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Date:18/08/2010 URL:
http://www.thehindubusinessline.com/2010/08/18/stories/2010081850650900.htm

Back Commodity futures: Breaking barriers

SURESH P. IYENGAR

MICROSCAN

The commodity futures market has been growing at a fast clip, and looks set to deepen if the
regulatory constraints are eased.

Regulatory constraints are preventing exchanges from fully contributing to growth.

The domestic commodity futures trading seems to have come out unscathed from the
economic turbulence that shook major markets across the globe.

The turnover on the 22 Indian commodity exchanges recorded a 48 per cent rise at Rs
77,64,754 crore last fiscal against Rs 52,48,956 crore logged during 2008-09. In the April-
June quarter of this fiscal it was up 57 per cent at Rs 24,55,987 crore (Rs 15, 64,115 crore).

The four online exchanges — MCX, NCDEX, NMCE and ICEX — account for a lion's
share of the total turnover.

Cumulatively, the value of trade in agricultural commodities last fiscal grew 94 per cent to
Rs 12,17,949 crore, despite the Government banning futures trading in sugar, rice, urad and
tur.

Bullion registered a modest growth of six per cent to Rs 31,64,152 crore, largely due to a
higher base.

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The 15 actively traded commodities such as spices, pulses, mentha and guarseed averaged
Rs 6,000 crore on a daily basis in the spot market.

Commodity futures trading in the country is still at a nascent stage as the market is only
about three times the consumption capacity. Globally, the futures market in commodities is
30-40 times the size of the underlying physical commodity trade.

Though a major part of the turnover spiral can be attributed to the spike in metal, energy and
agriculture commodity prices, the growth has been fascinating given that the better half of
the trading community, including institutional investors and banks, are not allowed to
directly trade.

FINANCING

A major portion of the funding to trade on the commodity exchanges, however, happens
through banks and non-banking financial companies (NBFCs), banks lending against
warehouse receipts and demat credits.

When a seller deposits goods on the accredited warehouse of an exchange, they are
dematerialised and credits are issued to his demat account. Based on the demat credit,
broking firms arrange finance for the seller from banks and NBFCs.

Leading broking firms such as Geojit Comtrade and Karvy Comtrade also fund their
customers through their NBFC subsidiary.

Mr Sushil Sinha, Head, Karvy Comtrade, points out that sellers can raise up to 50 per cent of
the total value of their demat credit after depositing their goods in the warehouse. The
lending period can extend up to a month with interest rate varying between 14 and 18 per
cent. In case of default, the loan can be recovered by auctioning the goods.

For buyers, funds cannot be channelled from banks and NBFCs unless they own any
tangible commodity asset to pledge. For speculators, their equity holding is a collateral for
raising money.

RBI's stance

The RBI, in its annual report for 2008-09, states that the prices of agricultural commodities
in India, after the introduction of futures, need to be seen in relation to a range of factors that
affect such prices — domestic production, buffer stock levels, Government intervention in
food markets through procurement policies and minimum support prices, agricultural
commodities' exports, international food prices scenario, and domestic supply and demand
dynamics .

According to the RBI, the market regulator, the Forward Markets Commission, has also
been monitoring the futures prices of sensitive commodities. To curb volatility and
speculation in prices in the futures market, margin requirements were imposed on sensitive
commodities.

Hurdles

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Commodity exchanges have managed to overcome policy hurdles with new companies
starting to use the platform for hedging and price-risk management. Of late, the civil
aviation sector is beginning to show keen interest in hedging its fuel price risk.

The energy portfolio on the futures platform includes ATF, crude, gasoline, heating oil,
imported thermal coal and natural gas. However, lack of liquidity has been a major concern
here.

Mr Lamon Rutten, Managing Director and CEO, MCX, says regulatory constraints are
preventing exchanges from fully contributing to growth of the nation.

For example, India has not yet seen the reduction of storage cost that would result if
investment funds and banks were permitted to take up hedged positions in metal stocks.

“And, we are just at the beginning of the process of linking spot trading, warehousing,
commodity finance and futures trading,” he said.

FCRA AMENDMENT

The Bill to amend the Forward Contract (Regulation) Act, 1952 has been pending in
Parliament for five years. The Bill was formulated to empower the commodity regulator, the
Forward Market Commission (FMC), to operate as an independent regulator like SEBI.

As of now, FMC remains a statutory body set up under the Forward Contracts (Regulation)
Act, under the Ministry of Consumer Affairs, Food and Public Distribution. The Bill could
also pave the way for introduction of new products such as Options and encourage corporate
houses, banks and institutional investors to get in.

With the Government concern over high inflation persisting, it is unlikely that the Bill will
be cleared anytime soon. The Opposition parties have been blaming the online futures
trading for the spike in agriculture commodity prices.

The blame game continues despite the Prof. Abhijit Sen Committee of 2008 noting that there
was no clear evidence of futures trading in agriculture commodities having either reduced or
increased the volatility of spot prices. Furthermore, the Committee recommended wider
participation of farmers in the futures market, expediting reforms in agricultural marketing
and designing appropriate contracts to serve the objective of risk management. “It makes no
sense to have such a large commodity futures market, without giving the regulator the tools
and powers that it needs, which can happen only when FMC becomes an autonomous body,”
says Mr Rutten, , who has also served as Chief of Finance, Risk Management, and
Information in the Commodities Branch of UNCTAD.

While charges and counter-charges for and against the futures trading continue as a matter of
routine, the futures market looks all set to deepen and reach more corporate-hedgers.

Related Stories:
Farm futures
Impact of futures

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