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COMMODITY DERIVATIVES TRADING IN INDIA

Evolution
 
Organized trading in commodity derivatives was initiated in India with the set up of Bombay Cotton Trade Association Ltd in 1875. Following this, Gujarati Vyapari Mandali was set up in 1900 to carryout futures trading in groundnut, castor seed and cotton.
Forward trading in Raw Jute and Jute Goods began in 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 centers at Punjab and U.P. The most notable amongst them was the Chamber of Commerce at Hapur, which was established in 1913. Futures market in Bullion began at Mumbai in 1920 and later similar markets came up at Rajkot, Jaipur, Jamnagar, Kanpur, Delhi and Calcutta.
 
During the Second World War Futures trading was prohibited. However, after independence, the Constitution of India brought the subject of "Stock Exchanges and futures markets" in the Union list. As a result, the responsibility for regulation of commodity futures markets devolved on Govt. of India and in December 1952 Forward Contracts (Regulation) Act, 1952, was enacted.
(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 notified 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 Certificate of Registration from the Forward Markets Commission.
 
The ECA, 1955 gives powers to control production, supply, distribution, etc. of essential commodities for maintaining or increasing g supplies and for securing their equitable distribution and availability at fair prices. Using the powers under the ECA, 1955 various Ministries/Departments of the Central Government have issued control orders for regulating production/distribution/quality aspects/movement etc. pertaining to the commodities which are essential and administered by them.
 
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. 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, the government of India appointed one more committee on Forward Markets under Chairmanship of Prof. K.N. Kabra in June 1993 and the Committee submitted its report in September 1994.
 
Following this, the government of India has issued notifications on April 1, 2003 permitting futures trading in commodities. Trading in commodity options, however, is still prohibited. The lifting of the 30-year ban on commodity futures trading in India has opened yet another avenue for investors.
 
Contract specifications
 
Forward contracts are broadly of two types:
 
·         Specific delivery contracts
·         Other than specific delivery contracts
 
Specific delivery contracts: Specific delivery contracts are essentially merchandising contracts, which enable producers and consumers of commodities to market their produce and cover their requirements respectively. These contracts are generally negotiated directly between parties depending on availability and requirement of produce. During negotiation, terms of quality, quantity, price, period of delivery, place of delivery, payment term, etc. are incorporated in the contracts. Specific delivery contracts are of two types:
 
i)        Transferable specific delivery contracts (T.S.D.)
j)        Non-transferable specific delivery contracts (NTSD).
 
In the TSD contracts, transfer of the rights or obligations under the contract is permitted while in NTSD it is not permitted.
 
Other than specific delivery contracts: Though this contract has not been specifically defined under the act, these are called as ‘future contracts’. Futures contracts are forward contracts other than specific delivery contracts. These contracts are usually entered into under the auspices of an Exchange or Association. In the futures contracts, the quality and quantity of commodity, the time of maturity of contract, place of delivery etc. are all standardized and contracting parties have to negotiate only the rate at which contract is entered into.
 
Forward trading in TSD and NTSD contracts is regulated by the government. As per the section 15 of the FCRA, 1952, every forward contract in notified goods that entered into except those between members of a recognized association or through or with any such member is treated as illegal or void. The section 18(1) of the Act exempts the NTSD contracts from the regulatory provisions.
 
However, over the years the regulatory provisions of the Act were applied to the NTSD contracts and 79 commodity items are currently prohibited for NTSD contracts under section 17 of the Act. Moreover, another 15 commodity items are brought under the regulatory provisions of the section 15 of the Act out of which trading in the NTSD contract has been suspended in 12 items. At present, the NTSD contracts in cotton, raw jute and jute goods are permitted only between, through or with the members of the associations specifically recognized for the purpose.
 
 
Commodities allowed for futures trading in India
 
As per the list presented on Forward Market Commission (FMC), there are more than 25 exchangesare in operation carrying out futures trading activities in a wide variety of commodity items under 8 major categories
 
  1. Vegetable oilseeds, oils and meals
  2. Pulses
  1. Cereals
  2. Spices
  3. Metals
  4. Energy products
  5. Fibres
  6. Other
 
Factors to be considered while trading
 
In order to trade in commodity futures, the participants need to keep certain facts in mind. These factors can be broadly grouped into the following categories.
 
Agricultural commodities
 
Carry over stocks: leftover stocks from the previous year’s production after meeting the demand.
 
Expected demand: average level of consumption and exports during the past few years
 
Crop acreage: Extent of area sown under the crop
 
Production: Estimated output based on the acreage and weather conditions and pest infestation etc.,
 
Imports and exports: in case of the commodities that have a sizeable amount of external trade (either imports or exports) such as edible oils and pulses, the traders need to know the details of important sources and destinations of the external trade. Further, the traders have to monitor the crop status in the respective countries.
 
Government policies: any change in government policy relating to the crops such as MSP: minimum support prices
 
Procurement: direct procurement by the government agencies and storage in warehouses change in tariff and base prices of externally traded goods will have a direct impact on the respective commodity prices.
 
Metals
 
·         Currency effects: main source of long-term volatility
·         Variation in supply and demand for risk capital. Risk capital is largely provided from established routes such as debt and equity. 
·         Shocks:
o   Unexpected changes in production techniques,
o   Massive changes in exploration techniques,
o   Changing geopolitics
o   Cartel instability
o   Environmental regulation with respect to production process 
·         Changes in consumption trends, due in part to price elasticity 
·         Inflation: change in global inflation as well as inflation in the US and the respective countries
 
Crude (energy) futures
    • Stocks of Crude Oil and Petroleum Variance from five year average
    • OPEC production variance from quota
    • Strategic Petroleum Reserve (SPR) variance from target
    • Demand factors
    • OPEC spare capacity (Saudi Arabia)
    • Refinery capacity variance
    • Interest rates
    • US dollar
 

 

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