A SUMMER TRAINING REPORT ON "Future of Commodity Derivatives Trading in India" Conducted at Fortune Equity Brokers (India) Limited

Contents

Chapter No. 1. 2. 3. 4. 5.

Description Introduction Company Profile Research Methodology Data Analysis and Discussions Conclusions and Suggestions Bibliography Questionnaire

Page No. 1-29 30-44 45 46-55 56-59 60 61-62

CHAPTER-1 INTRODUCTION
The term "derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the cash asset. A derivative contract or product, or simply "derivative", is to be sharply distinguished from the underlying cash asset, i.e. the asset bought/sold in the cash market on normal delivery terms. A general definition of "derivative" may be suggested here as follows: "Derivative" means forward, future or option contract of pre-determined fixed duration, linked for the purpose of contract fulfillment to the value of specified real or financial asset or to index of securities. Derivatives are meant essentially to facilitate temporarily (usually for a few months) hedging of price risk of inventory holding or a financial/commercial transaction over a certain period. In practice, every derivative "contract" has a fixed expiration date, mostly in the range of 3 to 12 months from the date of commencement of the contract. In the markets idiom, they are "risk management tools". The use of forward/futures contracts as hedging techniques is a well-established practice in commercial and industrial operations. Their application to financial transactions is relatively new, having emerged only about 25 years ago.

Derivative is a product whose value is derived from the value of one or more basic variables called bases (underlying asset index, or reference rate) in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date of eliminates the risk of a change in prices by that date. Such a transaction is an example of derivative. The price of this derivative is driven by the spot price of wheat which is the underlying. The securities Contracts (Regulation) Act, 1956 defines derivative to include:Derivatives are securities under the SC(R) Act and hence the trading of derivatives is governed by the regulatory framework under the SC(R) Act. Various types of Derivatives The most commonly sued derivatives contracts are forwards futures, options and swaps which we will discuss in detail later. Here we take a brief look at various derivatives contracts. Forwards: A forwards contract is a customized contract between two entities, where settlement takes place on a specific date in the future at todays pre agreed price.

Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former is standardized exhcngetraded contracts. Options: Options are of two types- calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Warrants: Options generally have lives of one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over the counter. Leaps: The LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of three years. Baskets: Basket options are options on portfolios of

underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a pre-arranged

formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: Interest Rate Swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency Swaps: These entail swapping both principal and interest between the parties. With he cash flows in one direction being in a different currency than those in the opposite direction. Swaptions: Swaptions are options to buy or sell as swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls an d puts, the swaption market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A prayer swaption is an option to pay fixed and receive floating. Evolution of Derivatives Derivatives have probably been around for as long as people have been trading with one another. Forward

contracting dates back at lest to the 12th century, and m ay well have been around before then. Merchants entered into contracts with one another for future delivery of specified amount of commodities at specified price. A primary

motivation for pre-arranging a buyer or seller for a stock of commodities in early forward contracts was to lessen the possibility that large swings would inhibit marketing the commodity after a harvest. The following factors have contributed to the growth of financial derivatives: 1. Increased volatility in asset prices in financial markets. 2. Increased integration of national financial markets with the international markets. 3. Market improvement in communication facilities and sharp decline in their costs. 4. Development of more sophisticated risk management tools, providing economic agents a wider choice of risk

management strategies, and 5. Innovations in the derivatives markets, which optimally combine the risks and returns over a larger number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets. History of Commodity Derivatives Policies, Rules and Regulations for the securities market and development of the commodities market are of different nature. The volume of trading in commodities will be much

higher than in securities. Commonly markets in India are more than 100 years old while stock derivatives are only 4 years old. With the removal of the ban on forward trading in all commodities, the Indian commodities futures market has been totally liberalized. Participants in the securities and other financial markets can now think of exploring the opportunities offered by the emerging commodities market. Even though there are differences markets, between yet they commodity and also have financial close

derivatives

some

resemblances in so far as trading practices and mechanisms are concerned. If the developments in the commodity derivatives market are compared with the securities market one would wonder at the differing pace of progress between the two. However, before attempting such a comparison it is important to keep in mind some of the basic difference between the two markets.

The history of Commodity Derivatives is very old. The following table shows the milestones in Commodity Derivatives since 1848. Year 1848 1875 Developments Setting up of Chicago Board of Trade-first Futures exchange in the US First organized futures Exchange in India, namely,

1920 1952 1955 1956

Bombay Cotton Traders Association Federal regulation of future trading in the USA Enactment of the Forward Contract Regulations Act based on Shroff Committee recommendations Commencement of futures trading in Cotton at East India Cotton Association Mumbai. Commencement of futures trading in castor seed at Mumbai. Commencement of futures trading in Turmeric at Sangli. Commencement of futures trading in the jute at Calcutta Suspension of futures trading in cotton and most of the commodities-Dantawala Committee Report Setting up of the Commodity Futures Trading

1958 1966 1974 1979 1994 1997 2000 2001 2005

Commission- the futures market regulator of the USA Khusro Committee Report Kabra Committee Report Permission for international futures contract in black pepper Permission for hedging in offshore exchange for actual uses of non-oil commodities Approval for futures trading in edible oil block and coffee. Permission for international futures contract in castor oil Permission for hedging in petro-products in offshore exchanges. Permission for futures trading in sugar and tea Permission for three National Level Multi Commodity

2007

Exchanges Recent Developments The globalization of the Indian Commodity Sector and the trade liberalization under the WTO regime offer really a new opportunity and challenge to the Indian commodity exchanges to make a success of futures trading in the country for efficient

price discovery and effective risk management to the diverse market functionaries in different commodities. 1. Demutualization of the Exchanges Earlier the Commodity Exchanges were not demutualized. Now the ownership of the exchange is being gradually divested from its management. Unlike the prevailing system where the exchanges are owned and managed by their trading members, in the new demutualised, form, the exchanges and their trading systems are managed

invariably by non-trading professionals. Even on the Boards of Directors of these commodity exchanges, the non-share holding professionals and experts drawn from different academic and market segments are either nominated or coopted in a sizeable strength and May at times, constitute a majority. 2. Trading Systems and Procedures The open outcry system is slowly giving way the screen based on line and even impersonal internet trading system. In the screen based electronic trading system, market operators are connected through their computer terminals with the central computer trading system of the exchange, which matches automatically the bids and offers.

3. Clearing House Systems and Procedures The in-house clearing system of the commodity exchanges has now been replaced by either an independent clearing house within the exchange or a separate system clearing conducts

corporation.

The

automated

clearing

clearing operations on a daily basis on the principle of marked to market. Thus, all the market participants settle their liabilities every day and do not accumulate these over even a single day. 4. Market Intelligence and Surveillance The old exchanges merely disseminated price information, and that too with a time lag but modern exchanges collect, updates and disseminate all market information influencing supply and demand of commodities traded on the exchange on a real time basis. Now a well equipped market intelligence cell is established in every exchange with qualified professional staff. 5. Certified Warehousing System The warehousing facility is a must for a commodity exchange. The modern commodity exchanges have either their own warehouses or they designate suitable

warehouses for the purpose of issuing or receiving deliveries

against the futures contracts traded in them. These warehouses are constructed according to the prescribed standards and adopt scientific storage and handling

systems to ensure that the goods stored in them do not deteriorate in either quantity or quality, and also losses do not result from storage, stacking or handling of goods while loading and unloading. The designated or certified

warehouses have their own grading facilities, and even quality testing laboratories, to certify the goods periodically for their grade and quality. All the information relating to the goods stored in such warehouses is computerized, and these warehouses are linked to the commodity exchange through computer network to facilitate the delivery of goods and quantity of goods delivered according to their

ownership. Now the practice of certified warehouses with the prescribed storage standards and handling norms indirectly brings pressure on the trade and industry to upgrade the quality of their goods to the level acceptable to the commodity exchanges as per its contract specifications for the different commodities. It also promotes the

standardization of the commodity trade in the physical markets for cash or forward deliveries, since the quality

10

certificates issued by the exchange designated warehouses facilitate the physical trade by mere description (instead of by physical inspection or samples, which is necessarily cumbersome and time consuming), and also serves as a norm for such trade. The issue of certified warehouses receipts by the authorized warehouse owners in fulfillment of the delivery orders tendered by the sellers also reduces the survey disputes relating to quality and weighment, which are common in the traditional commodity exchanges. PROBLEM FORMULATION The Modern Multi Commodity Exchanges are now well supported by adequately equipped research and training units/centers. Research is needed not only to assess the working and utility of the futures market organized by the exchanges, but also to ascertain from time to time the lacunae and weaknesses in the contract terms and

specifications, trading and clearing procedures, regulatory provisions, services. infrastructure The research facilities also and other support greater

helps

promote

understanding of the functions and uses of the futures market among its present potential users, as also among the policy makers, Government regulatory authorities and

11

other relevant Government departments concerned as well as the academicians, the consumer bodies and the public at large. DERIVATIVES TRADING IN INDIA The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws

(Amendment) Ordinance, 1995, which withdrew the prohibition on options in securities. The market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. SEBI set up a 24 member committee under the Chairmanship of Dr. L.C. Gupta on 18 th November 96 to develop appropriate regulatory framework for derivatives trading in India. The committee submitted its report on 17th March 98 prescribing necessary pre-conditions for introduction of derivatives trading in India. The committee recommended that derivatives should be declared as

securities so that regulatory framework applicable to trading of securities could also govern trading of securities SEBI also set up a group in June 1998 under the Chairmanship of Prof. J.R. Varma, to recommend measures for risk containment in derivatives market in India. the report, which ws submitted in October 1998, worked out the operational details of margining system, methodology for charging initial margins, broker net

12

worth,

deposit

requirement

and

real

time

monitoring

requirements. The SCRA was amended in December 1999 to include derivatives within the ambit of securities and the regulatory framework was developed for governing derivatives trading. Derivatives trading derivatives trading commenced in India in June 2007 after SEBI granted the final approval to this effect in May 2009. SEBI permitted the derivative segments of two stock exchanges. NSE and BSE, and their clearing

house/corporation to commence trading and settlement in approved derivatives contracts. To begin with, SEBI approved trading in index futures contracts based on S&P CNX Nifty and BSE 30 (Sensex) index. This was followed by approval; for trading in options based on these two indexes and options on individual securities. The trading in index options commenced in June 2007. Futures contracts on individual stocks were launched in November 2007. Trading and Settlement in derivative contracts is done in accordance with the rules, byelaws, and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette. Thus, the following five types of Derivatives are now being traded in the Indian Stock Market.

13

1. Stock Index Futures 2. Stock Index Options 3. Futures on Individual Stocks 4. Options on Individual Stocks 5. Interest Rate Derivatives

FEATURES OF INDIAN COMMODITIES MARKET The Indian commodities market stands out quite tall amongst the global markets for a variety of factors. And the reasons for the same are not difficult to understand (i) Supply Worlds leading producer of 17 Agricultural Commodities (ii) Demand Worlds largest consumer of Edible Oils, Gold Yellow Metal Mania. (iii) GDP Driver Predominantly an AGRARIAN Economy. (iv) Captive Market Agro products are produced and consumed locally. (v) Width and Spread Over 30 Major Markets and 7500 Mandies exists in the market. (vi) Waiting for Explode Value of Production around Rs. 3,00,000 crore and expected futures market potential

14

around

Rs.

30,00,000

crore

(This

is

assuming

conservative multiplier of 10 times which is case of US is 20 times and also assuming that all commodities have futures market over a period of time as the markets nature) Commodity V/s. Financial futures The basic difference between commodity and financial futures is the nature of the underlying instrument. In a commodity futures the underlying is a commodity which may be wheat, cotton, pepper, turmeric, corns, oats, soyabeans, orange juice, crude oil, natural gas, gold, silver, park bevies etc. is a financial instrument, the underlying can be treasuries Banks stocks, Stock index foreign exchange etc. As an evident a financial future is fairly standard and there are no Quality issues while a commodity instruments. COMPARISON Sr. Particulars
No .

Stock Market Securities & Exchange Board of India (SEBI) Mittal Court B Wing 224 Nariman Point Mumbai400 021 Ministry of Finance, Govt. of India, Economic Affairs Deptt. Stock
15

Commodity Market Forward Market Commission (FMC) Everest-3rd Floor 100 Marine Drive Mumbai400 002 Ministry of Consumer Affairs Food and Public Distribution,

1.

Regulatory Authority

2.

Ministry

Exchange Division New Delhi. 3. Act for Recognition/R egistration No. of Recognized Exchanges Trading SCR Act, 1956 & Rules 1957 and SEBI Act, 1992 23 Stock BondsIndices-Interest Currency-units of M.F.I. Derivatives Futures-OptionsInterest Rates SpeculationArbitrage and Hedging of Risk ElectronicComputerized & Fully Automated Recognized Stock Exchanges Yes of D.P. Service Both of NSDL and CDSL National Level & Regional Stock Brokers, Sub Brokers Depositories, Mutual Funds, Transfer Agents, Credit Rating Agencies, FIIS, Investors and Others

4. 5.

Deptt. of Consumer Affairs, New Delhi. Forward Contract (Regulation) Act 1952 and Rules 1954 25 Commodities and Precious Metals Futures Transfer of Hedging Risk and Price Discovery Computerized and Physical also Recognized Commodity Exchanges/Mandi Being worked out Through Ware Housing Receipts National Level Multi Commodity and Regional also Member Brokers, Commodity Mutual Funds, Clearing Houses, Collateral Managers, Commodity Brokers, Freight & Forward Agents Mandi Operators Warehouse Keepers and others

6. 7. 8. 9.

Derivative Instruments Purpose of Trading Mode of Trading Place of Trading

10 Existence/ . Availability of Demat Facility 11 Status of . Exchange 12 Intermediarie . s

16

CHANGING COMMODITIES SCENE By its sheer size and turnover, the Indian commodities market offers unparalleled growth opportunities and advantages to a large cross section of the participants including Producers, Traders, Corporate, Regional Trading Centers, Importers, Exporters, Cooperatives, Industry Associations, amongst

others-clearly, the lifeline of the national economy. The underlying economic purpose of a Commodity Exchange as a market place is to enable commodity produces to sell their produce in advance to protect against possible price falls in the future and allow consumers-traders, processors and exporters to buy in advance to protect against possible price increases. In the way they are also able to hedge their price risk, i.e. to lock in a price which they will receive and pay respectively, and hence secure financing from their bank, or just have peace of mind. This price-setting function is performed by providing a meeting-place for producers and the ultimate purchasers of the commodities. 1. Very deep level of intermediation 2. Hedging & Speculative trading provides equal liquidity 3. The Underlying are universally traded commodities 4. Unlike Equities, Commodities are Trade Driven 5. SPOT market trading drives Futures trading and vice-versa.

17

It is for these reasons the commodity exchanges actively encourage the participation of market specialist or Liquidity Providers, Hedgers and Arbitrageurs, who provide market, depth and liquidity in the system. This in turn introduces the element of Price Discovery, which increases the likelihood that buying and selling can be made at all levels and at all points of time, thereby ensuing continuous entry and exit route for any participant. In the Commodities markets too the situation is changing. Some commodity exchanges are specializing in specific areas with varying degrees of success. The task force has stressed the need to have at least a third of each exchange board manned by independent directors. Licenses have been given for Multiple Commodities Exchanges and Single Commodity Exchanges and for conducting trading on-line. Even a single commodity exchange can trade in multiple commodities after obtaining permission from the Forward Markets Commission (FMC). Commodity exchanges are promoted by institutions and associations. With convergence, there will be an opportunity to speed up the development of the commodity markets. Because of the economics of scale in operations there will be scope for further improvement.

18

COMMODITY EXCHANGES NATIONAL LEVEL COMMODITY EXCHANGES The modern Futures Exchanges exist for the purpose of bringing buyers and sellers together and providing facility where futures trading can take place. In some of the Commodity Exchanges, the trading facility is computerized with fully automated programmed for electronic trading from remote i.e. through computer screens. It provides the facility of hedging the risks as well as transfer of risks. The commodity markets scenario in the country is expected to go through a sea-change. Futures trading is now allowed across major commodities in three Multi commodity Exchanges:1. Multi Commodity Exchange of India Limited (MCX) It is located at Mumbai. It wants live on 19 th November 2006 with three futures and in Bullion on 11th November, 2006. Globally the value of commodities traded is three times the value of equity traded. This point to an opportunity for commodity exchanges worth $600 bullion. Just four commodities category could make this happen. (i) Agricultural Commodities have the potential to trade 10 times the underlying physicals of $30 bullion.

19

(ii)

Bullion has the potential to trade 20 times underlying Physicals of $8 bullion.

(iii) Edible Oils have the potential to trade 10 times underlying physicals of $5.4 bullion. (iv) Metals have the potentials of trading 10 times the underlying physicals of $2 bullion.

2. National Commodity & Derivatives Exchange (NCDEX) This Exchange is also located at Mumbai and it offers facilities in about 40 cities throughout the country. The Exchange has already started Trading in many commodities including Gold-Silver-Soyabean-Refined Soyabean Oil-

Rapeseed Mustard Seed Oil-RBD Palmolein-Crude Palm Oil and Raw Cotton and Wheat very recently. It affects its bullion futures trading could jump to Rs. 10 billion a day within one year. The Exchange is also intending to start Futures trading in other Agricultural Products, Metals, including Precious

Metals, Precious Stones, Diamonds, Petroleum and Energy Product and all other commodities and Securities in Spot Market and in Futures Market. It has accredited warehouses at many places as delivery centers.

20

3. National

Multi

Commodities

Exchange

of

India

(NMCE) Ahmadabad It is located at Ahmadabad. This exchange is already working since October 2005 and started trading in Bullion in early October 2004. They have 49 commodities, out of these 35 are varieties of oil, oil seeds and oil cakes out of remaining 6 are Non Ferros Metals two are Spices and Pulses and Gur-Sugar-Rubber-Pepper-Vanaspati etc. This Exchange has an arrangement with CWC Central Warehousing Corporation to assess the quality of goods deposited and the Warehouse Receipt will be dematerialized in due course. 4. National Board of Trade (NBOT) Indore It is located at Indore and is functional. It is one of the vibrant commodity exchanges with a Daily Turnover of around 350 cores to 400 cores. It may have Multi Commodity Exchange status in due course of time, the one which other three have now. Legal Framework After Independence, the Constitution of India adopted by Parliament on 26th January, 1950 placed the subject of "Stock Exchanges and Futures Market" in the Union list and therefore the responsibility for regulation of forward contracts devolved

21

on Government of India. The Parliament passed Forward Contracts (Regulation) Act, 1952 which presently regulated forward contracts in commodities all over India. The features of the Act are as follows: The Act applies to goods, which are defined as any movable property other than security, currency,

actionable claims. The very preamble of the Act announces the intention of the legislature to prohibit options in goods. By a specific provision, section 19, such agreements are prohibited. (The proposal to regulate options in goods is under consideration of Government). The Act classifies contracts/agreements into two broad categories, viz., ready delivery contract and forward contract. Ready delivery contract are those where delivery of goods and full payment of price therefore is made within a period of eleven days. (The proposal to extend the period to thirty days is under consideration of Government). It is further clarified that notwithstanding the period of performance contract, if the contract is performed by payment of money difference it would not be a ready delivery contract.

22

 The Act defines forward contract as the contract for delivery of goods which is not a ready delivery contract Forward contracts are implicitly classified into two broad categories, viz., specific delivery contract and nonspecific Though, delivery contract or standardized contract.

de-facto, the focus

of the regulation are

standardized contracts i.e., futures contracts, these are not defined in the present Act (it is proposed to introduce definition of "futures contract" in the Act). Specific delivery contracts (where the terms of the contracts are specific to each contract - customized contracts) in which, the buyer does not transfer the contract by merely transferring document of title to the goods and exchanging money difference between the sale and purchase price, termed as Non-transferable Specific Delivery Contract are normally outside the purview of the Act, but there is an enabling provision empowering the Government to regulate or prohibit such contracts. The Act provides for either regulation of the other forward contract in specified commodities or prohibition of specified commodities. which do not Such figure contracts in in the or

commodities

regulated

23

prohibited categories are outside the purview of the Act, except when they are organized by some Exchange. The Act envisages three-tier regulation. The Exchange which organizes forward trading in regulated

commodities can prepare its own rules (articles of association) and byelaws and regulate trading on a dayto-day basis. The Forward Markets Commission approves those rules It and also Byelaws acquires and provides regulatory powers of

oversight.

concurrent

regulation either while approving the rules and byelaws or by making such rules and byelaws under the delegated powers. The Central Government Department of

Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution - is the ultimate regulatory authority. Only those associations, which are granted recognition by the Government, are allowed to organize forward trading in regulated commodities. Presently the recognition is commodity-specific. Government has original powers to suspend trading, to call for information, require the

Exchanges

submit

periodical

returns,

nominate

directors on the Boards of the Exchanges, and supersede Board of Directors of the Exchange etc. Most of these powers are delegated to the FMC; otherwise the role of

24

FMC is recommendatory in nature. (The Government has full control over the FMC, which is the subordinate office of the Department of Consumer Affairs, depending upon the budget allocation for its existence. The FMC also is subject to the rules and regulations relating to all matters including appointment of staff and officers, incurring office expenses and conducting tours etc. as are

applicable to any Government Department.) Only police authorities have powers to enforce illegal trading in prohibited commodities and options in goods. FMC can merely forward information and render technical assistance to police. The penalties provided under the Act are nominal and does not have deterrent effect. Since judicial magistrate first class has jurisdiction to try offences under this Act, the fine cannot exceed Rs.10, 000. The minimum fine prescribed for the second offence is Rs. 1,000 only. There is no provision to relate the penalty to the amount involved in the offence. (The Government is considering amending the Act to raise the fine to Rs.5000) Policy Liberalization Forward trading was banned in 1960s except for Pepper, Turmeric, Castor seed and Linseed. A future trading in

25

Castorseed and Linseed was suspended in 1977. Apparently on the basis of the recommendations made by Khusro Committee forward trading in Potato and Gur was allowed in early 1980s and in Castor seed in 1985. After the process of liberalization of the economy started in 1990, the Government set up a Committee under the Chairmanship of Prof. K. N. Kabra in 1993 to examine the role of futures trading in the context of liberalization and globalization. The Kabra Committee

recommended allowing futures trading in 17 commodity groups. It also recommended strengthening of Forward

Markets Commission and amendments to Forward Contracts (Regulation) Act, 1952. The major amendments include

allowing options in goods, increase in outer limit for delivery and payment from 11 days to 30 days for the contract to remain ready delivery contract and registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and a future trading has been permitted in all recommended commodities except Bullion and Basmati Rice. Additional staff was provided to the FMC and the post of Chairman was upgraded to the legal of Additional Secretary to the Government of India. The recommendations to set up Regional office at Lucknow, Delhi and Kochi were kept in abeyance for the time

26

being. In Para 44 of the National Agricultural Policy announced by the Government in the year 1999 it was stated that the Government will enlarge the coverage of futures market to minimize the wide fluctuations in commodity prices, as also for hedging their risk. It was mentioned that an endeavor would be to cover all important agricultural products under futures trading in the course of time. An expert Committee on Agricultural Marketing linkage headed of by Shri and Shankerlal forward Guru

recommended

spot

markets,

introduction of electronic warehouse receipt system, inclusion of more and more commodities under futures trading and promotion of national system of warehouse receipt. The subgroup on forward and futures markets formed under the chairmanship of Dr. Kalyan Raipuria, Economic Adviser, and Department of Consumer Affairs to examine the feasibility of implementing the recommendations made by the Expert Committee chaired by Shankerlal Guru recommended that the commodity specific approach to the grant of recognition should be given up. The Exchanges, which meet the criteria to be stipulated by the Government, should be able to trade contracts in any permitted commodity. In the Budget speech made on 28th February 2007, the Finance Minister announced expansion of futures and forward

27

trading to cover all agricultural commodities. The economic survey for the year 2006-2007 indicated the intention of the Government to allow futures trading in Bullion. The policy statements announced by the Government indicate its resolve to introduce reforms in commodity sector. A number of initiatives were also taken to decontrol the spot markets in commodities. The number of commodities listed as essential commodities has been pruned down to 17. RATIONALE OF THE TOPIC A commodity is anything a market can place a value on derivatives are financial instruments that derives their value from the underlying physical commodity market. With a constant new stream of financial coming to the market each often more exotic and complicated than the last, the financial services industry which includes houses commodity and banks

derivatives

exchange

brokerage

providing price risk reduction services is one of the fastest growing industries. Although commodity derivatives command a humble share of 6% in derivatives markets across the world, yet these record high volumes in the markets the world over compared to equity derivatives. In this era risks to investments are on the rise. Integration of spot and forward market is another critical

28

factor for growth of commodity futures in India. Spot market is controlled to a large extent by state governments. There are restrictions on holding of stocks, turnover and movement of goods and there re variations in the duties levied by the different state government. Introduction of institutional reforms is also cited as a major factor affecting the growth and development of

commodity derivatives market. Setting up a modern and demutualised national wide multi commodity exchange is considered necessary to create competitive pressure on existing exchanges to adopt reforms. Now a days government would soon move towards having a single regular for equity and commodity markets has an expected created a flitter. Among commodity exchange especially the regional one. In this study I will cover how it will be beneficial to the different parties of commodity market. In the present state of economy there is an imperative need for the corporative client to protect their operating profile by shifting some of uncontrollable risks to those who are bale to bear and manage them. Thus the management becomes a must for survival. Since there is a high volubility in the present market. In this context derivatives occupy an important place as a risk reducing machinery.

29

This will protect the investors from the unforeseen risks and helps them to get their due operating profits. This study attempts to give an overview of the development in the commodity derivatives markets and tries to explain the scopes for this.

30

CHAPTER-2 COMPANY PROFILE

Fortune

Financial

Services

(India)

Limited

was

incorporated in the year 1991 by Mr. J. T. Poonja, Chairman and Mr. Nimish C Shah, Vice Chairman and Managing Director. Fortune Group which comprises the holding company Fortune Financial Services (India) Limited and its wholly-owned

subsidiaries, is engaged in providing a range of Financial Services right from Equities and Derivatives trading, Equity Research, Commodities Trading, Portfolio Management

Services, Distribution of Mutual Funds, IPO & Insurance products and also Investment banking services. The main activities of the company are conducted through Fortune Financial Services which is also the holding company & its wholly owned subsidiaries. A brief snapshot of all the companies is outlined as under. M/s. Fortune Financial Services (India) Ltd. M/s. Fortune Financial Services (India) Ltd. is listed on the Bombay Stock Exchange Ltd and is SEBI registered Category I Merchant Banker. It has recently got approval from SEBI to launch its Portfolio Management Services (PMS). FFSIL has four business verticals viz. Fortune Equity Brokers (India) Limited,

31

Fortune Commodities & Derivatives (India) Ltd., Fortune Credit Capital Ltd. and Fortune Financial India Insurance Brokers Limited. M/s. Fortune Equity Brokers (India) Ltd. M/s. Fortune Equity Brokers (India) Ltd. is 100%

subsidiary company of M/s. Fortune Financial Services (India) Ltd. It offers broking services in the Cash and Future & Option Segments of the National Stock Exchange of India Ltd and the Bombay Stock Exchange Limited. It is also a Depository Participant of Center Depository Services (India) Ltd. M/s. Fortune Commodities & Derivatives (India) Ltd. M/s. Fortune Commodities & Derivatives (India) Ltd. is subsidiary company of M/s. Fortune Financial Services (India) Ltd. and engaged in the business of commodities broking. It is having memberships with the MCX and NCDEX, two leading Indian Commodities Exchanges. M/s. Fortune Credit Capital Ltd. Fortune Credit Capital Ltd. is 100% subsidiary company of M/s. Fortune Financial Services Ltd. It is formed for the purpose of financing, lending to the clients. The Company has received license from RBI for NBFC operations.

32

M/s. Fortune Financial India Insurance Brokers Limited. M/s. Fortune Financial India Insurance Brokers Limited is 100% subsidiary company of Fortune Financial India Insurance Brokers Limited and formed for the purpose of providing insurance broking and related products and services. MANAGEMENT TEAM

Mr. J. T. Poonja, Co-Founder & Executive Chairman Mr. J. T. Poonja is first generation entrepreneur and has over 43 years of experience in Financial Service Sector ranging from Banking, Merchant Banking and Institutional Broking Activities. He presently oversees the group operations, expansion and extensively involved in strategic planning of Fortune's future growth plan.

33

Mr. Nimish C Shah Co-Founder, Vice-Chairman & Managing Director Nimish C Shah is first generation entrepreneur and has over 23 years of experience in Indian Capital Market. His core acumen lies in Investment Banking, Institutional & HNI Broking. He presently oversees assignments relating to structuring custom financial solutions for clients, assisting companies in raising capital (private equity / venture capital, debt and equity), mergers and acquisitions, strategic partnerships, valuations, other merchant banking activity. He is also actively involved in pitching ideas and concepts to prospective clients. He looks after the core business development and contributes to evolving new growth strategies.

34

Mrs. Sangeeta Poonja Director

Mrs. Sangeeta J Poonja is an M.A. in Economics and has good acumen in finance field. She is actively involved in various socio-cultural activities and is one of the

promoting directors of the Company

Mr. Ramesh Venkat Director

Mr. Ramesh Venkat is a fellow member of the Institute of Chartered Accountants of India and The Institute of Company Secretaries of India, Associate Member of Institute of Cost and Works Accountants of India. He has more than 23 years of

35

work experience in the fields of Banking, Corporate Finance and Treasury Management. Mr. Venkat is currently President of Finance at Anil Dhirubhai Ambani Enterprises (ADAE Group)

Mr. C. R. Mehta Director

Mr. C.R. Mehta is a Fellow Member of Institute of Chartered Accountant of India and Institute of Company Secretaries of India. In 1964, Mr. Mehta joined the Govt. of India in the Department of Company Affairs and held several positions in the Inspection and Investigation side. Later Mr. Mehta was appointed as the Registrar of Companies of Delhi as well as Registrar of Companies, Maharashtra, Mumbai. He also

occupied the position of Regional Director in the Department of Company Affairs for Northern Region at Kanpur as well as for Western Region at Mumbai. He was also in deputation to Shipping Development Fund Committee as Dy. Executive Director for about six years. He also acted as Govt. Nominee Director on the governing Board
36

of

Ahmadabad

Stock

Exchange for about two years. He was elected and appointed as the Member of Company Law Board and worked in the Western Region Bench at Mumbai and also in the principal Branch of the Company Law Board at Delhi. After serving the Govt. for more than 37 years, retired from the Government service in the year 2001.

Mr. Sohan. C. Mehta Director Mr. Sohan C. Mehta is an Engineer and has rich industry and professional experience in the fields of manufacturing, trading of chemical and other related fields.

Mr. Manoj Patel Director

37

Mr. Manoj Patel is a Science Graduate in Civil Engineering from U K. At present he is the Chairman of C Tiles Limited a wholly owned subsidiary of G A K Patel & Co. Ltd., the Company is engaged in manufacturing colored cement and tiles. Earlier he has handled the business of building and civil contracts, investment activities. funds, bottling plant and other distribution

Mr. H. R. Prasad Director Mr. H R Prasad is a graduate in Electrical Engineering from the University of Madras, Mr Prasad went to the United States under the Fulbright programmed and studied at the

Massachusetts Institute of Technology and Harvard Business School and graduated with a Master of Science degree in Management from the MIT Sloan School of Management. He also holds a diploma in Social service from madras. A former Managing Director and CEO of Schrader Duncan Ltd, Joint Managing Director of Gabriel India Ltd, Mr. Prasad is
38

the

Corporate

Group

Advisor

to

the

Anand

Group

of

Companies. He is a Director of Victor Gaskets India Ltd, Haldex India Limited, Uni Abex Alloy Products Ltd, Uni Deritend Ltd, Quorum Consulting PVT ltd. He also served as a Director of Perfect Circle India Ltd, Tata Unisys Ltd, Camphor & Allied Products Ltd, Pinsel Computer Products Ltd, N B Footwear Ltd, Terpene Industries Ltd, Profeel Sentinel Limited, SkyTel India Private Ltd, and Anand Technology Resource Park Private Ltd. He was a Member of the All India Board of Technician Education, Government of India, and of the Governing Council of Central Manufacturing Technology Institute, Government of India. He is Chairman of the Audit Committee and the Investors/ Shareholders Grievances Committee of Victor Gaskets India Ltd; is Chairman of the Audit Committee and the Remuneration Committee of Uni Deritend Ltd; is Member of the Audit Committees of Uni Abex Alloy Products Ltd and Haldex India Limited. Mr. Prasad is a former President of Indo-American Chamber of Commerce, Indo-American Society, American Alumni

Association and Bombay Management Association. Mr. Prasad was a Founding Member of the Advisory Committee of the School of Management, Indian Institute of Technology,

39

and Mumbai. He taught MBA students a course in International Management at the Graduate School of Business

Administration, University of Connecticut, USA. Mr. Prasad was a Member of the General Committee and the Executive Committee of the Willington Sports Club, Bombay from 1989 for three years during which period he served as Chairman of the Swimming Pool Subcommittee. He was a Member of the Clubs Managing Committee from 2001 for six years during which period he also served as Chairman of the Human Resource Development Subcommittee, the Special Projects Subcommittee, and as a Member of the Finance & Taxation Subcommittee. Mr. Prasad was Chairman of the Club for two years from October 2005 until September 2007.

Mr. Shailesh Haribhakti Alternate Director to Mr. Manoj Patel Mr. Shailesh V. Haribhakti is a Fellow Chartered Accountant. His professional interests spread across several industries, governance issues, risk management and standard setting.
40

Mr. Haribhakti is a Director on the board of many highly acclaimed & reputed public and private companies holding the position of Chairman or Member of Audit committee of the Board of Directors in some of these companies. In addition, he is a committee member of Futures & Options segment of National Stock Exchange of India and a member of SEBI Committee on disclosures and Accounting Standards. He serves as a member of managing committees of ASSOCHAM and IMC, Corporate Governance committee of ASSOCHAM and CII and is Chairman of the Global Warming Committee of IMC. He was a member of the ICAIs Group on Implementation of Convergence with IFRS. He was Member on the Standards Advisory Council of the International Accounting Standards Board. Mr. Haribhakti has in the past served as Chairman of the Indian affiliate of the Certified Financial Planner Board of Standards FPSB (India). He has been awarded The Best Non Executive Independent Director Award 2007 by the Asian Centre for Corporate Governance & IMC. His present associations also include: Membership of Rotary Club of Mumbai.

41

Mr. Sanjay Kothari Director

Mr. Sanjay Kothari is a Fellow member of The Institute of Chartered Accountants of India & the Institute of Company Secretaries of India & Associate member of The Institute of Cost & Works Accountants of India. He also holds a Diploma in Business Finance from The Institute of Chartered Financial Analysts of India. At present he is a Practicing Chartered Accountant specializing in corporate communications, loan syndications, equity

placements, and financial restructuring exercises. Between the period from 1987 to July 2000 and he has served in various capacities heading the finance & accounts Dept. of public companies and also served as Head of the Family Wealth Management Office of the promoter of Gujarat Ambuja. During the period August 2006 to December 2008.

42

Mr. Kothari is also a Guest Faculty at Welingkar Institute and Sydneham College for PGDBM course on project appraisals and financial markets. Mr. Kothari has served on the panel of the Stock Exchange, Mumbai for arbitration between members and non-members. Mr. Kothari was on the committee of Indian Merchants Chamber on capital markets and on Finance, Banking & Insurance. Retention In order to get the best out of its employees and retain them in a high attrition rate industry, Fortune has established a number of attractive schemes and incentive programs for its employees. All employees are full time salaried employees. These salaries, which are among the top tier of industry earnings, are complemented by performance-based incentives. Impeccable attendance rates and employee longevity are also recognized and bonuses paid accordingly. Fortune believes that recognition programs are vital to maintaining the highest levels of motivation. Career Development For promising employees, Fortune has a career development program in place. Employees ready to take on higher responsibilities are identified and relevant training is imparted

43

upon them. Employees are also encouraged to upgrade their skills from external sources if these skills are relevant to their current profiles. Training Fortune adopts a scheduled training process and a modular approach for imparting theoretical and practical knowledge in its trainees. Training Schedule Employees, on being hired, go through an intensive inductiontraining module, which covers technical enhancement and orientation in cross cultural sensitization. The induction

training is followed by process specific training, which is tailormade to the client's requirement

44

Training Tools Fortune's trainers make use of a wide variety of training tools and applications to make the learning process both fun and interesting. Tools and methodologies used include Discussions, Lecture Debates, Assignments, Shadowing Process, Movie Clips, and Reading exercises Fortune customers have the advantage of trading in all the market segments together in the same window, as we understand the need of transactions to be executed with high speed and reduced time. At the same time, they have the advantage of having all kind of Insurance & Investment Advisory Services for Life Insurance, General Insurance, Mutual Funds, and IPO's also. Fortune is a customer focused financial services organization providing a range of investment solutions to our customers. We work with clients to meet their overall investment objectives and achieve their financial goals. Our clients have the opportunity to get personalized services depending on their investment profiles. Our personalized approach enables clients to achieve their Total Investment Objectives.

45

CHAPTER-3 RESEARCH METHODOLOGY

Research methodology involves: To know why a research study has been undertaken How the research problem has been denied and in what why? What data have been collected and from which source? This study is Descriptive and Analytical in nature.

Descriptive study means we have to describe the thing, which already exists. Analytical study means in which we have to analyses the trends or the results we have with us. In this study I will find out the effect of commodity derivatives in risk management and how it is beneficial to use commodity derivatives as risk management tool. Research Tool Simple analytical and statistical tools shall be used in this study. OBJECTIVES OF PROPOSED PROJECT: Defining the Derivatives and its types? What are commodity derivatives? Evolution of commodity derivatives market in India?

46

 Regulations and policy issues for the commodity derivatives in India.

47

CHAPTER-6 DATA ANALYSIS AND INTERPRETATION

1. Yes 100 Are you aware with Commodity Derivatives? No 0

120 100 80 60 40 20 0 Yes

Inference: During the survey out of the 100 respondents all the respondents echoed that they are well aware with the commodity derivatives and they were indulge in commodity trading in somewhat manner. 2. Which commodity exchange do you prefer? National Multi National Commodities Board of Multi Commodity

Yes No

No

National Commodity &

48

Derivatives Exchange (NCDEX) 75

Exchange of India (NMCE) Ahmadabad 4

Trade (NBOT) Indore 6

Exchange of India Limited (MCX) 15

80 70 60 50 40 30 20 10 0 NCDEX
Inference: During the survey out of the 100 respondents 75 respondents were trading with NCDEX, followed by 15

75 15 4 NMCE 6 NBOT MCX

NCDEX NMCE NBOT MCX

respondents going with MCS. Only 6 and 4 respondents were involved with NBOT and NMCE respectively.

3.

Futures trading is allowed only across major commodities in three Multi commodity Exchanges, do you want to start in all exchanges?

Yes

No
49

Cant say

12

22

66

70 60 50 40 30 20 10 0 Yes
Inference: During the survey out of the 100 respondents 66 respondents could express their opinion, followed by 22 respondents going with negative remarks and 12 respondents going with positive remarks.

66

Yes No Cant say

22 12 No Cant say

4.

Do you think that trading in commodity impacts inflation?

Yes 22

No 72

Cant say 6

50

80 70 60 50 40 30 20 10 0 Yes
Inference: During the survey out of the 100 respondents 72 respondents don't thing that commodity trading is root cause of inflation, however 22 respondents blame it. Six respondents could not express their opinion.

72

Yes No Cant say

22 No

6 Cant say

5.

Do you think that trading on essential commodities should be banned?

Yes 14

No 69

Cant say 17

51

80 70 60 50 40 30 20 10 0 Yes
Inference: During the survey out of the 100 respondents 69 respondents don't recommend ban on trading of essential commodities, however 14 respondents recommended for ban. 17 respondents could not express their opinion.

69

Yes No Cant say 17

14 No Cant say

6.

Have

you

ever

availed

services

of

Fortune

Financial Services (India) Limited? Yes 63 No 37

52

70 60 50 40 30 20 10 0 Yes
Inference: During the survey out of the 100 respondents 63 respondents have availed the services of FFSIL: however 37 respondents have never availed any service from FFSIL.

63 37

Yes No

No

7.

If yes how was your experience? Average 19 Bad 2

Very good 42

53

45 40 35 30 25 20 15 10 5 0 Very good Average

Inference: During the survey out of the 63 respondents 42 respondents have very good experience with company, however 2 respondents have bad experience, and 19 have average experience.

42 19 2 Bad

Very good Average Bad

8.

Do you think government should lift the ban over trading of some commodities?

Yes 42

No 32

Cant say 26

54

45 40 35 30 25 20 15 10 5 0 Yes
Inference: During the survey out of the 100 respondents 32 respondents don't recommend government to lift ban some commodities, however 42 respondents recommended for lifting ban. 17 respondents could not express their opinion.

42

32

26

Yes No Cant say

No

Cant say

9.

Do you think commodity trading will proliferate more in future

Yes 71

No 17

Cant say 12

55

80 70 60 50 40 30 20 10 0 Yes
Inference: During the survey out of the 100 respondents 71 respondents feel that commodity trading will proliferate in future, however 17 respondents don't think so. 12 respondents could not express their opinion.

71

Yes No Cant say 17 12 Cant say

No

10. Yes 55

Would you recommend others to go for FFSIL? No 8

56

60 50 40 30 20 10 0 Yes No 8 55 Yes No

Inference: During the survey out of the 63 respondents 5

respondents feel that they would certainly recommend others, however 8 respondents don't have such an idea.

57

CHAPTER-5 FINDINGS
Basically speaking, derivatives are used for volatity, arbitrage, hedging risks spread strategies or cash extraction. The investors Fund Managers, institutions and Corporate can use this Financial Instrument with little risk if they have a clear understanding of the products. They should understand multiple derivative strategies, simple and complex. The importance of sound derivatives markets for the economic development particularly in emerging markets can not be overemphasized. However, emerging markets exchanges need solid foundations, for instance well functioning underlying markets. 1. History shows that the text book basics are not pre-se sufficient to make a derivatives market successful. 2. There should be product diversification to fulfill the market needs. 3. There should be continued education of the users, members and market makers. 4. The technology factor, speed, continued access and

connectivity are decisive for all exchanges. While analyzing the role of Commodity Exchanges in emerging markets, starting point is the recognition that the poorer

58

people are the costlier risks, because there is no back up. Managing these risks-particularly in agricultural commoditiestherefore, is a means of development. Current initiatives of development agencies are focusing on access strategies i.e. how to link the producers and exchanges. It is a fact that may commodities exchanges face similar bottlenecks usually unstable markets the successful contenders did not copy Western Exchanges but develop new innovative concepts. Commodities Futures Trading is a global phenomenon and offers tremendous potential to market participants for both profit taking on small price corrections as well as also it hedgers looking at managing price risk on account of price fluctuations. In fact, so well established is this market that a cursory glance at the trading turnover of the equities and the commodities markets, displays the reality.

The

exchange

can

appoint

intermediaries

from

the

existing commodity exchanges, securities exchanges and other sections of trade and industry to penetrate all sections of the economy connected with commodities production, consumption and trading. The commodity exchanges are to educate these intermediaries on a continuous basis to enable them to make use of this

59

market effectively. Further commodity exchanges are to work closely with trade and industry to create a user friendly and business oriented environment to tap the potential market and also in association with the existing securities derivative markets.
During the survey out of the 100 respondents all the respondents echoed that they are well aware with the commodity derivatives and they were indulge in commodity trading in somewhat manner. During the survey out of the 100 respondents 75

respondents were trading with NCDEX, followed by 15 respondents going with MCS. Only 6 and 4 respondents were involved with NBOT and NMCE respectively. During the survey out of the 100 respondents 66

respondents could express their opinion, followed by 22 respondents going with negative remarks and 12

respondents going with positive remarks. During the survey out of the 100 respondents 72

respondents don't thing that commodity trading is root cause of inflation, however 22 respondents blame it. Six respondents could not express their opinion.

60

 During

the

survey

out

of

the

100

respondents

69

respondents don't recommend ban on trading of essential commodities, however 14 respondents recommended for ban. 17 respondents could not express their opinion. During the survey out of the 100 respondents 63

respondents have availed the services of FFSIL: however 37 respondents have never availed any service from FFSIL. During the survey out of the 63 respondents 42 respondents have very good experience with company, however 2 respondents have bad experience, and 19 have average experience. During the survey out of the 100 respondents 32

respondents don't recommend government to lift ban some commodities, however 42 respondents recommended for lifting ban. 17 respondents could not express their opinion. During the survey out of the 100 respondents 71

respondents feel that commodity trading will proliferate in future, however 17 respondents don't think so. 12

respondents could not express their opinion. During the survey out of the 63 respondents 5 respondents feel that they would certainly recommend others, however 8 respondents don't have such an idea.

61

BIBLIOGRAPHY

Data have been collected from the Secondary sources: Books Magazines Stock Exchanges Internet Reports and Previous Studies References Options, future and other derivativesJohn C. Hull Kothari C.R. Research Methodology Methods and Techniques. www.wikipedia.com www.sharekhan.com

62

Questionnaire 1. Are you aware with Commodity Derivatives? i. Yes ii. No 2. Which commodity exchange do you prefer? i. National Commodity & Derivatives Exchange (NCDEX) ii. National Multi Commodities Exchange of India (NMCE) Ahmadabad iii. National Board of Trade (NBOT) Indore iv. Multi Commodity Exchange of India Limited (MCX) 3. Futures trading is allowed only across major commodities in three Multi commodity Exchanges, do you want to start all exchanges? i. Yes ii. No 4. Do you think that trading in commodity impacts inflation? i. Yes ii. No

iii. Can't say

5. Do you think that trading on essential commodities should be banned? i. Yes ii. No iii. Can't say

63

6.

Have

you

ever

availed

services

of

Fortune

Financial Services (India) Limited? i. Yes ii. No 7. If yes how was your experience? i. Very good ii. Average iii. 8. Bad

Do you think government should lift the ban over trading of some commodities? i. Yes ii. No iii. Can't say

9.

Do you think commodity trading will proliferate more in future i. Yes ii. No iii. Can't say

10.

Would you recommend others to go for FFSIL? i. Yes ii. No

64