COMMODITY MARKET

History of commodity market

Evolution of commodity market

Commodity futures trading have evolved from the need for ensuring continuous supply of seasonal agricultural crops. In Japan, merchants stored rice in warehouses for future use. In order to raise cash, warehouse holders sold recipes against the stored rice. These were known as rice tickets eventually, such rice tickets became accepted as a kind of general commercial currency. Rules came into being, to standardize the trading in rice tickets. The concept of organized trading in commodities evolved in the middle of the 19th century, in Chicago, United States. Chicago has emerged as a major commercial hub with railroad & telegraph lines connecting it with the rest of the world, thereby attracting wheat producers from mid-west to sell their produce to the dealer and distributors. However, lack of organized storage facilities & the absence of a uniform weighing/ grading mechanism often confined them to the mercy of sealers discretion. This led to inherent need to establish a common meeting place, both for farmers and dealers to transact in spot grain- to deliver wheat and receive cash in return. This happened in 1848. Gradually, the farmers (sellers) and dealers (buyers) started to make commitment to exchange the produce for cash in futures. This is how the contract for futures trading evolved whereby the producers would agree to sell his produce (wheat) to the buyer at a future delivery date at an agreed upon price. In this way the farmer knew in advance about what he would receive for this produce and the dealer would know about his costs involved. This arrangement was beneficial to both the producer and the trader. These contracts became popular very quickly and started changing hands even before the delivery date of the product. If a dealer is not interested in taking delivery of the produce, he would sell his contract to some one who needed the same. Similarly, the farmer who did not intend to deliver his crop would pass on the responsibility to another. the price of the contract would depend on the price movement in the wheat market.

COMMODITY MARKET

With some more modifications, such contracts gradually transformed into an instrument to protect the parties involved against adverse factors like unexpected price movements, unfavorable climatic factors etc. for ex; during bad weather, people having contracts to sell wheat would be interested to hold more valuable contract due to supply shortages. Conversely, if there is over supply, the sellers contract value would decline. This prompted the entry of traders in the futures market who had no intentions to buy or sell wheat but would purely speculate on price movements in the market to earn profits. Trading in futures as a result became a very profitable mode of activity that encouraged the entry of other commodities in the futures market thereby creating a platform to set up a body that can regulate and supervise this contract. Thus, during 1848, the Chicago board of trade (CBOT) was established. it was initially formed as a common location known both to the buyers and sellers negotiate forward contracts. However the popularity of the contracts and the success of CBOT in Chicago created interest in the other local markets catering to specific commodities to establish trade bodies that would facilitate dealing in futures contract. In t the early 20 th century, as communication and transportation became more advanced, centralized warehouses were built in the principal market centers to distribute goods more economically. Agricultural commodities were the most commonly traded, but it led to the fact that the market can flourish for any underlying as long as therein an active pool of buyers and sellers.

COMMODITY MARKET

COMMODITY MARKETS IN INDIA

The Forward Markets Commission (FMC) headquartered at Mumbai, is the .regulatory authority for Commodity Derivatives Markets in India. It is a statutory body set up in (1953 under the Forward Contracts (Regulation) Act, 1952. FMC is in turn supervised by the Ministry of Consumer Affairs, Food and Public Distribution, Govt. of India. The Act provides that the Commission shall consist of not less than two but not exceeding four members appointed by the Central Government out of them being nominated by the Central Government to be the Chairman thereof. Currently the Commission comprises four members among whom Shri S. Sundareshan, IAS, is the Chairman and Dr. Kewal Ram, lES, Dr. (Smt) Jayashree Gupta, CSS, and Shri. Rajeev Kumar Agarwal, IRS, are the Members of the Commission.

The functions of the Forward Markets Commission are as follows:

a) 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. b) To keep fonward 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.
3

COMMODITY MARKET

c) To collect and whenever the Commission feels 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; d) To make recommendations generally with a view to improving the organization and working of forward markets; e) 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. There are three National level Commodity Exchanges in India. They are Multi Commodity exchange of India Ltd., Mumbai, National Commodity and Derivatives Exchange (NCDEX), Mumbai and National Multi Commodity Exchange (NMCE), Ahmadabad. There are 21 other "regional" commodity exchanges situated in different parts of India.

COMMODITY MARKET

INTERNATIONAL COMMODITY EXCHANGES

Futures trading are a direct consequence of the problems related to the maintenance of a year-round supply of commodities / products that are seasonal as is the case of agricultural produce. Trading on the futures market platform provides the solution to these problems and opens up new opportunities as well. The economic benefits of exchange traded futures and options include the ability to shift and manage the price risk exposure of the market and tangible positions. With the liberalization in international trade policies, there is a new need felt in many countries for price discovery and the existence of a futures trading mechanism. This need can be met through commodity exchanges. As a result, recent years have witnessed a steep rise in the creation of commodity exchanges along with a consistent expansion of the existing ones. The United States, Japan, United Kingdom, Brazil, Australia and Singapore are homes to leading commodity futures exchanges in the world.

COMMODITY MARKET

World's Major Commodity Exchanges

The New York Mercantile Exchange (NYMEX)

The New York Mercantile Exchange is the world's biggest exchange for trading in physical commodity futures. It is the primary trading forum for energy products and precious metals. The Exchange has been in existence for 132 years and performs trades through two divisions, the NYMEX division, which deals in energy and platinum and the COMEX division, which trades in all the other metals. A major contribution of the Exchange has been to develop and launch energy futures and options contract in 1978 to facilitate price transparency and risk management in this key market. The Exchange has become a significant part of the commercial, civic and cultural life of New York. The Exchange also clears trades for market participants who wish to avoid counter-party credit risk by using standardized contracts for Natural Gas, Crude Oil, Refined Products and Electricity. Commodities traded: Light Sweet Crude Oil, Natural Gas, Heating Oil, Gasoline, RBOB Gasoline, Electricity, Propane, Gold, Silver, Copper, Aluminum, Platinum, Palladium, etc.

London Metal Exchange

The London Metal Exchange (LME) is the world's premier non-ferrous market, with highly liquid contracts. It is an innovative exchange that has maintained its traditional strengths in a modern business environment by remaining close to its core users by ensuring that its contracts continue to meet the high expectations of a demanding industry. It has become highly successful with a trading turnover value of more than US$2000 billion per annum and contributes substantially to the invisible earnings. The Exchange was formed in 1877 as a direct consequence of the industrial revolution witnessed in Britain in the 19th Century. The primary focus of LME is in providing a market for participants from the non-ferrous base metals related industry to safeguard against risk due to movements in base metal prices and also arrive at a price that sets the benchmark globally. The exchange trades 24 hours a day through an inter-office telephone market and also through an electronic trading platform. It is famous for its open-outcry trading between ring dealing members that takes place on the market floor. Commodities Traded: Aluminum, Copper, Nickel, Lead, Tin, Zinc, Aluminum Alloy, North American Special Aluminum Alloy (NASAAC), Polypropylene, Linear Low Density Polyethylene, etc. The LME metal futures contracts run on a daily basis for a period of three months, unlike other commodity markets that are primarily based on monthly prompt dates. The Exchange thus combines the convenience of settlement dates tailored to individual needs with the security of a clearinghouse for its clearing members. The LME also offers options contracts based on each of these futures contracts, together with Traded Average Price Options contracts (TAPOs) based

on the monthly average settlement price (MASP) for all metals futures contracts.

The Chicago Board of Trade

The first commodity exchange established in the world was the Chicago Board of Trade (CBOT) during the year 1848 by a group of Chicago merchants who were keen to establish a central market place for trade. This was situated in the premises of a flour store during its first four years. Prior to this, farmers often found no buyers for the grain they had transported to Chicago. Given the high transport costs, they had been left with little choice but to dump the unsold produce in the nearby lake. Presently, the Chicago Board of Trade is one of the leading exchanges in the world for trading in futures and options. More than 50 contracts on futures and options are being offered by CBOT currently through open outcry and/or electronically. CBOT is the oldest existing commodity exchange in the world having established in the year 1848. Initially, CBOT dealt only in agricultural commodities like corn, wheat " soybeans and oats. Futures contracts in CBOT evolved over a period of time to facilitate trading in non-storable agricultural commodities and non-agricultural products like gold and silver. The first electronic trading system in CBOT was introduced in 1994 after more than 150 years of open auction trading where traders used to meet to buy and sell futures contracts. Commodities traded: Corn, Soybeans, Soybean Oil, Soybean meal. Wheat, Oats, Ethanol, Rough Rice, Gold, Silver, etc. Like any other commodity exchange, the primary role of CBOT is to provide transparency and liquidity in its contracts to its members, clients and market

participants like farmers, corporate, small businessmen, financial service providers, international trading firms and speculators for price discovery, risk management and investment.

Tokyo Commodity Exchange (TOCOM)

The Tokyo Commodity Exchange (TOCOM) is the second largest commodity futures exchange in the world with trade in metals and energy contracts. It has made rapid advancement in commodity trading globally since inception 20 years back. One of the biggest reasons for this is the initiative TOCOM took towards establishing Asia as the benchmark for price discovery and risk management in commodities like the Middle East Crude Oil. TOCOM recent tie-up with the MCX to explore cooperation and business opportunities is seen as one of the steps towards providing a platform for futures price discovery in Asia for Asian players in Crude Oil since the demand-supply situation in U.S. that drives the NYMEX is different from the demand-supply situation in Asia. In January 2003, in a major overhaul of its computerized trading system, TOCOM fortified Its clearing system in June by being the first commodity exchange in Japan to introduce an in-house clearing system. TOCOM launched options on gold futures, the first options contract in Japanese market, in May 2004. Commodities Traded: Gasoline, Kerosene, Crude Oil, Gold, Silver, Platinum, Palladium, Aluminium, Rubber, etc.

Chicago Mercantile Exchange (CME)

The Chicago Mercantile Exchange (CME) is the largest futures exchange in the US and the largest futures clearing house in the world for futures and options trading. Formed in 1898 primarily to trade in agricultural commodities, the CME introduced the world's first financial futures more than 30 years ago. Today it trades heavily in interest rate futures, stock indices and foreign exchange futures. Its products often serve as a financial benchmark and witness the largest open interest in futures contracts compared to any other exchange in the world. The commodity futures profile of CME consists of livestock, dairy and forest products and enables small family farms to large agri-businesses to manage their price risks. Trading in the CME can be done either through pit trading or electronically. Commodities Traded: Butter, Milk, Diammonium Phosphate, Feeder cattle. Frozen Pork bellies. Lean Hogs, live Cattle, Non-fat Dry Milk, Urea, Urea Ammonium Nitrate, etc.

Some Major International Commodity Derivatives Exchanges

Sr. No 1.

Name and Address Chicago Exchange (CME) Mercantile

Contract Traded Butter, Milk, Diammonium

Phosphate, Feeder cattle, Frozen Pork bellies, Lean Hogs, Live Cattle, Non-fat Dry Milk, Urea, Urea Ammonium Nitrate, etc. Mercantile Light Sweet Crude Oil, Natural Gas, Heating Oil, Gasoline, RBOB Gasoline, Electricity, Copper, Propane, Aluminum, Gold, Silver, Platinum,

2.

New Exchange

York

(NYMEX)

3.

London Financial

Palladium, etc. International Cocoa, Robusta Coffee, Corn, Potato, Futures and Rapeseed, White Sugar, Feed Wheat, Milling Wheat, etc. Corn, Soybeans, Soybean Oil,

Options Exchange 4. (LIFFE) Chicago Board of Trade (CBOT) 5.

Soybean meal. Wheat, Oats, Ethanol,

Rough Rice, Gold, Silver, etc. London Metal Exchange Aluminum, Copper, Nickel, Lead, (LME) Tin, Zinc, Aluminum Alloy, North American Special Aluminum Alloy (NASAAC), Polypropylene, Linear Low

6.

New

York

Board

Density Polyethylene, etc. of Cocoa, Coffee, Cotton, Sugar, Frozen Concentrated Orange Juice, Pulp etc.

Ethanol,

Trade (NYBOT)

7.

Tokyo

Commodity

Gasoline, Gold, Silver,

Kerosene,

Crude

Oil,

Exchange (TOCOM) 8.

Platinum, Palladium,

Aluminum, Rubber, etc. Sydney Futures Exchange Greasy Wool, Fine Wool, Broad (SFE) Wool, Cattle, etc. Gold and Gold, Silver, Fuel Oil, Steel, Freight

9.

Dubai Commodities

Exchange Rates, Cotton, etc. Refined Bleached Deodorized

(DGCX) 10 Bursa Malaysia Berhad . 11 . 12 . 13 . 14 . 15 . 16 . Winnipeg Exchange Dalian Exchange Zheng Zhou Commodity Exchange (CZCE) Central Commodity Exchange Shanghai Exchange (SHFE) Brazilian Mercantile and Futures Exchange Futures Japan Commodity

Palmolein, Crude Palm Oil, Palm Kernel Oil, etc. Commodity Canola, feed Wheat, Western Barley, etc. Corn, Soybean, Soybean Meal, Soy Oil, etc. Wheat, Cotton, Sugar, etc.

Gasoline, Kerosene, Gas Oil, Eggs, Ferrous Scrap, etc. Copper, Aluminum, Natural Rubber, Plywood & Long Grained Rice Anhydrous Fuel Alcohol, Arabica Coffee, Robusta-Conillon Coffee, Corn, Cotton, Feeder cattle. Live Cattle,

17

Kansai

Soybean, Crystal Sugar, Gold, etc. Commodity Soybean, Raw Sugar, Raw Silk,

Exchange 18 . 19 . 20 . 21 . Osaka Exchange Singapore Exchange Tokyo Grain Exchange (TGE) Intercontinental Exchange (ICE)

Shrimp (frozen). Coffee, Corn, Azuki beans (Red), etc. Mercantile (Ribbed Smoked Sheets) RSS3,

(Technically Specified Rubber) TSR20, Nickel, Aluminum, Rubber Index Commodity Coffee, Rubber (RSS1, 2, 3)

Corn, Soybean Meal, Soybeans, Red Beans, Coffee, Sugar, Raw Silk, Vegetables, etc. Brent Crude Oil, Coal, Electricity, Emissions, Gas Oil, Heating Oil, Gasoline (RBOB), Natural Gas, WTI and all the futures contracts of its subsidiary - The international Petroleum Exchange (IPE)

COMMODITY FUTURES IN INDIA AND ITS REGULATIONS

Evolution of Commodity futures in India

The history of futures trading in commodities in India is almost as old as that of US. It has, however, passed through a turbulent past. India's first organized futures market was the Bombay Cotton Trade Association Ltd., which was set up in 1875. Futures trading in oilseeds started with the setting up of Gujarati Vyapari Mandali in 1900. Gold futures trading began in Mumbai in 1920. During the first half of the 20th century, there were several commodity futures exchanges trading in jute, pepper, turmeric, potatoes, sugar, etc. However, during the 1940s to 1960s, trading in forwards and futures became difficult as a result of price controls. Major policy decisions taken after Independence, mainly because of the then prevailing scarcity situation, adversely affected the development of futures and forwards markets in the country. In 1952, the Forward Contract Regulation Act was passed which controls all transferable forward and futures contracts. This again put restriction on futures trading. During the 1960s and 70s, the Government of India suspended trading in several commodities like cotton, jute, edible oilseeds, etc. as the government felt that these markets were increasing the prices of commodities. The government's twin policies of offering to buy agricultural produce at a "minimum support price" (MSP) and gaining a monopoly in storage/transportation/distribution of agricultural produce along with a ban on

futures and options trading were the major factors that weakened the agrocommodity markets in the country. The government appointed two committees to study this sector i.e. the Dantwala Committee in 1966, and the Khusro Committee in 1980, which recommended the reintroduction of futures trading in major commodities. The government finally brought back forward trading in agricultural commodities In the early 1980's. But, it was done for commodities that did not have a very significant role in the economy - such as castor seed and castor oil, jaggery, jute, pepper, potato and turmeric. Several localized exchanges started trading in the same commodity, each of them with a local broker/wholesale-merchandiser. But, even after a decade, none of the markets achieved the levels of liquidity that existed prior to the ban on commodity futures trading. Once futures trading became operational, in spite of liberalization, it has been difficult for trade to be transferred from illegal black markets, which have zero tax liability and no reporting requirements to the legal authorities as compared to the regulated markets, where taxes & reporting are part of the legal procedures. Further, responding to the need for commodity futures in India, in 1993, a committee was set-up for assessing the scope for forwards and futures trading in commodities and for recommending steps to be taken for development of futures trading in India. The Committee so instituted was known as the Kabra Committee and much of its recommendations have been implemented. Whereas, with the current initiatives of the regulators, these markets have shown revolutionary changes in the last few years, with the National-level multi commodity exchanges in India showing tremendous potential to tap the commodity derivatives market.

Before the advent of nationwide, online, multi commodity exchanges, the low volume in the regionalized exchanges in India were attributed to the following reasons:

1. Excessive government intervention in the form of subsidies, price control, compulsory purchasing and rationing in the agricultural markets. This led to inefficient functioning of the markets & lower yield in terms of income to the farmers. 2. Influential & large commodity producers / traders acting as members / brokers of commodity exchanges & manipulation in the prices of commodities. 3. Imperfect mechanisms & lack of standardization for physical delivery, settlement, documentation and warehousing arrangements. 4. Absence of organized interconnected spot markets, which resulted in flawed price discovery mechanisms and no means to arbitrage to achieve price efficiency in geographically separated markets. This resulted in fragmenting the volumes across the local exchanges.

The following suggestions were made to improve the commodities futures market

1. Allow commodity futures exchanges to be run by independent professionals, rather than by brokers. 2. Allow trading of short-term futures contracts in commodities, which has an existing cash market to enable hedgers to protect themselves against adverse price fluctuations.

3. To change the working of the Forward Markets Commission from micro management to macro management 4. Introduce commodity futures contracts with different grades for trading. 5. Eliminate price manipulation & circular trading. 6. Use of latest technology & systems that have been developed for the financial derivative markets 7. Introduce options contracts to augment futures. Currently the multi commodity exchanges in India, which started their operations in 2003, have done well in terms of nation wide reach, online trading and efficient and effective risk management and thereby generating appreciable volumes in the first year of their operations. With Commodity Ecosystem much bigger than the stock markets, we have witnessed how fast commodity futures have picked up compared to the stock futures when they were introduced. The permission granted to the stock broking community to participate in the commodity markets has further increased the scope of creating more liquid and vibrant contracts. Further liberalization, deregulation of markets, WTO implications, and technological and informational changes are going to add more fuel to the markets in the coming years. A preview of the Committee Report would help understand the markets that existed then and what needs to be done in developing these markets. Most of the recommendations have already been implemented.

Regulatory Framework

Forward Contracts (Regulation) Act, 1952

The Constitution of India brought the subject of stock exchanges and futures MARKET in Union list. As a result, the responsibility for regulation of commodity futures markets devolved on Govt of India. The Commodity Exchanges in India are governed and regulated under the Forward Contracts (Regulation) Act, 1952 and Rules framed there under. It provides for a 3 tier regulatory system, namely; an association recognized by the Government of India on

recommendation of Forward Markets Commission (FMC) the Forward Markets Commission (it was set up in Sept 1953) and the Central Government

Forward Markets Commission

The Forward Markets Commission, under the Ministry of Consumer Affairs, Food and Public Distribution, Government of India is the regulating authority for all Commodity Futures Exchanges in India.

Functions of the Forward Markets Commission - Statutory

a) To advise the Central Government in respect of the recognition of or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of this Act; b) To keep forward markets under observation and to take such action in relation to them as it ma) consider necessary, in exercise of the powers assigned to it by or under this Act; c) To collect and whenever the Commission thinks it necessary, publish information regarding the trading conditions in respect of goods to which any of the provisions of this Act is made applicable, including information regarding supply, demand and prices and to submit to the Central Government periodical reports on the operation of this Act and on the working of forward market! relating to such goods; d) To make recommendations generally with a view to improving the organization and working o forward markets; e) To undertake the inspection of accounts and other documents of any recognized association o registered association or any member of such association whenever it considers it necessary; and f) To perform such other duties and exercise such other powers as may be assigned to the Commission by or under this Act, or as may be prescribed. Principal Features of the FC(R)Act 1952 are as follows: The act enables the regulating authority to take such action as may be considered desirable respect of specified commodities and specified area without automatically applying the entire provisions of the act to all commodities in all areas in sec 15

The act prohibits option trading in all commodities The act ordinarily exempted non transferable specific delivery contracts from regulation: sec18{1) The act ordinarily covers transferable specific delivery contract as well as hedge contracts The act empowers the Govt to prohibit forward contracts in particular commodity by notification sec 17 The act provides for grant of recognition to associations concerned with forward tradio: sec 6 The act provides that the regulation of forward markets should ordinarily take place thought governing bodies of recognized associations sec 11

The act empowers the Central Govt to appoint not more than four members on k governing bodies of recognized associations sec 6{2b) It provides for a machinery for the supervision and regulation of the governing bodies from point of public interest this machinery is the forward markets commission

Regulatory measures evolved by the Commission.

a) Limit on open positions of an individual operator to prevent overtrading. b) Limit on price fluctuations to prevent abrupt upswing or downswing in prices. c) Special margin deposits to be collected on outstanding purchases or sales to curb excessive speculative activity through financial restraints.

d) Minimum / maximum prices to be prescribed to prevent futures prices from falling below) levels that are not remunerative and from rising above the levels not warranted by genuine supply and demand factors. e) During shortages, extreme steps like skipping trading in certain deliveries of the contract, closing the markets for a specified period and even closing out the contract to overcome emergency situations are taken.

Organizational Structures of Forward Market Commission

The Organizational Structures of Forward Market Commission is classified as follows: Commodity Division Enforcement Division Administrative Division

Proposed amendments to the FC(R) Act, 1952

The government has proposed certain amendments to the Forward Contracts (Regulation) Act, 1952. The amendments include setting up of a separate Clearing Corporation, registration of intermediaries and enhancement of penal provisions in the FC(R) Act. Exempting FMC from payment of tax on wealth, income and profits or gains; conferring powers upon the Centre to regulate forward contracts and options in goods. The Cabinet cleared the decks for the Forward Market Commission (FMC) to become an independent regulator for the commodities futures market. A Bill

will be introduced in Parliament during the next parliament session to amend the Forward Contracts (Regulations) Act of 1952. Once the Bill is passed, the FMC would be able to generate its own resources and have the powers to recognize or derecognize futures commodities exchanges. The amendments will allow trading in options in goods and registration of intermediaries with the FMC and redefine commodities to include energy, weather and other exotic products and also push forth demutualization of regional exchanges. With the FMC having recommended to thegovernmentto allow banks, Foreign Institutional Investors(FII) and Mutual Funds (MF) to participate in commodity futures market, it is expected that the daily trade volume to go up to Rs 25,000-30,000 crore in the coming years. Option trading is all set to play a dynamic role in commodities futures trade, following the expected change in regulatory framework.

Why do we require National level Multi Commodity Futures Exchanges in India?

To develop active trading interest across commodities, it is necessary to have a common platform of commodity futures exchange where demand and supply forces can act together in bringing out the best price for any commodity. The main economic purpose of a futures commodity exchange as a marketplace is to enable commodity producers / processors to sell their produce in advance to protect them against possible price fall for their commodities and allow consumers, traders, processors to buy in advance to protect against possible price increase. In this way they are able to "hedge" their price risk, by locking a price, which they will receive, and which they will pay respectively. Commodities futures trading is a global phenomenon and offers tremendous

potential to market participants for both profit taking on small price corrections as well as to hedgers looking at managing price risk on account of price fluctuations. In India, futures trading is now allowed in more than 100 commodities. Most of the allowable commodities are traded through various exchanges in India. Indian economy is directly and indirectly dependent on agricultural produce. The agricultural commodity market already has major share and with the availability of futures trading on national-level, commodity futures exchanges will provide more liquidity, management strategies. National price level discovery and better risk commodity exchanges will also

invite new streams of investors for new trading and business opportunities for diversification. With the Government control expected to gradually come to anend, all commodity prices will be market determined. It necessitates national level commodity futures exchanges to provide price discover better investment opportunities and prudent risk management practices. Three nationwide electronic exchanges in India and 21 recognized regional or small commodity exchanges in India had an estimated total combined turnover of Rs 21.34 Lakh crore for the year 2005 - 06. This translates into a 373% growth over the previous financial year. In developed markets, futures trading are conservatively estimated at 10 times the size of cash market in commodities. If we consider the fact that in the US, where futures trading are almost 20 times that of the cash market production, it would only be fair to suggest that our futures market Would be a very large and deep, easily many times more than that of the securities market itself.

Legal Framework
Commodity futures contracts and the commodity exchanges organising Trading in such contracts are regulated by the Government of India Under the Forward Contracts (Regulation) Act, 1952, and the rules Formed there under. The nodal agency for such regulations is the Forward Markets Commission (FMC), which functions under the aegis Of Ministry of Consumer Affairs, Food & Public Distribution of the Central Government. According to rough estimates, the unorganised commodity markets have an annual turnover in excess of Rs 12 lakh crore. Given the convenience and transparency in online trading, commodity markets has potential to grow to annual turnover of Rs 45-50 lakh Crore (assuming a future Trading multiple of about 4 times the physical market), which is about 2 to 3 times the size of equity markets in India. Even globally, commodity Markets are much bigger than equity markets. For instance, annual Trading of gold on New York Mercantile Exchange (Nymex) alone is Worth over $ 300 billion.

Why Commodity futures market ?

Unlike the physical market, futures markets trades in commodity are largely used as risk management (hedging) mechanism on either physical commodity itself or open positions in commodity stocks. For instance, a jeweler can hedge his inventory against perceived short-term downturn in gold prices by going short in the future markets. In addition to this, speculators and arbitragers participate to take benefit from changes in prices or price differential between two commodity exchanges and are not interested in taking physical delivery. Globally also Commodity future contracts are normally offset before the expiry and therefore do not result in physical movement of physical commodity.

Commodity Exchanges in India

National Level Multi Commodity Exchanges

Sr. No 1.

Name

and

Commodities Gold, Silver, Aluminum, Copper ,Nickel, Tin, Castor Oil, Castor Seeds Castor Seeds (Disa), Cottonseed, Crude Palm Oil, Groundnut Oil, Kapasia Khalli (Cottonseed Oilcake), Mustard Seed (Hapur), Mustard seed (Jaipur), Mustard / Rapeseed Oil, Mustard Seed (Sirsa), RBD Palmolein, Refined Soy Oil, Sesame seed, Soymeal, Soy Seeds, Ghana, Masur, Tur, Urad, Yellow peas, Rice, Basmati Rice, Wheat, Maize, Sarbati Rice, Black pepper, Red Chilli, Jeera, Turmeric, Cashew Kernel, Rubben Kapas, Cotton long staple, medium staple, short staple). Guar seed, Guargum, Gur, Mentha Oil, Sugar, High Density Polyethylene (HOPE), Polypropylene (PP), Brent Crude Oil, Crude Oil,

Address Multi Commodity Ltd., Mumbai

Exchange of India Sponge Iron, Steel Flat, Steel Long (Bhavnagar),

2.

National

Furnace Oil., Natural Gas, etc. Cashew, Castor Seed, Ghana, Chili, Coffee -

Commodity Derivatives Exchange Mumbai

& Arabica, Coffee -Robusta, Common Raw Rice, Common Parboiled Rice ,Crude Palm Oil, Ltd., Cotton Seed Oilcake, Expeller Mustard Oil, Grade A Parboiled Rice, Grade A Raw Rice, Groundnut (in shell). Groundnut Expeller Oil, Guar gum, Guar Seeds, Gur, Jeera, Jute sacking bags Lemon Tur, Indian Parboiled Rice, Indian Raw Rice, Indian 28 mm Cotton, Indian 31 mm Cotton, Maharashtra Lai Tur, Masoor Grain Bold, Medium Staple Cotton , Mentha Oil, Mulberry Green Cocoons, Mulberry Raw Silk, Mustard Seed, Pepper, Raw Jute, RapeseedMustard Seed Oilcake, RBD Palmolein, Refined Soy Oil, Rubber, Sesame Seeds, Soyabean, Sugar, Yellow Soybean Meal, Turmeric, Urad, V-797 Kapas, Wheat, Yellow Peas, Yellow Red Maize Electrolytic Copper Cathode, Mild Steel Ingots, Sponge Iron, Gold, Silver, Brent Crude Oil, Furnace Oil, etc. Multi Gur, RBD Pamolein, Sunflower Oil, Rapeseed/

3.

National Commodity

Groundnut Mustard

Oil, seed,

Exchange of India Rapeseed/Mustard seed Oil, Rapeseed/ Mustard Limited. Ahmedabad seed oilcake. Soy bean. Soy Oil, Copra, Cottonseed, Safflower, Groundnut, Sugar, Sacking, Coconut oil, Castor seed. Castor-oil, Groundnut oil cake, Cottonseed oil, Sesamum, Sesamum oil, Sesamum Oilcake, Safflower Oilcake, Rice Bran Oil, Safflower Oil, Sunflower Oilcake, Sunflower Seed, Pepper,

Crude Palm Oil, Guar seed. Castor Oilcake, Cottonseed ce Oilcake, Aluminum Ingots, Nickel, Vanaspati, Soybean Oilcake, Rubber, Copper, Zinc, Lead, Tin, Linseed, Linseed Oil, Linseed Oilcake, Coconut Oilcake, Gram, Gold, Silver, Rice, Wheat, Cardamom, Kilo oe Gold, Masoor, Urad, Tur, etc.

Regional Exchanges

Sr. 1 2

Name and Address Bhatinda Om & Oil

Commodities Gur Groundnut Oil, Groundnut, Cottonseed Oil, Castor seed, oil, Sunflower Castor see Oil, Cottonseed Safflower, Sesamum

The Ltd., Bhatinda. ExchangeBombay Commodity Exchange Ltd., Mumbai

3 4 5 6 7 8

Sesamum Oilcake Safflower Oilcake, The Rajkot Seeds oil & Rice Bran, Rice Bran Oil, Rice Bran Groundnut Oil, Castor seed Bullion Merchants" Association The Meerut Agro Commodities Exchange Co. The Spices and Oilseeds Ahmedabad Commodity Exchange Ltd., Ahmedabad Vijay Beopar Chamber Ltd., India Pepper Muzaffarnagar & Spice Trade Association. Kochi Gur Turmeric Cottonseed, Castor seed Gur, Mustard Seed Pepper Int'l-MLS Domestic-MG 1, Black Black ASTA, Pepper Pepper Pepper Domestic-500g/ 1,

Rajdhani Oils and Oilseeds

Int'l-VB ASTA, Black pepper Int'l FAQ, Gur, Rapeseed/Mustard seed

10

National Board of Trade (NBOT), Indore

Rapeseed / Mustard seed, rapeseed / Mustard seed oil Rapeseed / Mustard seed oilcake, soy bean, soy meal soy oil, oil.

11 12

The Chamber of Commerce, crude Rapeseed /palm Gur, Mustard seed The East India Cotton Indian Cotton Gur, Rapeseed / Mustard seed Hessian sacking

Association, Mumbai (EICA) 13 The Central India 14 Commercial Exchange Ltd., The East India Jute &

Hessian Exchange Ltd., 15 First Commodity Exchange 16 Bikaner Commodity 17

Copra, Coconut oil, copra cake Rapeseed / Mustard seed,

Exchange Ltd, Bikaner Rapeseed/Mustard seed oil The Coffee Futures Coffee - Plantation A, Coffee -

Exchange India Ltd. (COFC), Robusta Cherry AB, Ratf Coffee 18 E-Sugar-lndia Ltd. Sugar Grade - M, Sugar Grade - S 19 Surendranagar Cotton Oil Kapas 20 and Oilseeds Assoc. Ltd., Haryana Commodities Ltd., Ltd. and Rapeseed, Mustard seed, Rapeseed / Mustard seed oil

Hissar 21 E-Commodities

Bombay Bullion Association

COMMODITY FUTURES

Meaning and objectives of commodity futures

A commodity futures contract is an agreement between two parties to buy or sell a specified and standardized quantity and quality of a commodity at a certain time in future at a price agreed upon at the time of entering into the contract on the commodity futures exchange. The need for a futures market arises mainly due to the hedging function that it can perform. Commodity markets, like any other financial instrument, involve risks associated with frequent price volatility. The loss due to price volatility can be attributed to the following two reasons: Consumer Preference: In the short- term, their influence on price volatility is small since it is a slow process permitting manufacturers, dealers & wholesalers to adjust their inventory in advance Changes in Supply: They are abrupt & unpredictable bringing about wild fluctuations in prices. This can be especially noticed in agricultural commodities where the weather plays a major role in affecting the fortunes of people involved in this industry. The futures market has evolved to neutralize such risks through a mechanism; namely hedging.

The objectives of commodity futures are as follows:

Hedging with the objective of transferring risk related to the possession of physical assets through any adverse movements in price.

 Liquidity and Price discovery to ensure base minimum volume in trading of a commodity through market information and demand-supply factors that facilitates a regular and authentic price discovery mechanism. Maintaining buffer stock and better allocation of resources as it augments reduction in inventory requirement and thus the exposure to risks related with price fluctuation declines. Resources can thus be diversified for investments Price stabilization along with balancing demand and supply position. Futures trading leads to predictability in assessing the domestic prices, which maintains stability, thus safeguarding against any short-term adverse price movements. Liquidity in the contracts of the commodities traded also ensures in maintaining the equilibrium between demand and supply. Flexibility, certainty and transparency in purchasing commodities facilitate bank financing. Predictability in the prices of commodity would lead to stability, which in turn would eliminate the risks associated with running the business of trading commodities. This would make funding easier and less stringent for banks to commodity market players. In commodity futures, it is necessary to distinguish between investment commodities and consumption commodities. An investment commodity is generally held for investment purposes whereas consumption commodities are held mainly for consumption purposes. Gold and Silver can be classified as investment commodities whereas oil and steel can be classified as consumption commodities.

Participants in Commodity derivatives

Hedgers

Futures contracts have been used as financial offsets to cash market risk for more than a century. futures to reduce or limit the price risk of the physical asset. Hedging is an insurance used to avoid reduce price risks associated with any kind of futures transaction. Commodity futures markets provide insurance opportunities to commercials, merchant producers and processors, against the risk of price fluctuation. In the case of a trader, an adverse price change brought about by either supply or demand change, affects the total value of his commitment Larger the value of his inventory, larger the risk to which he is exposed. The futures market provides; mechanism for the trader to lower the inventory risk and his commitments in the cash market (where actual physical delivery of the commodity must eventually be made) through hedging. Hedging allow a market participant to lock in prices and margins in advance and reduce the potential for unanticipated loss or competitive disadvantage. A hedge involves establishing a position in the futures market this is equal and opposite to a position in the physical market. The principle behind establishing equal an opposite positions in the cash and futures markets is that a loss in one market should be offset b a gain in the other market. Hedging works because cash prices and futures prices tend to move tandem, converging as the futures contract reaches expiration.

The degree of effectiveness of a hedge Is determined by the percentage of the actual gain or lo: incurred in a futures transaction. Though most hedges reduce risks related to price variations, they not eliminate them altogether. "Margin" for futures contracts Is usually between 5% and 10% of the contract value and is put up if good faith, indicating the buyer or seller's willingness to pay or deliver the entire amount If the contract is held until delivery. Because margin requirements are so low, it is possible to hedge small or larges quantities of commodities. In fact, the low margins required for trading in futures contract provides high "leverage" for traders. This is because; the traders can take large exposures even by investin marginal (small) amount of deposit with the exchange. For e.g., on 15th May 2006, if a trader wants t( take a long position in August Gold futures contract at the prevailing futures price of Rs. 10,000 per gm, then he would be required to deposit the margin amount (4% or Rs. 40,000) with the exchange This enables him to obtain a leverage of up to 25 times of his margin deposit, since his total exposure in terms of the contract value is Rs. 10,00,000.

Speculators

When supplies of a commodity are greater than the present demand or need, prices tend to decline, If supplies appear to fall short of demand, prices trend upward. Estimating market supply and demand conditions are the challenges faced by market participants. It is generally accepted that speculators are interested in making fast money by anticipating future price movements. Commodity futures allow speculators to create high leveraged positions. A speculator accepts the risk that hedgers seek to avoid, giving the market the liquidity required to service hedge participants effectively by providing the

market with the necessary bids and offers for a continuous flow of transactions. Speculation is the opposite of hedging. A speculator holds no offsetting cash market position and deliberately incurs price risk In order to benefit from price movements. A speculator is an additional buyer of commodities whenever it seems that market prices are lower than they should be. Consumers consider this to be against their best interest. Conversely, when it appears that prices are too high, a speculator becomes an active seller. Individual speculators tend to trade a smaller number of contracts than hedgers and hold market positions for a shorter time, so several of them may be needed to offset one large hedge order. The maximum number of contracts that can be held by any one speculator is limited by exchange rules. The small amount of capital needed makes speculating in futures contracts very attractive. If the total value of the contract had to be paid, the rate of return on most commodities would be extremely small. The small margin provides speculators with the necessary leverage to generate a substantial rate of return. On the other side it also generates substantial risk

Arbitragers

Arbitragers are interested in making purchases and sales in different markets at the same time to profit from price discrepancy between the two markets. So arbitragers are interested in locking in a minimum profit by simultaneously entering into transactions intwoor more markets. Anarbitrager knows the minimum profit potential at the time of entering into transactions. Arbitragers

lock in profits when they spot cash and carry arbitrage opportunity or reverse cash and carry arbitrage opportunity. Traders who continually watch the markets can see inconsistencies in pricing and can make relatively low-risk profits by arbitraging those inconsistencies. In today's financial markets, most arbitrage opportunities occur either between regions, delivery periods, types of instruments (such as options to futures) or across a combination of these conditions. In addition to providing a low-risk benefit to trading companies, arbitrage helps the market in two ways: It provides pressure on prices to move to rational or normal levels and maintains liquidity in the markets.

Commodity as an Asset Class

Secular Bull market in Commodities globally World GDP Growth Drivers B R I C and other Asian and SA economies African Continent yet to integrate with World markets Commodities : Hedge against Currency Risk Political Risk Financial Markets Risk Promoter/Management Risk Opportunities: Time spreads, location spreads, Badla possible, ratio spread Commodity markets Equity markets fluctuate on local factors. In the short run particular shares can be manipulated by local players. Much higher Visibility of price direction in commodities as an asset class compared to equity Stocks. Common man Familiar with Commodities Indian markets are a part of Global markets in commodities Indian markets are not part of global equity markets

Market Moving Factors

Factors affecting commodity Prices: Most Important factor : Demand & Supply Weather and Climatic Conditions. Producer / miner hedging interest Total production & expected consumption around the world The Economic and Political Policies like US Dollar, Interest rates, inflation etc

MULTI COMMODITY EXCHANGE OF INDIA LTD.

About MCX

Multi Commodity Exchange of India Limited (MCX) is a "new order" exchange with permanent recognition from the Government of India for setting up a nationwide, online (electronic multi-commodity marketplace, offering "unparalleled efficiencies", "unlimited growth' and opportunities" to market participants. MCX, a nationwide multi-commodity exchange, is an indeper and demutualized exchange since inception. Promoted by Financial Technologies (India) Limited, has introduced a state-of-the-art, online digital exchange for commodities trading in the country. Ii with its strong belief of setting up a truly independent and a neutral platform, MCX is committed pursuit of broad basing its ownership and has accordingly Initiated several steps to make the exch; ownership pattern broader, representative and inclusive. At the time of writing this reference mati efforts are being made to go for an Initial Public Offering (IPO) to further make the organization r dynamic. Subsequent to this, the exchange would be accountable not only to FMC but also SEBI. In its endeavor towards establishing India as a major hub for global trading in commodities, has taken up the initiative by entering into tie-ups with major international exchanges and commodity trading centers. In a significant development that would have widespread ramifications across the entire commodity trading circles, MCX, in the first week of November, 2004, signed a Memorandum Understanding(MOU)with the Tokyo Commodity Exchange(TOCOM),which is one of the largest commodity futures

exchange in the world, very active in metals and energy futures contracts. The tie-up would h^ the two exchanges in information sharing, market development and monitoring, surveillance method market operations, trading practices and regulations in the commodities futures markets. This is the] authentic step in bringing global recognition to the Indian commodity markets and raises standard of commodity trading to globally acceptable levels. It would also open up opportunities for Indian producers and consumers to get the best prices for their products and consumables. MCX has also forged another partnership with a major international conglomerate, the Dubai Metals and Commodity Center (DMCC) in November 2004, to set up the Dubai Gold and Commodity Exchange (DGCX), which has become operational from 21st November 2005. The exchange, situated in the free trade zone of Dubai, offers a transparent trading environment for dollar denominated Gold futures contracts. DGCX is also on the anvil of launching currency futures contracts. Dubai has firmly established itself as the gateway of international gold market to India. The setting up of this exchange would fill a very critical gap for the International trading community since business from the Gulf is currently routed to New York, London and Tokyo. In yet another initiative taken by MCX to reduce the adverse impact of volatility in freight rates, it has entered into a strategic alliance with the Baltic Exchange, London, to introduce freight futures contracts in India for the first time. The move will have a significant impact on the Indian shipping industry as well as commodity traders, exporters and importers since the increasing cost of freight is increasingly impacting the transportation of cargo. This will facilitate the establishment of a very vibrant freight derivatives market in South-East Asia for freight risk management of trade done outside the region.

In October 2005, MCX and London Metal Exchange (LME) announced the signing of a licensing agreement that will allow the MCX to launch futures contracts in non-ferrous metals using LME prices as the basis of settlement. MCX has also signed a Memorandum of Understanding (MoU) to explore areas of cooperation and business opportunities with the goal of assisting and benefiting the underlying producers, end-users and investors in their commonly traded products by maximizing the application of International best practices for price risk management and exchange operations that could mutually benefit the exchanges.

Key Shareholders of MCX

Financial Technologies (India) Ltd. State Bank of India National Stock Exchange of India Ltd. (NSE) National Bank for Agriculture and Rural Development (NABARD) HDFC Bank Fidelity International Bank of India Union Bank of India Bank of Baroda State Bank of Indore State Bank of Hyderabad State Bank of Saurashtra SBI Life Insurance Co. Ltd. Canara Bank

MCX is well poised to emerge as the "Exchange of Choice" for the commodity futures trading community in the country. MCX has formulated strategic alliances with leading commodity trade associations in India, namely: Bombay Bullion Association (BBA) Bombay Metal Exchange (BME) Solvent Extractors' Association of India (SEA) Pulses Importers Association (PIA)

MCX has a strongly established growth path with its aim to offer:

Liquidity - Introduce new Commodities/Members/Measures Expansion - Enroll Institutional & other classes of Members Leadership -To be a Commodity Exchange of Choice Information - Disseminate trade & commodity information Technology - Continue technological leadership for cost effective expansion Trade friendliness - Work with trade & industry for growth Globalization - Market India's commodity sector globally Knowledge - Create & Share-pool of commodity knowledge Training Operations, commodity futures contra' Converge - Markets, Participants & Commodities - Industry & Professionals on Commodity Markets, Risk Man

Trading strategies such as hedging underlying exposures using

As of January 2006, MCX has already appointed more than 1500 members with over 900C Work Stations (TWS).

Business Operations

MCX is conducting trading in derivatives contracts in various commodities permitted Government of India under the Forward Contracts Regulations Act, 1952, subject to approval Forward Markets Commission.

Business Rules

Business Rules of Multi Commodity Exchange of India Limited is subject to the provision Forward Contracts (Regulations) Act, 1952, and Rules framed there under, Articles of Association Rules and Bye-Laws of Multi Commodity Exchange of India Limited (MCX), as applicable Members of the Exchange, their Representatives and their Clients.

Applicability

These Rules

are

enforceable

on

the

Members

of the

Exchange,

Clearing Banks, Constituents and all other Participants operating on or through the Exchange in respect of their rig obligations relating to trading on MCX. They are subject to jurisdiction of the Courts of I* /irrespective of the place of business of the Members of the Exchange or their customers and d India or elsewhere.

Eligibility for Trading

At MCX, only the members of the Exchange, who have been admitted as such by the Board, are ( to participate in trading. Persons, who are not members of the Exchange, can participate in trading as approved users or clients through a registered member of the Exchange.

Membership at MCX

Currently, there are three categories of membership available at MCX, depending upon the Trading the Clearing Rights. These Membership types are explained in detail as under.

CONTEMPORARY ISSUES IN COMMODITY MARKETS

Role of Banks in Commodity Markets

Financing of agriculture poses certain special risks for banks and so, banks need to mitigate these risks in order to ensure effective credit delivery to the agricultural sector. One of the key risks for banks is the commodity price risk. The volatility in the prices of agricultural commodities may cause severe loss to the farmer who may be unable to repay his dues to the bank. If the prices collapse, the distress in the farming community can be widespread and security obtained by the bank may have very limited usefulness, Commodity derivatives can mitigate these risks to a certain extent. The issue has been examined in greater detail later in the report. A well-established system of issuance of Warehouse Receipts is a prerequisite of an efficient market in commodity derivatives. Warehouse Receipts are also useful to the farmer in securing timely finance from banks at economical rates. In terms of Section 8 of the Banking Regulation Act, 1949, no banking company shall directly or indirectly deal in buying or selling or bartering of goods except in connection with realisation of securities given to or held by it, or engage in any trade or buy, sell or barter goods of others. For this purpose, "goods" means every kind of movable property, other than actionable claims, stocks, shares, money, bullion and spices and all instruments referred to in clause (a) of sub-section (1) of Section 6 of the B.R. Act, 1949. Thus, while bullion is specifically permitted for trading under the Act, banks are prohibited

from entering into commodity business and therefore, they are not permitted to participate in the commodity derivatives market. Banks do have an extensive rural reach and expertise in agricultural lending which enable them to play a big role in the development of the commodity market. As they have exposure to agriculture, which is a priority sector, they would be better off in case they were able to hedge their positions. Banks can also help to fund margin or trading capital requirements. Further, banks can provide loans against commodities by accepting warehouse receipts (WR) as collateral. The Working Group on Warehouse Receipts and Commodity Futures was set up by the Reserve Bank of India (RBI) with the task of evolving broad guidelines, criteria, limits, risk management system as also a legal framework for facilitating participation of banks in commodity (derivative) market and use of WR in financing of agriculture. The group has put forward guidelines for banks to extend loans against warehouse receipts and also offered a framework for participation in the commodity futures market. TheGroup had members from the RBI, Indian Banks'Association (IBA), Forward Markets Commission (FMC), NABARD and selected banks active in agricultural lending such as SBI, Punjab National Bank, ofBaroda and IGICI Bank. One of the major recommendations of the working group is to amend the Banking Regulation Act, 1949 permitting banks to deal in the business of agricultural commodities including derivatives. me final report was published in April 2005. Further it also recommended that banks can maintain :/oprietary positions with adequate limits in agri commodity derivatives to mitigate their risk while lending to armers. Besides, banks also may be granted general permission to become professional clearing nembers of commodity exchanges

subject to the condition that they should not assume any exposure sk on account of offering clearing services to their trading clients. Clearing bank entertains the opening of the clearing and settlement accounts for the exchange and its members, The settlement accounts provide the facility to transfer the funds between the members and clearing-house, In other words, clearing bank take electronic instruction from the exchange and respond for pay-ins and payouts. Agriculture is integral to economic development in India. For a long time, Indian agriculture has remained isolated from the mainstream development. Since independence, India has come a long way in removing technological isolation of agriculture. Efforts were made in introducing scientific methods in agriculture, including high yielding hybrid varieties. The resulting Green Revolution has solved the problem of food security for the country. There is a growing feeling that time has come to remove economic and financial isolation in which agricultural economy has been functioning so far. Of the efforts being made in several directions, managing of risks through commodity derivatives and facilitating financing of agriculture by using Warehouse Receipts has received particular attention in the recent years. In the Mid-term Review of the Annual Policy Statement for the year 200405, Governor, Reserve Bank of India announced constitution of a Working Group on Warehouse Receipts & Commodity Futures with a view to examining the role of banks in providing loans against Warehouse Receipts and evolving a framework for participation of banks in the commodity futures market. The Group had members from the Reserve Bank of India, Indian Banks' Association (IBA), Forward Markets Commission (FMC), NABARD and select banks active in agricultural lending such as State Bank of India, Punjab National Bank, Bank of Baroda and ICICI Bank Ltd. The Working Group was entrusted

with the task of evolving broad guidelines, criteria, limits, risk management system as also a legal framework for facilitating participation of banks in commodity (derivative) market and use of Warehouse Receipts in financing of agriculture.

The Terms of Reference of the Working Group were;

a) To examine the role of banks in developing commodity markets - both cash and derivative and lay down a road map for banks' participation in commodity markets as well as to suggest the criteria, limits and risk management systems for banks in relation to their commodities business; b) To examine whether banks may offer commodity derivative based products to farmers to enable them to hedge their risks as they do not have easy accessibility to the commodity exchanges and may lack necessary expertise; c) To suggest enabling measures to encourage flow of institutional finance to farmers includinglending against Warehouse Receipts; d) To examine the statutory provisions and suggest necessary amendments including the provisions of the Banking Regulation Act, 1949 in regard to dealing in commodities by banks and the Negotiable Instruments Act, 1881 for imparting negotiable status to Warehouse Receipts so as to enable the banks to play a meaningful role in developing commodity markets and extend necessary credit facilities; e) To recommend appropriate level of participation by banks in various capacities in the commodity exchanges and to suggest necessary regulatory arrangements; f) To examine whether the banks may be permitted to take and give physical delivery of contracts in the commodity derivative markets; and

g) To consider any other matter relevant to the subject by the Working Group.

Recommendations Of The Working Group On Warehouse Receipts And Commodity Futures By The Reserve Bank Of India (RBI)

1) The Group recommends that Central Government may issue a notification under clause (o) of sub-section (1) of Section 6 of the Banking Regulation Act, 1949 permitting banks to deal in the business of agricultural commodities including derivatives. 2) The Group recommends that a system needs to be evolved by which Warehouse Receipts become freely transferable between holders as it would reduce transaction costs and increase usage. 3) The Group recommends creating an umbrella structure, which may act as a Closed User Group (CUG) for everyone engaged in the agricultural commodities business. The membership of the CUG may extend to commodity exchanges, APMCs, commission agents registered with APMCs, warehouses, exporters, importers and domestic users of commodities, banks, insurance companies and producers. The umbrella structure or the CUG is envisaged as an electronic platform that would offer straight through processing for everyone connected with the commodities. There can be more than one CUG and that they will be subject to regulation and supervision by a regulatory authority such as FMC. 4) The Group recommends that proprietary positions in agricultural commodity derivatives could be used by banks to mitigate their risk in lending to farmers. To achieve this, they will have to buy options and options on futures. Therefore, the Group recommends that the Forward

Contracts (Regulation) Act, 1952 may be suitably amended and Fonward Markets Commission may evolve a suitable framework for option trading in agricultural commodities in India. 5) The Group recommends that banks may be permitted to have independent proprietary position in commodity futures linked in a macro way to their credit portfolio. Banks' exposure to a particular commodity is a general exposure and cannot be linked to a particular loan. Permitting banks to have independent proprietary positions is the best way in which banks can cover their risks. However, suitable risk control measures may have to be adopted by the banks. 6) The Group considered whether banks may be permitted to deal in commodities other than agricultural commodities such as oil and gas. However, keeping in view the current state of development of spot as well as futures markets, the Group recommends that for the present, it will be prudent to permit banks to deal in agricultural commodities only. 7) At present, purely cash settled contracts are not available in India. The banks trading or dealing in commodity contracts should therefore be prepared to make or accept delivery of physical goods. The Group recommends that while no restriction may be placed in this regard, banks may be persuaded to preferably close their positions and cash settle the contracts. 8) As the farmers are likely to find it difficult to assume positions in future market of their own, the Group deliberated whether banks can offer nonstandard contracts to the farmers and cover themselves in the exchange traded futures. The position was examined from the angle of FonA/ard Contracts (Regulation) Act, 1952. Accordingly, the Group recommends that banks may offer non-standard contracts to farmers to suit their needs. The Group also recommends that banks may be permitted to offer

commodity derivative based products to farmers to enable them to hedge their commodity price risk. 9) In regard to OTC contracts, the Group recommends that in order to make OTC contracts a feasible proposition for banks, the Government may exempt transferable specific delivery (TSD) contracts, where one of the parties to the contract is a bank authorized by RBI, from the operation of all or any of the provisions of FCRA, 1952. This would enable banks to provide bilateral contracts tailored to suit the needs of their customers without running the risk of taking or making delivery. 10) The Group recommends that banks may be granted general permission to become professional clearing members of commodity exchanges subject to the condition that they should not assume any exposure risk on account of offering clearing services to their trading clients. 11) 12) The Group recommends that at least for the present, banks may not The Group recommends that while banks may continue to hold be permitted to act as Trading Members in the Commodity Exchanges. their equity stake in the commodity exchanges in order to provide them financial strength and stability, the banks may reduce / divest their equity holding to a maximum permitted level of 5% over a period of time so as to avoid any conflict of interests and address the regulatory concern that owners of commodity exchanges do not also become traders in these exchanges. 13) In order to get a global perspective of how banks manage risks associated with trading in commodities, the Group examined the guidelines issued by Financial Services Authority (FSA), UK and Australian Prudential Regulation Authority (APRA). Accordingly, the Group recommends that the guidelines issued by FSA and APRA may be

suitably modified as would be consistent with the instructions issued by Reserve Bank on capital adequacy and market risk so far. 14) The Group recommends that initially a limit may be placed on a bank's total exposure or gross positions, long plus short regardless of maturity, in all the commodities in relation to net loans and advances and/or capital or net worth of the bank. Initially, the limit could be put at 5% of the net worth of the bank, which could be increased later in the light of experience gained.

Participation of Fll and Mutual Funds in Commodity Markets

Mutual Funds and Foreign Institutional Investors are presently not allowed to trade in commodity markets. The Government is considering the proposal to allow these entities to trade in commodity futures markets. For commodity markets to grow rapidly, retail participation is essential as has been the experience in developed countries. But the extent of knowledge dissemination of commodity futures among the mass market is at an abysmal level. Unlike the financial derivatives market, one can enter the commodity derivatives market with a much lower investment, since margins are lower in the range of 5-10%. The leverage that can be obtained in the commodity futures market is much higher. In case mutual funds are allowed to participate in commodity markets by structuring commodity funds for retail investors, this would prove to be an added advantage for the lay investor, who may not have the knowledge and wherewithal to trade in such markets. The commodity

futures exchanges remain largely in the shadows of the booming equity markets exchanges due to low awareness levels. Tracking commodity prices is not just a balance sheet analysis or a company specific study. Global factors and rather macro factors play a much important role into it. That demands domain expertise in commodities, market dynamics and price forecasting. This is the reason for mutual funds to participate in commodity markets, since; they are equipped with qualified analysts and fund managers who undertake value investing and boost up the reliability for the retail investors. Globally, commodity markets are being acknowledged as an effective market to hedge against the vagaries of the equity markets. The presence of foreign funds in the securities market has been found to have a high correlation with the interest as well as activity in equity segment. A similar scenario is expected to be replicated in the commodity market, in case regulation permits the entry of Foreign Institutional Investors into this market. Yet the other set of challenges in front of the exchanges are creating awareness and information dissemination. While volumes are important for commodity exchanges, what is probably more critical is awareness. There Is need for exchanges to keep relentlessly pursuing an awareness creation strategy. Awareness at the grassroots will be essential to materialize and sustain the success it is foreseeing. Disseminating market discovered prices to the farmer level calls for a mammoth structural framework and massive investments. Over here, all options need to be explored from IT-enabled facilities such as display boards and ticker boards to manual information spread where such facilities are not available. Initiatives such as ITC Ltd.'s e-choupal need to be encouraged to facilitate wider participation from the grassroots level of the society.

Conclusion

The history of commodity marketing has its origin in the rise of human civilization. As the nomadic man settle on land to grow crops, he began to provide service such as those of carpenter, ironsmith, goldsmith, washer man, and barber. Thus began the exchange of different goods and services between the producers of different agricultural crop and the service provider. The barter trade evolved as a result, an in due course emerged the bazaars or markets. The 21st century saw the beginning of a transformation in the commodity market of the country. At the dawn of century the government lifted the Ban on futures trading and allowed the commodity exchanges to develop futures market in different commodity and their product so that such trading could effectively and efficiently serve its twin economic functions of the price discovery and price risk management. While the old regional and single-commodity exchanges were permitted to revive future trading in their traditional commodities, three new demutualised national exchanges were also set up.

Visit to MCX (multi Commodity Exchange)

To Understand and study the commodity market point of view on the investment exchange. I visited the MCX Spared some of his valuable times to explain in brief about the commodity market he also answered to some of my question

Which are the national level multi-commodity exchanges?

The national level multi-commodity exchanges are :
National Commodity Derivatives Exchange Ltd. (NCDEX) Mumbai. www.ncdex.com Multi Commodity Exchange of India Ltd. (MCX) Mumbai. www.mcxindia. Com National Board of Trade, Indore(N-BOT) www.nbotind.org . National Multi Commodity Exchange of India Ltd. , Ahmedabad (NMCE) www.nmce.com Are the trading terminals / systems for commodity Futures separate from those of equity futures ?
Since the exchanges are separate, the VSATs, trading CTCL terminals risk Management Systems, contract notes, etc. are independent of those for equity futures. We can connect through VSATs, High Speed Internet Broad bands(Reliance WLL, Tata Indicom Broad bands, etc. )

It is mandatory to take Delivery ?

It is not mandatory to take the delivery of a commodity in a futures trading contract. However there is always a provision for delivery in commodity futures trading to ensure that the futures prices are in conformity with the underlying.The option for delivery is normally with the seller; the buyer/ Seller ; the buyer/seller has to express his intention for delivery about five to seven days before the expiry. However, provision vary from exchange to exchange, For instance in MCX u have to give intention to back office person in head office they will give intention to exchanges by fax and for Ncdex u have to give intention both in back office as well as dealers in head office so that dealers have to punch intention in Trader Workstation Corporate ID on expiry date before 5 pm . Exchange will take this file for allocation of commodities with quantity to other counter parties confirmation of delivery can be know next day of expiry at morning as exchange release Delivery allocation file. How is a contract settled ?

The contract which are not assigned for delivery will be settled in cash. How much margin is applicable in commodities market And how is it arrived at ? Margin is different for each commodity and also changes depending on the changes in prices and volatility . Under normal circumstances, margin is between 10 15 % of the contract value. As in Stocks, the margin in commodities is calculated in VaR system. Commodities, like equities, also have a system of initial margin and mark-to-mark (MTM) margin. Commodities have many qualities how do I Know which Quality is being traded in futures ? The specification of each commodity will be given and mentioned in the Contract master as attached with this presentation. Each participant will Be trading in that particular quality only. How much margin is applicable in commodities market And how is it arrived at ? Margin is different for each commodity and also changes depending on the changes in prices and volatility . Under normal circumstances, margin is between 10 15 % of the contract value. As in Stocks, the margin in commodities is calculated in VaR system. Commodities, like equities, also have a system of initial margin and mark-to-mark (MTM) margin. Is sales tax applicable on trades ? If so , is registration Mandatory ? If a trade is squared off no sales tax is applicable. Sales Tax is applicable only if a trade results in delivery. Normally it is the sellers responsibility to collect and pay sales tax. This sales tax is applicable at the place of delivery should have sales tax registration number for seller not for buyer.

How does the clearing and settlement take place ? The clearing and settlement takes place through banks arranges by the exchanges which have tied up with different banks/ Institutions. Ncdex has tied up with NSCCL for clearing purpose. Mcx has tied up with HDFC Bank and IndusInd Bank for providing clearing and settlement facilities.

Without owning the commodity,how is it possible to sell It ? One doesnt need to have commodity physically or to own a contract for The commodity to enter into a sale contract in the futures market. The Contract is simply an agreement to sell the physical commodity at later Date or sell it short. It is possible to repurchase the contract before the Maturity, there by dispensing with delivery of goods. What happens if there is any delivery or fund default ? The exchange have a penalty clause whenever the fund or delivery default happens . There is also a separate arbitration panel of exchanges.

Both the exchanges (Mcx and Ncdex) will also maintain settlement Guarantee funds. Are options also allowed in commodity derivatives ? Options in goods are presently prohibited under section 19 of the Forward Contracts (Regulation) Act, 1952. No exchange or person can organize or enter into or make or perform options in goods. However the market expects the government to permit options trading in commodities soon.

Unit of Trading

1 Pound = 0.454Kg 1 Quintal =100 Kg 1 MT = 1000 Kg 1 Barrel = 159.60 Liter 1 Maund = 0.373242 Quintal 1 Mann (Gujarati) = 20Kg

1 Kg = 1000 Grams
1 Bales = 500 Bags 1 Cartoon = 22.68 Kg 10 MT = 10000 Kg 1 Kg = 31.99 ounce (Gold 0.995 Purity) 1 Kg = 32.119 ounce (Gold 0.999 Purity) 1 Kg = 32.1507 ounce (Silver 0.999 Purity)
Contract Value = Total Qty X Price Base price = 20 Kgs

Bibliography
Books:
Commodity Vision [ Magazine, July-issue 1 Commodity Future [ Quidance Booklet fromMCX]

Websites:

www.thefreedictionery.com www.google.com www.mcx.com www.nseindia.com