The Role of Futures Trading and Commodity Exchanges in India FOCUS – IT IN AGRIBUSINESS FICCI - FOOD 360 TajKrishna, Hyderabad 6 Nov 2012
Agenda • Importance of Commodity Exchanges • History of Futures Trading in India • Regulatory Structure • Role of Futures Market • Technology Behind Working of Exchanges • How Commodity Futures Work • Furthering the Objectives • Challenges and Way Forward • About NCDEX
Economic Importance Commodity Exchanges • Commodity prices fluctuate due to changes in supply and demand • Firms/People involved in production, processing, manufacturing and trading of commodities are therefore exposed to price fluctuation risks • Low margins in competitive business can be wiped out due to such price movements, and therefore need a mechanism to protect margins
Risks faced by an Enterprise Foreign exchange risk Interest rate risk • Commodity price risk includes: • Increase in input cost vis-à-vis commitment on sales price • Change in value of inventory • Counterparty risk translating into commodity price risk Commodity price risk Credit risk Operational risk
Market/Price Uncertainty faced by Farmers Should I sell soon after harvest or wait for better price? Will prices in future be high enough to cover my cost of carry? What will be the price at the time of harvest?? What will be the prices in different markets? Should I plan a crop on the basis of its last season’s price??
Need for Derivatives • Online format enables wider participation of value chain participants and leads to better price discovery • Large number of anonymous participants prevents price distortion by individual/group of individuals • Demat/electronic trading does not entail difficulties of physical trade • Price risk gets transferred from hedgers (farmers/ value chain participants) to speculators • Positions can be entered and exited within the day
Global History of Futures Trading • Trading in rice tickets - - Japan - early 17th century • Forward markets - London - end of the 17th century • Forward markets -US, Canada, Japan and Egypt –18th century • Chicago Board of Trade – 1848; trading in futures type contracts in 1865 • New York Board of Cotton - 1870 • Chicago Mercantile Exchange- set up -1919 • Options traded on exchange- US - 1973
Structure of Indian Commodity Futures Exchanges FMC Commodity Exchanges National Exchanges Regional Exchanges NCDEX NMCE MCX ICEX ACE 16Regional Exchanges
Regulatory Structure – Agri Spot & Futures State Governments Ministry of Consumer Affairs, Food and Public Distribution Forward Markets Commission (FMC) Spot Market/APMC Futures Market/ Commodity Exchanges Unlike Forex and Stock Markets, Spot Markets in Commodities are not under the same Regulator who regulates forward contracts
Role of Futures Market Futures are the efficient market mechanisms for price discovery
Use of Technology in Exchanges Use of technology is imperative in present day commodity exchanges since: • Price quotes should reach all members and clients across the country in real-time • Price dissemination has to be real-time or with a difference of a few seconds • Surveillance has to be real-time and trade-wise • Positions of a very large number of clients and members has to be observed on a continuous basis • Clearing and settlement is on a daily basis • Tracking of exchange deposits, demat goods, validity and expiry of various commodities at various centers
Trading System • Automated trading mechanism • No physical interaction between buyers and sellers • Nation-wide reach and equal access • Order matching on “Price-Time” priority • Price Priority – The order having the best price gets priority • Time Priority – If two orders have same price, the order which entered the trading system first gets higher priority • Time stamping for each order and trade • Complete audit trail
Clearing & Settlement • Clearing and settlement on a daily basis • Daily Settlement Price (DSP) • Mark-to-market profit/loss • Final settlement at the expiry of contract • Final Settlement Price (FSP) • Convergence of Spot and Futures Prices • Physical Deliveries • Major deterrent to price manipulation • Threat of deliveries ensures right price discovery The above processes are possible only with application of IT at each and every step
Maize – Spot & Near Month Price Correlation 80% correlation between Spot and Near Month Futures Prices – An Indication of Price Discovery Efficiency
Ref. Soya Oil – Spot & Near Month Price Correlation >95% correlation between Spot and Near Month Futures Prices – An Indication of Price Discovery Efficiency
Hedging • Hedging is a strategy used in futures markets to manage price risk • Hedging is a loss minimizing strategy • It is not a profit making tool, but a tool to safeguard profit • Hedging is not just about futures market and trading in futures contract • It’s about integration of spot transaction with futures transaction to fix the returns
Arbitrage • In simple words, it means buying commodities where prices are lower and selling where prices are higher • Arbitrage can be Spot-to-Futures or Futures-to-Futures • Helps to remove inefficiencies in prices between different markets in time and space • Directly impacts physical deliveries on the Exchange system
Current Spot Market Structure in India • Over 28090 Spot markets (7557 regulated) • Opaque price discovery • Subjective grading • Long value chain – several intermediaries • Asymmetric market and price information • Buy/sell decision influenced by geography and individuals. • Spot markets under State Govt. and Derivatives under Union Govt.
NCDEX Spot Exchange – New Paradigm in Agri Marketing • NCDEX Spot Exchange Ltd. (NSPOT) is a professionally managed online commodity spot exchange established on October 18, 2006 (Wholly owned subsidiary of NCDEX) • NSPOT provides transparent, online Spot market pan-India basis • We partner with local and government agencies, leveraging their strengths and offering e-trading platform
Purpose of NSPOT (Electronic spot market) • To reduce intermediaries by linking producer with the end consumer • Mandi Modernization project (MMP) • Use of ICT • Grading and certification for different commodities • Pan India Buyer participation-Better price realization • Enhance efficiencies of existing value chain of commodities by: • Financing of commodities based on credible warehouse management arrangements – E–Pledge
Initiatives of NCDEX to Promote Futures Trading • NCDEX has taken up following steps to promote futures trading among various stakeholders: • Price Dissemination – Installation of price ticker boards at APMCs, jointly with FMC • Awareness programs and workshops for investors, hedgers and the broking community • Working with farmer societies, co-operatives, SHGs and NGOs for farmer aggregation • Generating awareness among students, investors, govt. officials about benefits of futures trading • Fundamental reports generated regularly (daily, weekly, monthly); reports on monsoon, economic indicators etc.
Challenges • Large variety of grades and quality in the same commodity • Farmers may not have sufficient quantities to hedge (10 MT) • Awareness about Exchange rules and regulations – MTM, penalty clauses etc. • Awareness about associated risks • Lack of sufficient market information (supply-demand) • Farmers largely prefer delivery based trade, which is possible only after integration of spot and futures
Way Forward • Aggregation at farmer level (Producer organisations, Co-ops, NGOs) • Conducive policy for development of agri-commodity futures • WDRA expected to make commodity funding in warehouses easier • Uniform tax and duty structure for commodities across the country • Amendments of state APMC Acts
To Conclude • The full potential of commodity derivatives as risk management products is yet to be tapped • Besides greater awareness what is needed is greater proliferation of aggregators who can bring economies of scale • Way ahead is exciting!
About NCDEX • The Exchange started trading in 2003 • Initial promoters include ICICI Bank, LIC, NABARD and NSE • Active trading in 32 commodities • More than 100,000 MT delivered every month • Accredited warehouse space of nearly 13 lakh MT • Nearly 850 members and 25000 terminals across the country • Leading exchange in India for agricultural commodities • NCDEX prices are the international benchmark for certain commodities NCDEX focuses on price discovery of commodities in India
THANK YOUMr. AleenMukherjeeExec. Vice President, NCDEXaleen.firstname.lastname@example.org