otherwise profitable activities. There are various ways to cope with
this problem. Apart from increasing stability of the market by direct government intervention thwarting the
market mechanism, various actors in the farm sector can better manage their activities in an environment of
unstable prices through derivative markets. These markets serve a risk-shifting function, and can be used to
lock-in prices instead of relying on uncertain price developments.
Derivatives like forwards, futures, options, swaps, etc, are extensively used in many developed and
developing countries in the world. The Chicago Mercantile Exchange, Chicago Board of Trade, New York
Mercantile Exchange, International Petroleum Exchange, London, London Metal Exchange, London Futures
and Options Exchange, ‘Marche a Terme International de France’, Sidney Futures Exchange, Singapore
International Monetary Exchange, Singapore Commodity Exchange, Kuala Lumpur Commodity Exchange,
‘Bolsa de Mercadorias & Futuros’ (in Brazil); the Buenos Aires Grain Exchange, etc, are some of the leading
commodity exchanges in the world engaged in trading of derivatives in commodities. Even in China during
the last 10 years of liberalisation of internal market many exchanges were set up for exclusive trading in
commodity futures and most of them like Shanghai Metals Exchange; China Commodity Futures Exchange;
China Zhengzhou Commodity Exchange, Beijing Commodity Exchange, etc, have witnessed tremendous
growth [UNCTAD 1998]. However, they have been utilised on a very limited scale in India. The objective of
this paper is to bring to focus the problems and prospects of the futures market in agricultural commodities
in India. On the basis of visit to some of the recognised commodity exchanges (see the list in Table 2) the
study identifies bottlenecks in the organisational, trading and regulatory set-up of these exchanges and
recommends certain broad policy alternatives for the revival of commodity exchanges in general.
Historical Perspective
Although India has a long history of trade in commodity derivatives, this segment remained underdeveloped
due to government intervention in many commodity markets to control prices. The production, supply and
distribution of many agricultural commodities are still governed by the state and forwards and futures trading
are selectively introduced with stringent controls. While free trade in many commodity items is restricted
under the Essential Commodities Act (ECA), 1955, forward and futures contracts are limited to certain
commodity items under the Forward Contracts (Regulation) Act (FCRA), 1952.
The first commodity exchange was set up in India by Bombay Cotton Trade Association and formal
organised futures trading started in cotton in 1875. Subsequently, many exchanges came up in different
parts of the country for futures trade in various commodities. The Gujarati Vyapari Mandali came into
existence in 1900 which has undertaken futures trade in oilseeds first time in the country. The Calcutta
Hessian Exchange and East India Jute Association were set up in 1919 and 1927 respectively for futures
trade in raw jute. In 1921, futures in cotton were organised in Mumbai under the auspices of East India
Cotton Association (EICA). Many exchanges were set up in major agricultural centres in north India before
world war broke out and they were mostly engaged in wheat futures until it was prohibited. The existing
exchanges in Hapur, Muzaffarnagar, Meerut, Bhatinda, etc, were established during this period. The futures
trade in spices was first organised by India Pepper and Spices Trade Association (IPSTA) in Cochin in 1957.
Futures in gold and silver began in Mumbai in 1920 and continued until it was prohibited by the government
by mid-1950s. Though options are permitted now in stock market, they are not allowed in commodities. The
commodity options were traded during the pre-independence period. Options on cotton were traded until
they along with futures were banned in 1939 [Ministry of Food and Consumer Affairs 1999]. However, the
government withdrew the ban on futures with passage of FCRA in 1952. The act has provided for the
establishment and constitution of Forward Markets Commission (FMC) for the purpose of exercising the
regulatory powers assigned to it by the act. Later, futures trade was altogether banned by the government in
1966 in order to have control on the movement of prices of many agricultural and essential commodities.
After the ban of futures trade all the exchanges went out of business and many traders started resorting to
unofficial and informal trade in futures. On recommendation of the Khusro Committee in 1980 government
reintroduced futures on some selected commodities including cotton, jute, potatoes, etc. As part of economic
liberalisation of 1990s an expert committee on forward markets under the chairmanship of K N Kabra was
appointed by the government of India in 1993. Its report submitted in 1994 recommended the reintroduction
of futures which were banned in 1966 and also to widen its coverage to many more agricultural commodities
and silver. In order to give more thrust on agricultural sector, the National Agricultural Policy 2000 has
envisaged external and domestic market reforms and dismantling of all controls and regulations in
agricultural commodity markets. It has also proposed to enlarge the coverage of futures markets to minimise
the wide fluctuations in commodity prices and for hedging the risk arising from price fluctuations. In line with
the proposal many more agricultural commodities are being brought under futures trading.
The Present Status
Presently, 15 exchanges are in operation in India carrying out futures trading in as many as 30 commodity
items (details are given in Table 1). Out of these, two exchanges, viz, IPSTA, Cochin and the Bombay
Commodity Exchange (BCE) have been recently upgraded to international exchanges to deal in
international contracts in pepper and castor oil respectively. Moreover, permission has been given to
another two exchanges, viz. The First Commodities Exchange of India, Kochi (for copra/coconut, its oil and
oilcake), and Keshav Commodity Exchange, Delhi (for potato), where futures trading is expected to start
soon. Another eight new exchanges are proposed to set up and some of them are expected to start
operation shortly. The government has also permitted four exchanges, viz, EICA, Mumbai; Central Gujarat
Cotton Dealers Association, Vadodara; South India Cotton Association, Coimbatore; and Ahmedabad
Cotton Merchants Association, Ahmedabad, for conducting NTSD contracts (explained below) in cotton.
Lately, as part of further liberalisation of trade in agriculture and dismantling of ECA, 1955 futures trade in
sugar has been permitted and three new exchanges, viz, e-Commodities, Mumbai; NCS Infotech,
Hyderabad; and e-Sugar India.Com, Mumbai, have been given approval for conducting sugar futures
[Ministry of Food and Consumer Affairs 1999].
Table 1:Profile of Commodity Futures Exchanges
Active Commodity Volume in Lakh Tonnes
Exchange
Members Traded (Value in Rs Crore)
1996- 1997- 1998- 1999- 2000-
199920002001
97 98 99 00 01
India Pepper and Spice
0.86 1.56 1.73 1.24 1.29
Trade Association, 55 42 31 Pepper
(765) (2834) (3411) (2862) (2580)
Cochin
Pepper 007 0.40 0.02
- 3 7 - -
(intl) (15) (106) (5.6)
The Bombay
Castor 2.53 0.25 0.11 0.9 0.10
Cpmmodity Exchange, 8 6 5
seed (279) (30) (17) (15) (14)
Mumbai
0.04
3 2 2 Castor oil - - - 0.01(5)
(14)
RBD 0.04
- 9 - - - - -
Palmol (9)
Mustard
Kanpur Commodity 0.108
- 8 5 seed, oil - - - -
Exchange, Kanpur (14)
and cake
The EAst India Cotton 0.02 0.35 0.21
15 17 7 Cotton - -
Association, Mumbai (9) (143) (139)
The Chamber of 0.79 1.76 0.09 0.22 0.52
36 36 21 Potato
Commerce, Hapur (29) (56) (5) (5) (14)
29.28 30.10 23.85 23.79 28.80
26 34 26 Gur
(1655) (2760) (2162) (2236) (2555)
Coffee Futures 5 5 4 Coffee - - - - 0.50
 Exchange, Bangalore (289)
Ahmedabad Castor 54.84 68.76 44.91 30.68 24.73
38 36 55
Commodity Exchange seed (5981) (8006) (6854) (5220) (3469)
The Rajkot Seeds Oil
19.85 21.36 16.77 16.35 18.94
and Bullion Mercehants 12 8 -
(2167) (2495) (2562) (2811) (2761)
Association
Soy seed,
National Board of 1.093 32.56
- 48 51 oil and - - -
Trade, Indore (261) (7874)
cake
Mustard
seed and 0.13
- 4 - - - - -
mustard (31)
oil
Vijai Beopar Chamber, 40.71 44.06 61.34 47.48 31.28
40 35 35 Gur
Muzaffarnagar (2281) (3429) (9518) (4510) (2877)
Bhatinda Om Oil and
29.81 23.60 20.41 21.88 21.24
Oilseeds Exchange, 16 16 15 Gur
(1936) (1896) (1813) (2263) (2060)
Bhatinda
The Meerut Agro
2.45 3.25 3.58 4.1 3.7
Commodities 10 11 11 Gur
(144) (248) (304) (389) (311)
Exchanges Co, Meerut
The Rajdhani Oils and
8.51 28.60 4.51 8.24 7.78
Oilseeds 17 21 24 Gur
(548) (2231) (383) (787) (668)
Exchange,Delhi
The East India Jute
25.21 5.58 7.88
and Heesian 57 40 71 Sacking - -
(5022) (1234) (1703)
Exchange, Calcutta
41.38 26.60 2.43 0.003 0.0008
1 1 1 Hessian
(15604) (7342) (569) (0.81) (0.22)
The Spices and
0.83 0.81 0.01 0.0002 0.0002
Oilseeds Exchange, - 3 7 Turmeric
(149) (152) (6) (0.03) (0.21)
Sangli

Source: Forward Markets Commission, Mumbai

A brief profile of the exchanges which are currently in operation has been presented in Table 1. Many of the
existing exchanges have become weak in spite of considerable membership strength and potential for large
volume of trade. Some of the observations drawn on the basis of visit to six of these exchanges have been
presented later in the paper. The number of members who are actively involved in trading in all these
exchanges is abysmally low. It is important to know why traders who in spite of setting up the exchange are
not keen to participate in trading actively. It has been observed from many exchanges that trading was
unprofitable and could not be relied on it as a full-time business. Any attempt to revive the exchanges and
rejuvenate the futures market in India needs to address this issue first.
It is interesting to note that even in case of commodities in which very active domestic and international
ready market exists with volatile prices, futures trade in those commodities are no attraction to the
merchandisers. The IPSTA located in Cochin which is known for futures trade in spices for over five
decades has not attracted many traders. It is the only exchange in the world engaged in trading of futures in
pepper. Kerala being the producer of lion’s share (around 95 per cent) of pepper in India and Cochin being
the port city where a majority of pepper exporters are operating the existing futures exchange should have a
larger role to play [UNCTAD 1995]. However, in spite of having more than 150 members in the exchange,
only around 10 members’ cubicles in the trading ring were occupied by the respective representatives during
the trading hour. A further inquiry into the issue reveals that these members hail from families which are into
pepper trade for generations and no new member from outside has come into the business. It is not clear as
to why members of the exchange are keen to retain the status of the exchange as a specialised single-
commodity exchange.
The BCE arguably the richest exchange in India in terms of its infrastructure, is also facing the problem of
empty trading ring. Though the exchange has a membership strength close to 600, less than five members
are trading actively. Data in Table 1 shows that the volume in castor seed futures declined from 2.53 lakh
tonnes during 1996-97 to just 10,000 tonnes during 2000-01.
The EICA which is one of the oldest exchanges in the country has a different story to tell. Cotton has a long
tradition of futures trading in India. Cotton futures started in 1857 and continued until it was suspended in
1966. Cotton has large potential for futures trading due to its uncontrolled and uncertain supply and
variability of prices. While prices within a crop season fluctuate between 7.5 and 26.2 per cent in the last
decade, its output varied as much as 14 per cent from one year to the next. It has a strong domestic and
international market. India is the third largest producer and the second largest consumer of cotton in the
world. Moreover, cotton is placed under OGL list with zero import duty, and quota system for its exports is
likely to be dismantled by 2005. Nevertheless, the present status of cotton exchange and the Indian cotton
futures contract is no different from other exchanges. Although the exchange has a membership strength
over 400, not more than 10 members actively trade in the exchange. It is often argued by the exchange
authorities that the government’s indirect control on supply and prices by its procurement makes the futures
market in cotton unattractive and worthless.
Futures market in many other commodities indeed shows that there is scope for the rejuvenation of this
sector in the country. The buoyant trading activities in the newly started National Board of Trade at Indore,
the old exchanges like the Chamber of Commerce, Hapur; Viajai Beopar Chamber, Muzaffarnagar;
Ahmedabad Commodity Exchange; Bhatinda oil exchange; East India Jute Exchange, Calcutta, etc, are the
indications of prospects of futures trade in agricultural commodities.
Commodity Futures Contract
Futures contracts are an improved variant of forward contracts. They are agreements to purchase or sell a
given quantity of a commodity at a predetermined price, with settlement expected to take place at a future
date. The futures contracts as against forwards are standardised in terms of quality and quantity, and place
and date of delivery of the commodity. The commodity futures contracts in India as defined by the FMC has
the following features [Forward Markets Commission 2000]:
(a) Trading in futures is necessarily organised under the auspices of a recognised association so that such
trading is confined to or conducted through members of the association in accordance with the procedure
laid down in the rules and bye-laws of the association.
(b) It is invariably entered into for a standard variety known as the ‘basis variety’ with permission to deliver
other identified varieties known as ‘tenderable varieties’.
(c) The units of price quotation and trading are fixed in these contracts, parties to the contracts not being
capable of altering these units.
(d) The delivery periods are specified.
(e) The seller in a futures market has the choice to decide whether to deliver goods against outstanding sale
contracts. In case he decides to deliver goods, he can do so not only at the location of the association
through which trading is organised but also at a number of other pre-specified delivery centres.
(f) In futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly
squared up before the due date of the contract and contracts are settled by payment of differences without
any physical delivery of goods taking place.
The terms and specifications of futures contracts, however, vary depending on the commodity and the
exchange in which it is traded. The relevant terms and conditions of contracts traded in six sample
exchanges in India are presented in Table 2. These terms are standardised and applicable across the
trading community in the respective exchanges and are framed to promote trade in the respective
commodity. For example, the contract size is important for better management of risk by the customer. It has
implications for the amount of money that can be gained or lost relative to a given change in price levels. It
also affects the margins required and the commission charged. Similarly, the margin to be deposited with
the clearing house has implications for the cash position of customers because it blocks working capital for
the period of the contract to which he is a party.
Organisational Set-up
In the Indian context, the scope of commodity exchanges has been limited to futures trading. They are
associations of members which provide all organisational support for carrying out futures trading in a formal
environment. These exchanges are managed by a board of directors which is composed primarily of the
members of the association. There are also representatives of the government and public nominated by
FMC. The majority of members of the board have been chosen from among the members of the association
who have trading and business interest in the exchange. The board appoints a chief executive officer who
with his team assists the board in day-to-day administration of the exchange. There are different classes of
members who capitalise the exchange by way of participation in the form of equity, admission fee, security
deposits, registration fee, etc. They are classified as ordinary members, trading members, trading-cum-
clearing members, institutional clearing members, and designated clearing bank. The membership
requirements for and the composition of members, however, vary from one exchange to the other. In some
exchanges there are exclusive clearing members, broker members and registered non-members in addition
to the above category of members.
Clearinghouse is the organisational set up adjunct to the futures exchange which handles all back-office
operations including matching up of each buy and sell transactions, execution, clearing and reporting of all
transactions, settlement of all transactions on maturity by paying the price difference or by arranging
physical delivery, etc, and assumes all counterparty risk on behalf of buyer and seller. There is no
clearinghouse in a forward market due to which buyers and sellers face counterparty risk. In a futures
exchange all transactions are routed through and guaranteed by the clearinghouse which automatically
becomes a counterpart to each transaction. It assumes the position of counterpart to both sides of the
transaction by selling contract to the buyer and buying the identical contract from the seller. Therefore,
traders obtain a position vis-a-vis the clearinghouse. It ensures default risk-free transactions and provides
financial guarantee on the strength of funds contributed by its members and through collection of margins,
marking-to-market all outstanding contracts, position limits imposed on traders, fixing the daily price limits
and settlement guarantee fund.
The organisational structure and membership requirements of clearinghouses vary from one exchange to
the other. The BCE and IPSTA have set up separate independent corporations (namely, Prime Commodities
Clearing Corporation of India, and First Commodities Clearing Corporation of India, respectively) for
handling clearing and guarantee of all futures transactions in the respective exchanges. While Coffee
Futures Exchange India (COFEI), Bangalore has a clearinghouse as a separate division of the exchange,
many other exchanges like the Chamber of Commerce, Hapur; Kanpur Commodity Exchange (KCE) and
EICA, Mumbai run in-house clearinghouses as part of the respective exchanges. The clearing and guaranty
are managed in these exchanges by a separate committee (normally called the clearinghouse committee).
Membership of clearinghouse requires capital contribution in the form of equity, security deposit, admission
fee, registration fee, guarantee fund contribution in addition to networth requirement depending on its
organisational structure. For example, in the BCE the minimum capital requirement for membership in its
clearinghouse as applicable to trading-cum-clearing members is Rs 50,000 each towards equity and security
deposit, Rs 500 as annual subscription, and additionally, members are required to have networth of Rs 3
lakh. Similarly, COFEI prescribes Rs 5 lakh each towards equity and guarantee fund contribution and Rs
40,000 towards admission fee for a trading-cum-clearing member. However, in exchanges where clearing
house is a part of the exchange the payment requirements are lower. For example, KCE prescribes payment
of only Rs 25,000, Rs 1,000 and Rs 500 towards security deposit, registration fee and annual fee
respectively for a clearing-cum-trading member.
Margins (also called clearing margins) are good-faith deposits kept with a clearinghouse usually in the form
of cash. There are two types of margins to be maintained by the trader with the clearinghouse: initial margin
and maintenance or variation margins. They have important bearing on the success of futures. As they are
non-interest bearing deposits payable to the clearinghouse up-front working capital of the trading parties
gets blocked to that extent. While a higher margin requirement prevents traders from participating in trading,
a lower margin makes the clearinghouse financially weak and hence more vulnerable to default.
Internationally, many developed exchanges maintain a low margin on positions due to their better financial
strength along with massive volume of trade resulting in large income accruing to them. However, this has
not been the case with many exchanges in India. For example, the initial margin liability for transacting the
minimum lot size in pepper is Rs 30,000 for domestic contracts and US$ 312.50 for international contracts.
Similarly, the volume of transactions these clearinghouses deal in many exchanges in India is abysmally low
making their existence financially unviable.
For ensuring financial integrity of the exchange and for counterparty risk-free trade position (exposure) limits
have been imposed on clearing members apart from mandatory margins. These limits which are stringent in
some exchanges and are liberal in others are normally linked to the members’ contribution towards equity
capital or security deposit or a combination of both and settlement guarantee fund. In the BCE exposure limit
of a clearing member is the sum of 50 times the face value of contribution to equity capital of the
clearinghouse and 30 times the security deposit the member has maintained with the clearinghouse. While
COFEI prescribes the limit of 80 times the sum of member’s equity investment and the contribution to the
guarantee fund, EICA has stipulated a liberal exposure limit on open positions. It has a limit of 200 and
1,500 units (recall that one contract unit is equivalent to 93.5 quintals of cotton) respectively for composite
and institutional members. The IPSTA has fixed a net exposure limit of 60 units (equivalent to 1,500
quintals) for domestic contracts and 90 units (equivalent to 2,250 quintals) for international contracts.
Moreover, the settlement guarantee fund helps clearinghouse to honour all payments in case any trader
defaults. The KCE maintains a trade guarantee fund with a corpus of Rs 100 lakh while COFEI in addition to
a guarantee fund has substituted itself as party to clear all transactions.
Yet another check on the possible default is through prescribing maximum price fluctuation on any trading
day which helps limit the probable profit/loss from each unit of transaction. The relevant data on permitted
price limit has been presented in Table 2. It is clear from the table that the maximum profit/loss potential
from trade in each contract unit varies from as low as Rs 800 for potato futures in Chamber of Commerce,
Hapur to as high as Rs 15,000 for pepper in IPSTA. Similarly, given the permissible open position of 200
units for a trading-cum-clearing member and maximum price fluctuation of Rs 150 per 100 kg for cotton
futures in EICA, the maximum potential loss/profit in a trading day works out to be Rs 28.05 lakh.
Regulation of Commodity Futures
Merchandising and stockholding of many commodities in India have always been regulated through various
legislations like FCRA 1952; ECA 1955 and Prevention of Blackmarketing and Maintenance of Supplies of
Commodities Act (PBMSCA) 1980. The ECA 1955 gives powers to control production, supply, distribution,
etc, of essential commodities for maintaining or increasing supplies and for securing their equitable
distribution and availability at fair prices. Using the powers under the ECA, 1955 various
ministries/departments of the central government have issued control orders for regulating
production/distribution/quality aspects/movement, etc, pertaining to the commodities which are essential and
administered by them. Currently, 29 commodity groups have been declared essential under the act. The
PBMSCA 1980 targets the prevention of unethical trade practices like hoarding and blackmarketing, etc, in
essential commodities. It is being implemented by state governments to detain persons who obstruct the
supplies of essential commodities. The FCRA 1952 provided for three-tier regulatory system for commodity
futures trading in India: (a) an association recognised by the government of India on the recommendation of
FMC, (b) the FMC and (c) the central government (department of consumer affairs).
Stock exchanges and futures markets being a part of the union list their regulation is the responsibility of the
central government. All types of forward contracts in India are governed by the provisions of the FCRA,
1952. The act divides commodities into three categories with reference to extent of regulation, viz, (a) the
commodities in which futures trading can be organised under the auspices of recognised association, (b) the
commodities in which futures trading is prohibited and (c) the free commodities which are neither regulated
nor prohibited. While options in goods are prohibited by the FCRA, 1952, the ready delivery contracts
remain outside its purview. The ready delivery contract as defined by the act is the one which provides for
the delivery of goods and payment of a price therefor, either immediately or within a period not exceeding 11
days after the date of the contract. All ready delivery contracts where the delivery of goods and/or payment
for goods is not completed within 11 days from the date of the contract are forward contracts. The act
classifies forward contracts into two: (a) specific delivery contracts and (b) other than specific delivery
contracts or futures contracts. Specific delivery contract means a forward contract which provides for the
actual delivery of specific qualities or types of goods during a specified time period at a price fixed thereby or
to be fixed in the manner thereby agreed and in which the names of both the buyer and the seller are
mentioned.
The specific delivery contracts are of two types: transferable and non-transferable. The distinction between
the transferable specific delivery (TSD) contracts and non-transferable specific delivery (NTSD) contracts is
based on the transferability of the rights or obligations under the contract. Forward trading in TSD and NTSD
contracts are regulated by FCRA 1952. As per the section 15 of the act every forward contract in notified
goods (currently 36 commodity items) which is entered into except those between members of a recognised
association or through or with any such member is treated as illegal or void. As per the section 17(1) of the
act, 82 items are prohibited from entering into forward contract. The section 18(1) of the act exempts the
NTSD contracts from the regulatory provisions. However, over the years the regulatory provisions of the act
were applied to the NTSD contracts as well and 79 commodity items are currently prohibited from NTSD
contracts under section 17 of the act. Moreover, another 15 commodity items are brought under the
regulatory provisions of the section 15 of the act out of which trading in the NTSD contract has been
suspended in 12 items. At present, the NTSD contracts in cotton, raw jute and jute goods are permitted only
between, through or with the members of the associations specifically recognised for the purpose.
Subsequent to the report of the Committee on Forward Markets (known as the Kabra Committee) submitted
in 1994 the government has so far permitted futures trading in nearly 35 commodities under the auspices of
23 commodity exchanges located in different parts of the country. The commodities in which futures trading
is permitted are: pepper, turmeric, gur, castorseed, hessian, jute sacking, cotton, potato, castor oil,
soyabean and its oil and cake, coffee, mustardseed and its oil and oilcake, ground nut and its oil, sunflower
oil, copra/coconut and its oil and oilcake, cottonseed and its oil and oilcake, kapas, RBD palmolein, rice bran
and its oil and oilcake, sesame seed and its oil and oilcake, safflower seed and its oil and oilcake, and
sugar. This list may get enlarged further with the repeal of ECA 1955 and with further liberalisation of farm
sector as envisaged in the National Agricultural Policy 2000 and the Union Budget 2002-03.
The exchanges are required to get prior approval of the FMC for opening of each contract in commodities
which are notified under section 15 of the FCRA 1952. Regulation is essential especially in a private
ownership and market-oriented system to ensure the necessary checks and balances in the system.
However, stringent and continuous regulation for long period of time would do no good to the system. The
initial stringent regulation should ensure that a foolproof and growth oriented control system in terms of set-
up of the exchange and its sound management, a clearinghouse which can promote trade and its financial
integrity, sound and facilitating contract terms and conditions, etc, is in place. The exchanges are already
assumed to be self-regulatory agencies. Their role must get strengthened further along with FMC minimising
its role as a facilitator making the existing regulation an ‘appropriate regulation’.
Constraints and Policy Options
Commodity exchanges in India are in their nascent stage of development. There are numerous bottlenecks
in the growth of this particular segment in India. These problems are not unknown to the government and
the FMC. The FMC has already coordinated a number of studies carried out by experts with funding from
World Bank during 1999-00. An integrated report [Youssef 2000] of these wide ranging studies has
highlighted several issues for the consideration of government and FMC. These institutional and policy level
issues have to be addressed by the government and the FMC for rejuvenating the paralysed agricultural
futures markets. Some of the major problems that handicap the commodity exchanges are discussed below
[Sahadevan 2002a].
Constitution of exchanges: All commodity exchanges in India are mutual organisations. They are promoted
by traders who carryout trading as well as keep the management control of exchanges. The exchange staff
including the chief executive officer/secretary is the staff of promoters. This structure poses a serious threat
to the integrity of exchanges. The structure needs to be altered so as to ensure an arms length relationship
between those who promote and manage the exchange on the one hand and those who have trading
interest in exchanges on the other. Many leading exchanges in the world like Chicago Mercantile Exchange,
International Petroleum Exchange, and New York Mercantile Exchange, etc, are demutualised organisations
where arms-length relationship between management and trading is maintained. The pepper exchange in
Cochin is seriously considering change in its set up from a non-profit making organisation to a profit-making
equity-based organisation with public participation.
Trading parameters: The terms and conditions of contracts play a crucial role in the growth and development
of trading in any exchange. They should be market friendly in the sense that the terms are affordable to
large traders as well as small traders and should be attractive to all prospective beneficiaries of futures
trading including growers, processors, merchandisers, consumers, etc. However, the contract specifications
(as given in Table 2) in many exchanges are prohibitive to many segments. For example, the lot size of
cotton contract in EICA is 55 bales which is equivalent to nearly 10 tonnes of cotton. Similarly, the costlier
commodity like pepper for which the lot size fixed by the pepper exchange, Cochin is 2.5 tonnes with 15
tonnes as deliverable quantity. Many such finer aspects of contracts can be pointed out which apparently
seem to go against the wider interests of prospective beneficiaries of futures trading. One needs to really go
into the micro details of these specifications before making any judgments as to how market friendly these
contracts are.

Table 2: Important Specifications of Futures Contracts

Maximum Price
Fluctuation in IM
any Trading Initial Contracts1
Liability
Commodity/ Contract Day Margin (IM)/ (Duration
for Clearing
Exchange Unit Variation in
and Results One
Margin(VM) Months)
Lot A in Lot
Size Price Profit/Loss
 (LS) Change Per
of Contract
Unit
IM: Rs
10,000 per
Rs unit over Rs
Rs 150 14,025 and above 10,000 Dec
Cotton; 55
per the free limit (7),
East bales Daily
100 kg of 300 units. Feb (7)
India (93.5 at
VM: 2.5 to Apr (6),
Cotton quintals) settlement
7.5 per cent June
Association,LS: 55 price
of BMP (5) Sep
Mumbai bales
depending (6)
on variation
in
the BMP2

Rs
3/1.50
Rs 1,800
per Kg
for Rs
1,000/600 for
Plantation 3,600
kgs for Plantation Jan,
A and IM: Rs 6 per for
raw/pro A/RC Mar,
Coffee; Rs 900 Kilo for Plantation
- AB, Daily May,
Coffee for RB Plantation A (Rs
cessed Rs at July,
Futures AB A, and Rs 3 1,800
coffee 125/Rs settlementSep
Exchange, Rs per kilo for for
LS: 60 per price and
Bangalore 2,500/Rs1,200Robesta Robesta
1,000/ bag of Nov 18
for Cherry AB
600 50 kg months)
Arabica/ Chery
kgs for
Robes AB)
Arabica/
Cherry
Robes
Chery

Rs 30
IM: Rs 500
per
per unit up
quintal
to 100 units
4,000 over Mar
Gur; and Rs 600
kg (40 the (4),
The for each unit Daily
quintals) clearing May
Chamber above 100 at
LS: rate on Rs 1,200 Rs 500 (3),
of units VM: 2 settlement
4,000 the July
Commerce, to 4 per cent price
kg (40 last (3),
Hapur of the BMP
quintals) day of Dec (6)
depending
the
on variation
previous
in the BMP3
week

Rs 20 IM: Rs 500
per per unit up
quintal to 100 units Daily
Potato; 4,000 over and Rs 600 Rs 500 at
Rs 800
The kg (40 the for each unit settlementMar
Chamber quintals) clearing for above price (6),
of LS: rate on 100 units July
Commerce, 4,000 the VM: 2 to 4 (5), Oct
Hapur kg (40 last per cent of (4)
quintals) day of the BMP
the depending
previous on variation
week in the BMP3

IM: Rs 1.5
per cent per
unit for net
open
position
ranging
between 6-
250 and 2.5
Mustard
2 per cent for 1.5 per May
Seed;
metric 251.500 cent of (6),
The Rs 65
tonnes VM: 2 per the Daily July
Kanpur per Rs 1,300
LS: 2 cent of the value clearing (4), Oct
Commodity 100 kg
metric BMP if of (4), Jan
Exchange,
tonnes closing pricecontract (9)
Kanpur
rises/falls by
more than
10 per cent
of BMP and
4 per cent if
it is more
than 15 per
cent

IM: No
margin if
Gross
Exposure5
< Rs 10
lakh, 1.5 per
cent for Rs
10- 50 lakh, Feb,
4 per Rs 0.6 lakh Apr,
1 Varies
The cent of +3 per cent Daily June,
metric Depends depending
Bombay the of the GE in at Aug,
tonne on the on the
Commodity OCP4 excess of official Oct
LS: 1 closing value
Exchange, of the Rs 50 lakh closing and
metric day of
Mumbai previous Delivery price Dec6
tonne contract
day period (6
margin: 10 months)
per cent if
the GE < Rs
50 lakh, Rs
5 lakh + 20
per cent if
the GE > Rs
50 lakh

IM: US$ 125

and 375 per
tonne
 respectively
for net open
position up
to 150 and
from 151 to
225 tonnes
Rs 1,200,
1,600, 2,000
US$ and Rs
125 2,800 per
per US$ quintal for US$
2.5
tonne 312.50 net open 312.50
metric
for and position up for For all
tonnes
internationalRs15,000 to 100, 150, internationalDaily 12
Pepper LS: 2.5
contracts for 200 and contract clearing months
Exchange, MT
and Rs international above 200 and Rs and in an
Cochin8 and 15
600 and tonnes 30,000 settlementyear (6
MT as
per domestic respectively for months)
deliverable
quintal contracts SM: 10, 20 domestic
quantity
for respectively and 30 per contract
domestic cent
contracts respectively
of the BMP7
if it
increases
>20 per
cent, >30
per cent and
>40 per
cent

Notes: IM and SM represent initial margin and special margin

respectively.
Price limit and margins vary from time to time.
1 Delivery month of the contract.
2 Bench Mark Price is the average of the opening, highest, lowest
and the closing prices of the first three trading days of
commencement month of any contract.
3 Bench Mark Price is arrived at by taking the average of the
opening, highest, lowest and closing prices of the commencement
day of trading of any contract.
4 The official closing price (OCP) is the weighted average price of
the trades executed during the last 30 minutes of the trading
session.
5 Gross Exposure (GE) means the sum total of net outstanding
position.
6 Delivery month relating to international castor oil contracts and
all other specifications are common for all commodities traded in
Bombay Commodity Exchange.
7 The Bench Mark Price (BMP) is determined by taking the
weighted average of the transacted price of all the contracts
traded on the first five days of the contract.
Source: Bye-Laws of the respective exchanges.
Infrastructure: Lack of efficient and modern infrastructural facilities are bottlenecks in the growth of futures
markets in India. Though some of the exchanges notably BCE and EICA own huge office premises, they
lack necessary institutional infrastructure including warehousing facilities, independent clearing house in
addition to modern trading ring. The KCE for example, lacks basic facilities to disseminate the trading
information. The exchange has only a couple of small office rooms and a poorly maintained trading ring
which seem to have never been utilised.
Trading system: Most of the exchanges till date have open outcry system. Of the sample of six exchanges
visited, only COFEI has introduced electronic trading system. The FMC has been emphasising the need for
automation and on-line trading system for ensuring better transparency and fairness in trading practices. It
has been observed that less than 10 per cent of members are only actively trading in these exchanges.
Volume of trade has been consistently declining. In some exchanges, e g, KCE, the market is non-existent.
An active and vibrant market is necessary for introducing electronic trading system. Steps have to be
initiated for creating market and making the exchange financially sound for investing in automation and on-
line trading. It has been noticed that after introducing computerised trading in COFEI, trade volume dropped
substantially leaving a large financial burden on the exchange. Moreover, majority of trading members in
some of the exchanges are not educated enough to handle English language and to operate computer. For
example, most of the members of the Chamber of Commerce, Hapur said to have no working knowledge of
English without which computerised trading is difficult. Therefore, the priority of FMC and exchanges should
be the creation of a better environment for active trading. Computerisation can be second step once a
vibrant market is in place.
Broking community: Although a large number of members exist in the records of exchanges, most of them
shy away from trading due to the fact that the business is not very profitable. It is essential to attract large-
scale broking firms who have diversified into stock broking and other related businesses. Regulation
including setting standards for brokers, imposing capital adequacy norms, qualification criterion, etc, would
become more meaningful when more and more active traders are attracted to the business.
Existence of unofficial market: The grey/black market which existed outside the exchange premises during
the ban on futures trading for over 30 years still continues to exist even inside the exchanges. It has been
widely accepted and admitted by some of the CEOs/secretaries of exchanges that at least 25-30 per cent
trade in the exchanges go unreported. The unofficial market operating outside the official exchange is much
larger. These unofficial traders find the margin, stamp duty and income tax requirements least encouraging
to come to the official contract channels.
Multiplicity of exchanges: Currently 20 exchanges are operational of which three are specifically for
conducting NTSD contracts and the remaining are in the trade of nearly 30 commodity items. Recently, five
new exchanges have been approved and three of them are exclusively for futures contract in sugar. Many of
these exchanges are set up as specialised ones for trading in one or a few commodities. The international
experience however shows that exchanges are only to provide a platform for trade in many commodities and
different forms of contracts. The Chicago Mercantile Exchange started as an agricultural exchange, and now
largely relies on trade in financial futures; while the New York Mercantile Exchange, now the world’s largest
energy exchange, once traded butter and potatoes. If an exchange provides a well organised trading system
for certain commodities, with well-developed procedures, a good intermediary structure, and a sound
clearing house, it can build on these strengths to introduce new products and to attract large number of
traders which would eventually make the exchange more broad-based and financially sound.
Controlled market: Price variability is an essential precondition for futures markets. Any distortion in the
market mechanism where free play of supply and demand forces for commodities determines prices will
dilute the process of natural variability of prices and potential risk. It is imperative that for a vibrant futures
market commodity pricing must be left to market forces, without monopolistic or undue government control.
However, in India many of the commodities in which futures trading is allowed have been still protected
under ECA 1955. There are also commodity-based specialised government agencies like Cotton
Corporation of India, NAFED, Jute Corporation of India, etc, which seek to control supplies of some farm
products.
Regulation: The government has two important roles to play – an oversight role by which the government
disciplining those who try to manipulate the markets for their own benefit, and ensuring the sanctity of
contracts; and secondly, an enabling role by which the government providing the necessary legal and
regulatory framework for the smooth functioning of the system. The regulatory intervention should be most
active at the time of the establishment of the exchange and of contracts. If the contracts are well formulated,
and delivery modalities provide effective line of defence against attempts at manipulation, government has
to only act as a watchdog intervening only when necessary. The goal of the regulatory agency is not only to
regulate but also to inculcate the culture of self-regulation among the participants. This in turn, over a period
of time, will give way for more self-regulation supported by the advisory role of state regulation.
Promotion of the use of derivatives: With the increasing technological sophistication of trading methods,
better transparency and guarantee of trade in futures, more institutional players like mutual funds, foreign
institutional investors should be allowed to trade in recognised commodity exchanges. The exchanges under
the guidance of the FMC must undertake publicity and mass awareness programmes for the promotion of
this segment. For this purpose it would be beneficial for FMC to have a broad based functional alliance with
its counterpart in stock markets. Modification of income tax provisions and rationalisation of stamp duty: In
the past, speculative and non-speculative businesses were treated equally for taxation so far as right to set
off or carry forward of loss was concerned. As a result, it was possible to set off speculative losses against
speculative profits. Current tax rule however does not allow for setting off or carrying forward of speculative
losses against regular business income. It does not treat losses on futures transaction as a normal business
expense. The futures trading industry has been demanding amendments in the tax law for the promotion of
futures trading activities. Similarly, the stamp duty provisions on futures trading make the transaction cost
higher and moreover, the rates vary from one state to the other. While states like Gujarat, Madhya Pradesh,
Kerala do not impose stamp duty on futures trading, some other states like Maharashtra imposes stamp
duty on futures trading of certain commodity items.
Conclusions
Commodity derivatives have a crucial role to play in the price risk management process especially in
agriculture dominated economy. Derivatives like forwards, futures, options, swaps, etc, are extensively used
in many developed as well as developing countries in the world. However, they have been utilised in a very
limited scale in India. The production, supply and distribution of many agricultural commodities are controlled
by the government and only forwards and futures trading are permitted in certain commodity items. The
present study is an investigation into the present status, growth constraints and developmental policy
alternatives for derivative markets in agricultural commodities in India. The study has surveyed the
recognised exchanges and their organisational, trading and the regulatory set up for futures trading. In the
light of visit to six exchanges the study identified the problems and prospects of the futures markets and
outlined various policy alternatives for revival of agricultural commodity futures in India. A review of the
nature of institutional and policy level constraints facing this segment calls for more focused and pragmatic
approach from government, the regulator and the exchanges for making the agricultural futures markets a
vibrant segment for risk management.
[This paper is drawn on the report entitled ‘Derivatives and Price Risk Management: A Study of Agricultural
Commodity Futures in India’ which is a broader study carried out by the author with financial support from
Indian Institute of Management, Lucknow.]
References
Forward Markets Commission, Ministry of Food and Consumer Affairs, Government of India (2000): Forward
Trading and Forward Markets Commission.
Ministry of Food and Consumer Affairs, Government of India (1999): Futures Trading, Commodity
Exchanges and Forward Markets Commission, New Delhi.
Sahadevan, K G (2002a): ‘Risk Management in Agricultural Commodity Markets: A Study of Some Selected
Commodity Futures’, Working Paper Series: 2002-07, Indian Institute of Management, Lucknow.
– (2002b): ‘Derivatives and Risk Management: A Study of Agricultural Commodity Futures in India’, A
Research Project Report, Indian Institute of Management, Lucknow.
United Nations Conference on Trade and Development (1995): ‘Feasibility Study on a Worldwide Pepper
Futures Contract’, (UNCTAD/COM/64).
– (1998): ‘A survey of Commodity Risk Management Instruments’, (UNCTAD/COM/15/Rev2).
Youssef, Frida (2000): ‘Integrated Report on Commodity Exchanges and Forward Markets Commission’,
Report of the World Bank Project for the Improvement of the Commodities Futures Markets in India.