Вы находитесь на странице: 1из 16

Project

On
Commodity Derivative market
in India

(Faculty - Professor P.C Biswal)

Aditya Rastogi – 09EMP1-01


Rajesh Dabral – 09EMP1-45
Shivanand Gupta – 09EMP1-54
Shronik Soni – 09EMP1-55

Executive Management Program


TABLE OF CONTENTS

1. Acknowledgment.
2. Introduction/Agenda (Executive Summary)
3. Commodity Derivatives – The Need
4. Difference between a commodity and financial derivative
4.1. Physical Settlement
4.2. Warehousing
4.3. Quality of underlying assets
5. Indian commodity derivative market
5.1. Milestones
5.2. History
5.3. Change in Government Policy
5.4. Modern Commodity Exchanges
6. The Growth
7. Unresolved issues and Future prospects
8. Conclusion
9. Bibliography
Acknowledgement

We would like to express our deepest gratitude to our professor Prof. P C Biswal for guiding us and
helping us understand the fundamentals of Derivative Market. This project has given us the
opportunity to analyze the practical aspects of applying Hedging strategies using futures and options
in Stocks, Currency and Commodities to get sustainable competitive advantage.

The various case studies and assignments have helped us in understanding the key concepts of
derivative market and the hedging strategies adopted by different organizations under different
circumstances and contexts using the derivative market.
2. Introduction/Agenda
(Executive Summary)

This report examines the importance of commodity trading in the derivative market, Commodities
were traded even before the currency was discovered, people in ancient civilizations used to barter
goods to meet their daily needs, the very reason for this lies in the fact that commodities represent the
fundamental elements of utility for human beings.

The term commodity refers to any material which can be bought and sold. A commodity in a market’s
context refers to any movable property other than actionable claims, money and securities. Over the
years commodities markets have been experiencing tremendous progress, which is evident from the
fact that the trade in this segment is standing as the boon for the global economy today.

Commodity derivatives were first created for farmers, to offer them protection against crop values
falling below the cost of growing the crop. This protection comes in the form of derivative contracts,
and these contracts cover commodities such as white pepper, wheat, rice, coffee, cotton, and many
others. Commodity derivatives started out as the first risk management options for commodities, but
now they have become an important investment tool. Commodity derivatives are now commonly
invested in by investors who have nothing to do with agriculture, or who do not need the actual
commodity.
A commodity derivatives market (or exchange) is, in simple terms, nothing more or less than a public
marketplace where commodities are contracted for purchase or sale at an agreed price for delivery at a
specified date. These purchases and sales, which must be made through a broker who is a member of
an organized exchange, are made under the terms and conditions of a standardized futures contract.
Commodity prices do vibrate more rapidly and provide profitable opportunities, accordingly
recessions, depressions and booms offer many opportunities to scoop up profits. Exchange Traded
Derivatives can be broadly classified into Futures and Options.

The first exchange created that had trades for commodities was in Chicago. This is the oldest
exchange and one of the largest in the world, and is the Chicago Board of Trade, also called CBOT.
This exchange has numerous contracts on various commodities traded frequently, and it was founded
in the year 1848. Another commodities exchange is the Chicago Produce Exchange, which is one of
the largest commodity exchanges globally and was opened in the year 1874.

The size of the commodities markets in India quite significant, of the country's GDP of Rs13, 20,730
crore (Rs13, 207.3 billion). Commodities constitute almost 48% of our GDP. Commodity derivatives
in India have a chequered history.
Commodity derivatives, which were traditionally developed for risk management purposes, are now
growing in popularity as an investment tool. The commodity derivatives market is a direct way to
invest in commodities rather than investing in the companies that trade in those commodities. India's
No.1 online trading platform, Integrated Online Platform, Unbiased Approach, Member of both
NCDEX & MCX, Daily market outlook report before market opens and intra-day calls during the
trading hours, Comprehensive research reports on various commodities enabling companies to
understand the basic fundamentals of the market are some reasons why companies invest in
commodity market.
Even though the commodity derivatives market has made good progress in the last few years, the real
issues facing the future of the market have not been resolved. Agreed, the number of commodities
allowed for derivative trading have increased, the volume and the value of business has zoomed, but
the objectives of setting up commodity derivative exchanges may not be achieved and the growth
rates witnessed may not be sustainable unless these real issues are sorted out as soon as possible.
3. Commodity Derivatives – The Need

India being an agricultural economy is among the top-5 producers of most of the commodities, in
addition to being a major consumer of bullion and energy products. Agriculture contributes about
22% to the GDP of the Indian economy. It employees around 57% of the labor force on a total of 163
million hectares of land. Agriculture sector is an important factor in achieving a GDP growth of 8-
10%. All this indicates that India can be promoted as a major center for trading of commodity
derivatives.

It is unfortunate that the policies of FMC during the most of 1950s to 1980s suppressed the very
markets it was supposed to encourage and nurture to grow with times. It was a mistake other
emerging economies of the world would want to avoid. However, it is not in India alone that
derivatives were suspected of creating too much speculation that would be to the detriment of the
healthy growth of the markets and the farmers. Such suspicions might normally arise due to a
misunderstanding of the characteristics and role of derivative product.

It is important to understand why commodity derivatives are required and the role they can play in
risk management. It is common knowledge that prices of commodities, metals, shares and currencies
fluctuate over time. The possibility of adverse price changes in future creates risk for businesses.
Derivatives are used to reduce or eliminate price risk arising from unforeseen price changes. A
derivative is a financial contract whose price depends on, or is derived from, the price of another
asset.

Two important derivatives are futures and options.

1. Commodity Futures Contracts: A futures contract is an agreement for buying or selling a


commodity for a predetermined delivery price at a specific future time. Futures are standardized
contracts that are traded on organized futures exchanges that ensure performance of the contracts
and thus remove the default risk. The commodity futures have existed since the Chicago Board of
Trade (CBOT, www.cbot.com) was established in 1848 to bring farmers and merchants together.
The major function of futures markets is to transfer price risk from hedgers to speculators. For
example, suppose a farmer is expecting his crop of wheat to be ready in two months time, but is
worried that the price of wheat may decline in this period. In order to minimize his risk, he can
enter into a futures contract to sell his crop in two months’ time at a price determined now. This
way he is able to hedge his risk arising from a possible adverse change in the price of his
commodity.

2. Commodity Options contracts: Like futures, options are also financial instruments used for
hedging and speculation. The commodity option holder has the right, but not the obligation, to
buy (or sell) a specific quantity of a commodity at a specified price on or before a specified date.
Option contracts involve two parties – the seller of the option writes the option in favor of the
buyer (holder) who pays a certain premium to the seller as a price for the option. There are two
types of commodity options: a ‘call’ option gives the holder a right to buy a commodity at an
agreed price, while a ‘put’ option gives the holder a right to sell a commodity at an agreed price
on or before a specified date (called expiry date). The option holder will exercise the option only
if it is beneficial to him; otherwise he will let the option lapse.

For example, suppose a farmer buys a put option to sell 100 tonnes of wheat at a price of `1000 per
tonne and pays a ‘premium’ of `10 per tonne (or a total of `1000). If the price of wheat declines to
say `950 before expiry, the farmer will exercise his option and sell his wheat at the agreed price of
`1000 per tonne. However, if the market price of wheat increases to say `1050 per tonne, it would be
advantageous for the farmer to sell it directly in the open market at the spot price, rather than exercise
his option to sell at `1000 per tonne.
Futures and options trading therefore helps in hedging the price risk and also provide investment
opportunity to speculators who are willing to assume risk for a possible return. Further, futures
trading and the ensuing discovery of price can help farmers in deciding which crops to grow. They
can also help in building a competitive edge and enable businesses to smoothen their earnings because
non-hedging of the risk would increase the volatility of their quarterly earnings. Thus futures and
options markets perform important functions that can not be ignored in modern business environment.
At the same time, it is true that too much speculative activity in essential commodities would
destabilize the markets and therefore, these markets are normally regulated as per the laws of the
country.
4. Difference between a commodity and financial derivative

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

4.1 Physical settlement

Physical settlement involves the physical delivery of the underlying commodity, typically at an
accredited warehouse. The seller intending to make delivery would have to take the commodities to
the designated warehouse and the buyer intending to take delivery would have to go to the designated
warehouse and pick up the commodity. This may sound simple, but the physical settlement of
commodities is a complex process. The issues faced in physical settlement are enormous. There are
limits on storage facilities in different states. There are restrictions on interstate movement of
commodities. Besides state level octroi and duties have an impact on the cost of movement of goods
across locations. The process of taking physical delivery in commodities is quite different from the
process of taking physical delivery in financial assets.

4.2 Warehousing

One of the main differences between financial and a commodity derivative is the need for
warehousing. In case of most exchange traded financial derivatives, all the positions are cash settled.
Cash settlement involves paying up the difference in prices between the time the contract was entered
into and the time the contract was closed. For instance, if a trader buys futures on a stock at Rs.100
and on the day of expiration, the futures on that stock close Rs.120, he does not really have to buy the
underlying stock. All he does is take the difference of Rs.20 in cash. Similarly the person who sold
this futures contract at Rs.100, does not have to deliver the underlying stock. All he has to do is pay
up the loss of Rs.20 in cash.
In case of commodity derivatives however, there is a possibility of physical settlement. This means
that if the seller chooses to hand over the commodity instead of the difference in cash, the buyer must
take physical delivery of the underlying asset. This requires the exchange to make an arrangement
with warehouses to handle the settlements. The efficacy of the commodities settlements depends on
the warehousing system available. Most international commodity exchanges used certified
warehouses (CWH) for the purpose of handling physical settlements.
Such CWH are required to provide storage facilities for participants in the commodities markets and
to certify the quantity and quality of the underlying commodity. The advantage of this system is that a
warehouse receipt becomes good collateral, not just for settlement of exchange trades but also for
other purposes too. In India, the warehousing system is not as efficient as it is in some of the other
developed markets. Central and state government controlled warehouses are the major providers of
agricultural produce storage facilities. Apart from these, there are a few private warehousing being
maintained. However there is no clear regulatory oversight of warehousing services.

4.3 Quality of underlying assets

A derivatives contract is written on a given underlying. Variance in quality is not an issue in case of
financial derivatives as the physical attribute is missing. When the underlying asset is a commodity,
the quality of the underlying asset is of prime importance. There may be quite some variation in the
quality of what is available in the marketplace. When the asset is specified, it is therefore important
that the exchange stipulate the grade or grades of the commodity that are acceptable. Commodity
derivatives demand good standards and quality assurance/ certification procedures. A good grading
system allows commodities to be traded by specification. Currently there are various agencies that are
responsible for specifying grades for commodities. For example, the Bureau of Indian Standards
(BIS) under Ministry of Consumer Affairs specifies standards for processed agricultural commodities
whereas AGMARK under the department of rural development under Ministry of Agriculture is
responsible for promulgating standards for basic agricultural commodities. Apart from these, there are
other agencies like EIA, which specify standards for export oriented commodities.
5. Indian commodity derivative market

5.1 Milestones
Organized commodity derivatives in India started as early as 1875, barely about a decade after they
started in Chicago. However, many feared that derivatives fuelled unnecessary speculation and were
detrimental to the healthy functioning of the markets for the underlying commodities. This resulted in
ban on cash settlement of commodity futures were banned in 1952. Until 2002 commodity derivatives
market was virtually non-existent, except some negligible activity on an OTC basis.

In September 2005, the country has 3 national level electronic exchanges and 21 regional exchanges
for trading commodity derivatives. As many as eighty (80) commodities have been allowed for
derivatives trading. The value of trading has been booming and is likely to touch $5 Trillion in a few
years.

5.2 History
The history of organized commodity derivatives in India goes back to the nineteenth century when the
Cotton Trade Association started futures trading in 1875, barely about a decade after the commodity
derivatives started in Chicago. Over time the derivatives market developed in several other
ommodities in India. Following cotton, derivatives trading started in oilseeds in Bombay (1900), raw
jute and jute goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in Bombay (1920).
However, many feared that derivatives fuelled unnecessary speculation in essential commodities, and
were detrimental to the healthy functioning of the markets for the underlying commodities, and hence
to the farmers. With a view to restricting speculative activity in cotton market, the Government of
Bombay prohibited options business in cotton in 1939. Later in 1943, forward trading was prohibited
in oilseeds and some other commodities including food-grains, spices, vegetable oils, sugar and cloth.

After Independence, the Parliament passed Forward Contracts (Regulation) Act, 1952 which regulated
forward contracts in commodities all over India. The Act applies to goods, which are defined as any
movable property other than security, currency and actionable claims. The Act prohibited options
trading in goods along with cash settlements of forward trades, rendering a crushing blow to the
commodity derivatives market. Under the Act, only those associations/exchanges, which are granted
recognition by the Government, are allowed to organize forward trading in regulated commodities.
The Act envisages three-tier regulation:
(i) The Exchange which organizes forward trading in commodities can regulate trading on a
day-to-day basis;
(ii) the Forward Markets Commission provides regulatory oversight under the powers
delegated to it by the central Government,and
(iii) the Central Government - Department of Consumer Affairs, Ministry of Consumer
Affairs,

Food and Public Distribution - is the ultimate regulatory authority. The already shaken commodity
derivatives market got a crushing blow when in 1960s, following several years of severe draughts that
forced many farmers to default on forward contracts (and even caused some suicides), forward trading
was banned in many commodities considered primary or essential. As a result, commodities
derivative markets dismantled and went underground where to some extent they continued as OTC
contracts at negligible volumes. Much later, in 1970s and 1980s the Government relaxed forward
trading rules for some commodities, but the market could never regain the lost volumes.

5.3 Change in Government Policy


After the Indian economy embarked upon the process of liberalization and globalisation in 1990, the
Government set up a Committee in 1993 to examine the role of futures trading. The Committee
(headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also
recommended strengthening of the Forward Markets Commission, and certain amendments to
Forward Contracts (Regulation) Act 1952, particularly allowing options trading in goods and
registration of brokers with Forward Markets Commission. The Government accepted most of these
recommendations and futures trading was permitted in all recommended commodities.

Commodity futures trading in India remained in a state of hibernation for nearly four decades, mainly
due to doubts about the benefits of derivatives. Finally a realization that derivatives do perform a role
in risk management led the government to change its stance. The policy changes favouring
commodity derivatives were also facilitated by the enhanced role assigned to free market forces under
the new liberalization policy of the Government. Indeed, it was a timely decision too, since
internationally the commodity cycle is on the upswing and the next decade is being touted as the
decade of commodities.

5.4 Modern Commodity Exchanges


To make up for the loss of growth and development during the four decades of restrictive government
policies, FMC and the Government encouraged setting up of the commodity exchanges using the
most modern systems and practices in the world. Some of the main regulatory measures imposed by
the FMC include daily mark to market system of margins, creation of trade guarantee fund, back-
office computerization for the existing single commodity Exchanges, online trading for the new
Exchanges, demutualization for the new Exchanges, and one-third representation of independent
Directors on the
Boards of existing Exchanges etc.
Responding positively to the favourable policy changes, several Nation-wide Multi-Commodity
Exchanges (NMCE) have been set up since 2002, using modern practices such as electronic trading
and clearing. The national exchanges operating in the Indian commodity futures market are the Multi-
Commodity Exchange of India (MCX), National Commodity and Derivative Exchange of India
(NCDEX) and National Multi Commodity Exchange of India (NMCE). Recently, one new national
exchange has been given permission to start and another regional exchange has been permitted to
upgrade to a national exchange. In line with its modern financial infrastructure, India is one of the few
countries worldwide to have commodities’ delivery in electronic (dematerialised) form.Selected
Information about the two most important commodity exchanges in India [Multi-Commodity
Exchange of India Limited (MCX), and National Multi-Commodity & Derivatives
Exchange of India Limited (NCDEX)] are given below;

MCX
Headquartered in Mumbai, Multi Commodity Exchange of India Ltd (MCX) is a state-of-the-art
electronic commodity futures exchange. The demutualised Exchange set up by Financial
Technologies (India) Ltd (FTIL) has permanent recognition from the Government of India to facilitate
online trading, and clearing and settlement operations for commodity futures across the country.

Having started operations in November 2003, today, MCX holds a market share of over 80% of the
Indian commodity futures market, and has more than 2000 registered members operating through over
100,000 trader work stations, across India. The Exchange has also emerged as the sixth largest and
amongst the fastest growing commodity futures exchange in the world, in terms of the number of
contracts traded in 2009.

MCX offers more than 40 commodities across various segments such as bullion, ferrous and non-
ferrous metals, and a number of agri-commodities on its platform. The Exchange is the world's largest
exchange in Silver, the second largest in Gold, Copper and Natural Gas and the third largest in Crude
Oil futures, with respect to the number of futures contracts traded.

MCX has been certified to three ISO standards including ISO 9001:2000 Quality Management
System standard, ISO 14001:2004 Environmental Management System standard and ISO 27001:2005
Information Security Management System standard. The Exchange’s platform enables anonymous
trades, leading to efficient price discovery. Moreover, for globally-traded commodities, MCX’s
platform enables domestic participants to trade in Indian currency.
The Exchange strives to be at the forefront of developments in the commodities futures industry and
has forged strategic alliances with various leading International Exchanges, including Euronext-
LIFFE, London Metal Exchange (LME), New York Mercantile Exchange, Shanghai Futures
Exchange (SHFE), Sydney Futures Exchange, The Agricultural Futures Exchange of Thailand
(AFET), among others. For MCX, staying connected to the grassroots is imperative. Its domestic
alliances aid in improving ethical standards and providing services and facilities for overall
improvement of the commodity futures market.

Key shareholders
Promoted by FTIL, MCX enjoys the confidence of blue chips in the Indian and international financial
sectors. MCX's broad-based strategic equity partners include NYSE Euronext, State Bank of India
and its associates (SBI), National Bank for Agriculture and Rural Development (NABARD), National
Stock Exchange of India Ltd (NSE), SBI Life Insurance Co Ltd, Bank of India (BOI) , Bank of
Baroda (BOB), Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, Fid Fund
(Mauritius) Ltd. - an affiliate of Fidelity International, ICICI Ventures, IL&FS, Kotak Group, Citi
Group and Merrill Lynch.

NCDEX
National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed on-line
multi commodity exchange. The shareholders of NCDEX comprises of large national level
institutions, large public sector bank and companies.

Promoter shareholders: ICICI Bank Limited (ICICI)*, Life Insurance Corporation of India (LIC),
National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of
India Limited (NSE).
Other shareholders: Canara Bank, Punjab National Bank (PNB), CRISIL Limited, Indian Farmers
Fertiliser Cooperative Limited (IFFCO), Goldman Sachs, Intercontinental Exchange (ICE) and Shree
Renuka Sugars Limited

NCDEX is the only commodity exchange in the country promoted by national level institutions. This
unique parentage enables it to offer a bouquet of benefits, which are currently in short supply in the
commodity markets. The institutional promoters and shareholders of NCDEX are prominent players
in their respective fields and bring with them institutional building experience, trust, nationwide
reach, technology and risk management skills.

NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956.
It obtained its Certificate for Commencement of Business on May 9, 2003. It commenced its
operations on December 15, 2003.

NCDEX is a nation-level, technology driven de-mutualised on-line commodity exchange with an


independent Board of Directors and professional management - both not having any vested interest in
commodity markets. It is committed to provide a world-class commodity exchange platform for
market participants to trade in a wide spectrum of commodity derivatives driven by best global
practices, professionalism and transparency.

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

NCDEX headquarters are located in Mumbai and offers facilities to its members from the centres
located throughout India.

The Exchange, as on May 21, 2009 when Wheat Contracts were re-launched on the Exchange
platform, offered contracts in 59 commodities - comprising 39 agricultural commodities, 5 base
metals, 6 precious metals, 4 energy, 3 polymers, 1 ferrous metal, and CER. The top 5 commodities, in
terms of volume traded at the Exchange, were Rape/Mustard Seed, Gaur Seed, Soyabean Seeds,
Turmeric and Jeera.
6. The Growth

The growth paradigm of India’s commodity markets is best reflected by the figures from the
regulator’s official website, which indicated that the total value of trade on the commodity futures
market in the financial year 2008/09 was INR52.49 lakh crore (over US$1 trillion) as against
INR40.66 lakh crore in the preceding year, registering a growth of 29.09%, even under challenging
economic conditions globally. The main drivers of this impressive growth in commodity futures were
the national
commodity exchanges. MCX, NCDEX and NMCE along with two regional exchanges – NBOT
Indore and ACE, Ahmedabad – contributed to 99.61% of the total value of commodities traded during
2008/09.
7 Unresolved Issues and Future Prospects

Even though the commodity derivatives market has made good progress in the last few years, the real
issues facing the future of the market have not been resolved. Agreed, the number of commodities
allowed for derivative trading have increased, the volume and the value of business has zoomed, but
the objectives of setting up commodity derivative exchanges may not be achieved and the growth
rates witnessed may not be sustainable unless these real issues are sorted out as soon as possible.
Some of the main unresolved issues are discussed below.

(i) Cash Versus Physical Settlement: It is probably due to the inefficiencies in the present
warehousing system that only about 1% to 5% of the total commodity derivatives trade in
the country are settled in physical delivery. Therefore the warehousing problem obviously
has to be handled on a war footing, as a good delivery system is the backbone of any
commodity trade. A International Research Journal of Finance and Economics - Issue 2
(2006) 161 particularly difficult problem in cash settlement of commodity derivative
contracts is that at present, under the Forward Contracts (Regulation) Act 1952, cash
settlement of outstanding contracts at maturity is not allowed. In other words, all
outstanding contracts at maturity should be settled in physical delivery. To avoid this,
participants square off their positions before maturity. So, in practice, most contracts are
settled in cash but before maturity. There is a need to modify the law to bring it closer to
the widespread practice and save the participants fromunnecessary hassles.

(ii) The Regulator: As the market activity pick-up and the volumes rise, the market will
definitelyneed a strong and independent regular, similar to the Securities and Exchange
Board of India (SEBI) that regulates the securities markets. Unlike SEBI which is an
independent body, the Forwards Markets Commission (FMC) is under the Department of
Consumer Affairs (Ministry of Consumer Affairs, Food and Public Distribution) and
depends on it for funds. It is imperative that the Government should grant more powers to
the FMC to ensure an orderly development of the commodity markets. The SEBI and
FMC also need to work closely with each other due to the inter-relationship between the
two markets.

(iii) Lack of Economy of Scale: There are too many (3 national level and 21 regional)
commodity exchanges. Though over 80 commodities are allowed for derivatives trading,
in practice derivatives are popular for only a few commodities. Again, most of the trade
takes place only on a few exchanges. All this splits volumes and makes some exchanges
unviable. This problem can possibly be addressed by consolidating some exchanges.
Also, the question of convergence of securities and commodities derivatives markets has
been debated for a long time now. The Government of India has announced its intention
to integrate the two markets. It is felt that convergence of these derivative markets would
bring in economies of scale and scope without having to duplicate the efforts, thereby
giving a boost to the growth of commodity derivatives market. It would also help in
resolving some of the issues concerning regulation of the derivative markets. However,
this would necessitate complete coordination among various regulating authorities such as
Reserve Bank of India, Forward Markets commission, the Securities and Exchange Board
of India, and the Department of Company affairs etc.

(iv) Tax and Legal bottlenecks: There are at present restrictions on the movement of certain
goods from one state to another. These need to be removed so that a truly national market
could develop for commodities and derivatives. Also, regulatory changes are required to
bring about uniformity in octroi and sales taxes etc. VAT has been introduced in the
country in 2005, but has not yet been uniformly implemented by all states.
8. Conclusion

The trade in global commodity market is worth US $600 billion; India should put in place world
standard trading exchanges to tap this huge global commodities market while protecting the interests
of the domestic farmers from sharp price fluctuations. For achieving this goal, we have to equip
ourselves with the appropriate markets instruments and institutions by building a commodity trading
exchange of global standards, India has an opportunity to chase a US$ 600 billion market opportunity,
this would have to be done through connecting village mandis and the urban markets through
commodity exchanges.
Amidst the turmoil of a risky market, stiff competition and many introduction failures, the commodity
derivatives industry needs a conceptual model that incorporates all aspects relevant to the success and
failure of commodity derivatives. In order to meet this need, a new and integrative approach towards
commodity derivatives management is needed, which makes it easier to gain insight into the viability
of new commodity derivatives before introduction, to assess and improve the viability of existing
commodity derivatives
At a time when India is fast catching up with the world’s leading manufacturing centers and being
home to back office work of the leading global companies, new multi commodity exchanges, using
latest technologies, can help accelerate the process and also help financial markets to allocate finance
to right sectors. It’s a right step in the direction of integration with the global commodity markets.
India being a developing country where majority of population is still dependent on the agriculture,
modern commodities exchanges can be used as tool to improve the life of such people, by making
commodities market more efficient.
Instability of commodity prices has always been a major concern of the producers, processors, traders
as well as the consumers in agriculture -dominated country like India. Commodity exchanges provide
a mechanism to lock-in prices, thus insulating the participants from the adverse price risk.
Commodity market helps the farmer by signaling him the price that is expected to prevail in future, so
he can decide which crop to grow, thus making his expectations aligned with the market. Farmers can
also cover their risk by locking in the price by selling their crop in futures market (selling futures).
Farmers’ direct exposure to price fluctuations, for instance, makes it too risky for many farmers to
invest in otherwise profitable activities. There are various ways to cop with this problem. Apart from
increasing the stability of the market, various actors in the farm sector can better manage their
activities in an environment of unstable prices through commodity exchanges.
It must be ensured that this system (futures) actually benefits the farmers, and not just traders. For
this, central and state government agencies have to take necessary steps, including rapid expansion of
rural warehousing facilities.
Modern commodities market namely MCX, NCME, NCDEX use latest technology in their
operations, they are transparent, demutualised, and investor friendly. All these attributes, help them in
attracting retail investors and farmers thereby increasing the depth in the market and making it more
efficient. But there are problems as there are 22 exchanges which trade in only a few commodities.
Despite the different systems of exchanges, the combined volumes of trading of all exchanges are
marginal compared to production levels. These exchanges are not transparent in their operations,
limited and closed in nature of membership. All the measures to reform them have been met with stiff
resistance from these exchanges and only one or two have agreed to reform themselves.
Also the derivatives trading in the securities market means most of its infrastructure and skills can be
used by the commodity derivatives market and they can work together. There is also a proposal to use
regional stock exchanges for trading in commodity derivatives.
In the end all one can say is that there is huge potential in commodity derivatives market, if are able to
tap this potential, this would change the lives of our farmers and provide new investment
opportunities to the investors in the country.
All this would require a concentrated effort on the part of central and state governments and the
trading community. Rules and regulations must be harmonized across different states and trading
community should be encouraged to adopt modern trading practices.
9. Bibliography

Financial Risk Management, John Hull, 2008 ed


http://nseindia.com
http://mcxindia.com
http://religare.com
http://ncdex.com
http://eurojournal.com