Challenges To Commodity Markets In

India

Definition

Commodity – As Asset Class

Commodity – Uniqueness

Classification of Commodities

Indian Commodity Market Size

Performance of Indian Commodity Market

History of commodity 2

Interventions by Govt.

FC(R) A ,1952

Evolution of FMC

Kabra committee report

Challenges faced by commodity markets presently

Legal Challenges

Regulatory challenges

Infrastructural challenges

Awareness amongst investors and farmers

Other Challenges

Suggested measures for smooth operations of commodity markets

Index

1

Commodities – in Real LifeWheat in your bread

Petrol in your vehicle

Coffee on your table

Sugar in your sweets

Chana in your chhole

Gold in your necklace

……… and so on …….

Commodities are everywhere

2

Characteristics Commodity is anything movable (a good) that has

following characteristics Fungible, i.e. the same no matter who produces it Derivatives, i.e. involves further processing into number

of products Economic cost, i.e. production of it involves some cost

A commodity is any good or service produced by human labour and offered as a product for general sale on the market - Karl Max

3

In financial parlance, assets are economic resources that is capable of being owned or controlled to produce value

Commodity too has gained importance currently as independent asset class

Commodity, being the natural goods are independent of other asset classes

Assets Classes

Equities : Performer during economic expansion & an out performer over very long term…

Fixed Income : Performs at the later stage of recession…

Real Estate : Performs during early expansion…

Commodities : Performance spread evenly over the economic cycle…

Commodity – As Asset Class

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1. Seasonality A major force in the commodities markets

2. Correlation Unlike other asset class, commodities

are positively and negatively correlated within & outside the group which is

unique to commodities only

3. Weather No other asset class are so much influenced by weather patterns

4. Hedge Provides natural hedge against war, inflation, other asset portfolios, recession etc. example -GOLD

Commodity – Unique points of diversification

5

Commodity – PerformanceCommodity – PerformanceReturns Over Different Asset Classes in 4 Yrs.

69.5173.72 75.95

88.46

31.55

-1.44-10

0

10

20

30

40

50

60

70

80

90

100

SENSEX NIFTY CNX 500 NCDEXAGRI INDEX

INR MCXMETALINDEXSource:Bloomberg,Way2Wealth Research

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Commodity – Performance

Various Asset Classes Performance

60

80

100

120

140

160

180

200

220

240

260

Oct-05 May-06 Dec-06 Jul-07 Feb-08 Sep-08 Apr-09 Nov-09

NCDEX Ag Index Nifty USDINR MCX Metal Index

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Contribution in global landscape

Indian Share in Global Commodity Market

91%

9%

Global India

Global Vs. India

Global commodity has relatively long history Size is 9 times larger than India

India

Commodity futures, though active since 19th century was banned later in 1970’s

Commodity volumes shoots up significantly after re-launch in 2003

MCX emerged as world’s Sixth largest exchange

Volumes on Indian exchanges are increasing at CAGR of 73.7 percent

2009 2008Global 14831317 11712611India 1469673 1067984

Commodity Trading ( Value in Million USD)

8

Classification of Commodities

9

Commodity – Indian Structure

20 Other Regional ExchangesNMCE

Commodity Exchanges

MCX

National Exchanges Regional Exchanges

FMC – The Regulator

NBOTNCDEX

Leadership position with >90% share

10

Indian Growth so far

0

100

200

300

400

500

600

700

2004 2005 2006 2007 2008 2009 2010MCX NCDEX TOTAL

Source:FMC,Way2Wealth Research

2004-05 2005-06 2006-07 2007-08 2008-09 2009-10Bullion and other metals 31.5 36.1 57.9 64.6 56.7 40.8Other than bullion metals

- - - -- 23.2

Agriculture 68.2 55.3 35.8 23.1 11.9 15.7Energy 0.3 8.4 6.3 12.3

-20.3

Others 0.0 0.1 0.0 0.0 31.4 0.0Source:FMC,Way2Wealth Research

Segment wise % Share of Commodities

* 2008-09 other segment includes energy& other metals

Significant rise in volume since launch of exchanges in 2003

MCX Leader in Metals & Energy

NCDEX Leader in Agri

> 65% CAGR Growth

Volume Growth in Indian Exchanges

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Indian Growth during 2004-09

India Commodity Wise Market Share in 2004

17%

15%

1%0%67%

0%

Gold Silver Crdue oil Copper Total agri Others

India Commodity Wise Market Share in 2009

31%

15%20%

13%

12%

9%

Gold Silver Crdue oil Copper Total agri Others

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Returns in Indian commoditiesReturns Across Various Commodities in 5 Yrs.

92.8662.54

3.83

-12.36-45.21

9.25

87.12

22.25 4.96 9.6551.16

142.80

94.21

485.86

23.60

-100

0

100

200

300

400

500

600G

old

Silv

er

Cru

de o

il

Copper

Zin

c

Alu

min

ium

Lead

Guar

Seed

Guar

Gum

Soy O

il

Soybean

Pepper

Jeera

Turm

eric

Menth

a O

il

Source:Bloomberg,Way2Wealth Research

Almost 45 commodities are available for trading in both NCDEX & MCX Though few have been de-listed during high inflation times, re-listing also has happened Bullion, Base metals, energy & Agri are the major contributors in terms of volumes

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History of commodity trading in India

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1875- Establishment of Bombay Cotton Trade Association

1893- Establishment of Bombay Cotton Exchange Ltd.

1912-Future trading in raw jute and jute goods began in Calcutta1913-Wheat markets in Hapur began functioning1919-Calcutta Hessian Exchange

1926- Seed Traders Association Ltd started in Bombay1927- East Indian Jute Association

Amalgamation of Calcutta Hessian Exchange and East Indian Jute Association

1936- Commodity Exchange Act was passed

1939-Ban on markets due to WWII1964- Futures trading in raw jute suspended

1974- Amendment in Commodity Exchange Act

2003- Reintroducing future trading by government

2008- Ban on four commodities

The Timeline of commodity Trading in India

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The criteria to assess the success or failure of any government intervention:-

Objective of interventionAlternative tools available for achieving the objectivesSuccess of the intervention in achieving the objectiveCost (risks, unintended side effects) of intervention

Intervention by Government

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Development was constrained Ban on cotton, food grains, spices and sugar Wagons only used for military transport as a

result it caused shortages in essential commodities

Rampant hoarding Futures trading was halted Food grains, jute and oilseeds were banned

under Defence of India rules.

The onset of WWII and growing intervention by Govt

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Enables the authority to take appropriate actions that may be considered desirable.

The act prohibits option trading in all commodities.

Empowers the govt to ban forward contracts in a particular contracts in a particular commodity by a notification.

Non-transferable specific delivery contracts are ordinarily exempted from regulation.

Empowers the central govt to call for periodical returns,annual returns of any other information.

Provides penalties against persons who contravene the provisions of the act and the qualifications thereof.

Provides for the regulation of the Forwards markets through the governing bodies of recognized associations.

Empowers the central government to supersede the governing body of recognized associations and the order it to suspect its business.

Empowers the central government to appoint not more than four members on the governing bodies who may act against public interest in the form of FMC.

Forwards Contracts (Regulation) Act, 1952

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The parliament passed Forward Contracts (Regulation) Act,1952

The Act envisages 3-tier regulationo The exchange which organizes forward trading in commodities can

regulate trading on a day-to-day basis.o The Forward Market Commission provides regulatory oversight under

the powers delegated to it by the central government ando The central government, Department of consumer affairs, Food and

Public distribution is the ultimate regulatory authority.

In 1960's following 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.

Evolution of Forward Market Commission after Independence

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Government set up a committee in 1993 to examine the role of future trading.

The Kabra committee recommended allowing futures trading in 17 commodities groups

The committee recommended certain amendments to forward contracts (Regulations) Act 1952, particularly allowing option trading in goods and registration of brokers with FMC.

Policy Shift- Kabra Committee

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The government accepted most of these recommendations and futures trading was permitted in all recommended commodities

Derivatives do perform a role in risk management led the government to change its stance.

Liberalization facilitates market forces to act freely

The next decade is being touted as the decade of commodities

After Effects of Kabra Committee

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Potential market growth loss due to regulatory uncertainty

Loss of turnover for brokerage houses and hedgers

Absence of information future price for govt to plan procurement

price volatility

Consequences

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Transforms the role of FMC to an independent regulator (similar to SEBI). Allows trading in all commodity derivatives and also options on goods and

commodity derivatives. Makes a provision for corporatisation and demutualisation of all recognised

associations to be approved by the FMC. At present ready delivery contracts need to be delivered and paid for immediately or

within 11 days. The bill extends this period to 30 days. The number of members of the FMC has been increased from 4 to 9 including one

chairman and 3 whole time members. the bill vests powers in the FMC to impose penalties in cases of failure to furnish

information or comply with the directions of the commissions indulging in insider trading or fraudulent and unfair trade practices and in case of contravention of the provisions of the FCRA 1952.

The bill makes a provision for the transfer of duties and functions presently performed by a clearing house to a clearing corporation.

The Central Government would have the power to issue direction to the FMC on matters of policy and to supersede it in certain cases.

Forward Contracts (Regulation) Act Amendments

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Legal challengesRegulatory challengesInfrastructural challengesAwareness among investors and producersOther challenges regarding trading

Challenges faced by commodity markets presently

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Amendment in FCRA Amendment in Banking regulations actEssential commodities act

Legal Challenges

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Inadequate regulation by FMCAnalyzing the adequacy of powers of FMCDeficiencies in the existing pattern

• Organizational• Functional• Operational

Regulatory challenges

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The FMC needs to operate under a regulatory framework that enables it to:

Protect market integrity. To preserve the economic functions of the

commodity markets to shift commercial price risk and aid in price discovery.

Ensure market fairness. Ensure financial safety and soundness by

guarding against systemic risk.

Forward Market Commission

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Warehousing and standardization facilities Physical deliveries need back up Cah versus physical settlement Clearing house Modern trading rings

Infrastructural challenges

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Lack of awareness among investors and farmers lead to losses to them for which seminars and mock trading sessions should be arranged

Awareness Among Investors and Producers

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Size of contracts too big for small traders and producers

Mutual funds and FIIs should be allowed to trade on exchanges

Farmers not beneficiaries in price riseLack of economies of scaleIndoctrination is ineffectiveIssues on warehouse receipts

Other Challenges Regarding Trading

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Commodity exchanges and brokerage houses should be hosting seminar on commodity market awareness.

Conducting mock trading, to providing commodity-specific training on the functioning of the exchange.

Commodity market education should be provided through other media such as educational CDs and cartoon books in order to reach out to more people.

Size of contracts should be split. Introduction of modern warehouse and clearing house

infrastructure. Giving the FMC the status and power similar to SEBI by

passing the FC (R) A Amendment bill.

Suggested Measures for Smooth Operations of Commodity Markets

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