Commodity Market

Study Material on Commodity Market

Compiled by: Prof. Anil Suvarna

Anil Suvarna 1

Commodity Market

Syllabus

No.

Contents

Section 1: Introduction to Derivatives 1.1 Derivatives defined 1.2 Products, participants and functions 1.3 Derivatives markets Section 2: Instruments available for trading 2.1 Forward contracts 2.2 Introduction to futures 2.3 Introduction to options Section 3: Indian History in Commodities 3.1 3.2 3.3 Its Evolution in India T e !a"ra committee report #eadin$ commodit% markets of India& '(), *(DE), *'(E

Section 4: Commodity Market: Theoretical s!ects +.1 'a,or (ommodit% E-c an$e +.2 .e$ulation of commodit% markets +.3 /tructure of (ommodit% 'arket +.+ Deliver% Process +.0 1 % c oose (ommodities over E2uities3 Section ": Commodity Market: #ractical s!ects 0.1 Pricin$ commodit% futures& T e cost of carr% model 0.2 (ommodities 'arkets 4verall Perspective 0.3 .e$ulator% framework 0.+ Product *otes on 5$ro and 'etal (ommodities Section $: #ractical Session

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Commodity Market

Introduction to Derivatives
The origin of derivatives can be traced back to the need of farmers to protect themselves against fluctuations in the price of their crop. From the time it was sown to the time it was ready for harvest farmers would face price uncertainty. Through the use of simple derivative products it was possible for the farmer to partially or fully transfer price risks by locking. in asset prices. These were simple contracts developed to meet the needs of farmers and were basically a means of reducing risk. ! farmer who sowed his crop in "une faced uncertainty over the price he would receive for his harvest in September. #n years of scarcity he would probably obtain attractive prices. $owever during times of oversupply he would have to dispose off his harvest at a very low price. Clearly this meant that the farmer and his family were e%posed to a high risk of price uncertainty. &n the other hand a merchant with an ongoing re'uirement of grains too would face a price risk - that of having to pay e%orbitant prices during dearth although favorable prices could be obtained during periods of oversupply. (nder such circumstances it clearly made sense for the farmer and the merchant to come together and enter into a contract whereby the price of the grain to be delivered in September could be decided earlier. )hat they would then negotiate happened to be a futures. type contract which would enable both parties to eliminate the price risk. #n *+,+ the Chicago -oard of Trade or C-&T was established to bring farmers and merchants together. ! group of traders got together and created the .to.arrive/ contract that permitted farmers to lock in to price upfront and deliver the grain later. These to-arrive contracts proved useful as a device for hedging and speculation on price changes. These were eventually standardi0ed and in *123 the first futures clearing house came into e%istence. Today derivative contracts e%ist on a variety of commodities such as corn pepper cotton wheat silver etc. -esides commodities derivatives contracts also e%ist on a lot of financial underlying like stocks interest rate e%change rate etc.

Derivatives defined
! derivative is a product whose value is derived from the value of one or more underlying variables or assets in a contractual manner. The underlying asset can be e'uity fore% commodity or any other asset. #n our earlier discussion we saw that wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an e%ample of a derivative. The price of this derivative is driven by the spot price of wheat which is the underlying. in this case.

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Commodity Market The Forwards Contracts 45egulation6 !ct *132 regulates the forward7 futures contracts in commodities all over #ndia. !s per this the Forward Markets Commission 4FMC6 continues to have 8urisdiction over commodity forward7 futures contracts. 9erivatives trading in securities were introduced in 2::*. The term ;security< in the Securities Contracts 45egulation6 !ct *13= 4SC5!6 was amended to include derivative contracts in securities. Conse'uently regulation of derivatives came under the purview of Securities >%change -oard of #ndia 4S>-#6. )e thus have separate regulatory authorities for securities and commodity derivative markets. 9erivatives are securities under the SC5! and hence the trading of derivatives is governed by the regulatory framework under the SC5!. The Securities Contracts 45egulation6 !ct *13= defines ;derivative< as ! security derived from a debt instrument share loan whether secured or unsecured risk instrument or contract for differences or any other form of security. ! contract which derives its value from the prices or inde% of prices of underlying securities.

Products, participants and functions

9erivative contracts are of different types. The most common ones are forwards futures options and swaps. ?articipants who trade in the derivatives market can be classified under the following three broad categories. $edgers Speculators !rbitragers.

Hedgers: The farmer/s e%ample that we discussed about was a case of hedging. $edgers face risk associated with the price of an asset. They use the futures or options markets to reduce or eliminate this risk. Speculators: Speculators are participants who wish to bet on future movements in the price of an asset. Futures and options contracts can give them leverage@ that is by putting in small amounts of money upfront they can take large positions on the market. !s a result of this leveraged speculative position they increase the potential for large gains as well as large losses. Arbitragers: !rbitragers work at making ?rofit by taking advantage of discrepancy between prices of the same product across different markets. #f for e%ample they see the Anil Suvarna 4

Commodity Market futures price of an asset getting out of line with the cash price they would take offsetting positions in the two markets to lock in the ?rofit

Derivatives markets
9erivative markets can broadly be classified as commodity derivative market and financial derivatives markets. !s the name suggest commodity derivatives markets trade contracts for which the underlying asset is a commodity. #t can be an agricultural commodity like wheat soybeans rapeseed cotton etc or precious metals like gold silver etc. Financial derivatives markets trade contracts that have a financial asset or variable as the underlying. The more popular financial derivatives are those which have e'uity interest rates and e%change rates as the underlying. The most commonly used derivatives contracts are forwards futures and options.

Spot versus forward transaction

(sing the e%ample of a forward contract let us try to understand the difference between a spot and derivatives contract. >very transaction has three components trading clearing and settlement. ! buyer and seller come together negotiate and arrive at a price. This is trading. Clearing involves finding out the net outstanding that is e%actly how much of goods and money the two should e%change. For instance ! buys goods worth 5s.*:: from - and sells goods worth 5s.3: to -. &n a net basis ! has to pay 5s.3: to -. Settlement is the actual process of e%changing money and goods. #n a spot transaction the trading clearing and settlement happens instantaneously i.e. .on the spot. Consider this e%ample. &n *st "anuary 2::, !ditya wants to buy some gold. The goldsmith 'uotes 5s.= ::: per *: grams. They agree upon this price and !ditya buys 2: grams of gold. $e pays 5s.*2 ::: takes the gold and leaves. This is a spot transaction. Aow suppose !ditya does not want to buy the gold on the *st "anuary but wants to buy it a month later. The goldsmith 'uotes 5s.= :*3 per *: grams. They agree upon the forward price for 2: grams of gold that !ditya wants to buy and !ditya leaves. ! month later he pays the goldsmith 5s.*2 :B: and collects his gold. This is a forward contract a contract by which two parties irrevocably agree to settle a trade at a future date for a stated price and 'uantity. Ao money changes hands when the contract is signed. The e%change of money and the underlying goods only happens at the future date as specified in the contract. #n a forward contract the process of trading clearing and settlement does not happen instantaneously. The trading happens today but the clearing and settlement happens at the end of the specified period. ! forward is the most basic derivative contract. )e call it a derivative Anil Suvarna 5

Commodity Market because it derives value from the price of the asset underlying the contract in this case gold. #f on the *st of February gold trades for 5s.= :3: in the spot market the contract becomes more valuable to !ditya because it now enables him to buy gold at 5s.= :*3. #f however the price of gold drops down to 5s.3 11: he is worse off because as per the terms of the contract he is bound to pay 5s.= :*3 for the same gold. The contract has now lost value from !ditya/s point of view. Aote that the value of the forward contract to the goldsmith varies e%actly in an opposite manner to its value for !ditya.

Exchange traded versus

!" derivatives

9erivatives have probably been around for as long as people have been trading with one another. Forward contracting dates back at least to the *2th century and may well have been around before then. These contracts were typically &TC kind of contracts. &ver the counter 4&TC6 derivatives are privately negotiated contracts. Merchants entered into contracts with one another for future delivery of specified amount of commodities at specified price. ! 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. Cater many of these contracts were standardi0ed in terms of 'uantity and delivery dates and began to trade on an e%change. The &TC derivatives markets have the following features compared to e%change-traded derivatives: The management of counter-party 4credit6 risk is decentrali0ed and located within individual institutions. There are no formal centrali0ed limits on individual positions leverage or margining. There are no formal rules for risk and burden-Sharing. There are no formal rules or mechanisms for ensuring market stability and integrity and for safeguarding the collective interests of market participants. The &TC contracts are generally not regulated by a regulatory authority and the e%change/s self-regulatory organi0ation although they are affected indirectly by national legal systems banking supervision and market surveillance.

The &TC derivatives markets have witnessed rather sharp growth over the last few years which have accompanied the moderni0ation of commercial and investment banking and globali0ation of financial activities. The recent developments in information technology have contributed to a great e%tent to these developments. )hile both e%change-traded and &TC derivative contracts offer many benefits the former have rigid structures compared to Anil Suvarna 6

Commodity Market the latter. The largest &TC derivative market is the interbank foreign e%change market. Commodity derivatives the world over are typically e%change-traded and not &TC in nature.

Some commonly used derivatives

$ere we define some of the more popularly used derivative contracts. Some of these namely futures and options will be discussed in more details at a later stage. #orwards: !s we discussed a forward contract is an agreement between two entities to buy or sell the underlying asset at a future date at today/s pre-agreed price. #utures: ! futures contract is an agreement between two parties to buy or sell the underlying asset at a future date at today/s future price. Futures contracts differ from forward contracts in the sense that they are standardi0ed and e%change traded. ptions: There are two types of options - calls and puts. Calls give the buyer the right but not the obligation to buy a given 'uantity of the underlying asset at a given price on or before a given future date. ?uts give the buyer the right but not the obligation to sell a given 'uantity of the underlying asset at a given price on or before a given date. $arrants: &ptions generally have lives of upto one year the ma8ority of options traded on options e%changes having a ma%imum maturity of nine months. Conger-dated options are called warrants and are generally traded over-the-counter. %askets: -asket options are options on portfolios of underlying assets. The underlying asset is usually a weighted average of a basket of assets. >'uity inde% options are a form of basket options. Swaps: Swaps are private agreements between two parties to e%change cash Dows in the future according to a prearranged 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 the cash flows in one direction being in a different currency than those in the opposite direction. Anil Suvarna 7

Commodity Market Swaptions: Swaptions are options to buy or sell a swap that will become operative at the e%piry of the options. Thus a swaption is an option on a forward swap.

Instruments available for trading

#n recent years derivatives have become increasingly popular due to their applications for hedging speculation and arbitrage. -efore we study about the applications of commodity derivatives we will have a look at some basic derivative products. )hile futures and options are now actively traded on many e%changes forward contracts are popular on the &TC market.

#orward contracts
! forward contract is an agreement to buy or sell an asset on a specified date for a specified price. &ne of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. &ther contract details like delivery date price and 'uantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the e%changes. The salient features of forward contracts are: Anil Suvarna 8

Commodity Market

They are bilateral contracts and hence e%posed to counter party risk. >ach contract is custom designed and hence is uni'ue in terms of contract si0e e%piration date and The asset type and 'uality. The contract price is generally not available in public domain. &n the e%piration date the contract has to be settled by delivery of the asset. #f the party wishes to reverse the contract it has to compulsorily go to the same counterparty which often results in high prices being charged. $owever forward contracts in certain markets have become much standardi0ed as in the case of foreign e%change thereby reducing transaction costs and increasing transactions volume. This process of standardi0ation reaches its limit in the organi0ed futures market. Forward contracts are very useful in hedging and speculation. The classic hedging application would be that of an e%porter who e%pects to receive payment in dollars three months later. $e is e%posed to the risk of e%change rate fluctuations. -y using the currency forward market to sell dollars forward he can lock on to a rate today and reduce his uncertainty. Similarly an importer who is re'uired to make a payment in dollars two months hence can reduce his e%posure to e%change rate fluctuations by buying dollars forward. #f a speculator has information or analysis which forecasts an upturn in a price then he can go long on the forward market instead of the cash market. The speculator would go long on the forward wait for the price to rise and then take a reversing transaction to book profits. Speculators may well be re'uired to deposit a margin upfront. $owever this is generally a relatively small proportion of the value of the assets underlying the forward contract. The use of forward markets here supplies leverage to the speculator.

&imitations of forward markets

Forward markets world-wide are affected by several problems: Cack of centrali0ation of trading #lli'uidity and Counterparty risk

#n the first two of these the basic problem is that of too much fle%ibility and generality. The forward market is like a real estate market in that any two consenting adults can form

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Commodity Market contracts against each other. This often makes them design terms of the deal which are very convenient in that specific situation but makes the contracts non-tradeable. Counterparty risk arises from the possibility of default by any one party to the transaction. )hen one of the two sides to the transaction declares bankruptcy the other suffers. >ven when forward markets trade standardi0ed contracts and hence avoid the problem of illi'uidity still the counterparty risk remains a very serious issue.

Introduction to futures
Futures markets were designed to solve the problems that e%ist in forward markets. ! 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. -ut unlike forward contracts the futures contracts are standardi0ed and e%change traded. To facilitate li'uidity in the futures contracts the e%change specifies certain standard features of the contract. #t is a standardi0ed contract with standard underlying instrument a standard 'uantity and 'uality of the underlying instrument that can be delivered 4or which can be used for reference purposes in settlement6 and a standard timing of such settlement. ! futures contract may be offset prior to maturity by entering into an e'ual and opposite transaction. More than 11E of futures transactions are offset this way. The standardi0ed items in a futures contract are: Fuantity of the underlying Fuality of the underlying The date and the month of delivery The units of price 'uotation and minimum price change Cocation of settlement

Distinction between futures and forwards contracts

Fundamentally forward and futures contracts have the same function: both types of contracts allow people to buy or sell a specific type of asset at a specific time at a given price. $owever it is in the specific details that these contracts differ. First of all futures contracts are e%change-traded and therefore are standardi0ed contracts. Forward contracts on the other hand are private agreements between two parties and are not as rigid in their stated terms and conditions. -ecause forward contracts are private agreements there is always a Anil Suvarna 10

Commodity Market chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions which drastically lowers the probability of default to almost never. Secondly the specific details concerning settlement and delivery are 'uite distinct. For forward contracts settlement of the contract occurs at the end of the contract. Futures contracts are marked-to-market daily which means that daily changes are settled day by day until the end of the contract. Furthermore settlement for futures contracts can occur over a range of dates. Forward contracts on the other hand only possess one settlement date. Castly because futures contracts are 'uite fre'uently employed speculators who bet on the direction in which an asset/s price will move they are usually closed out prior to maturity and delivery usually never happens. &n the other hand forward contracts are mostly used by hedgers that want to eliminate the volatility of an asset/s price and delivery of the asset or cash settlement will usually take place.

#utures terminology
Spot price: The price at which an asset trades in the spot market. Futures price: The price at which the futures contract trades in the futures market. Contract cycle: The period over which a contract trades. The commodity futures contracts on the AC9>G have one-month two-months and three-month e%piry cycles which e%pire on the 2:th day of the delivery month. Thus a "anuary e%piration contract e%pires on the 2:th of "anuary and a February e%piration contract ceases trading on the 2:th of February. &n the ne%t trading day following the 2:th a new contract having a three-month e%piry is introduced for trading. Expiry date: #t is the date specified in the futures contract. This is the last day on which the contract will be traded at the end of which it will cease to e%ist. elivery unit: The amount of asset that has to be delivered under one contract. For instance the delivery unit for futures on Cong Staple Cotton on the AC9>G is 33 bales. The delivery unit for the Hold futures contract is * kg. !asis: -asis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract. #n a normal market basis will be positive. This reflects that futures prices normally e%ceed spot prices. Cost of carry: The relationship between futures prices and spot prices can be summari0ed in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to Finance the asset less the income earned on the asset. "nitial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin. Anil Suvarna 11

Commodity Market Marking#to#market $M%M&: #n the futures market at the end of each trading day the margin account is ad8usted to reflect the investor/s gain or loss depending upon the futures closing price. Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. #f the balance in the margin account falls below the maintenance margin the investor receives a margin call and is e%pected to top up the margin account to the initial margin level before trading commences on the ne%t day.

Introduction to options
#n this section we look at another interesting derivative contract namely options. &ptions are fundamentally different from forward and futures contracts. !n option gives the holder of the option the right to do something. The holder does not have to e%ercise this right. #n contrast in a forward or futures contract the two parties have committed themselves to doing something. )hereas it costs nothing 4e%cept margin re'uirements6 to enter into a futures contract the purchase of an option re'uires an upfront payment.

ption terminology
Commodity options: Commodity options are options with a commodity as the underlying. For instance a gold options contract would give the holder the right to buy or sell a specified 'uantity of gold at the price specified in the contract. Stock options: Stock options are options on individual stocks. &ptions currently trade on over 3:: stocks in the (nited States. ! contract gives the holder the right to buy or sell shares at the specified price. !uyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to e%ercise his option on the seller7 writer. 'riter of an option: The writer of a call7 put option is the one who receives the option premium and is thereby obliged to sell7 buy the asset if the buyer e%ercises on him. There are two basic types of options call options and put options. Call option: ! call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. Put option: ! put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. (ption price: &ption price is the price which the option buyer pays to the option seller. #t is also referred to as the option premium. Anil Suvarna 12

Commodity Market Expiration date: The date specified in the options contract is known as the e%piration date the e%ercise date the strike date or the maturity. Strike price: The price specified in the options contract is known as the strike price or the e%ercise price.

Different types of

ptions

American options: !merican options are options that can be e%ercised at any time upto the e%piration date. Most e%change-traded options are !merican. European options: >uropean options are options that can be e%ercised only on the e%piration date itself. >uropean options are easier to analy0e than !merican options and properties of an !merican option are fre'uently deduced from those of its >uropean counterpart. "n#t)e#money option: !n in-the-money 4#TM6 option is an option that would lead to a positive cash flow to the holder if it were e%ercised immediately. ! call option on the inde% is said to be in-the-money when strike price 4i.e. spot price I strike price6 #f the inde% is much higher than the strike price the call is said to be #TM. #n the case of a put the put is #TM if the inde% is below the strike price. At#t)e#money option: !n at-the-money 4!TM6 option is an option that would lead to 0ero cash flow if it were e%ercised immediately. !n option on the inde% is at-the-money when the current inde% e'uals the strike price 4i.e. spot price J strike price6. (ut#of#t)e#money option: !n out-of-the-money 4&TM6 option is an option that would lead to a negative cash flow if it were e%ercised immediately. ! call option on the inde% is out-of-the-money when the current inde% stands at a level which is less than the strike price 4i.e. spot price D strike price6. #f the inde% is much lower than the strike price the call is said to be deep &TM. #n the case of a put the put is &TM if the inde% is above the strike price. "ntrinsic value of an option: The option premium can be broken down into two components K intrinsic value and time value. The intrinsic value of a call is the amount the option is #TM if it is #TM. #f the call is &TM its intrinsic value is 0ero. ?utting it another way the intrinsic value of a call is Ma% L: 4St-M6N which means the intrinsic value of a call is the greater of : or 4St-M6.Similarly the intrinsic value of a put is Ma%L: 4M-St6Ni.e. the greater of : or 4M-St6. M is the strike price and St6 O is the spot price. %ime value of an option: The time value of an option is the difference between its premium and its intrinsic value. -oth calls and puts have time value. !n option that is Anil Suvarna 13

Commodity Market &TM or !TM has only time value. (sually the ma%imum time value e%ists when the option is !TM. The longer the time to e%piration the greater is an option/s time value all else e'ual. !t e%piration an option should have no time value.

Indian 'istory in "ommodities

Introduction
#ndia a commodity based economy where twothird of the one billion population depends on agricultural commodities surprisingly has an under developed commodity market. (nlike the physical market futures markets trades in commodity are largely used as risk management 4hedging6 mechanism on either physical commodity itself or open positions in commodity stock. For instance a 8eweler can hedge his inventory against perceived short-term downturn in gold prices by going short in the future markets. The article aims at know how of the commodities market and how the commodities traded on the e%change. The idea is to understand the importance of commodity derivatives and learn about the market from #ndian point of view. #n fact it was one of the most vibrant markets till early P:s. #ts development and growth was shunted due to numerous restrictions earlier. Aow with most of these restrictions being removed there is tremendous potential for growth of this market in the country.

"ommodity
Commodities actually offer immense potential to become a separate asset class for marketsavvy investors arbitrageurs and speculators. 5etail investors who claim to understand the e'uity markets may find commodities an unfathomable market. -ut commodities are easy to understand as far as fundamentals of demand and supply are concerned. 5etail investors should understand the risks and advantages of trading in commodities futures before taking a leap. $istorically pricing in commodities futures has been less volatile compared with e'uity and bonds thus providing an efficient portfolio diversification option.

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Commodity Market #n fact the si0e of the commodities markets in #ndia is also 'uite significant. &f the country/s H9? of 5s *B 2: PB: crore 45s *B 2:P.B billion6 commodities related 4and dependent6 industries constitute about 3+ per cent. Currently the various commodities across the country clock an annual turnover of 5s * ,: ::: crore 45s * ,:: billion6. )ith the introduction of futures trading the si0e of the commodities market grows many folds here on.

It(s Evolution in India -ombay Cotton Trade !ssociation Ctd. set up in *+P3 was the first organi0ed futures market. -ombay Cotton >%change Ctd. was established in *+1B following the widespread discontent amongst leading cotton mill owners and merchants over functioning of -ombay Cotton Trade !ssociation. The Futures trading in oilseeds started in *1:: with the establishment of the Hu8arati Qyapari Mandali which carried on futures trading in groundnut castor seed and cotton. Futures/ trading in wheat was e%istent at several places in ?un8ab and (ttar ?radesh. -ut the most notable futures e%change for wheat was chamber of commerce at $apur set up in *1*B. Futures trading in bullion began in Mumbai in *12:. Calcutta $essian >%change Ctd. was established in *1*1 for futures trading in raw 8ute and 8ute goods. -ut organi0ed futures trading in raw 8ute began only in *12P with the establishment of >ast #ndian "ute !ssociation Ctd. These two associations amalgamated in *1,3 to form the >ast #ndia "ute R $essian Ctd. to conduct organi0ed trading in both 5aw "ute and "ute goods. Forward Contracts 45egulation6 !ct was enacted in *132 and the Forwards Markets Commission 4FMC6 was established in *13B under the Ministry of Consumer !ffairs and ?ublic 9istribution. #n due course several other e%changes were created in the country to trade in diverse commodities.

!he )abra committee report

!fter the introduction of economic reforms since "une *11* and the conse'uent gradual trade and industry liberali0ation in both the domestic and e%ternal sectors the Hovernment of #ndia appointed in "une *11B a committee on Forward Markets under chairmanship of ?rof. M.A. Mabra. The committee was setup with the following ob8ectives: To assess The working of the commodity e%changes and their trading practices in #ndia and to make suitable recommendations with a view to making them compatible with those of other countries Anil Suvarna 15

Commodity Market

The role of the Forward Markets Commission and to make suitable recommendations with a view to making it compatible with similar regulatory agencies in other countries so as to see how effectively these agencies can cope up with the reality of the fast changing economic scenario.

To review the role that forward trading has played in the #ndian commodity markets during the last *: years. To e%amine the e%tent to which forward trading has special role to play in promoting e%ports. To suggest amendments to the Forward Contracts 45egulation6 !ct in the light of the 5ecommendations particularly with a view to effective enforcement of the !ct to check illegal forward trading when such trading is prohibited under the !ct. To suggest measures to ensure that forward trading in the commodities in which it is allowed to be operative remains constructive and helps in maintaining prices within reasonable limits. To assess the role that forward trading can play in marketing7 distribution system in the commodities in which forward trading is possible particularly in commodities in which resumption of forward trading is generally demanded. The committee submitted its report in September *11,. The recommendations of the committee were as follows The Forward Markets Commission 4FMC6 and the Forward Contracts 45egulation6 !ct *132 would need to be strengthened. 9ue to the inade'uate infrastructural facilities such as space and telecommunication facilities the commodities e%changes were not able to function effectively. >nlisting more members ensuring capital ade'uacy norms and encouraging computeri0ation would enable these e%changes to place themselves on a better footing. #n-built devices in commodity e%changes such as the vigilance committee and the panels of surveyors and arbitrators be strengthened further. The FMC which regulates forward7 futures trading in the country should continue to act a watch.dog and continue to monitor the activities and operations of the commodity e%changes. !mendments to the rules regulations and bye-laws of the commodity e%changes should re'uire the approval of the FMC only. #n the conte%t of globali0ation commodity markets in #ndia could not function effectively in an isolated manner. Therefore some of the commodity e%changes

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Commodity Market particularly the ones dealing in pepper and castor seed be upgraded to the level of international futures markets. The ma8ority of the committee recommended that futures trading be introduced in the following commodities: -asmati rice 5aw 8ute 5ice bran oil Cotton and kapas Hroundnut rapeseed7mustard seed Castor oil and its oilcake Cinseed Silver &nions

The liberali0ed policy being followed by the government of #ndia and the gradual withdrawal of the procurement and distribution channel necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management. The national agriculture policy announced in "uly 2::: and the announcements in the budget speech for 2::2-2::B were indicative of the governments resolve to put in place a mechanism of futures trade7market. !s a follow up the government issued notifications on *7:,72::B permitting futures trading in the commodities with the issue of these notifications futures trading is not prohibited in any commodity. !n option trading in commodity is however presently prohibited.

Different types of "ommodities !raded

)orld-over one will find that a market e%its for almost all the commodities known to us. These commodities can be broadly classified into the following: Pulses: Chana (rad R Tur Spices: ?epper 8eera Chilli Turmeric R Cardamom Precious *etals: Hold Silver ?latinum etc ther *etals: Aickel !luminum Copper etc +gro,%ased "ommodities: )heat Corn Cotton &ils &ilseeds. Soft "ommodities: Coffee Cocoa Sugar etc &ive,Stock: Cive Cattle ?ork -ellies etc Energy: Crude &il Aatural Has Hasoline etc thers: Huar Seed )heat Sugar Mentha &il ?otato Mapas Soya >tc.

&eading commodity markets of India

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Commodity Market Conse'uently four commodity e%changes have been approved to commence business in this regard. They are: Multi Commodity >%change 4MCG6 located at Mumbai. Aational Commodity and 9erivatives >%change Ctd 4AC9>G6 located at Mumbai. Aational Multi Commodity >%change 4AMC>6 located at !hmadabad. Aational -oard of Trade 4A-&T6 located at #ndore.

*ulti "ommodity Exchange

*ulti "ommodity Exchange 4*"-6 is an independent commodity e%change based in #ndia. #t was established in 2::B and is based in Mumbai. #t has an average daily turnover of around (SS*.33 billion. MCG offers futures trading in !gricultural Commodities -ullion Ferrous R Aon-ferrous metals ?ulses &ils R &ilseeds >nergy ?lantations Spices and other soft commodities. MCG has also setup in 8oint venture the Aational Spot >%change a purely agricultural commodity e%change and Aational -ulk $andling Corporation 4A-$C6 which provides bulk storage and handling of agricultural products. MCG is an independent and de-mutilated multi commodity e%change. #t was inaugurated on Aovember *: 2::B by Mr. Mukesh !mbani Chairman and Managing 9irector 5eliance #ndustries Ctd.@ and has permanent recognition from the Hovernment of #ndia for facilitating online trading clearing and settlement operations for commodities futures market across the country. Today MCG features amongst the world/s top three bullion e%change and top four energy e%change. MCG offers a wide spectrum of opportunities to a large cross section of participants including producers7 processors traders corporate regional trading centre importers e%porters co-operatives and industry associations amongst others. $ead'uartered in the financial capital of #ndia Mumbai MCG is led by an e%pert management team with deep domain knowledge of the commodities futures market. ?resently the average daily turnover of MCG is around (S9*.33 bn 45s.P ::: crore !pril 2::=6 with a record peak turnover of (S9B.1+ bn 45s.*P 1+P crore6 on !pril 2: 2::=. #n the first calendar 'uarter of 2::= MCG holds more than 33E market share of the total trading volume of all the domestic commodity e%changes. The e%change has also affected large deliveries in domestic commodities signifying the efficiency of price discovery. -eing a nation-wide commodity e%change having state-of-the-art infrastructure offering multiple commodities for trading with wide reach and penetration MCG is well placed to tap the vast potential poised by the commodities market. Anil Suvarna 18

Commodity Market +chievement and #eatures )ith a growing share of P2E MCG continues to be #ndia/s Ao. * commodity e%change Hlobally MCG ranks no. * in silver no. 2 in natural gas no. B in crude oil and gold in futures trading MCG has *: strategic alliances with leading commodity e%change across the globe The average daily turnover of MCG is about (SS 2.:+ billion MCG now reaches out to about 3:: cities in #ndia with the help of about *: ::: trading terminals MCG C&M9>G is #ndia/s first and only composite commodity futures price inde% Cive Trading Since Aovember *: 2::B !verage 9aily Turnover K 5s. +2B2 crores 4Single Sided6 $ighest Single 9ay Turnover - 5s.*P 1+P.=3 Crores Crude &il ?eak 9aily Turnover: +1.B Cac barrels 45s.23,: Cr6 &pen #nterest: Crude oil 4*+ lakh barrels6 Hold 4+ Tons6 Silver 43:: tons6 &perations from 3::O centers with over *:::O members R 3:::O Trading Terminals 4T)S6 Connectivity through QS!T #nternet leased line etc. 5eal-time price R information dissemination through website and info vendors.

Anil Suvarna 19

Commodity Market

!urnover in Different "ommodities Segments

Anil Suvarna 20

Commodity Market

.ational "ommodity and Derivatives Exchange &td

AC9>G is the only commodity e%change in the country promoted by national level institutions. This uni'ue parentage enables it to offer a bou'uet of benefits which are currently in short supply in the commodity markets. The institutional promoters and shareholders of AC9>G are prominent players in their respective fields and bring with them institutional building e%perience trust nationwide reach technology and risk management skills. AC9>G is a public limited company incorporated on !pril 2B 2::B under the Companies !ct *13=. #t obtained its Certificate for Commencement of -usiness on May 1 2::B. #t commenced its operations on 9ecember *3 2::B. AC9>G is a nation-level technology driven de-mutualised on-line commodity e%change with an independent -oard of 9irectors and professional management - both not having any vested interest in commodity markets. #t is committed to provide a world-class commodity e%change platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices professionalism and transparency. AC9>G is regulated by Forward Markets Commission. AC9>G is sub8ected to various laws of the land like the Forward Contracts 45egulation6 !ct Companies !ct Stamp !ct Contract !ct and various other legislations. #t is located in Mumbai and offers facilities to its members about 33: centres throughout #ndia. The reach will gradually be e%panded to more centers.

Anil Suvarna 21

Commodity Market

!urnover in Different "ommodities Segments

Anil Suvarna 22

Commodity Market

.ational *ulti "ommodity Exchange /.*"E0

Aational Multi Commodity >%change of #ndia Ctd. 4AMC>6 was promoted by Central )arehousing Corporation 4C)C6 Aational !gricultural Cooperative Marketing Federation of #ndia 4A!F>96 Hu8arat !gro-#ndustries Corporation Cimited 4H!#CC6 Hu8arat State !gricultural Marketing -oard 4HS!M-6 Aational #nstitute of !gricultural Marketing 4A#!M6 and Aeptune &verseas Cimited 4A&C6. )hile various integral aspects of commodity economy vi0. warehousing cooperatives private and public sector marketing of agricultural commodities research and training were ade'uately addressed in structuring the >%change finance was still a vital missing link. ?un8ab Aational -ank 4?A-6 took e'uity of the >%change to establish that linkage. >ven today AMC> is the only >%change in #ndia to have such investment and technical support from the commodity relevant institutions. AMC> facilitates electronic derivatives trading through robust and tested trading platform 9erivative Trading Settlement System 49TSS6 provided by CMC. #t has robust delivery mechanism making it the most suitable for the participants in the physical commodity markets. #t has also established fair and transparent rule-based procedures and demonstrated total commitment towards eliminating any conflicts of interest. #t is the only Commodity >%change in the world to have received #S& 1::*:2::: certification from -ritish Standard #nstitutions 4-S#6. AMC> was the first commodity e%change to provide trading facility through internet through Qirtual ?rivate Aetwork 4Q?A6. AMC> follows best international risk management practices. The contracts are marked to market on daily basis. The system of upfront margining based on Qalue at 5isk is followed to ensure financial security of the market. #n the event of high volatility in the prices special intra-day clearing and settlement is held. AMC> was the first to initiate process of demateriali0ation and electronic transfer of warehoused commodity stocks. The uni'ue strength of AMC> is its settlements via a 9elivery -acked System an imperative in the commodity trading business. These deliveries are e%ecuted through a sound and reliable )arehouse 5eceipt System leading to guaranteed clearing and settlement.

Anil Suvarna 23

Commodity Market

*arket Share of .ational Exchange in India

Anil Suvarna 24

Commodity Market

*a1or "ommodity Exchange

! commodities exchange is an exc)ange where various commodities and derivatives products are traded. Most commodity markets across the world trade in agricultural products and other ra* materials 4like *)eat barley sugar mai+e cotton cocoa coffee milk products oil metals etc.6 and contracts based on them. These contracts can include spot prices for*ards futures and options on futures. &ther sophisticated products may include interest rates environmental instruments s*aps or ocean freight contracts. #n today/s world of speciali0ation we see that domestic and international commodity e%changes have also grabbed on to the concept of focusing in on an area of e%pertise. The most robust commodity e%changes in the world today and their specialty commodities include: .ew 2ork %oard of !rade /.2% !0 - which includes coffee cocoa cotton orange 8uice and sugar. .ew 2ork *ercantile Exchange /.2*E-0 - which speciali0es in energy products such as crude and heating oil gasoline natural gas coal propane as well as metal such as gold silver platinum copper aluminum and palladium. "hicago %oard of !rade /"% !0 - which speciali0es in bonds and more traditional commodities such as corn 7 mai0e oats rough rice soybeans soybean meal soybean oil and wheat. Anil Suvarna 25

Commodity Market

"hicago *ercantile Exchange /"*E0 - which speciali0es in bond futures and more traditional commodities such as live and feeder cattle lumber beef boneless beef trimmings lean hogs fro0en pork bellies fresh pork bellies milk and butter. &ondon *etal Exchange /&*E0 - which speciali0es in the trading of metals such as copper lead 0inc aluminum tin and nickel. &ondon "ommodity Exchange 3 Euro next - which speciali0es in the trading of commodities such as grains and meat. I"E #utures - the #nternational ?etroleum >%change speciali0es in commodities such as crude and heating oil natural gas and unleaded gasoline Shanghai *etal Exchange /S'*E0 - one of the national level futures e%changes of China was established on 2+ May *112. S$M> is a non-profit self-regulating corporation. The e%change was created for trading in non-ferrous metals and currently contracts for several non-ferrous metals including copper aluminum lead 0inc tin and nickel. )ansas %oard of !rade - Mansas -oard of Trade in (S speciali0es in hard red winter wheat. $ard winter wheat constitutes the ma%imum of (S production. This e%change is benchmark for bread wheat prices. !okyo "ommodity Exchange /! " *0 - Tokyo Commodity >%change 4T&C&M6 is the largest e%change in "apan and second largest commodity e%change in the world for futures and options. Crude oil gasoline kerosene gas oil gold silver aluminium platinum and rubber are the commodities that are actively traded. &ondon International #inancial #utures and ptions Exchange /&I##E0 , Condon #nternational Financial Futures and &ptions >%change 4C#FF>6 also know as >uro ne%t. !mong actively commodities trades are cocoa robusta coffee corn potato rapeseed sugar and wheat. 5obusta coffee prices are determined through this e%change. Dalian "ommodity Exchange - 9alian Commodity >%change in China trades in corn and soybean. The e%change is planning to introduce futures and options in crude oil power steel and plastic. Anil Suvarna 26

Commodity Market

"hicago %oard of !rade /"% !0

This commodity e%change was established in *+,+. #t trades in financial and agricultural contracts. &riginally this e%change only traded agricultural commodities such as corn soybeans and wheat. Aow it offers futures and options contracts on a variety of products including Silver Hold >nergy and (.S. Treasury bonds. More than 3: different options and futures contracts are traded by over B =:: C-&T members through open outcry and eTrading. Qolumes at the e%change in 2::B were a record breaking ,3, million contracts. &n *2 "uly 2::P the C-&T merged with the CM> and ceased to e%ist as an independent entity.

History
4567, C-&T listed the first ever standardi0ed Te%change tradedT forward contracts which were called futures contracts. #n *1*1 the Chicago -utter and >gg -oard a spin-off of the C-&T was reorgani0ed to enable member traders to allow future trading and its name was changed to Chicago Mercantile >%change 4CM>6. 4868, C-&T begins trade in first non-grain product with a Silver futures contract and C-&T started trade in B kilo gold future in *1P,. 489:, Members of the C-&T start Chicago -oard &ptions >%change 4C-&>6 the world/s first stock options e%change. 489;, C-&T launches first interest rate futures contract Hovernment Aational Mortgage !ssociation futures@ sets stage for a huge increase in trading volume a new era of growth and trading instruments for futures e%changes around the world. 4887, C-&T launches ?ro8ect ! its after-hours electronic trading system for futures and futuresoptions. 4889, C-&T launches the C-&T 9ow "ones #ndustrial !verage #nde% U futures and options on futures contracts. C-&T opens the world/s largest trading floor =: ::: s'. ft. for financial futures and futures-options on February *+ *11P. <==9, C-&T and the CM> merged to form the CM> Hroup.

Anil Suvarna 27

Commodity Market

!rading Products
Today the C-&T supports the trading of four product types - agricultural metals interest rates and the 9ow. +gricultural "ommodities !gricultural commodities include items such as corn soybeans 4meal and oil6 ethanol oats wheat and rice. Trading in these products is standardi0ed as to 'uantities and product condition. For e%ample agricultural products are traded in a raw 7 unprocessed state. *etal "ommodities The most common metal commodities are gold and silver - the price of which is stated in dollars per ounce. The most familiar trading 'uantities on the C-&T include:

*:: ounce Hold Futures Mini-si0ed Hold - BB.2 fine troy ounces of gold 3 ::: ounce Silver Futures Mini-si0ed Silver - * ::: troy ounces of silver

Dow #utures 9ow futures include the 9ow "ones !#H Commodity inde% the 9ow "ones #ndustrial !verage Futures and the mini-si0ed 9ow. The strategy of trading in 9ow futures is also called Ttrading the markets.T )ith 9ow futures you are attempting to predict the future direction of the stock market and the 9ow in particular. Interest >ates Finally the last product type offered by the C-&T falls into the category of interest rates. The most common of the interest rate trades includes treasury bonds fed funds and municipal bonds. )hen trading in the interest rate market you are attempting to capitali0e on the long and short term changes in the yield curve. Said another way you/re taking a financial position that interest rates are going to rise or fall in the future. ther "ommodities There are many other commodities that can be traded from tin to coffee beans or stock inde%es to pork bellies.

"hicago *ercantile Exchange 4T!he *ercT6

Chicago Mercantile >%change is an !merican financial e%change based in Chicago. The CM> was founded in *+1+ as the Chicago -utter and >gg -oard. &riginally the e%change was a not-for-profit organi0ation. The e%change demutuali0ed in Aovember 2::: went Anil Suvarna 28

Commodity Market public in 9ecember 2::2 and merged with the Chicago -oard of Trade in "uly 2::P. The Chief >%ecutive &fficer of the Merc is Craig S. 9onohue. !nother one of the ma8or e%changes is in Chicago as well. This one popularly known as CM> has been in business for over a hundred years. The main commodities traded here are live and feeder cattle hogs pork bellies lumber milk butter and fertili0er. Aow it serves as a marketplace for stock inde% interest rate foreign e%change and single-stock futures. &ne of the fairly uni'ue instruments being traded is the weather and real estate derivatives. These future contracts speculate on weather anywhere in the world at different times of the year. &n &ctober *P 2::= the Chicago Mercantile >%change announced the purchase of the Chicago -oard of Trade for S+ billion in stock re8oining the two financial institutions as CM> Hroup #nc. C-&T currently uses outsourced technology platforms but will move to CM>/s Hlobe% trading system. This will provide much of the merger/s anticipated savings. The merger will also strengthen the combined group/s position in the global derivatives market !rading *ethods Trading is conducted in two methods@ an open outcry format and the CM> Hlobe%U electronic trading platform. !ppro%imately P: percent of total volume at the e%change occurs on CM> Hlobe%. pen utcry

"*E ?lobex

.ew 2ork *ercantile Exchange /.2*E-0

The Aew Vork Mercantile >%change 4AVM>G6 is the world/s largest physical commodity e%change and oldest e%changes located in Aew Vork City. #t speciali0es in petroleum and metal products. #ts two principal divisions are the Aew Vork Mercantile >%change and the Aew Vork Commodities >%change 4C&M>G6 which were once independent companies but are now merged. The Aew Vork Mercantile >%change is now traded publicly as its parent company@ AVM>G $oldings became listed on the Aew Vork Stock >%change on Aovember *P 2::= under the ticker symbol AMG. The Aew Vork Mercantile >%change handles billions of dollars worth of energy products metals and other commodities being bought and sold on the trading floor and the overnight electronic trading computer systems. The prices 'uoted for transactions on the e%change are the basis for prices that people pay for throughout the world. Anil Suvarna 29

Commodity Market The floor of the AVM>G is regulated by the Commodity Futures Trading Commission an independent agency of the (nited States government. >ach individual company that trades on the e%change must send their own independent brokers. Therefore a few employees on the floor of the e%change represent a big corporation and the e%change employees only record the transactions and have nothing to do with the actual trade. The AVM>G is one of the few e%changes in the world to maintain the open outcry system where traders employ shouting and comple% hand gestures on the physical trading floor. &n February 2= 2::B the Aew Vork -oard of Trade 4AV-&T6 signed a lease agreement with the AVM>G to move into its )orld Financial Center head'uarters and trading facility after the AV-&T/s original head'uarters and trading floor was destroyed in the September ** 2::* terrorist attacks on the )orld Trade Center. !fter the terrorist attacks the AVM>G built a S*2 million trading floor backup facility outside of Aew Vork City with P:: trader/s booths 2 ::: telephones and a backup computer system. This backup is in case of another terrorist attack on Cower Manhattan or a natural disaster.

.ew 2ork %oard of !rade /.2% !6

The Aew Vork -oard of Trade U 4AV-&T U6 a wholly-owned subsidiary of #nterContinental >%change 4AVS>: #C>6 provides the worldWs premiere futures and options markets for several internationally traded agricultural commodities: cocoa, coffee, cotton, orange 1uice and sugar@ #t is a physical commodity futures e%change located in Aew Vork City. #t originated in *+P: as the Aew Vork Cotton >%change 4AVC>6. #n *11+ the Aew Vork -oard of Trade became the parent company of both the Aew Vork Cotton >%change and the Coffee Sugar and Cocoa >%change 4CSC>6 4founded in *++26 and that now function as divisions of the AV-&T. &n September *, 2::= AV-&T agreed to become a unit of #C> and this transaction was completed on "anuary *2 2::P. For well over a century representatives of these primary commodity industries have 8oined traders and investors in the Aew Vork -oard of Trade 4AV-&T6 markets to engage in price discovery price risk transfer and price dissemination for these products. Aew VorkWs original futures e%change also provides futures and options markets for currency cross rates as well as for the 5ussell >'uity #nde%es AVS> Commodity #nde% U 5euters "efferies C5- #nde% Continuous Commodity #nde% 4CC#6 (S 9ollar #nde% U 4(S9G U6 and the F#A>G >uro Currency #nde% along with new markets for >thanol and ?ulp.

&ondon *etal Exchange /&*E0

Anil Suvarna 30

Commodity Market >stablished for over *B: years and located in the heart of The City of Condon the Condon Metal >%change is the worldWs premier non-ferrous metals market. The Condon Metal >%change or CM> is the futures e%change with the world/s largest market in options and futures contracts on base and other metals. !s the CM> offers contracts with daily e%piry dates up to three months from trade date along with longer dated contracts it also allows for cash trading. #t offers hedging worldwide reference pricing and storage for physical delivery of trades. The CM> is a highly li'uid market and in 2::= achieved volumes of +P million lots e'uivalent to S+ *:: billion annually and between SB3-,3 billion on an average business day. 9espite its Condon location the CM> is a global market with an international membership and with more than 13E of its business coming from overseas. 'istory The Condon Metal Market and >%change Company were founded in *+PP but the market traces its origins back to *3P* during the reign of Fueen >li0abeth period and the opening of the 5oyal >%change. !t first only copper was traded lead and 0inc were soon added but only gained official trading status in *12:. The e%change was closed over )) ## and did not re-open until *132. &ther metals traded e%tended to include aluminum 4*1P+6 nickel 4*1P16 and aluminum alloy 4*1126. -ase metals are traded through the CM> since 2:::. #n 2::3 the >%change launched the worldWs first futures contracts for plastics@ for polypropylene and linear low density polyethylene with the introduction of regional plastics contracts in 2::P. #n addition it offers CM> minis which are smaller-si0ed contracts for copper aluminum and 0inc plus an inde% contract 4CM>G6. The >%change is forward looking and is in the process of implementing its ;2 by 2< strategy which will see the CM> developing two streams of organic growth from nonferrous into ferrous metals and from Futures into &TC trading. #t is designed to double trading volumes at the CM> within the ne%t three to five years.

*ember of the Exchange

!malgamated Metal TradinH Aati%is Commodity Markets Calyon Financial SAC M!5>G Financial Cimited MF Hlobal SociXtX HXnXrale Triland Metals -arclays Capital Metdist Trading Sucden 4(M6 Cimited Sempra Metals

$orld "ommodities Exchanges Aolumes <==;

Anil Suvarna 31

Commodity Market

Source: >%change data

Percentage $ise Aolumes

Source: >%change data Anil Suvarna 32

Commodity Market

>egulation of commodity markets

"ountry B@) Exchange >egulator

B@S@+

India

Chicago -oard of Trade CommodityFuture Trading Chicago Mercantile >%change Commission Aew Vork -oard of Trade Aew Vork Mercantile >%change Mansas City -oard of Trade Aational Commodity R 9erivatives Forward Markets >%change Commission AationalMulti-Commodity >%change Condon Metal >%change Financial Services !uthority >urone%t Condon #nternational 4*1+=6 Financial Futures >%change 9alian Commodity >%change ChinaSecurities 5egulatory Shanghai Futures >%change Commission

"hina

Structure of "ommodity *arket

Ministry of Consumer Affairs

FMC

Commodity Exchange Anil Suvarna 33

Commodity Market

National Exchange

Regional Exchange

NCDEX

MCX

NBOT

! other Regional Exchange

NMCE

Delivery Process
Pre,>eCuisite for Delivery pen a commodity demat account 9eliveries at >%changes take place in demat form. #t is mandatory to open an 9emat account with both the depositories i.e. AS9C R C9SC.

Sales !ax >egistration -oth seller R buyer should have sales ta% registration at the location of the warehouse. #n case the client does not have a sales ta% registration he has to appoint a CRF agent for the same. ;,9 Days advance intimation to delivery team@

$arehouse "ost Anil Suvarna 34

Commodity Market The warehouse cost has to be borne by the holder of the commodity till the time he holds the commodity in the warehouse. )arehousing cost differs from commodity to commodity as prescribed the warehouses from time to time.

Aalidity Date #t means the date up to which the commodity is valid for delivery on the e%change platform. !fter the e%piry of the validity date the commodity should be either withdrawn from warehouse or further revalidated if final e%piry date is not reached.

*argins The client has to pay all applicable margins i.e. #nitial 7e%posure 7additional 7tender period R delivery period margins for his open position marked for delivery from time to time as per the rates prescribed by the >%changes.

Delivery Process

"ettlement of #remium$ Discounts % sales Tax ) Days #rior

Ta(e #osition

#ay Out of Commodity$ Funds

Deli&ery 'ntension

) Days #rior Anil Suvarna 35

Commodity Market

Exchange of Buyers % "ellers 'dentity #ay*'n of Commodity$ Funds

) Days #rior

#ay Deli&ery Margin

Matching By Exchange

Delivery Process for Seller

O+en O+en a a Commodity Commodity Demat Demat A$C A$C ,ith ,ith Designated Designated D-# D-#

Client Client 1et 1et Demat Demat Credit Credit in in his his A$c A$c after after the the "tandard "tandard Deduction Deduction

Contact Contact the the .arehouse .arehouse for for A&aila/ility A&aila/ility of of "+ace "+ace

'f 'f A++ro&ed A++ro&ed /y /y Assayer Assayer Client Client has has to to su/mit su/mit Commodity Commodity De+osit De+osit form form along along ,ith ,ith Assayer Assayer

RE#ORT RE#ORT

Anil Suvarna 36

Assayer Assayer ta(es ta(es "am+le "am+le and and 'ssues 'ssues a a 0uality 0uality Re+ort Re+ort

Commodity Market

Ta(e Ta(e #hysical #hysical Commodity Commodity to to the the .arehouse .arehouse for for Assaying Assaying

.arehouse .arehouse 'ssues 'ssues s s Recei+t Recei+t against against the the De+osit De+osit of of Commodity Commodity

Delivery Process for %uyer

Ta(e Ta(e O+en O+en #osition #osition

Mar( Mar( Deli&ery Deli&ery 'ntension 'ntension

#ay*in$ #ay*in$ #ay* #ay* out out of of funds$ funds$ Commodity Commodity

Anil Suvarna 37

Commodity Market

"ales "ales Tax Tax "ettlement "ettlement

Re&alidate Re&alidate 'f 'f 2alidity 2alidity of of 's 's in in has has to to /e /e Extended Extended

Remat Remat if if Client Client ,ant ,ant #hysical #hysical Deli&ery Deli&ery or or 's 's in in has has Ex+ired Ex+ired

Daily !ime of Different Exchange

Exchange
Tokyo Commodity >%change Shanghai Metal >%change Condon Metal >%change C&M>G7AVM>G7C-&T MCG R AC9>G

!iming IS!
3.B: am K *2 pm =.B: am - *2.B: pm 3:2: ?M - *::B: ?M 4)inter6 ,:2: ?M - 1:B: ?M 4Summer6 =:,: ?M - **:B: ?M 4)inter6 3:,: ?M - *::B: ?M 4Summer6 *:::: !M - 2B:33 ?M 4)inter6 *:::: !M - 2B:B: ?M 4Summer6

$hy choose "ommodities over ECuitiesD

#n developed countries commodity market is 5 times bigger than e'uity markets. Anil Suvarna 38

Commodity Market Market has grown from 2:: Cr in 2::B to *,::: Cr in 2::= per day R e%pected to be around 23::: Cr till 9ec 2::P. Cow number of commodities therefore choice is easy. Ao need to go into e%otic ma0e of financial statements created by corporate world. Margins are low@ therefore return ratios are favorable on winning deals. Ao single individual can control on longer terms basis on demand and supply in commodities. 9oes not involve individual 7 company specific risk.

"ommodity Derivatives and #inancial Derivatives

C(MM( "%, E-".A%".ES F"/A/C"A0 E-".A%".ES

Commodity 9erivatives are settled by actual Financial 9erivatives are only cash settled deliveries today Fuantity and 'uality differences e%ist $olding cost includes assaying warehousing R insurance costs ?hysical markets are seasonal in nature Ao such differences e%ist $olding costs normally consists of only interest costs. Cash markets are active throughout the year.

Factors #mpacting : 9emand R Supply #mport->%port 5egulations Hovernment #ntervention

Factors #mpacting : Hlobal R Cocal >conomic Condition ?erformance of the entity Ta%ation Structure

Anil Suvarna 39

Commodity Market

"omparative returns from Aarious +sset "lasses

Months ago 3nits Rs$dollar Rs$euro Rs$1/+ Rs$9! gms Rs$(gs Rs$Barrels Rs$(g Rs$(g Rs$9!!=gs Rs$(gs Rs$9!!(g Rs$9!!(gs Rs$(gs Rs$9!!(gs Rs$(gs Rs$9! (gs Fe/!4 96 4 9 6 9 :5< ;; )< <4 :6 < !;<6 44!5 4 9:!9 : 9: )4; 9<<< 9 6< 9! ; 9)99 ;<) ;;5 #rice !:; 694 9;9 9;!:9 ;; )4 <4 : ; 9::55 69 69 94!: 9!64) )<! 9<:4 9 4:) <; 4 96!! ;44 ;) 8 )-< ;-! ;-! *<* 9-! -! ;-< 5-) ;-5 99*95-6 *9-! *!-; *;-9 9-) *)-6 9-4 * -! 5Months ago #rice 56! 4;9 <) 956:6 ;) ): << : 6: !5:) <<: 5 ! 9;<9 4:59 66: 9:9: 999!) 4665 94)4 )5 ;66 8 *6-9 *!-4 * -6 *)-) *9*9-: *9-6 5-: !-; *6-; *9;-: <-; 96*9;*9-6 9!-) 55-4 *9;-! *<-< *;-< 6Months ago #rice 496 6<) 55) 55) ;6 6! << :6: 9::6: 5 )6 5)< 9)<; <49! )4! 96)) 99)<! <<: 9< 5 )4 ;5) 8 *9<-; 9-; *;-4 9!-6 *;-: * -6 * -! *!-4 -6 *94-! * 5-< !-! )-< !-4 9;-9 )-: 9)*94-9 *9)-! 7ear ago #rice <: 9:6) 9<<: 9!54! ;; )5 4< <99 9;!;: 45: 96 646 < 5 ;)4 96!; 4);9 )45: !69 )49 54< 8 *55<-; 94-< ;-< *!-) :-< 99-5 9<-4 ;)-< *9-5 6-9 9<9-9 9 -9 )-6 94-4 6 -4 4<-) * 6-4 *9)-! 94-

Commodity $'ndices MCX Energy MCX Metal MCX Comdex B"E "EN"EX 3"D Euro 1B# 1old "il&er Crude Oil Co++er Nic(el Ru//er Mentha Castor "eed #e++er >eera "ugar 1uarRef "oya oil

Anil Suvarna 40

Commodity Market

Pricing commodity futures

!he cost of carry model
)e use arbitrage arguments to arrive at the fair value of futures. For pricing purposes we treat the forward and the futures market as one and the same. A futures contract is nothing but a forward contract that is exchange traded and that is settled at the end of each day. The buyer who needs an asset in the future has the choice between buying the underlying asset today in the spot market and holding it or buying it in the forward market. #f he buys it in the spot market today it involves opportunity costs. $e incurs the cash outlay for buying the asset and he also incurs costs for storing it. #f instead he buys the asset in the forward market he does not incur an initial outlay. $owever the costs of holding the asset are now incurred by the seller of the forward contract who charges the buyer a price that is higher than the price of the asset in the spot market. This forms the basis for the cost-ofcarry model where the price of the futures contract is defined as:

FJS-C )here: F -Futures price S -Spot price C -$olding costs or carry costs The fair value of a futures contract can also be e%pressed as: Anil Suvarna 41

4*6

Commodity Market

FJ S 4*Or6 r )here: r ?ercent cost of financing T Time till e%piration

426

)henever the futures price moves away from the fair value there would be opportunities for arbitrage. #f FIS 4*Or6 r or FYS 4*Or6 r arbitrage would e%ist. )e know what are the spot and futures prices but what are the components of holding costsZ The components of holding cost vary with contracts on different assets. !t times the holding cost may even be negative. #n the case of commodity futures the holding cost is the cost of financing plus cost of storage and insurance purchased. #n the case of e'uity futures the holding cost is the cost of financing minus the dividends returns. >'uation 426 uses the concept of discrete compounding where interest rates are compounded at discrete intervals for e%ample annually or semiannually. ?ricing of options and other comple% derivative securities re'uires the use of continuously compounded interest rates. Most books on derivatives use continuous compounding for pricing futures too. )hen we use continuous compounding e'uation 426 is e%pressed as: F- SerT 4B6

)here: r Cost of financing 4using continuously compounded interest rate6 T Time till e%piration e 2.P*+2+ So far we were talking about pricing futures in general. To understand the pricing of commodity futures let us start with the simplest derivative contract . a forward contract. )e use e%amples of forward contracts to e%plain pricing concepts because forward contracts are easier to understand. $owever the logic for pricing a futures contract is e%actly the same as the logic for pricing a forward contract. )e begin with a forward contract on an asset that provides the holder with no income and has no storage or other costs. Then we introduce real world factors as they apply to investment commodities and later to consumption commodities. Consider a three-month forward contract on a stock that does not pay dividend. !ssume that the price of the underlying stock is 5s.,: and the three-month interest rate is 3E per annum. )e consider the strategies open to an arbitrager in two e%treme situations.

Anil Suvarna 42

Commodity Market Suppose that the forward price is relatively high at 5s.,B. !n arbitrager can borrow 5s.,: from the market at an interest rate of 3E per annum buy one share in the spot market and sell the stock in the forward market at 5s.,B. !t the end of three months the arbitrager delivers the share and receives 5s.,B. The sum of money re'uired to pay off the loan is ,:e :.:3[:.23 -,:.3:. -y following this strategy the arbitrager locks in a profit of 5s.,B.:: 5s.,:.3: J 5s.2.3: at the end of the three month period. Suppose that the forward price is relatively low at 5s.B1. !n arbitrager can short one share for 5s.,:@ invest the proceeds of the short sale at 3E per annum for three months and take a long position in a three-month forward contract. The proceeds of the short sale grow to ,:e :.::3[:.23 J ,:.3: in three months. !t the end of the three months the arbitrager pays 5s.B1 takes delivery of the share under the terms of the forward contract and uses it to close his short position in the process making a net gain of 5s.*.3: at the end of three months.

Pricing futures contracts on investment commodities

#n the e%ample above we saw how a futures contract on gold could be priced using arbitrage arguments and the cost-of-carry model. #n the e%ample we considered the gold contract was for *: grams of gold. $ence we ignored the storage costs. $owever if the one-month contract was for a *:: kgs of gold instead of *: Hms then it would involve non-0ero holding costs which would include storage and insurance costs. The price of the futures contract would then be 5s.P:+=.+: plus the holding costs. Table 4*6 gives the indicative warehouse charges for accredited warehouses7 vaults that will function as delivery centres for contracts )arehouse charges include a fi%ed charge per deposit of commodity into the warehouse and a per unit per week charge. The per unit charges include storage costs and insurance charges. )e saw that in the absence of storage costs the futures price of a commodity that is an investment asset is given by FJSerT. Storage costs add to the cost of carry. #f  is the present value of all the storage costs that will be incurred during the life of a futures contract it follows that the futures price will be e'ual to FJ 4SO(6 erT )here: r Cost of financing 4annuali0ed6 T Time till e%piration ( ?resent value of all storage costs Anil Suvarna 43 4,6

Commodity Market For ease of understanding let us consider a one-year futures contract on gold. Suppose the fi%ed charge is 5s.B*: per deposit upto 3:: kgs. and the variable storage costs are 5s.33 per week it costs 5s.B*P: to store one kg of gold for a year432 weeks6. !ssume that the payment is made at the beginning of the year. !ssume further that the spot gold price is 5s.=::: per *: grams and the risk-free rate is PE per annum. )hat would the price of one year gold futures be if the delivery unit is one kgZ FJ4SO(6 e rT J 4=:::::OB*:O2+=:6 e :.:P[* J =,=1:,.P=

"ommodity ?old

#ixed "harges :4=

$arehouse "harges per unit3week ;; per )?

)e see that the one-year futures price of a kg of gold would be 5s.= ,= 1:,.P=. The oneyear futures price for *: grams of gold would be about 5s.=,=1. Aow let us consider a three-month futures contract on gold. )e make the same assumptions the fi%ed charge is 5s.B*: per deposit upto 3:: kgs and the variable storage costs are 5s.33 per week. #t costs 5s.*:23 to store one kg of gold for three months4*B weeks6. !ssume that the storage costs are paid at the time of deposit. !ssume further that the spot gold price is 5s.=::: per *: grams and the risk-free rate is PE per annum. )hat would the price of three month gold futures if the delivery unit is one kgZ F J 4SO(6 e rT J 4=:::::OB*:OP*36 e :.:P[:.23 J =**=B3.3: )e see that the three-month futures price of a kg of gold would be 5s.= ** =B3.3:. The three-month futures price for *: grams of gold would be about 5s.=**=.

?ricing futures contracts on consumption commodities )e used the arbitrage argument to price futures on investment commodities. For commodities that are consumption commodities rather than investment assets the arbitrage arguments used to determine futures prices need to be reviewed carefully. Suppose we have Anil Suvarna 44

Commodity Market FI4S O (6 e rT 436

To take advantage of this opportunity an arbitrager can implement the following strategy: -orrow an amount SO( at the risk-free interest rate and use it to purchase one unit of the commodity and pay storage costs. Short a forward contract on one unit of the commodity. #f we regard the futures contract as a forward contract this strategy leads to a profit of F 4S O (6 e rT at the e%piration of the futures contract. !s arbitragers e%ploit this opportunity the spot price will increase and the futures price will decrease until >'uation 436 does not hold well. Suppose ne%t that F Y 4S O (6 e rT 4=6

#n case of investment assets such as gold and silver many investors hold the commodity purely for investment. )hen they observe the ine'uality in e'uation 4=6 they will find it profitable to trade in the following manner: Sell the commodity save the storage costs and invest the proceeds at the risk-free interest rate. Take a long position in a forward contract.

This would result in a profit at maturity of (S + U e r! " # relative to the position that the investors would have been in had they held the underlying commodity. !s arbitragers e%ploit this opportunity the spot price will decrease and the futures price will increase until e'uation 4=6 does not hold well. This means that for investment assets e'uation 4,6 holds good. $owever for commodities like cotton or wheat that are held for consumption purpose this argument cannot be used. #ndividuals and companies who keep such a commodity in inventory do so because of its consumption value not because of its value as an investment. They are reluctant to sell these commodities and buy forward or futures contracts because these contracts cannot be consumed. Therefore there is unlikely to be arbitrage when e'uation 4=6 holds good. #n short for a consumption commodity therefore F YJ 4S O (6 e rT 4P6 That is the futures price is less than or e'ual to the spot price plus the cost of carry.

Anil Suvarna 45

Commodity Market

"ommodities *arkets

verall Perspective

%ackground Commodities e%changes in #ndia were established in 2::B with MCG commencing operations in Aov 2::B and AC9>G in 9ec 2::B. The national-level online commodity e%changes were established primarily for the purpose of 4*6 >fficient ?rice 9iscovery 426 ?rice 5isk Management #nitially AC9>G was the leader in Commodities >%changes as volumes of agricommodities picked up substantially but later on MCG took the lead in #nternational commodities which helped MCG become the largest e%change cornering almost +3E - 1:E of the total average daily business of 5s. 23 ::: crores 4MCG K 5s.22 ::: K 5s.2B ::: crores 7 AC9>G K 5s.2:::-5s.23:: crores6 per day.

The present growth in commodities markets can be attributed to the following: 4*6 &verall downturn in other asset classes especially e'uity markets globally led investors to look at commodities markets for returns. #ncreased volatility in commodities in the past * year or so have generated interest amongst traders globally to participate in this market Hold R Crude particularly are7were the ma8or volume drivers on the e%changes due to numerous global economic factors

426

4B6

Aolume Perspective Domestic Since the beginning combined volumes at both e%changes has increased many fold to presently 5s.23 ::: crores per day all in a time span of 3 years. The e%changes clocked its highest turnover of 5s.B, P:: crores on *1 th March 2::1 with MCG contributing 5s.B2 ::: crores and AC9>G 5s.2P:: crores. Qolumes in #ndian >'uities markets currently average around 5s.33 ::: K 5s.=: ::: crores per day which includes Cash and FR& segment. Anil Suvarna 46

Commodity Market International Hlobally commodity markets in developed countries are about B-, times the si0e of e'uities markets primarily due to the level of maturity in the markets and the larger universe of market participants which is not the case currently in our domestic markets.

!urnover %reakup
"ommodity %ullion %ase *etals Energy +gri@ "ommodities !otal *"!urnover /E0 =3 ** 2: , *:: ."DE!urnover /E0 1: *: *:: !urnover /"rs@0 *3::: 23:: ,3:: *::: <:===

"ommodity +gri@ "ommodities thers !otal

!urnover /"rs@0 223: 23: <;==

Product Perspective )orld over the commodities e%change volumes are primarily driven by *:-*2 ma8or commodities and hence the number of ma8or commodities traded on the e%changes rarely e%ceeds 2:. -ullion ?ack 4Hold R Silver6 trade heavily on C&M>G 49ivision of AVM>G6@ >nergy Comple% 4Crude &il Aatural Has $eating &il6 on AVM>G and -ase Metals on CM>. Similarly agri-commodities like Soy -ean Soy &il )heat are traded on C-&T Sugar R Cotton are trade on #C> 4#ntercontinental >%change6 earlier known as AV-&T. ?alm &il is traded at -ursa Malaysia 9erivatives >%change 4-M96. The number of commodities traded on the #ndian e%changes e%ceeds ,: in number many of them very illi'uid such as Cardamom7"ute7Mentha7Carbon Credit7Coriander7Chilli etc. Anil Suvarna 47

Commodity Market

*arket Participants ?resently participation is restricted to corporate 4*edium R Small6 physical players and retail segment. The volumes are primarily driven by regional unorgani0ed players arbitrageurs 8obbers who contributed close to P:E - P3E of the total turnover. *3E - 2:E is through participation by retail R the rest by corporate 43E - *:E6. ?aps in the Present Structure !s the #ndian commodities e%changes are still in a nascent stage only the nearmonth contracts have sufficient volumes. This acts as a roadblock for corporate and traders who are interested in taking a long-term view and hedge positions on the e%changes as they would have to undertake rollover of contracts fre'uently. This issue is for both international commodities as well as agri-commodities. #ndian Commodity Futures Markets being still in an early growth phase therefore to an e%tent lack strict regulation and compliance norms as in e'uities markets now. This could be due to lack of autonomy at 5egulatorWs level. (norgani0ed trading 4i.e. 9abba trading6 is rampant all across #ndia in various commodities through the local players. This hampers the growth in bringing efficiency and transparency in the markets. ?hysical markets 4i.e. Mandis6 of agro commodities are not that well developed in terms of processes which at times leads to mismatch between Spot Qs Futures prices. This leads to discrepancies in price discovery mechanism. Sales Ta% Calculations and #mplementation across different states in the country also make the integration process of spot versus futures more comple%. Fuality concerns with regard to Spices 45ed Chilli7"eera6 have been raised time and again. #ssues of this sort create credibility concerns amongst the physical market players and traders. This segment of market participants is highly important for the development and growth in business volumes in agri-commodities. Mnee "erk decisions of the govt. such as banning certain commodities as and when deemed fit is very damaging for the commodities markets as this creates uncertainty in the minds of the market participants as well as internationally too. Aon availability of other products like &ptions is a dampener and restricts the choices for the corporate or traders to hedge their positions and minimi0e their risk.

Steps .eeded !o Propel #urther ?rowth in "ommodities %usiness in India Anil Suvarna 48

Commodity Market

Participation of

ther #inancial Intermediaries

#ndustry -odies should make representations to the FMC R Ministry of Consumer !ffairs to permit other market participants into the market such as Mutual Funds7-anks7Financial #nstitutions7A5#s etc. The #ndian Hovt.7Ministry of !griculture does not appear to be greatly inclined towards further liberali0ing the commodities e%changes on fears that increased trading activities could take place in agri-commodities which could lead to a spurt in inflation. The inflation fears can still be understood as far as agri-commodities are concerned but it is beyond anyoneWs understanding as to what is holding the FMC from allowing the MFs79F#s7A5#s7-anks from trading in international commodities such as the -ullion ?ack 4Hold R Silver6@ -ase Metals 4Copper !luminium Cead \inc Aickel R Tin6 R >nergy 4Crude Aatural Has R $eating &il6. The prices of these commodities are driven by international markets and we are 8ust price followers and not price setters. #f and when the govt. decides to allow these players in the commodities derivatives we shall see the ne%t ma8or phase of growth of commodities markets in #ndia.

"reating +wareness F Education Conduct #nvestor )orkshops R Seminars across #ndia to create awareness about commodities e%changes their functions and their usefulness in the minds of corporate 7 e%porters 7 importers 7 traders. This activity is currently being undertaken at various levels by FMC7>%changes7-rokers but there is a need for coordinated R concerted effort from all stakeholders. )e at !ngel believe strongly that this activity is of prime importance for sustained growth of business over the long-term. &ur initiatives like Mnowledge Series 5esearch (pdates along with regular 8oint seminars and workshops with e%changes and other association bodies help us to reach out to the investor at large across country. o !utonomy for the 5egulator 4FMC6 K Forwards Market Commission FMC should be made an autonomous body on the lines of S>-# to provide it with the necessary powers to take decisions for the betterment and growth of the #ndian Commodities Markets.

Anil Suvarna 49

Commodity Market !mendments in the FC5! 4Forward Contracts R 5egulation !ct6 which is long overdue is the need of the hour. These amendments as proposed would allow &ptions Trading in Commodities >%changes. ?ermit ?ortfolio Management Services 4?MS6. For this proper certification on the line of CT!s in (S! 7 ?ortfolio Managers in e'uity by S>-# can be undertaken. !tleast a beginning can be initiated in this direction which will bring in professional participation in the markets. !s #ndia is an agri-based economy there is tremendous potential for agricommodities business on the e%changes. Farmers7Co-operative Societies7!gri#ndustries should be closely involved in developing supply chain across regions. >ducating farmers as to the benefits of the commodities e%changes would also go a long way in ensuring the growth of the agri commodities business. ?resently the hedged positions on the e%changes is very miniscule which has potential to be increased greatly. #nternationally it has been found that commercials or hedgers hold close to ,:E - 3:E of total &pen #nterest. $ence monitoring the &pen #nterest ?ositions of $edgers and trying to increase this E is the need of the hour.

ther +ncillary Points >esponsibility of Exchanges The real purpose of the e%changes areK 4a6 to provide a hedging platform R 4b6 provide efficient price discovery mechanism. This purpose needs to propagated across #ndia targeting corporate of all hues from blue-chips to the SM>s. >nsure smooth functioning of the operations and closely monitor price moves of all commodities particularly of illi'uid commodities. 5emove illi'uid commodities from trading as manipulation is most likely in such commodities 4Cike Cardamom7?otato7"ute7Coriander7Mentha etc.6

Indian "ommodities *arkets as Price Setters

Anil Suvarna 50

Commodity Market #ndia is the 2nd fastest growing economy in the world after China. #n commodities consumption be it agri-commodities or gold we are playing a crucial role in world demand 7 supply. !lthough we are amongst the top producers in Sugar7)heat and other agricommodities and the largest consumer in gold yet we are far behind the other countries such as (S7>urope when it comes to the focused approach towards developing domestic commodities business on the physical side. Further the presence of commodities specific funds in the developed markets has given them an edge to command the prices. Hold for e%ample is traded heavily in (M 4Spot6 R (S 4Futures6 from decades. )e also derive the prices from C-M! for our gold imports whereas for the futures prices the world looks at C&M>G. !s the markets for specific commodities are very well developed in these countries both from trading the physical side as well as financial markets side it would take 'uite sometime before we can raise our level of being in command position to determine and set prices.

%anning of +gri,"ommodities The Hovt. had banned futures trading in (rad Tur )heat R 5ice in "anuary R February 2::P. !gain in May 2::+ the Hovernment banned ?otato 5efined Soy &il Chana R 5ubber as it feared that the trading of these commodities on the futures e%changes was leading to rise in inflation.

>elisting of 7 "ommodities Futures trading in Soya oil Chana ?otato and 5ubber resumed on ,th 9ecember 2::+ on the MCG AC9>G AMC> and A-&T platforms after a near si%-month ban on the four items ended on B:th Aovember 2::+. Futures trading in these four items had come under attack when the country/s inflation starting climbing at double-digit level. !lthough !bhi8it Sen committee report concluded that there is no relation between inflation and futures market the trading of the above mentioned commodity were Anil Suvarna 51

Commodity Market suspended mainly due to the pressure from the Ceft party which blamed futures trading for price rise. The relaunch of these agro-commodities is likely to go some way in restoring investors confidence in the futures markets. &owering !ransaction "harges This point was the latest hot debate between the regulator 4FMC6 and AC9>G wherein AC9>G proposed to slash drastically the Transaction charges levied for evening trading session. The proposed charges were only 5s. 3 per crore against 5s. ,:: per crore 4highest slab6 in the morning session. This created a row in the markets wherein FMC opposed the same and AC9>G filed the case to challenge the FMC order in Mumbai $igh Court. !fter hearing the $igh Court passed an order in favour of FMC and thereby AC9>G had to withdraw the case. Transaction charges per crore in Futures Contracts in >'uity is 5s.2::7crore whereas in Commodities there is an incremental slab based on average daily volumes ranging from 5s.,::7crore to 5s.*::7crore.

*a1or ?lobal Exchanges AVM>G R C&M>G 4a division of AVM>G6 is the world leader in Crude &il7Aatural Has7Hold R Silver. ,2B million contracts were traded in 2::+. &n an average *.P million contracts are being traded as in "anuary 2::1. CM> is the worldWs leader in non-ferrous metals market. <==5 annual &*E turnover: S*:.2, trillion a rise of PE against 2::P. In <==5, over **B million lots were traded giving a year-on-year rise of 22E. Tokyo Commodity >%change 4T&&C&M6 is also amongst the worldWs top largest e%changes in Crude7-ullion R 5ubber. *"- G It is globally ranked 4a6 Brd in Aumber of Hold Contracts Traded 4b6 *st in Aumber of Silver Contracts Traded 4c6 B rd in Aumber of Copper Contracts 4d6 Brd in Aumber of Crude Contracts

"apital +ccount "onvertibility Anil Suvarna 52

Commodity Market This measure would definitely open the gates for efficient foreign e%change transactions but the important point to note is that F##s would be more interested to trade #nternational Commodities on AVM>G 7 C&M>G rather than #ndian Commodity >%changes as volumes li'uidity and maturity is more on the #nternational e%changes. -ut at the same time those F##s that are catering to the domestic investors could in all likelihood trade on #ndian Commodity >%changes. Further commodities are global in nature so there is not much differentiation in the products.

"ommodities in ?lobal #inancial "risis Hlobal financial markets are under strain and e'uities as well as commodities have been affected. Commodity markets have faced pressure due to a sharp decline in corporate profits. )ith a decline in profitability the demand for raw materials from companies has declined which in turn has led to the decline in commodity prices. The current crisis is e%pected to last longer and global growth is e%pected to fall to ] percent in 2::1 as per #MF estimates. There could be further downgrades to these estimates as the banking sector is under a rubble as global policymakers come together to solve the financial crisis. 9espite policy measures by governments to provide capital and boost economies financial market conditions have deteriorated. Financial markets are e%pected to remain under stress throughout 2::1 as until the credit markets are unfree0ed corporate activity will remain subdued. Though financial markets have suffered a severe recession Hold has been the only commodity which has been able to rise. This is because investment in gold is considered as a safe-haven and a traditional form of investment. !lso there has been a diversification in investment away from e'uities. Commodities have emerged as a different asset class but investment in Hold is considered as a safe bet amid turbulent times and from the longterm perspective. Cower commodity prices and sluggish real activity have dampened inflationary pressures. !s per #MF estimates headline inflation in the advanced economies is e%pected to decline from B-*72 percent in 2::+ to a record low of ^ percent in 2::1. $owever some advanced economies could also e%perience a very low or negative inflation. #n emerging Anil Suvarna 53

Commodity Market economies inflation is e%pected to fall from 1-*72 percent in 2::+ to 3-B7, percent in 2::1 and 3 percent in 2:*:. ')en t)e 1S snee+es2 t)e rest of t)e *orld catc)es cold # )hat started as a subprime mortgage crisis in the (S eventually turned out to be a global economic problem. The credit crunch hurt e%pansion plans of companies across the globe and today industrial activity has declined sharply. >'uity and commodity markets have slumped to multi-year lows and H9? growth has declined. (S being the worldWs largest economy has affected the global economic situation in advanced and emerging economies. Hoing forward performance of emerging economies will depend on how the (S recovers from this crisis as a lot of countries are e%port-dependant as they sell goods to the (S. )ith the decline in economic activity in the (S e%ports of countries like China to the (S have been affected leading to lower e%port trade. The current recession is e%pected to last longer and financial markets are e%pected to remain under stress. (ntil the situation of the banking sector improves in the (S activity in other countries will remain stagnant.

Anil Suvarna 54

Commodity Market

>egulatory framework
!t present there are three tiers of regulations of forward7futures trading system in #ndia namely government of #ndia Forward Markets Commission 4FMC6 and commodity e%changes. The need for regulation arises on account of the fact that the benefits of futures markets accrue in competitive conditions. ?roper regulation is needed to create competitive conditions. #n the absence of regulation unscrupulous participants could use these leveraged contracts for manipulating prices. This could have undesirable influence on the spot prices thereby affecting interests of society at large.. 5egulation is also needed to ensure that the market has appropriate risk management system. #n the absence of such a system a ma8or default could create a chain reaction. The resultant financial crisis in a futures market could create systematic risk. 5egulation is also needed to ensure fairness and transparency in trading clearing settlement and management of the e%change so as to protect and promote the interest of various stakeholders particularly non-member users of the market.

>ules governing commodity derivatives exchanges

The trading of commodity derivatives on the AC9>G is regulated by Forward Markets Commission 4FMC6. (nder the Forward Contracts 45egulation6 !ct *132 forward trading in commodities notified under section *3 of the !ct can be conducted only on the e%changes which are granted recognition by the central government 49epartment of Consumer !ffairs Ministry of Consumer !ffairs Food and ?ublic 9istribution6. !ll the e%changes which deal with forward contracts are re'uired to obtain certificate of registration from the FMC. -esides they are sub8ected to various laws of the land like the Companies !ct Stamp !ct Contracts !ct Forward Commission 45egulation6 !ct and various other legislations which impinge on their working. Forward Markets Commission provides regulatory oversight in order to ensure financial integrity 4i.e. to prevent systematic risk of default by one ma8or operator or group of operators6 market integrity 4i.e. to ensure that futures prices are truly aligned with the prospective demand and supply conditions6 and to protect and promote interest of customers7 non-members. #t prescribes the following regulatory measures: Cimit on net open position as on the close of the trading hours. Some times limit is also imposed on intraday net open position. The limit is imposed operator-wise and in some cases also member-wise. Circuit-filters or limit on price fluctuations to allow cooling of market in the event of abrupt upswing or downswing in prices. Anil Suvarna 55

Commodity Market Special margin deposit to be collected on outstanding purchases or sales when price moves up or down sharply above or below the previous day closing price. -y making further purchases7sales relatively costly the price rise or fall is sobered down. This measure is imposed only on the re'uest of the e%change. Circuit breakers or minimum7ma%imum prices: These are prescribed to prevent futures prices from falling below as rising above not warranted by prospective supply and demand factors. This measure is also imposed on the re'uest of the e%changes. Skipping trading in certain derivatives of the contract closing the market for a specified period and even closing out the contract: These e%treme measures are taken only in emergency situations.

-esides these regulatory measures the F.C456 !ct provides that a client/s position cannot be appropriated by the member of the e%change e%cept when a written consent is taken within three days time. The FMC is persuading increasing number of e%changes to switch over to electronic trading clearing and settlement which is more customer-friendly. The FMC has also prescribed simultaneous reporting system for the e%changes following open out.cry system. These steps facilitate audit trail and make it difficult for the members to indulge in malpractices like trading ahead of clients etc. The FMC has also mandated all the e%changes following open outcry system to display at a prominent place in e%change premises the name address telephone number of the officer of the commission who can be contacted for any grievance. The website of the commission also has a provision for the customers to make complaint and send comments and suggestions to the FMC. &fficers of the FMC have been instructed to meet the members and clients on a random basis whenever they visit e%changes to ascertain the situation on the ground instead of merely attending meetings of the board of directors and holding discussions with the office-bearers.

>ules governing intermediaries

#n addition to the provisions of the Forward Contracts 45egulation6 !ct *132 and rules framed thereunder e%changes are governed by its own rules and bye laws 4approved by the FMC6. #n this section we have brief look at the important regulations that govern AC9>G. For the sake of convenience these have been divided into two main divisions pertaining to trading and clearing. The detailed bye laws rules and regulations are available on the AC9>G home page.

!rading Anil Suvarna 56

Commodity Market The AC9>G provides an automated trading facility in all the commodities admitted for dealings on the spot market and derivative market. Trading on the e%change is allowed only through approved workstation4s6 located at locations for the office4s6 of a trading member as approved by the e%change. #f C!A or any other way to other workstations at any place connects an approved workstation of a trading Member it shall re'uire an approval of the e%change. >ach trading member is re'uired to have a uni'ue identification number which is provided by the e%change and which will be used to log on 4sign on6 to the trading system. ! trading member has a non-e%clusive permission to use the trading system as provided by the e%change in the ordinary course of business as trading member. $e does not have any title rights or interest whatsoever with respect to trading system its facilities software and the information provided by the trading system. For the purpose of accessing the trading system the member will install and use e'uipment and software as specified by the e%change at his own cost. The e%change has the right to inspect e'uipment and software used for the purposes of accessing the trading system at any time. The cost of the e'uipment and software supplied by the e%change installation and maintenance of the e'uipment is borne by the trading member. !rading members and users@ Trading members are entitled to appoint 4sub8ect to such terms and conditions as may be specified by the relevant authority6 from time to time K !uthori0ed persons !pproved users Trading members have to pass a certification program which has been prescribed by the e%change. #n case of trading members other than individuals or sole proprietorships such certification program has to be passed by at least one of their directors7 employees7 partners 7 members of governing body. >ach trading member is permitted to appoint a certain number of approved users as notified from time to time by the e%change. The appointment of approved users is sub8ect to the terms and conditions prescribed by the e%change. >ach approved user is given a uni'ue identification number through which he will have access to the trading system. !n approved user can access the trading system through a password and can change the password from time to time. The trading member or its approved users are re'uired to maintain complete secrecy of its password. !ny trade or transaction done by use of password of any approved user of the trading member will be binding on such trading member. !pproved user shall be re'uired to change his password at the end of the password e%piry period. Anil Suvarna 57

Commodity Market !rading days The e%change operates on all days e%cept Saturday and Sunday and on holidays that it declares from time to time. &ther than the regular trading hours trading members are provided a facility to place orders off-line i.e. outside trading hours. These are stored by the system but get traded only once the market opens for trading on the following working day. The types of order books trade books price limits matching rules and other parameters pertaining to each or all of these sessions are specified by the e%change to the members via its circulars or notices issued from time to time. Members can place orders on the trading system during these sessions within the regulations prescribed by the e%change as per these bye laws rules and regulations from time to time. !rading hours and trading cycle The e%change announces the normal trading hours7 open period in advance from time to time. #n case necessary the e%change can e%tend or reduce the trading hours by notifying the members-Trading cycle for each commodity7 derivative contract has a standard period during which it will be available for trading. "ontract expiration 9erivatives contracts e%pire on a pre-determined date and time up to which the contract is available for trading. This is notified by the e%change in advance. The contract e%piration period will not e%ceed twelve months or as the e%change may specify from time to time. !rading parameters The e%change from time to time specifies various trading parameters relating to the trading system. >very trading member is re'uired to specify the buy or sell orders as either an open order or a close order for derivatives contracts. The e%change also prescribes different order books that shall be maintained on the trading system and also specifies various conditions on the order that will make it eligible to place it in those books. The e%change specifies the minimum disclosed 'uantity for orders that will be allowed for each commodity7 derivatives contract. #t also prescribes the number of days after which Hood Till Cancelled orders will be cancelled by the system. #t specifies parameters like lot si0e in which orders can be placed price steps in which orders shall be entered on the trading system position limits in respect of each commodity etc. #ailure of trading member terminal Anil Suvarna 58

Commodity Market #n the event of failure of trading membersW workstation and7 or the loss of access to the trading system the e%change can at its discretion undertake to carry out on behalf of the trading member the necessary functions which the trading member is eligible for. &nly re'uests made in writing in a clear and precise manner by the trading member would be considered. The trading member is accountable for the functions e%ecuted by the e%change on its behalf and has to indemnity the e%change against any losses or costs incurred by the e%change. !rade operations Trading members have to ensure that appropriate confirmed order instructions are obtained from the constituents before placement of an order on the system. They have to keep relevant records or documents concerning the order and trading system order number and copies of the order confirmation slip7 modification slip must be made available to the constituents. The trading member has to disclose to the e%change at the time of order entry whether the order is on his own account or on behalf of constituents and also specify orders for buy or sell as open or close orders. Trading members are solely responsible for the accuracy of details of orders entered into the trading system including orders entered on behalf of their constituents. Trades generated on the system are irrevocable and .locked in/. The e%change specifies from time to time the market types and the manner if any in which trade cancellation can be effected. )here a trade cancellation is permitted and trading member wishes to cancel a trade it can be done only with the approval of the e%change. *argin reCuirements Sub8ect to the provisions as contained in the e%change bye-laws and such other regulations as may be in force every clearing member in respect of the trades in which he is party to has to deposit a margin with e%change authorities. The e%change prescribes from time to time the commodities7 derivative contracts the settlement periods and trade types for which margin would be attracted. The e%change levies initial margin on derivatives contracts using the concept of Qalue at 5isk 4Qa56 or any other concept as the e%change may decide from time to time. The margin is charged so as to cover one-day loss that can be encountered on the position on 11E of the days. !dditional margins may be levied for deliverable positions on the basis of Qa5 from the e%piry of the contract till the actual settlement date plus a mark up for default. The margin has to be deposited with the e%change within the time notified by the e%change. The e%change also prescribes categories of securities that would be eligible for a margin deposit as well as the method of valuation and amount of securities that would be re'uired to be deposited against the margin amount. The procedure for refund7 ad8ustment of margins is Anil Suvarna 59

Commodity Market also specified by the e%change from time to time. The e%change can impose upon any particular trading member or category of trading member any special or other margin re'uirement. &n failure to deposit margin7s as re'uired under this clause the e%change7clearing house can withdraw the trading facility of the trading member. !fter the pay-out the clearing house releases all margins. Bnfair trading practices Ao trading member should buy sell deal in derivatives contracts in a fraudulent manner or indulge in any unfair trade practices including market manipulation. This includes the following: >ffect take part either directly or indirectly in transactions which are likely to have effect of artificially raising or depressing the prices of spot7 derivatives contracts. #ndulge in any act which is calculated to create a false or misleading appearance of trading resulting in reflection of prices which are not genuine. -uy sell commodities7 contracts on his own behalf or on behalf of a person associated with him pending the e%ecution of the order of his constituent or of his company or director for the same contract. 9elay the transfer of commodities in the name of the transferee. #ndulge in falsification of his books accounts and records for the purpose of market manipulation. )hen acting as an agent e%ecute a transaction with a constituent at a price other than the price at which it was e%ecuted on the e%change. >ither take opposite position to an order of a constituent or e%ecute opposite orders which he is holding in respect of two constituents e%cept in the manner laid down by the e%change.

"learing !s mentioned earlier Aational Securities Clearing Corporation Cimited 4ASCCC6 undertakes clearing of trades e%ecuted on the AC9>G. !ll deals e%ecuted on the >%change are cleared and settled by the trading members on the settlement date by the trading members themselves as clearing members or through other professional clearing members in accordance with these regulations bye laws and rules of the e%change. Cast day of trading Cast trading day for a derivative contract in any commodity is the date as specified in the respective commodity contract. #f the last trading day as specified in the respective commodity contract is a holiday the last trading day is taken to be the previous working day of e%change.

Anil Suvarna 60

Commodity Market &n the e%piry date of contracts the trading members7 clearing members have to give delivery information as prescribed by the e%change from time to time. #f a trading member7 clearing member fails to submit such information during the trading hours on the e%piry date for the contract the deals have to be settled as per the settlement calendar applicable for such deals in cash together with penalty as stipulated by the e%change. 9elivery 9elivery can be done either through the clearing house or outside the clearing house. &n the e%piry date during the trading hours the e%change provides a window on the trading system to submit delivery information for all open positions. !fter the trading hours on the e%piry date based on the available information the matching for deliveries takes placefirstly on the basis of locations and then randomly keeping in view the factors such as available capacity of the vault7 warehouse commodities already deposited and demateriali0ed and offered for delivery and any other factor as may be specified by the e%change from time to time. Matching done is binding on the clearing members. !fter completion of the matching process clearing members are informed of the deliverable 7 receivable positions and the unmatched positions. (nmatched positions have to be settled in cash. The cash settlement is only for the incremental gain7 loss as determined on the basis of the final settlement price. !ll matched and unmatched positions are settled in accordance with the applicable settlement calendar. The e%change may allow an alternate mode of settlement between the constituents directly provided that both the constituents through their respective clearing members notify the e%change before the closing of trading hours on the e%piry date. They have to mention their preferred identified counter-party and the deliverable 'uantity along with other details re'uired by the e%change. The e%change however is not be responsible or liable for such settlements or any conse'uence of such alternate mode of settlements. #f the information provided by the buyer7 seller clearing members fails to match then the open position would be settled in cash together with penalty as may be stipulated by the e%change. The clearing members are allowed to deliver their obligations before the pay in date as per applicable settlement calendar whereby the clearing house can reduce the margin re'uirement to that e%tent. The e%change specifies the parameters and methodology for premium7 discount as the case may be from time to time for the 'uality7 'uantity differential sales ta% ta%es government levies7 fees if any. ?ay in7 ?ay out for such additional obligations are settled on the supplemental settlement date as specified in the settlement calendar. Procedure for payment of sales tax3A+! The e%change prescribes procedure for payment of sales ta%7Q!T or any other state7local7central ta%7fee applicable to the deals culminating into sale with physical Anil Suvarna 61

Commodity Market delivery of commodities. !ll members have to ensure that their respective constituents who intend to take or give delivery of commodity are registered with sales ta% authorities of all such states in which the e%change has a delivery center for a particular commodity in which constituent has or is e%pected to have open positions. Members have to maintain records7details of sales ta% registration of each of such constituent and furnish the same to the e%change as and when re'uired. The seller is responsible for payment of sales ta%7Q!T however the seller is entitled to recover from the buyer the sales ta% and other ta%es levied under the local state sales ta% law to the e%tent permitted by law. #n no event is the e%change7 clearing house liable for payment of sales ta%7 Q!T or any other local ta% fees levies etc. Penalties for defaults #n the event of a default by the seller or the buyer in delivery of commodities or payment of the price the e%change closes out the derivatives contracts and imposes penalties on the defaulting buyer or seller as the case may be. #t can also use the margins deposited by such clearing member to recover the loss. The settlement for the defaults in delivery is to be done in cash within the period as prescribed by the e%change at the highest price from the last trading date till the final settlement date with a mark up thereon as may be decided from time to time. Process of dematerialiHation 9emateriali0ation refers to issue of an electronic credit instead of a vault7 warehouse receipt to the depositor against the deposit of commodity. !ny person 4a constituent6 seeking to demateriali0e a commodity has to open an account with an approved depository participant 49?6. The e%change provides the list of approved 9?s from time to time. #n case of commodities 4other than precious metals6 the constituent delivers the commodity to the e%change-approved warehouses. The commodity brought by the constituent is checked for the 'uality by the e%change-approved assayers before the deposit of the same is accepted by the warehouse. #f the 'uality of the commodity is as per the norms defined and notified by the e%change from time to time the warehouse accepts the commodity and sends confirmation in the re'uisite format to the 5 R T agent who upon verification confirms the deposit of such commodity to the depository for giving credit to the demat account of the said constituent. #n case of precious metals the commodity must be accompanied with the assayers/ certificate. The vault accepts the precious metal after verifying the contents of assayersW certificate with the precious metal being deposited. &n acceptance the vault issues an acknowledgement to the constituent and sends confirmation in the re'uisite Anil Suvarna 62

Commodity Market format to the 5 R T agent who upon verification confirms the deposit of such precious metal to the depository for giving credit to the demat account of the said constituent. Aalidity date #n case of commodities having validity date assigned to it by the approved assayer the delivery of the commodity upon e%piry of validity date is not considered as a good delivery. The clearing member has to ensure that his concerned constituent removes the commodities on or before the e%piry of validity date for such commodities. For the depository commodities which have reached the trading validity date are moved out of the electronic deliverable 'uantity. Such commodities are suspended from delivery. The constituent has to remateriali0e such 'uantity and remove the same from the warehouse. Failure to remove deliveries after the validity date from warehouse is levied with penalty as speciDed by the relevant authority from time to time.

Process of rematerialiHation 5e-materiali0ation refers to issue of physical delivery against the credit in the demat account of the constituent. The constituent seeking to remateriali0e his commodity holding has to make a re'uest to his 9? in the prescribed format and the 9? then routes his re'uest through the depository system to the 5 RT agent issues the authori0ation addressed to the vault7 warehouse to release physical delivery to the constituent. The vault7warehouse on receipt of such authori0ation releases the commodity to the constituent or constituent/s authori0ed person upon verifying the identity. Delivery through the depository clearing system 9elivery in respect of all deals for the clearing in commodities happens through the depository clearing system. The delivery through the depository clearing system into the account of the buyer with the depository participant is deemed to be delivery notwithstanding that the commodities are located in the warehouse along with the commodities of other constituents. Payment through the clearing bank ?ayment in respect of all deals for the clearing has to be made through the clearing bank4s6@ ?rovided however that the deals of sales and purchase e%ecuted between different constituents of the same clearing member in the same settlement shall be offset by process of netting to arrive at net obligations. Anil Suvarna 63

Commodity Market "learing and settlement process The relevant authority from time to time fi%es the various clearing days the pay-in and pay-out days and the scheduled time to be observed in connection with the clearing and settlement operations of deals in commodities7 futures contracts. Settlement obligations statements for %CMs3 The e%change generates and provides to each trading clearing member settlement obligations statements showing the 'uantities of the different kinds of commodities for which delivery7 deliveries is7 are to be given and7 or taken and the funds payable or receivable by him in his capacity as clearing member and by professional clearing member for deals made by him for which the clearing Member has confirmed acceptance to settle. The obligations statement is deemed to be confirmed by the trading member for which deliveries are to be given and7 or taken and funds to be debited and7 or credited to his account as specified in the obligations statements and deemed instructions to the clearing banks7 institutions for the same. Settlement obligations statements for PCMs3 The e%change7 clearing house generates and provides to each professional clearing member settlement obligations statements showing the 'uantities of the different kinds of commodities for which delivery7 deliveries is7 are to be given and7 or taken and the funds payable or receivable by him. The settlement obligation statement is deemed to have been confirmed by the said clearing member in respect of every and all obligations enlisted therein. Delivery of commodities -ased on the settlement obligations statements the e%change generates delivery statement and receipt statement for each clearing member. The delivery and receipt statement contains details of commodities to be delivered to and received from other clearing members the details of the corresponding buying7 selling constituent and such other details. The delivery and receipt statements are deemed to be confirmed by respective member to deliver and receive on account of his constituent commodities as specified in the delivery and receipt statements. &n respective pay-in day clearing members effect depository delivery in the depository clearing system as per delivery statement in respect of depository deals. 9elivery has to be made in terms of the delivery units notified by the e%change. Commodities which are to be received by a clearing member are delivered to him in the depository clearing system in respect of depository deals on the respective pay-out day as per instructions of the e%change7 clearing house. Anil Suvarna 64

Commodity Market Delivery units The e%change specifies from time to time the delivery units for all commodities admitted to dealings on the e%change. >lectronic delivery is available for trading before e%piry of the validity date. The e%change also specifies from time to time the variations permissible in delivery units as per those stated in contract specifications. Depository clearing system The e%change specifies depository through which depository delivery can be effected and which shall act as agents for settlement of depository deals for the collection of margins by way of securities for all deals entered into through the e%change for any other commodities movement and transfer in a depository between clearing members and the e%change and between clearing member to clearing member as may be directed by the relevant authority from time to time. >very clearing member must have a clearing account with any of the 9epository ?articipants of specified depositories. Clearing Members operate the clearing account only for the purpose of settlement of depository deals entered through the e%change for the collection of margins by way of commodities for deals entered into through the e%change. The clearing member cannot operate the clearing account for any other purpose. Clearing members are re'uired to authori0e the specified depositories and depository participants with whom they have a clearing account to access their clearing account for debiting and crediting their accounts as per instructions received from the e%change and to report balances and other credit information to the e%change.

>ules governing investor grievances, arbitration

#n matters where the e%change is a party to the dispute the civil courts at Mumbai have e%clusive 8urisdiction and in all other matters proper courts within the area covered under the respective regional arbitration center have 8urisdiction in respect of the arbitration proceedings falling7 conducted in that regional arbitration center. For the purpose of clarity we define the following: Arbitrator means a sole arbitrator or a panel of arbitrators. Applicant means the person who makes the application for initiating arbitral proceedings. -espondent means the person against whom the applicant lodges an arbitration application whether or not there is a claim against such person. #f the value of claim difference or dispute is more than 5s.23 Cakh on the date of application then such claim difference or dispute are to be referred to a panel of three Anil Suvarna 65

Commodity Market arbitrators. #f the value of the claim difference or dispute is up to 5s.23 Cakh then they are to be referred to a sole arbitrator. )here any claim difference or dispute arises between agent of the member and client of the agent of the member in such claim difference or dispute the member to whom such agent of the member is affiliated is impeded as a party. #n case the warehouse refuses or fails to communicate to the constituent the transfer of commodities the date of dispute is deemed to have arisen on The date of receipt of communication of warehouse refusing to transfer the commodities in favour of the constituent. The date of e%piry of 3 days from the date of lodgment of demateriali0ed re'uest by the constituent for transfer with the seller whichever is later.

Procedure for arbitration The applicant has to submit to the e%change application for arbitration in the specified form 4Form Ao. #7#!6 along with the following enclosures: The statement of case 4containing all the relevant facts about the dispute and relief sought6. The statement of accounts. Copies of member-constituent agreement. Copies of the relevant contract notes invoice and delivery challan..

The !pplicant has to also submit to the e%change the following along with the arbitration form: ! che'ue7 pay order7 demand draft for the deposit payable at the seat of arbitration in favour of Aational Commodity R 9erivatives >%change Cimited. Form Ao. ##7##! containing list of names of the persons eligible to act as arbitrators. #f any deficiency7 defect in the application is found the e%change calls upon the applicant to rectify the deficiency7 defect and the applicant must rectify the deficiency7 defect within *3 days of receipt of intimation from the e%change. #f the applicant fails to rectify the deficiency7 defect within the prescribed period the e%change returns the deficient7 defective application to the applicant. $owever the applicant has the right to Dle a revised application which will be considered as a fresh application for all purposes and dealt with accordingly. (pon receipt of Form Ao. #7#! the e%change forwards a copy of the statement of case and related documents to the respondent. The respondent then has to submit Form ##7##! to the e%change within P days from the date of receipt. #f the respondent fails to submit Form Anil Suvarna 66

Commodity Market ##7##! within the time period prescribed by the e%change then the arbitrator is appointed in the manner as specified in the regulation. The respondent4s6 should within *3 days from the date of receipt of Form Ao. #7#! from the e%change submit to the e%change in Form Ao. ###7###! three copies in case of sole arbitrator and five copies in case of panel of arbitrators along with the following enclosures: The statement of reply 4containing all available defences to the claim6 The statement of accounts Copies of the member constituent agreement. Copies of the relevant contract notes invoice and delivery challan Statement of the set-off or counter claim along with statements of accounts and copies of relevant contract notes and bills The respondent has to also submit to the e%change a che'ue7 pay order7 demand draft for the deposit payable at the seat of arbitration in favour of Aational Commodity R 9erivatives >%change Cimited along with Form Ao.###7###! #f the respondent fails to submit Form ###7###! within the prescribed time then the arbitrator can proceed with the arbitral proceedings and make the award e%-parte. (pon receiving Form Ao. ###7###! from the respondent the e%change forwards one copy to the applicant. The applicant should within ten days from the date of receipt of copy of Form ###7###! submit to the e%change a reply to any counterclaim if any which may have been raised by the respondent in its reply to the applicant. The e%change then forwards the reply to the respondent. The time period to Dle any pleading referred to herein can be e%tended for such further periods as may be decided by the relevant authority in consultation with the arbitrator depending on the circumstances of the matter.

'earings and arbitral award

Ao hearing is re'uired to be given to the parties to the dispute if the value of the claim difference or dispute is 5s.23 ::: or less. #n such a case the arbitrator proceeds to decide the matter on the basis of documents submitted by both the parties provided. $owever the arbitrator for reasons to be recorded in writing may hear both the parties to the dispute. #f the value of claim difference or dispute is more than 5s.23 ::: the arbitrator offers to hear the parties to the dispute unless both parties waive their right for such hearing in writing. The e%change in consultation with the arbitrator determines the date the time and place of the Drst hearing. Aotice for the first hearing is given at least ten days in advance unless the parties by their mutual consent waive the notice. The arbitrator determines the date the time and place of subse'uent hearings of which the e%change gives a notice to the parties concerned. #f after the appointment of an arbitrator the parties settle the dispute Anil Suvarna 67

Commodity Market then the arbitrator records the settlement in the form of an arbitral award on agreed terms. !ll fees and charges relating to the appointment of the arbitrator and conduct of arbitration proceedings are to borne by the parties to the reference e'ually or in such proportions as may be decided by the arbitrator. The costs if any are awarded to either of the party in addition to the fees and charges as decided by the arbitrator.

Product .otes on "ommodities ? &D

Description
Hold is a brilliant yellow precious metal that is resistant to air and water corrosion. #t is a very soft and pure metal 42, Mt.6. Hold is the most malleable and ductile metal found on earth. ThatWs why it is e%pensive and it is alloyed with other metals usually copper and silver to make it less e%pensive and harder. ! karat is the unit that measures the purity of gold 8ewelry or else it is hallmarked with a three-digit number that indicates the parts per thousand of gold. Some countries hallmark gold with a three-digit number that indicates the parts per thousand of gold. The alloyed gold comes in many colors and may not be bright yellow all the time.

verview
Hold is traded as a commodity but primarily it is a monetary asset. #t counts up to more than =3E of gold/s total accumulated holdings when it comes to /value for investmentW by central bank reserves private players and high-carat 8ewelry. The remaining accumulated gold deposits are as a /commodity/ for 8ewelry in )estern markets and usage in industry. #t is a highly li'uid market. #t is argued that the real price of gold is should be driven by stock e'uilibrium rather than flow e'uilibrium due to large stocks of Hold as against its demand. )orldWs largest gold producing country is South !frica with B1, tons in 2::*. &n the other hand world/s largest gold consuming country is #ndia with an annual demand of +,B.2 tonnes comprising of 2=.2E of total world demands. )orldWs gold demand is constantly increasing and it is nearing record levels at ,::: tonnes per year while the mine production is constant at 223: tonnes per annum 4Source: )orld Hold Council6 The gold prices are moving upwards due to the reduction in production level as compared to the demand and also due to the weakening economy of the (S.

Anil Suvarna 68

Commodity Market #t has been found out the total world gold production would decline about B:E over the ne%t P years as the new discoveries in the ma8or gold producing countries have become difficult e%pensive and time consuming according to the studies done by The )orld -ank and -eacon Hroup.

'istory Since ancient times gold has always been an important asset and a value store. Hold was used as an e%change medium even before the 5oman >mpire e%isted. The gold was also used for currency by Chinese and $indu cultures. This shows that the gold was used not only by the western cultures but the eastern cultures also. Hreat -ritain started the suit by adopting a gold-backed paper currency and the rest of the industriali0ed world followed this. The (nited States also started using gold in its currency and by the end of *1BB the (nited States 9ollar was e'ual to *72:th of an ounce of gold. Hold backed up the (nited States 9ollar under an agreement known as the -retton )oods agreement. (nder this agreement a specific value of gold tied the 9ollar and also the other global currencies. This specific value was SB37o0 of gold from *1B, to *1=+. That made it illegal for the citi0ens of the (S to own gold so that the level of gold and subse'uently the value of dollar could be protected. )hen the Hold Standard was evocated it became a popular investment medium and it led to risen gold prices to S+::7o0 from SB37o0. Since then no matter whatever happened be it famines floods or even world wars goldWs importance as an investment medium hasnWt changed at all. Since *Pth century Condon has been the center of gold trading. #t was because the gold was brought to Condon for refining and distribution purposes. Meanwhile it began a method for disseminating the price of Hold known as the TFi%T in *1*1 as the center of distribution. The price at which the most buy and sell orders of the members or Fi%ing Seat $older/s match or balance is known as the Fi%. ! large volume of physical Hold can be bought or sold at a single clearly posted price the fi%. The fi% is a benchmark price for many transactions worldwide whether for mines fabricators or central banks because it is undisputed prices at which all si% of the largest Hold trading houses are willing do business. History of gold in "ndia

Anil Suvarna 69

Commodity Market ?rior to *1=2 #ndia was the world/s largest gold market and the main trading center was -ombay. #n *1=2 the government enacted the Hold Control !ct which prohibited the citi0ens of #ndia from holding pure gold bars and coins due to loss of reserves during the indo-china war. #t was declared that the old holdings in pure gold had to be compulsorily converted into 8ewelry. ?ure gold bars and coins were to be dealt only by licensed dealers. ! large unofficial market sprung up which dealt in cash only as a conse'uence of this legislation that adversely affected the official gold market. This also made way for smuggling and black marketing which comprised of many 8ewelers and bullion traders. #n *11: #ndia was on a verge of default of e%ternal liabilities as it had a ma8or foreign e%change problem. #t had to give up the concept of controlling and licensing as it led to nothing more than corruption and shortages. !s a result the #ndian government pledged ,: tonnes from their gold reserves with the -ank of >ngland. #ndia had to adopt the concept of liberali0ation. The government abolished the *1=2 Hold Control !ct in *112 and liberali0ed the import of gold in #ndia for a duty payment of 5s. 23: per *: grams. The government made up for the foreign e%change problem by allowing free imports and earning the ta%es. This step e%panded the gold market and it also waved off the unofficial trade i.e. smuggling and black marketing. This makes #ndia the most price-sensitive market for gold in the world. ?old producing countries South !frica Canada (0bekistan Chile (nited States 5ussia ?apua Aew Huinea ?hilippines !ustralia #ndonesia Hhana Mali China ?eru -ra0il Me%ico

The largest producer of Hold is South !frica. #t accounts for an estimated *=.3 million ounces of Hold annually in the ne%t B years@ and produces almost 2: percent of the worldWs bullion. $oping to control its declining production trend due to the e%tended weakness in the price of Hold in recent years the South !frican Hold #ndustry is working in the direction to lower its production costs and boost productivity. The second largest producer of gold is (nited States. #t accounts for an estimated *:., million ounces of Hold annually by 2::* and produces about *2.3E of the worldWs Hold supply. 9ue to the e%pansion (S Mining operations and because of the reduced profitability due to the low price of Hold reduction in mine production is e%pected by 1E by the (S during the ne%t three years. The third largest producer of gold is !ustralia with an estimated 1.= million ounces annual production by 2::*. Aearly ,3E of the world Hold supply was produced by the top three producing nations. Anil Suvarna 70

Commodity Market Catin !merica 4Me%ico ?eru Chile and -ra0il6 and the Far >ast producers are e%pected to increase production in the ne%t three years. Though these countries add up to a very small share in worldWs total supply their production increase will counteract some of the production cuts made by the top three big producers.

Production of gold in India

Hold holdings in #ndia are estimated to be in the range of *::::-*B::: tonnes and are predominantly private. #ndiaWs gold consumption is 23E of worldWs total gold production. #ndia has a very limited gold production of around 1 tonnes in 2::2The domestic production of the gold is very limited which is around 1 tonnes in 2::2 including 2.1,: tonnes from mines and =.2:B tonnes from -irla Copper More than =:E of #ndian consumption is met through imports The availability of recycled Hold is price sensitive and the fabricated old Hold scraps is price elastic and was estimated to be near ,3: tonnes in 2::2 rose almost more than ,:E.

Indian gold market

Hold comes second after bank deposits when it comes to the preference for investment in #ndia and considered a savings and investment vehicle. #ndia is the world/s largest consumer of gold in 8ewelry as investment. The commercial banks were authori0ed to import gold from 8ewelers and e%porters for sale or loan in *11P by the 5-#. #n #ndia *B banks are involved in the imports of gold currently. !s a result the difference in international and domestic prices is reduced from 3PE during *1+= to *11* to +.3 percent in 2::*. #n #ndian society the gold hoarding tendency is well ingrained. Monsoon harvest and marriage season dictates the domestic consumption. #ndian 8ewelry is highly volatile and sensitive. Stock market and a wide range of consumer goods are providing competition to gold in cities. !s compared to the rest of the world facilities for refining assaying making them into standard bars in #ndia are insignificant both 'ualitatively and 'uantitatively.

Market Moving Factors

5eclaimed scrap and official gold loans 4!bove ground supply from sales by central banks6 ?roducer 7 miner hedging interest. )orld macro-economic factors - (S 9ollar #nterest rate. Comparative returns on stock markets 9omestic demand based on monsoon and agricultural output. Anil Suvarna 71

Commodity Market emand and Supply patterns in "ndia HoldWs total consumer demand is more than B,:: tonnes per year i.e. S,: billion worth. ?redominated by females "ewelry is form of gold in which more than +:E of the gold is consumed while bars and coins occupy not higher than *:E of the Hold consumed. #ndia demand about +:: tonnes of gold which makes the largest market in the world followed by (S! Middle >ast and China. #ndia is also the largest repository of gold in terms of total gold within the national boundaries.

2ears *11= *11P *11+ *111 2::: 2::*

Indian !otal $orld Indian demand as E of demand demand the total Demand 3:+ PBP +*3 +B1 +B: +,B 2P+: B:3, 2P*, B2+, B2=, B2*+ *+E 2,E B:E 23E 23E 2=E

+verage price />s per 4= grams0 3*1* ,33= ,*+2 ,B2P ,3*+ ,:+:
#igures in metric tons

5egarding pattern of demand about +:E of gold is demanded for 8ewelry fabrication and *3E for investor-demand and barely 3 E for industrial uses. The demand for Hold 8ewelry is dependent on various factors- religions rituals preference of wealth for women and hedging against inflation. These factors are difficult to prioriti0e but it can be said that the demand for 8ewelry is a combined effect of all the factors and placing any one of these factors as the most important would not be realistic. More than P:E of the Hold consumed in #ndia is consumed by the rural #ndia. Hold and Silver 8ewelry forms a ma8or component of the gifts given to a woman at the time of marriage in the $indu "ain and Sikh community. ThatWs why gold play an important role in marriage and religious festivals in #ndia. The average gifts estimated would not be less than *:: grams of gold per marriage. This has led to the making the Hold market to the si0e of 3:: tonnes on an average ten millions marriage per annum. Temple system in #ndia also occupies a significant position where gold is used to prepare idols and devotees offer gold in temple. Thus we can say that a ma8or portion of the gold demand in #ndia lies n the current social and cultural systems and it is taken into account in the formulation of government policies. !ccording to the )orld Hold #nstitute/s !nnual ?roduction report in 2::* the world gold mine production has reached +B.3 million ounces as result of Anil Suvarna 72

Commodity Market subse'uent increase of one percent a year between *11+ and 2::*. This is in contrast to that of increase in *1+: when mine production increased from ,* million ounces to =3 million ounces. !s a conse'uence production has gone slow and emphasis is on lowering the production costs. This change in emphasis is e%pected to reduce the total production of Hold by *3 million ounces in the ne%t three years. *a1or trading centers of gold

Condon 4clearing house6 Aew Vork 4home of futures trading6 \urich 4physical turntable6 #stanbul 9ubai Singapore and $ong Mong 4doorways to important consuming regions6 Tokyo Mumbai 4#ndia/s liberali0ed gold regime6

$ote: %ore &etail 'roduct $ote will be &iscuss brief in the Coming Sections

Anil Suvarna 73