Sagar

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International Journal of Research in Management &
Business Studies (IJRMBS 2014)
2014 IJRMBS, All Rights Reserved
38
Vol. 1 Issue 2 April - June 2014
ISSN : 2348-6503 (Online)
ISSN : 2348-893X (Print)
Commodity Futures Market in India: The Legal Aspect
and its Rationale
Sagar Suresh Dhole
PhD Scholar (LLB, MBA), Nagpur University, India
I. Overview of Commodity Market
A commodity market is a market that trades in primary rather
than manufactured products. Soft commodities are agricultural
products such as wheat, coffee, cocoa, sugar etc. Hard commodities
are mined, such as (Precious metal, rubber, oil,etc). Investors
access about 50 major commodity markets worldwide with purely
fnancial transactions increasingly outnumbering physical trades in
which goods are delivered. Futures contracts are the hoariest way
of investing in commodities. Futures are secured by physical assets.
Commodity markets can include physical trading and derivatives
trading using spot prices, forwards, futures, and options on futures.
Farmers have used a simple form of derivative trading in the
commodity market for centuries for price risk management.
A fnancial derivative is a fnancial instrument whose value is
derived from a commodity termed an underlier. Derivatives are
either exchange-traded or over-the-counter (OTC). An increasing
number of derivatives are traded via clearing houses some with
Central Counterparty Clearing, which provide clearing and
settlement services on a futures exchange, as well as off-exchange
in the OTC market. Derivatives such as futures contracts, Swaps,
Exchange-traded Commodities (ETC), forward contracts have
become the primary trading instruments in commodity markets.
Futures are traded on regulated commodities exchanges. Over-
the-counter (OTC) contracts are "privately negotiated bilateral
contracts entered into between the contracting parties directly" .
Exchange-traded funds (ETFs) began to feature commodities in
2003. ETFs is a security that tracks an index, a commodity or a
basket of assets like an index fund, but trades like a stock on an
exchange. ETFs experience price changes throughout the day
as they are bought and sold. Gold ETFs are based on "electronic
gold" that does not entail the ownership of physical bullion, with
its added costs of insurance and storage in repositories such as the
London bullion market. According to the World Gold Council,
ETFs allow investors to be exposed to the gold market without
the risk of price volatility associated with gold as a physical
commodity.
II. Development of the Commodity Market in India
Commodity trading in India has a long history. The Indian
experience in commodity futures market dates back to thousands
of years. References to such markets in India appear in Kautialyas
Arthasastra. The words, Teji, Mandi, Gali, and Phatak
have been commonly heard in Indian markets for centuries which
seem to be coined in 320 BC. The Arthashastra is an ancient
Indian treatise on statecraft, economic policy and military strategy,
written in Sanskrit whereby it is found that Commodity Futures
did existed in ancient times related to agricultural produce,
Precious metals and Animals. India has an elongated history of
trading commodities and considered the pioneer in some forms
of derivatives trading. In fact, commodity trading in India started
much before it started in many other countries. The frst organized
futures market was however established in 1875 under the aegis
of the Bombay Cotton Trade Association to trade in cotton
contracts. This was followed by establishment of futures markets
in edible oilseeds complex, raw jute and jute goods and bullion.
This became an active industry with volumes reported to be large.
Futures trading in oilseeds were organized in India for the frst
time with the setting up of Gujarati Vyapari Mandali in 1900,
which carried on futures trading in groundnut, castor seed and
cotton. Before the Second World War broke out in 1939 several
futures markets in oilseeds were functioning in Gujarat and
Punjab. Futures trading in Raw Jute and Jute Goods began in
Abstract
The history of commodity Futures market in India dates back to the ancient times citied in Kautialyas Arthasastra, Words like,
Teji, Mandi, Gali, and Phatak have been commonly heard in Indian markets for centuries which seems to be coined in
320 BC and also referred in Forward Contracts (Regulation) Act, 1952 ;The frst organized futures market in India was however
established in 1875 under the aegis of the Bombay Cotton Trade Association to trade in cotton contracts. This was followed by
establishment of futures markets in edible oilseeds complex, raw jute and jute goods and bullion. Post-independence, in the 1950s,
India continued to struggle with feeding its population and the government increasingly restricting trading in food commodities.
Just at the time the FMC Forward Markets Commission was established in 1953 under the provisions of the Forward Contracts
(Regulation) Act, 1952, the government felt that derivative markets increased speculation which led to increased costs and price
instabilities. However, by mid 1960s government took a drastic step by banning derivatives trade altogether. The commodity derivative
market remained virtually absent in next four decades and it made the restart only in early 2000s. The market has made gargantuan
evolvement in terms of technology, transparency and the trading activity. Intriguingly, this has transpired only after the Government
prohibition was removed from a number of commodities, and market forces were allowed to play their role. This should act as a
major lesson for the policy makers in developing countries, that pricing and price risk management should be left to the market
forces rather than trying to achieve these through administered price mechanisms. An elite effort have been made in this paper
to explain, the growth, the legal aspect and rationale of Commodity Futures Trading Market in India along with typical structure of
commodity futures markets in India.
Key Words
Commodity Futures market, Forward Contracts, Commodity Trading, and legal aspect.
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Calcutta with the establishment of the Calcutta Hessian Exchange
Ltd., in 1919. Later East Indian Jute Association Ltd. was set up
in 1927 for organizing futures trading in Raw Jute. These two
associations amalgamated in 1945 to form the present East India
Jute & Hessian Ltd., to conduct organized trading in both Raw
Jute and Jute goods. In case of wheat, futures markets were in
existence at several centres at Punjab and U.P. The most notable
amongst them was the Chamber of Commerce at Hapur, which
was established in 1913. Other markets were located at Amritsar,
Moga, Ludhiana, Jalandhar, Fazilka, Dhuri, Barnala and Bhatinda
in Punjab and Muzaffarnagar, Chandausi, Meerut, Saharanpur,
Hathras, Gaziabad, Sikenderabad and Barielly in U.P.
Futures market in Bullion began at Mumbai in 1920 and later
similar markets came up at Rajkot , Jaipur, Jamnagar , Kanpur,
Delhi and Calcutta. In due course several other exchanges were
also created in the country to trade in such diverse commodities as
pepper, turmeric, potato, sugar and gur (jaggory). The derivatives
trading in India however did not have uninterrupted legal approval.
By the Second World War, i.e., between the 1920s &1940s,
futures trading in organized form had commenced in a number
of commodities such as cotton, groundnut, groundnut oil, raw
jute, jute goods, castor seed, wheat, rice, sugar, precious metals
like gold and silver. During the Second World War futures trading
was prohibited under Defence of India Rules.
However, in 1935 a law was passed allowing the government to
in part restrict and directly control food production (Defence of
India Act, 1935). This included the ability to restrict or ban the
trading in derivatives on those food commodities.
Post-independence, in the 1950s, India continued to struggle with
feeding its population and the government increasingly restricting
trading in food commodities. Just at the time the FMC Forward
Markets Commission was established, the government felt that
derivative markets increased speculation which led to increased
costs and price instabilities. However, years of foreign rule,
droughts and periods of scarcity and Government policies caused
the commodity trading in India to diminish. Commodity trading
was, however, restarted in India recently. FMC, Established in
1953 under the provisions of the Forward Contracts (Regulation)
Act, 1952, it consists of two to four members, all appointed by the
Indian Government. Currently, the Commission allows commodity
trading in 22 exchanges in India, of which 6 are national. Futures
trading in commodities particularly, cotton, oilseeds and bullion,
was at its peak during this period. However following the scarcity
in various commodities, futures trading in most commodities was
prohibited in mid-sixties. There was a time when trading was
permitted only two minor commodities, viz., pepper and turmeric.
The long spell of prohibition had stunted growth and modernization
of the surviving traditional commodity exchanges. Therefore,
along with liberalization of commodity futures, the Government
initiated steps to cajole and incentives the existing Exchanges to
modernize their systems and structures. Faced with the grudging
reluctance to modernize and slow pace of introduction of fair and
transparent structures by the existing Exchanges, Government
allowed setting up of new modern, demutualised Nation-wide
Multi-commodity Exchanges with investment support by public
and private institutions. National Multi Commodity Exchange
of India Ltd. (NMCE) was the frst such exchange to be granted
permanent recognition by the Government Deregulation and
liberalization following the forex crisis in early 1990s, also triggered
policy changes leading to re-introduction of futures trading in
commodities in India. The growing realization of imminent
globalization under the WTO regime and non-sustainability of
the Government support to commodity sector led the Government
to explore the alternative of market-based mechanism, viz., futures
markets, to protect the commodity sector from price-volatility. In
April, 1999 the Government took a landmark decision to remove
all the commodities from the restrictive list. Food-grains, pulses
and bullion were not exceptions.
III. The Forward Markets Commission
The Forward Markets Commission (FMC) is the chief regulator
of forwards and futures markets in India. As of March 2009, it
regulated Rs 52 trillion worth of commodity trades in India. It is
headquartered in Mumbai and this fnancial regulatory agency is
overseen by the Ministry of Finance. The industry was pushed
underground and the prohibition meant that development and
expansion came to a halt. In the 1970 as futures and options
markets began to develop in the rest of the world, Indian
derivatives markets were left behind. The apprehensions about
the role of speculation, particularly in the conditions of scarcity,
prompted the Government to continue the prohibition well into
the 1980s.The result of the period of prohibition left India with a
large number of small and isolated regional futures markets. The
futures markets were dispersed and fragmented, with separate
trading communities in different regions with little contact
with one another. The exchanges had not yet embrace modern
technology or modern business practices.Next to the offcially
approved exchanges, there were also many havala markets. Most
of these unoffcial commodity exchanges have operated for many
decades. Some unoffcial markets trade 2030 times the volume
Organization Structure of Forward Markets Commission
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of the "offcial" futures exchanges. They offer not only futures,
but also option contracts. Transaction costs are low, and they
attract many speculators and the smaller hedgers. Absence of
regulation and proper clearing arrangements, however, meant
that these markets were mostly "regulated" by the reputation of
the main players.
A. Responsibilities and functions of Forward Markets
Commission:
The functions of the Forward Markets Commission are as
follows:
To advise the Central Government in respect of the recognition
or the withdrawal of recognition from any association or in
respect of any other matter arising out of the administration
of the Forward Contracts (Regulation) Act 1952.
To keep forward markets under observation and to take such
action in relation to them, as it may consider necessary, in
exercise of the powers assigned to it by or under the Act.
To collect and whenever the Commission thinks it necessary,
to publish information regarding the trading conditions in
respect of goods to which any of the provisions of the act is
made applicable, including information regarding supply,
demand and prices, and to submit to the Central Government,
periodical reports on the working of forward markets relating
to such goods;
To make recommendations generally with a view to improving
the organization and working of forward markets;
To undertake the inspection of the accounts and other
documents of any recognized association or registered
association or any member of such association whenever it
considers it necessary.
It allows futures trading in 23 Fibers and Manufacturers,15
spices, 44 edible oils, 6 pulses, 4 energy products, single
vegetable,20 metal futures,33 others Futures.
The commission appeared in the news in March 2012 for
their controversial ban on guar gum futures trading after it
said the price quadrupled due to its use in fracking causing
food infation.
B. Initiatives taken by the Commission
It may be mentioned that in the Commodity Futures Market, the
only product traded currently is futures contract. Options have
not been permitted. In order to ensure that the stakeholders have a
proper understanding of the functioning of commodity markets, the
Commission has undertaken various initiatives such as awareness
programmes, capacity building programmes, internships and other
activities for raising awareness about the commodity futures
market build capacities among the stakeholders. The details of
the initiatives during the past fve years are indicated below :
Details of The Initiatives During The Past Five Years
Collaboration with International Regulators
In order to strengthen co-operation with international regulators,
the FMC has taken steps for collaborating with regulators in
other countries. FMC is also an associate member of IOSCO, an
international organization of Security and Commodities Market
Regulators. In addition, FMC has also signed Memorandum
of Understanding with the United States Commodity Futures
Trading Commission (USCFTC) in October 2006, the China
Securities Regulatory Commission (CSRC) in November 2006
and the Commissao de Valores Mobiliarios CVM (Securities
and Exchange Commission of Brazil), in January 2010.
C. Overview of Enactment and the Committee
Recommendations
Today, apart from numerous regional exchanges, India has
six national commodity exchanges namely, Multi Commodity
Exchange (MCX), National Commodity and Derivatives Exchange
(NCDEX), National Multi-Commodity Exchange (NMCE) and
Indian Commodity Exchange (ICEX), the ACE Derivatives
exchange ( ACE )and the Universal commodity exchange (UCX).
The regulatory body is Forward Markets Commission (FMC)
which was set up in 1953.
Forward Contracts (Regulation) Act, 1952, provided for 3-tier
regulatory system;
(a) An association recognized by the Government of India on
the recommendation of Forward Markets Commission,
(b) The Forward Markets Commission (it was set up in September
1953) and
(c) The Central Government.
Forward Contracts (Regulation) Rules were notifed by the Central
Government in July 1954.
The Act divides the commodities into 3 categories with reference
to extent of regulation, viz:
(a) The commodities in which futures trading can be organized
under the auspices of recognized association.
(b) The Commodities in which futures trading is prohibited.
(c) Those commodities, which have neither been regulated for
being traded under the recognized association nor prohibited,
are referred as Free Commodities and the association
organized in such free commodities is required to obtain
the Certifcate of Registration from the Forward Markets
Commission.
In the seventies, most of the registered associations became
inactive, as futures as well as forward trading in the commodities
for which they were registered came to be either suspended or
prohibited altogether. The Khusro Committee (June 1980) had
recommended reintroduction of futures trading in most of the
major commodities, including cotton, kapas, raw jute and jute
goods and suggested that steps may be taken for introducing
futures trading in commodities, like potatoes, onions, etc. at
appropriate time. The government, accordingly initiated futures
trading in Potato during the latter half of 1980 in quite a few
markets in Punjab and Uttar Pradesh.
After the introduction of economic reforms since June 1991 and
the consequent gradual trade and industry liberalization in both
the domestic and external sectors, the Govt. of India appointed
in June 1993 one more committee on Forward Markets under
Chairmanship of Prof. K.N. Kabra. The Committee submitted its
report in September 1994. The majority report of the Committee
recommended that futures trading be introduced in:
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1) Basmati Rice
2) Cotton and Kapas
3) Raw Jute and Jute Goods
4) Groundnut, rapeseed/mustard seed, cottonseed, sesame seed,
sunfower seed, saffower seed, copra and soybean, and oils
and oilcakes of all of them.
5) Rice bran oil
6) Castor oil and its oilcake
7) Linseed
8) Silver
9) Onions.
The committee also recommended that some of the existing
commodity exchanges particularly the ones in pepper and
castor seed may be upgraded to the level of international futures
markets.
The liberalised policy being followed by the Government of India
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 July 2000 and the
announcements of Finance Minister in the Budget Speech for
2002-2003 were indicative of the Governments resolve to put
in place a mechanism of futures trade/market. As a follow up the
Government issued notifcations on 1.4.2003 permitting futures
trading in the commodities, with the issue of these notifcations
futures trading is not prohibited in any commodity. Options
trading in commodity are, however, presently prohibited.From
2013 September 09, the commission is overseen by the Ministry
of Finance. Since futures traded in India are traditionally on food
commodities, earlier it was overseen by Ministry of Consumer
Affairs, Food and Public Distribution (India).
IV. Regulatory Tools
The Commission has been keeping the commodity futures markets
well regulated. In order to protect market integrity, the Commission
has prescribed the following measures
1) Limit on open position of an individual members as well as
client to prevent over trading;
2) Limit on price fuctuation (daily/weekly) to prevent abrupt
upswing or downswing in prices;
3) Special margin deposits to be collected on outstanding
purchases or sales to curb excessive speculative activity
through fnancial restraints;
During shortages, extreme steps like skipping trading in certain
deliveries of the contract, closing the markets for a specifed period
and even closing out the contract to overcome emergency situations
are taken. In addition to the above measures, the regulator calls
for daily reports from the Exchanges and takes other pro-active
steps to ensure that there is no misuse of the market and that the
prices refected on the Exchange platform are governed by the
demand and supply factors in the physical markets. Thus, to check
excessive speculation and price volatility, the futures market in
commodities is kept under constant watch and surveillance.
The Khusro Committee (June 1980) had recommended
reintroduction of futures trading in most of the major commodities ,
including cotton, kapas, raw jute and jute goods and suggested that
steps may be taken for introducing futures trading in commodities,
like potatoes, onions, etc. at appropriate time. The government,
accordingly initiated futures trading in Potato during the latter half
of 1980, in a few markets in Punjab and Uttar Pradesh. Futures
trading were also resumed in castorseed, and gur (jaggery), and
in 1992, extended to Hessian (Jute). After the introduction of
economic reforms in June 1991 and the consequent trade and
industry liberalization in both the domestic and external sectors,
the Govt. of India appointed in June 1993, a committee on Forward
Markets under the Chairmanship of Prof. K.N. Kabra. The
Committee submitted its report in September 1994. The majority
view of the Committee was that futures trading be introduced
in Basmati Rice, Cotton and Kapas, Raw Jute and Jute Goods,
Groundnut, rapeseed/mustard seed , cottonseed , sesame seed ,
sunfower seed , saffower seed , copra and soybean oilseeds, oils
and their oilcakes, Rice bran oil, Castor oil and its oilcake, Linseed,
Silver and Onion. The Committee also recommended that some of
the existing commodity exchanges particularly those with futures
trading in pepper and castor seed, may be upgraded to the level of
international futures markets. In April 1999, futures trading was
permitted in various edible oilseed complexes.
The National Agriculture Policy announced in July 2000 and the
announcements of Honble Finance Minister in the Budget Speech
for 2002-2003 indicated the Governments resolve to put in place
a mechanism of futures trade/market. Futures trading in sugar was
permitted in May 2001 and the Government issued notifcations on
1.4.2003 permitting futures trading in all the commodities. With
the issue of these notifcations, futures trading is not prohibited
in any commodity. Options trading in commodity is, however,
presently prohibited.
A. Characteristics of Futures Trading :
Futures Contract is a highly standardized contract with certain
distinct features. Some of the important features are as under :
a) Futures trading is necessarily organized under the auspices
of a market association so that such trading is confned to or
conducted through members of the association in accordance
with the procedure laid down in the Rules & Bye-laws of
the association.
b) It is invariably entered into for a standard variety known as
the "basis variety" with permission to deliver other identifed
varieties known as "tenderable varieties".
c) The units of price quotation and trading are fxed in these
contracts , parties to the contracts not being capable of
altering these units.
d) The delivery periods are specifed.
e) The seller in a futures market has the choice to decide whether
to deliver goods against outstanding sale contracts. In case he
decides to deliver goods, he can do so not only at the location
of the Association through which trading is organized but
also at a number of other pre-specifed delivery centres.
f) In futures market actual delivery of goods takes place only in a
very few cases. Transactions are mostly squared up before the
due date of the contract and contracts are settled by payment
of differences without any physical delivery of goods taking
place.
B. Commodities exchange:
A commodities exchange is an exchange where various
commodities and derivatives are traded. Most commodity markets
across the world trade in agricultural products and other raw
materials (like wheat, barley, sugar, maize, cotton, Cocoa bean/
cocoa, coffee, milk products, pork bellies, oil, metals, etc.) and
contracts based on them. These contracts can include spot prices,
forwards, futures and options on futures. Other sophisticated
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products may include interest rates, environmental instruments,
swaps, or freight contracts.
C. Exchange-Traded Commodity
Exchange-traded commodity is a term used for commodity
exchange-traded funds (which are funds) or commodity exchange-
traded notes (which are notes). These track the performance of an
underlying commodity index including total return indices based
on a single commodity. They are similar to ETFs and traded and
settled exactly like stock funds. ETCs have market maker support
with guaranteed liquidity, enabling investors to easily invest in
commodities.
They were introduced in 2003. At first only professional
institutional investors had access, but online exchanges opened
some ETC markets to almost anyone. ETCs were introduced
partly in response to the tight supply of commodities in 2000,
combined with record low inventories and increasing demand
from emerging markets such as China and India Exchange-traded
commodity is a term used for commodity exchange-traded funds
(which are funds) or commodity exchange-traded notes (which are
notes). These track the performance of an underlying commodity
index including total return indices based on a single commodity.
They are similar to ETFs and traded and settled exactly like stock
funds. ETCs have market maker support with guaranteed liquidity,
enabling investors to easily invest in commodities. They were
introduced in 2003.
Derivatives are fnancial evolved from simple commodity future
contracts into a diverse group of fnancial instruments that apply to
every kind of asset, including mortgages, insurance and many more.
Futures contracts, Swaps (1970s-), Exchange-traded Commodities
(ETC), forward contracts, etc. are examples. They can be traded
through formal exchanges or through Over-the-counter (OTC).
Commodity market derivatives unlike credit default derivatives
for example, are secured by the physical assets or commodities.
D. Over-the-counter (OTC) commodities derivatives
Over-the-counter (OTC) commodities derivatives trading
originally involved two parties, without an exchange. Exchange
trading offers greater transparency and regulatory protections. In
an OTC trade, the price is not generally made public. OTC are
higher risk but may also lead to higher profts. Between 2007 and
2010, global physical exports of commodities fell by 2%, while
the outstanding value of OTC commodities derivatives declined by
two-thirds as investors reduced risk following a fve-fold increase
in the previous three years.
Money under management more than doubled between 2008 and
2010 to nearly $380 billion. Infows into the sector totaled over
$60 billion in 2010, the second highest year on record, down from
$72bn the previous year. The bulk of funds went into precious
metals and energy products. The growth in prices of many
commodities in 2010 contributed to the increase in the value of
commodities funds under management.
Let us discuss few vital terminologies associated with the
Commodity Futures market:
Forward contract
A Forward contract is an agreement between two parties to
exchange at some fxed future date a given quantity of a commodity
for a price defned when the contract is fnalized. The fxed price
is known as the forward price. Such forward contracts began as
a way of reducing pricing risk in food and agricultural product
markets, because farmers knew what price they would receive for
their output. Forward contracts for example, were used for rice in
seventeenth century Japan.
Futures contracts
Futures contracts are standardized forward contracts that are
transacted through an exchange. In futures contracts the buyer
and the seller stipulate product, grade, quantity and location and
leaving price as the only variable. Agricultural futures contracts
are the oldest, in use in the United States for more than 170 years.
Modern futures agreements, began in Chicago in the 1840s,
with the appearance of the railroads. Chicago, centrally located,
emerged as the hub between Midwestern farmers and east coast
consumer population centers.
Swaps
A Swaps is a derivative in which counterparties exchange the cash
fows of one party's fnancial instrument for those of the other
party's fnancial instrument. They were introduced in the 1970s.
Source: International Trade Centre
V. Futures Trading and Inflation
The price of any commodity is determined by the actual
demand and supply position in the market. In an open market
situation, prices are bound to fuctuate either way, depending on
the additional information/data which infuences expectations
of market participants, relating to future demand and supply
conditions. The futures market does not alter the basic condition
of demand and supply but merely estimates the prices based on
the actual and expected demand and supply factors. The demand
and supply conditions also infuence prices of commodities in
which there is no futures trading. The demand supply gap causes
price rise in such commodities too. Therefore, futures trading is
not responsible for increase in the prices of commodities. The RBI
conducted a detailed study (Annual Report 2009-10) of the futures
market since the start of the electronic commodity trading. The
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empirical analysis using the monthly data for the period 2004 to
2009 revealed that several commodities which are not traded in
the commodities exchange, such as vegetables, fruits and milk,
exhibited signifcant price increases during the year 2009-2010.
Moreover, certain commodities that were suspended for trading in
2007, such as rice, wheat, tur and urad, also exhibited signifcant
price increases subsequently. In conclusion, the report stated
that commodity prices in India seem to be infuenced more by
other drivers of price changes, particularly demand-supply gap
in specifc commodities, the degree of dependence on imports
and international price movements in these commodities. The
Committee set up by the Government under the Chairmanship of
Prof. AbhijitSen (report submitted in April 2008) also could not
fnd any conclusive causal relationship between futures trading
& infation.
VI. Structure, Conduct & Current Status
Broadly, the commodities market exists in two distinct forms
the over-the-counter (OTC) market and the exchange based
market. Further, as in equities, there exists the spot and the
derivatives segments. Spot markets are essentially OTC markets
and participation is restricted to people who are involved with
that commodity, such as the farmer, processor, wholesaler, etc. A
majority of the derivatives trading takes place through the exchange-
based markets with standardized contracts, settlements, etc. The
exchange-based markets are essentially derivative markets and are
similar to equity derivatives in their working, that is, everything
is standardized and a person can purchase a contract by paying
only a percentage of the contract value. A person can also go short
on these exchanges. Moreover, even though there is a provision
for delivery, most contracts are squared-off before expiry and are
settled in cash. As a result, one can see an active participation by
people who are not associated with the commodity. The typical
structure of commodity futures markets in India is as follows:
Typical Structure Of Commodity Futures Markets In India
At present, there are 26 exchanges operating in India and carrying
out futures trading activities in as many as 146 commodity items.
As per the recommendation of the FMC, the Government of India
recognized the National Multi Commodity Exchange (NMCE),
Ahmadabad; Multi Commodity Exchange (MCX), National
Commodity and Derivative Exchange (NCDEX), Mumbai and
Indian Commodity Exchange ( ICEX) as nation-wide multi-
commodity exchanges. As compared to 59 commodities in
January 2005, 94 commodities were traded in December 2006 in
the commodity futures market. These commodities included major
agricultural commodities such as rice, wheat, jute, cotton, coffee,
major pulses (such as urad, arahar and chana), edible oilseeds (such
as mustard seed, coconut oil, groundnut oil and sunfower), spices
(pepper, chillies, cumin seed and turmeric), metals (aluminium,
tin, nickel and copper), bullion (gold and silver), crude oil, natural
gas and polymers, among others. Gold accounted for the largest
share of trade in terms of value. A temporary ban was imposed on
futures trading in urad and tur dal in January 2007 to ensure orderly
market conditions. An effcient and well-organised commodities
futures market is generally acknowledged to be helpful in price
discovery for traded commodities.
Today, apart from numerous regional exchanges, India has six
national commodity exchanges namely as below:
National Exchanges
1) Multi Commodity Exchange of India Ltd.,
Mumbai
MCX
2) National Commodity & Derivatives Exchange
Ltd., Mumbai
NCDEX
3) National Multi Commodity Exchange of India
Limited., Ahmedabad
NMCE
4) Indian Commodity Exchange Limited, New
Delhi
ICEX
5) Ace Derivatives and Commodity Exchange
Limited,Mumbai
ACE
6) Universal Commodity Exchange Ltd., Navi
Mumbai
UCX
Regional Exchanges
1 Bikaner Commodity Exchange Ltd., Bikaner
2 Bombay Commodity Exchange Ltd., Vashi
3 Chamber Of Commerce, Hapur
4 Central India Commercial Exchange Ltd., Gwalior
5 Cotton Association of India, Mumbai
6 East India Jute & Hessian Exchange Ltd., Kolkata
7 First Commodities Exchange of India Ltd., Kochi
8 India Pepper & Spice Trade Association., Kochi
9 Haryana Commodities Ltd., Sirsa
10 Meerut Agro Commodities Exchange Co. Ltd., Meerut
11 National Board of Trade, Indore
12 Rajkot Commodity Exchange Ltd., Rajkot
13 Rajdhani Oils and Oilseeds Exchange Ltd., Delhi
14 Surendranagar Cotton oil & Oilseeds Association Ltd.,
Surendranagar
15 Spices and Oilseeds Exchange Ltd. Sangli
16 Vijay Beopar Chamber Ltd., Muzaffarnagar
VII. Current Scenario
Currently 5 national exchanges, viz. Multi Commodity Exchange,
Mumbai; National Commodity and Derivatives Exchange, Mumbai
and National Multi Commodity Exchange, Ahmedabad, Indian
Commodity Exchange Ltd., Mumbai (ICEX) and ACE Derivatives
and Commodity Exchange, regulate forward trading in 113
commodities. Besides, there are 16 Commodity specifc exchanges
recognized for regulating trading in various commodities approved
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44
by the Commission under the Forward Contracts (Regulation)
Act, 1952 .
The commodities traded at these exchanges are mentioned in
Annex I.
As of March 2012, futures trading in urad, tur and rice remain
suspended. Out of recognized exchanges, Multi Commodity
Exchange (MCX), Mumbai, National Commodity and Derivatives
Exchange (NCDEX), Mumbai, National Board of Trade (NBOT),
Indore, National Multi Commodities Exchange, (NMCE),
Ahmedabad, and the ACE Derivatives & Commodity Exchange
Ltd., contributed 99% of the total value of the commodities
traded during the year 2011-12. Out of the 113 commodities,
regulated by the FMC, in terms of value of trade, Gold, Silver,
Copper, Zinc, Guarseed, Soy Oil, Jeera, Pepper and Chana are
the prominently traded commodities. The total volume of trade
across all Exchanges in 2011-12 was 14,025.74 lakh MT at a
value of Rs.181,26,103.78 Crores.The total of deliveries of all
commodities on Commodity Exchange platform is 8,88,250 MT
during the year 2010-11.
The different intermediaries and clients registered at these
recognized national exchanges are,
Members - 4081,
Other intermediary - 234,
Warehouse service provider / warehouse - 35 and
Clients - 33,75,123 as on 31.1.2012 .
Rationale for Commodity Futures Markets:
Forward/ Futures trading in a commodity is a mechanism for
price discovery and price risk management and is useful to all
sectors of the economy including the farmers and consumers. The
prices of agricultural commodities are generally at their lowest at
the harvest time as the supply far exceeds the immediate, short
term demand by the consumers, processors and other stakeholders
associated with the commodity markets and increase substantially
in the lean season when the demand by the consumers, processors
etc exceeds the supply. This adversely affects the farmers (as they
realize lower prices of their produce in the harvest season) and
consumers (as they have to pay higher prices in the lean season
to meet their requirements). Forward/ futures markets provide
a market mechanism to balance this imbalance of the supply
demand pattern of agricultural commodities. Futures trading
provides a means of appraising the supply-and-demand conditions
and dealing with price risks, over time and distance. Trading in
futures not only provides price signals to the market of today, but
also of months ahead, and affords guidance to sellers (farmers/
growers/ processors) and buyers (consumers) of agricultural
commodities in planning ahead and, in fnancing and marketing
commodities from one season to the another. Futures markets
therefore are benefcial to both the consumers and farmers.
VIII. Benefits of Commodity Futures Markets to farmers
and other stakeholders
Farmers and growers beneft through the price signals emitted by
the futures markets even though they may not directly participate
in the futures market. The futures markets lead to reduction in the
amplitude of seasonal price variation and help the farmer realize
a better price at the time of harvest. This also helps the farmer in
planning his cultivation in advance as well as to determine the kind
of crop which he would prefer to raise, by taking advantage of the
advance information of the future price trends, and probable supply
and demand of various commodities in advance. By providing the
manufacturers and the bulk consumers a mechanism for covering
price-risks, the futures market induces them to pay higher price to
the producers, as the need to pass on the price-risk to farmers is
obviated. The manufacturers are able to hedge their requirement of
the raw materials and as also their fnished products. This results
in greater competition in the market and ensure viability of the
manufacturing units.
Benefits of Commodity Futures Markets
The primary objectives of any futures exchange are authentic
price discovery and an effcient price risk management. The
benefciaries include those who trade in the commodities being
offered in the exchange as well as those who have nothing to
do with futures trading. It is because of price discovery and risk
management through the existence of futures exchanges that a lot
of businesses and services are able to function smoothly.
1. Price Discovery:-Based on inputs regarding specifc market
information, the demand and supply equilibrium, weather
forecasts, expert views and comments, inflation rates,
Government policies, market dynamics, hopes and fears,
buyers and sellers conduct trading at futures exchanges. This
transforms in to continuous price discovery mechanism.
The execution of trade between buyers and sellers leads to
assessment of fair value of a particular commodity that is
immediately disseminated on the trading terminal.
2. Price Risk Management: - Hedging is the most common
method of price risk management. It is strategy of offering
price risk that is inherent in spot market by taking an equal
but opposite position in the futures market. Futures markets
are used as a mode by hedgers to protect their business from
adverse price change. This could dent the proftability of
their business. Hedging benefts who are involved in trading
of commodities like farmers, processors, merchandisers,
manufacturers, exporters, importers etc.
3. Import- Export competitiveness: - The exporters can hedge
their price risk and improve their competitiveness by making
use of futures market. A majority of traders which are involved
in physical trade internationally intend to buy forwards. The
purchases made from the physical market might expose them
to the risk of price risk resulting to losses. The existence
of futures market would allow the exporters to hedge their
proposed purchase by temporarily substituting for actual
purchase till the time is ripe to buy in physical market. In
the absence of futures market it will be meticulous, time
consuming and costly physical transactions.
4. Predictable Pricing: - The demand for certain commodities
is highly price elastic. The manufacturers have to ensure that
the prices should be stable in order to protect their market
share with the free entry of imports. Futures contracts will
enable predictability in domestic prices. The manufacturers
can, as a result, smooth out the infuence of changes in
their input prices very easily. With no futures market, the
manufacturer can be caught between severe short-term price
movements of oils and necessity to maintain price stability,
which could only be possible through suffcient fnancial
reserves that could otherwise be utilized for making other
proftable investments.
5. Benefts for farmers/Agriculturalists: - Price instability has
a direct bearing on farmers in the absence of futures market.
There would be no need to have large reserves to cover
against unfavorable price fuctuations. This would reduce the
risk premiums associated with the marketing or processing
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45
margins enabling more returns on produce. Storing more
and being more active in the markets. The price information
accessible to the farmers determines the extent to which
traders/processors increase price to them. Since one of the
objectives of futures exchange is to make available these
prices as far as possible, it is very likely to beneft the farmers.
Also, due to the time lag between planning and production,
the market-determined price information disseminated by
futures exchanges would be crucial for their production
decisions.
6. Credit accessibility: - The absence of proper risk management
tools would attract the marketing and processing of
commodities to high-risk exposure making it risky business
activity to fund. Even a small movement in prices can eat
up a huge proportion of capital owned by traders, at times
making it virtually impossible to pay back the loan. There is
a high degree of reluctance among banks to fund commodity
traders, especially those who do not manage price risks. If in
case they do, the interest rate is likely to be high and terms
and conditions very stringent. This possesses a huge obstacle
in the smooth functioning and competition of commodities
market. Hedging, which is possible through futures markets,
would cut down the discount rate in commodity lending.
7. Improved product quality: - The existence of warehouses
for facilitating delivery with grading facilities along
with other related benefts provides a very strong reason
to upgrade and enhance the quality of the commodity to
grade that is acceptable by the exchange. It ensures uniform
standardization of commodity trade, including the terms of
quality standard: the quality certifcates that are issued by the
exchange-certifed warehouses have the potential to become
the norm for physical trade.
IX. Conclusion
The antiquity of commodity Futures market in India epochs back
to the ancient times citied in Kautialyas Arthasastra, and have
been commonly heard in Indian markets for centuries,seems to
be coined in 320 BC, referred in Forward Contracts (Regulation)
Act, 1952. India being one of the top producers of a large number
of commodities, and also has an extended history of trading in
commodities and related derivatives. The Indian commodities
Futures market has seen ups and downs, but seem to have fnally
arrived now. The market has made enormous advancement in terms
of technology, transparency and the trading activity. Interestingly,
this has happened only after the Government protection was
removed from a number of commodities, and market forces were
allowed to play their role. This should act as a major lesson for
the policy makers in developing countries, that pricing and price
risk management should be left to the market forces rather than
trying to achieve these through administered price mechanisms.
No doubt the role of Khusro Committee (June 1980); National
Agriculture Policy announced in July 2000 and Forward Contracts
(Regulation) Act, 1952 was immense and incredible but since
the Forward Markets Commission (FMC) is the chief regulator
of forwards and futures markets in India, it pertains the most
vital responsibilities which impacts not only Indian Markets but
also at global arena.Broadly, the commodities market exists in
two distinct formsthe over-the-counter (OTC) market and the
exchange based market. Further, as in equities, there exists the
spot and the derivatives segments. Spot markets are essentially
OTC markets and participation is restricted to people who are
involved with that commodity, such as the farmer, processor,
wholesaler, etc. A majority of the derivatives trading takes place
through the exchange-based markets with standardized contracts,
settlements, etc.At present, there are 26 exchanges operating in
India and carrying out futures trading activities in as many as 146
commodity items. As per the recommendation of the FMC, the
Government of India recognized the National Multi Commodity
Exchange (NMCE), Ahmadabad; Multi Commodity Exchange
(MCX), National Commodity and Derivative Exchange (NCDEX),
Mumbai and Indian Commodity Exchange ( ICEX) as nation-wide
multi-commodity exchanges. Rational Government policies and
the plinth of effective laws have benefted in many ways like
Credit accessibility, improved product quality, Predictable Pricing,
Import-Export competitiveness, Price Risk Management & Price
Discovery. Still at the outset even in 20th century the benefts to the
real producers of primary sector is remote. The government needs
to concentrate upon the farmers/animal husbandries personal/
Gardeners and orchard personal/etc. The Rural population which is
ultimately responsible for the Primary sector needs to be benefted.
Justice to the enactment and the all the rich endeavors which
government had made could be achieved in real essence only when
the real benefts would reach to the actual producers, Farmers
and Stakeholders which shall not only motivate them but also
attract new generation to enter into the primary sector and give
enhancement to Indian Economy.
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Annexure I
LISTOFCOMMODITIESNOTIFIEDUNDERSECTION15OFTHEF.C.(R.)ACT1952
Sl.No. Commodity Sr.No. Commodity
I Food Grains and Pulses II Oil seeds and Oils
1 ArharChuni 29 Cottonseed
2 Bajra 30 Cottonseed Oil
3 Barley 31 Cottonseed Oilcake
4 Gram 32 CPO Refned
5 GramDal 33 Crude Palm Oil
6 Guar 34 Crude Palm Olive
7 Jowar 35 Groundnut
8 Kulthi 36 Groundnut Oil
9 Lakh(Khesari) 37 Groundnut Oilcake
10 Maize 38 Linseed
11 Masur 39 Linseedoil
12 Moth 40 LinseedOilcake
13 Mung 41 RapeseedOil/MustardOil
14 MungChuni 42 RapeseedOilcake/Mustard
seedOilcake
15 MungDal 43 Rapeseed/Mustardseed
16 Peas 44 RBDPalmolein
17 Ragi 45 RiceBran
18 RiceorPaddy 46 RiceBranOil
19 SmallMillets(KodanKulti, Kodra,Korra,Vargu, Sawan,
Rala, Kakun, Samai,Vari&Banti)
47 RiceBranOilcake
20 TurDal(ArharDal) 48 Saffower
21 Tur(Arhar) 49 SaffowerOil
22 Urad(Mash) 50 SaffowerOilcake
23 Uraddal 51 Sesame(Til)
24 Wheat 52 SesameOil
II Oilseeds and Oils 53 SesameOilcake
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25 Celeryseed 54 Soymeal
26 CopraOil/CoconutOil 55 SoyOil,
27 CopraOilcake/Coconut
Oilcake 56 Soybean
28 Copra/Coconut 57 SunfowerOil
58 SunfowerOilcake (VI) Others
59 SunfowerSeed 88 Camphor
III Spices 89 Castorseed
60 Aniseed 90 CharaorBerseem (including
charaseedorberseemseed)
61 Betelnuts 91 CrudeOil
62 Cardamom 92 GramHusk(GramChilka)
63 Chillies 93 Gur
Sl.No. Commodity Sr.No. Commodity
64 Cinnamon 94 KhandsariSugar
65 Cloves 95 Polymer
66 Corianderseed 96 Potato
67 Ginger 97 Rubber
68 Methi 98 Seedlac
69 Nutmegs 99 Shellac
70 Pepper 100 Sugar
71 Turmeric 101 FurnaceOil
IV Metals 102 Ethanol
72 Copper 103 CookingCoal
73 Zinc 104 Electricity
74 Lead 105 NaturalGas
75 Tin 106 Onion
76 Gold 107 Carbon Credit
77 Silver 108 Thermalcoal
78 SilverCoins 109 Methanol
(V) Fibres and
Manufactures 110 Melted Menthol Flakes
79 ArtSilkYarn 111 MenthaOil
80 CottonCloth 112 MentholCrystals
81 Cottonpods 113 IronOre
82 CottonYarn
83 Indian Cotton (Full pressed, halfpressedor
loose)
84 Jutegoods(Hessian and Sacking sand cloth
and /or bags,twines and/or yarns mfd. by any
of the mill sand/or any other manufacturers of
what ever nature made from jute)
85 Kapas
86 Raw Jute Including Mesta
87 Staple Fiber Yarn

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