100 marks commodity project
TRANSCRIPT
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COMMODITY MARKETSBACHELOR OF COMMERCE
FINANCIAL MARKETSSEMESTER V
(2011)SUBMITTED
BY:LAVINA PRADEEP CHANDALIA
ROLL NO. 02UNDER THE GUIDANCE OFMr mandar khandkar
SIES COLLEGE OF COMMERCE AND ECONOMICS,Plot No. 71/72, Sion Matunga Estate
T.V. Chidambaram Marg,Sion (East), Mumbai 400022.
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COMMODITY MARKETSBACHELOR OF COMMERCE
FINANCIAL MARKETSSEMESTER V
(2011)SUBMITTED
In Partial Fulfillment of the requirementsFor the Award of Degree of
Bachelor of Commerce Financial MarketsBY:
LAVINA PRADEEP CHANDALIAROLL NO. 02
UNDER THE GUIDANCE OFMr mandar khandkar
SIES COLLEGE OF COMMERCE AND ECONOMICS,Sion (East), Mumbai 400022.
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CERTIFICATEThis is to certify that Miss._________________________________ of
B.Com Financial Markets Semester V (2011) has successfully
completed the project on 30-09-2011 under the guidance ofMr.mandar khandkar
________________ ________Course Coordinator Principal_______________Project Guide/ Internal Examiner
________________External Examiner
DATE: PLACE:
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DECLARATION
I, ________________________________, the student of B.com(Financial Markets) semester V (2011) hereby declare that Ihave completed the project on 30-09-2011. The informationpresented through this project is true and original to thebest of my knowledge.
Date:
Place:
________________StudentS Signature
LAVINA CHANDALIAROLL NO: 02
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ACKNOWLEDGEMENT
With great pleasure I would like to thankMr mandarkhandkar and my course CoordinatorMR. TAMBE of South
Indian Education Society College of Commerce and Economics,
for giving me the opportunity to do this project on COMMODITYMARKETS. I would also like to thank him for being an
inspiration in the completion of this project. He gave me his
invaluable advice and help without which this project would
not have materialized.
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Objective
To give a basic introduction of exchange tradedcommodity future markets in India
To understand the difference between commodity &financial derivative
To understand merits & demerits of Indian exchangetraded commodity markets
To understand basics of trading, clearing & settlementon Indian commodity exchange
To understand how risk is managed in Indian commodityexchange
To understand the regulatory framework of Indiancommodity markets
To gain theoretical knowledge of gold as a commodity
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Summary
Trading in commodities existed in India since a long decade. But it has been organized
only few years ago. India is one of the top producers of large number of commodities
and also has a long history of trading in commodities and related derivatives. The
Commodities Derivatives market has seen ups and downs, but seems to have finally
arrived now.
The market has made enormous progress in terms of Technology, transparency and
trading activity. Interestingly, this has happened only after the Government protection
was removed from a number of Commodities, and market force was allowed to play
their role.
Transparent trading & clearing settlement mechanism has helped commodity markets
to gain popularity.Possibility of default by the participating players is minimized through
proper monitoring of the market, strong surveillance systems and implementation ofstrong risk management procedures.
Long term fundamentals of commodity markets appear bright given the supply demand
mismatch.
Gold as a trading commodity has been of great advantage to individuals & corporate.
The recent introduction of gold petal has made gold our traditional investment, within
the reach of common man, who otherwise finds it difficult to buy gold with ease
because of its rising price.
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Index
Sr no. Topic Page no
1 Introduction to commodity markets 9-212 Evolution of commodity markets 22-253 Indian commodity exchanges 26-364 Current Scenario in Indian Commodity Market 37-395 Trading 40-466 Clearing & settlement 47-567 Risk management 57-598 Regulatory framework 60-649 case study ; gold 65-68
10 Bibliography 69-69
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CHAPTER 1 INTRODUCTION TO COMMODITY MARKETCOMMODITYA commodity is a product, which is of uniform quality and traded across various
markets. There are generally two types of commodities, hard commodities and soft
commodities. Hard commodities include crude oil, iron ore, gold, and silver and have a
long shelf life. Agricultural products such as soybean, rice or wheat, are considered soft
commodities since they have a limited shelf life. These commodities have to be similar
and interchangeable. For example, soybean from one country or market should be of
the same quality wise as soybean from another, or gold in one country should be of the
same purity as gold from another. Consumer products like televisions or computers vary
from manufacturer to manufacturer and hence cannot be traded as commodities.
Hence, any product which is traded on an authorized commodity exchange is known as
commodity. The article should be movable of value, something which is bought or sold
and which is produced or used as the subject or barter or sale. In short commodity
includes all kinds of goods. Indian Forward Contracts (Regulation) Act (FCRA), 1952
defines goods as every kind of movable property other than act ionable claims, money
and securities.
In current situation, all goods and products of agricultural (including plantation), mineral
and fossil origin are allowed for commodity trading recognized under the FCRA. The
national commodity exchanges, recognized by the Central Government, permits
commodities which include precious (gold and silver) and non-ferrous metals, cereals
and pulses, ginned and un-ginned cotton, oilseeds, oils and oilcakes, raw jute and jute
goods, sugar and gur, potatoes and onions, coffee and tea, rubber and spices. Etc.
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Spot MarketThe spot commodity market is governed by State Agricultural Marketing Boards
(SAMB), MandiBoard (Farmers, Traders, State). There are more than 7000 Mandis
trading in about 140 crops. Participants in this market are Farmers, Licensed Traders,
and Brokers & Wholesale Dealers. Mandi Inspectors issue type & quantity certificate.
Mandifees: Transaction fee, Taxes; total varies between 4% and 12% Trading, Clearing
and Settlement.
Derivatives MarketA derivative is a product whose value is derived from the value of one or more
underlying variables or assets in a contractual manner. The underlying asset can be
equity, forex, commodity or any other asset.
The Forward Contracts (Regulation) Act, 1952, regulates the forward/ futures contracts
in commodities all over India. As per this Act, the Forward Markets Commission (FMC)
continues to have jurisdiction over commodity forward/ futures contracts. However,
when derivatives trading in securities was introduced in 2001, the term 'security' in the
Securities Contracts (Regulation) Act, 1956 (SC(R) A), was amended to include
derivative contracts in securities. Consequently, regulation of derivatives came under
the purview of Securities Exchange Board of India (SEBI). We thus have separate
regulatory authorities for securities and commodity derivative markets. Derivatives are
securities under the SC(R) A and hence the trading of derivatives is governed by the
2 ways of tradingin commodity
markets
Spot market Derivative market
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regulatory framework under the SC(R) A. The Securities Contracts (Regulation) Act,
1956 defines 'derivative' to include
1. A security derived from a debt instrument, share, loan whether secured or unsecured,
risk instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices, of underlying
securities.
COMMODITY EXCHANGEA commodity exchange is an association or a company or any other body corporate
organizing futures trading in commodities for which license has been granted by
regulating authority.Commodity Futures
A Commodity futures is an agreement between two parties to buy or sell a specified
and standardized quantity 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 risk associated with
frequent price volatility.
The loss due to price volatility can be attributed to the following reasons:
Consumer Preferences: - In the short-term, their influence on price volatility is small
since it is a slow process permitting manufacturers, dealers and wholesalers to adjust
their inventory in advance.
Changes in supply: - They are abrupt and unpredictable bringing about wild
fluctuations in prices. This can 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.
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The objectives of Commodity futures Hedging with the objective of transferring risk related to the possession of
physical assets through any adverse moments in price. Liquidity and Price
discovery to ensure base minimum volume in trading of a commodity through
market information and demand and supply factors that facilitates a regular price
discovery mechanism.
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 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 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.
The major participants in commodity markets include1. Commodity Producers/Consumers
These participants are long (producers) and short (consumers) positions in the relevant
commodity. The inherent risk-exposure drives the use of commodity derivatives by
producers and users.
The application of commodity derivatives is frequently driven by the pattern of cash
flows. Producers must generally make significant capital investments (sometime
significant in scale) to undertake the production of the commodity. This investment must
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generally be made in advance of production and sale of the commodity. This means
that the producer is exposed to the price fluctuations in the commodity.
If prices decline sharply, then revenues may be insufficient to cover the cost of servicing
the capital investment .This means that there is a natural tendency for producers to
hedge at levels that ensure adequate returns without seeking to optimize the potential
returns from higher returns. This may also be necessitated by the need to secure
financing for the project.
Consumer hedging behavior is more complex. Consumer desire to undertake hedging is
influenced by availability of substitute products and the ability to pass on higher input
costs in its own product market. In many commodities, producer and consumer deal
directly with each other. The form of arrangement may include negotiated bilateral longterm supply or purchase contracts between the producers and consumers. The
contracts may include fixed price arrangements to reduce the price risk for both parties.
These arrangements create a number of difficulties. These include lack of transparency,
low liquidity and exposure to counterparty credit risk. The bilateral structure also creates
potential adverse performance incentives. This reflects the fact that the contracts
combine supply/purchase obligations and price risk elements in a single contract.
2. Commodity Processors
These participants have limited outright price exposure. This reflects the fact the
processors have a spread exposure to the price differential between the cost of the
input and the cost of the output. For example, oil refiners are exposed to the differential
between the price of the crude oil and the price of the refined oil products (diesel,
gasoline, heating oil, aviation fuel, etc.). The nature of the exposure drives the types of
hedging activity and the instruments used.
3. Commodity Traders
Commodity markets have complex trading arrangements. This may include the
involvement of trading companies (such as the Japanese trading companies and
specialized commodity traders). Where involved, the traders act as an agent or principal
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to secure the sale/purchase of the commodity. Traders increasingly seek to add value to
pure trading relationship by providing derivative/risk management expertise. Traders
also occasionally provide financing and other services. Commodity traders have
complex hedging requirements, depending on the nature of their activities.
A trader as a pure agent will generally have no price exposure. Where a trader acts as a
principal, it will generally have outright commodity price risk that requires hedging.
Where traders provide ancillary services such as commodity derivatives as the principal,
the market risk assumed will need to be hedged or managed.
4. Financial Institution/Dealers
Dealer participation in commodity markets is primarily as a provider of finance orprovider of risk management products. The dealers role is similar to that in the
derivative market in other asset classes. The dealers provide credit enhancement,
speed, immediacy of execution and structural flexibility. Dealers frequently bundle risk
management products with other financial services such as provision of finance.
5. Investors
This covers financial investors seeking to invest in commodities as a distinct and
a separate asset class of financial investment. The gradual recognition of
commodities as a specific class of investment assets is an important factor that
has influenced the structure of commodity derivatives markets.
Difference between Commodity and Financial DerivativesThe basic concept of a derivative contract remains the same whether the underlying
happens to be a commodity or a financial asset. However, there are some features
which are very peculiar to commodity derivative markets. In the case of financial
derivatives, most of these contracts are cash settled. Since financial assets are not
bulky, they do not need special facility for storage even in case of physical settlement.
On the other hand, due to the bulky nature of the underlying assets, physical settlement
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in commodity derivatives creates the need for warehousing. Similarly, the concept of
varying quality of asset does not really exist as far as financial underlings are
concerned. However, in the case of commodities, the quality of the asset underlying a
contract can vary largely. This becomes an important issue to be managed.
1 .Physical Settlement
Physical settlement involves the physical delivery of the underlying commodity, typically
at an accredited warehouse. The seller intending to make delivery would have to take
the commodities to the designated warehouse and the buyer intending to take delivery
would have to go to the designated warehouse and pick up the commodity. This may
sound simple, but the physical settlement of commodities is a complex process. Theissues faced in physical settlement are enormous. There are limits on storage facilities
in different states. There are restrictions on interest rate movement of commodities.
Besides state level octroi and duties have an impact on the cost of movement of goods
across locations. The process of taking physical delivery in commodities is quite
different from the process of taking physical delivery in financial assets.
1. a. Delivery notice period
Unlike in the case of equity futures, typically a seller of commodity futures has the
option to give notice of delivery. This option is given during a period identified as
`delivery notice period'.
1. b. Assignment
Whenever delivery notices are given by the seller, the clearing house of the Exchange
identifies the buyer to whom this notice may be assigned. Exchanges follow different
practices for the assignment process.
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1. c. Delivery
The procedure for buyer and seller regarding the physical settlement for different types
of contracts is clearly specified by the Exchange. The period available for the buyer to
take physical delivery is stipulated by the Exchange. Buyer or his authorized
representative in the presence of seller or his representative takes the physical stocks
against the delivery order.
Proof of physical delivery having been affected is forwarded by the seller to the clearing
house and the invoice amount is credited to the seller's account.
The clearing house decides on the delivery order rate at which delivery will be settled.
Delivery rate depends on the spot rate of the underlying adjusted for discount/ premium
for quality and freight costs. The discount/ premium for quality and freight costs are
published by the clearing house before introduction of the contract. The most active
spot market is normally taken as the benchmark for deciding spot prices.
2. Warehousing
One of the main differences between financial and commodity derivative is the need for
warehousing. In case of most exchange-traded financial derivatives, all the positions arecash settled. Cash settlement involves paying up the difference in prices between the
time the contract was entered into and the time the contract was closed. For instance, if
a trader buys futures on a stock at Rs.100 and on the day of expiration, the futures on
that stock close at Rs.120, he does not really have to buy the underlying stock. All he
does is take the difference of Rs.20 in cash. Similarly, the person who sold this futures
contract at Rs.100 does not have to deliver the underlying stock. All he has to do is pay
up the loss of Rs.20 in cash.
In case of commodity derivatives however, there is a possibility of physical settlement. It
means that if the seller chooses to hand over the commodity instead of the difference in
cash, the buyer must take physical delivery of the underlying asset. This requires the
Exchange to make an arrangement with warehouses to handle the settlements. The
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efficacy of the commodities settlements depends on the warehousing system available.
Such warehouses have to perform the following functions:
Earmark separate storage areas as specified by the Exchange for storing
commodities;
Ensure proper grading of commodities before they are stored;
Store commodities according to their grade specifications and validity period; and
Ensure that necessary steps and precautions are taken to ensure that the quantity and
grade of commodity, as certified in the warehouse receipt, are maintained during the
storage period. This receipt can also be used as collateral for financing.
In India, NCDEX has accredited over 775 delivery centers which meet the requirements
for the physical holding of goods that are to be delivered on the platform. As future
trading is delivery based, it is necessary to create the logistics support for the same.
3. Quality of Underlying Assets
A derivatives contract is written on a given underlying. Variance in quality is not an issue
in case of financial derivatives as the physical attribute is missing. When the underlyingasset is a commodity, the quality of the underlying asset is of prime importance. There
may be quite some variation in the quality of what is available in the marketplace. When
the asset is specified, it is therefore important that the Exchange stipulate the grade or
grades of the commodity that are acceptable. Commodity derivatives demand good
standards and quality assurance/ certification procedures. A good grading system
allows commodities to be traded by specification.
Trading in commodity derivatives also requires quality assurance and certifications fromspecialized agencies. In India, for example, the Bureau of Indian Standards (BIS) under
the Department of Consumer Affairs specifies standards for processed agricultural
commodities. AGMARK, another certifying body under the Department of Agriculture
and Cooperation, specifies standards for basic agricultural commodities.
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Benefits of Commodity Futures MarketsThe primary objectives of any futures exchange are authentic price discovery
and an efficient price risk management. The beneficiaries 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 specific 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 ManagementHedging 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 profitability of
their business. Hedging benefits 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
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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 influence of changes intheir 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 sufficient financial
reserves that could otherwise be utilized for making other profitable investments.
5. Benefits 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
fluctuations. This would reduce the risk premiums associated with the marketing or
processing 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 benefit 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.
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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 payback 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 posses 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 benefits 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 certificates that are issued by the exchange-certified warehouses have
the potential to become the norm for physical trade.
Disadvantages of commodity markets1. PRINCIPLE IS NOT GUARENTEED
Like trading stocks, there is no guarantee of your initial investment. However, in buying
stock in a company, your loss is limited to the amount you paid for the stock. In
commodity future trading, losses can mount to a greater amount then your initial marginused to open the position and additional capital through margin calls may be necessary
if the market goes against your position.
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2. High risk due to leverage
Using leverage only requires a small amount of initial capital to initiate a new position
and price volatility can lead to big profits or big losses. That is why many people
suggest using stop orders to limit potential losses.
3. High price volatility could lead to margin call
A margin call is when the market is going your position additional capital is required. At
this time, additional margin will be deducted from your account balance. If there are
insufficient funds in your account, your broker will notify you of the additional amount
that is required .if these additional funds are not promptly deposited into traders
account, their positions will be automatically liquidated by the broker.
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Chapter 2. Evolution of commodity marketsHistory of commodity markets globally
Commodities future trading was evolved from need of assured continuous supply of
seasonal agricultural crops. The concept of organized trading in commodities evolved in
Chicago, in 1848. But one can trace its roots in Japan. In Japan merchants used to
store Rice in warehouses for future use. To raise cash warehouse holders sold receipts
against the stored rice. These were known as rice tickets. Eventually, these rice tickets
become accepted as a kind of commercial currency. Latter on rules came in to being, to
standardize the trading in rice tickets. In 19 th century Chicago in United States had
emerged as a major commercial hub. So that wheat producers from Mid-west attracted
here to sell their produce to dealers & distributors. Due to lack of organized storage
facilities, absence of uniform weighing & grading mechanisms producers often confined
to the mercy of dealers discretion. These situations lead to need of establishing a
common meeting place for farmers and dealers to transact in spot grain to deliver wheat
and receive cash in return.
Gradually sellers & buyers started making commitments to exchange the
produce for cash in future and thus contract for futures trading evolved. Whereby the
producer would agree to sell his produce to the buyer at a future delivery date at an
agreed upon price. In this way producer was aware of what price he would fetch for his
produce and dealer would know about his cost involved, in advance. This kind of
agreement proved beneficial to both of them. As if dealer is not interested in taking
delivery of the produce, he could sell his contract to someone who needs the same.
Similarly producer who not intended to deliver his produce to dealer could pass on the
same responsibility to someone else. The price of such contract would dependent on
the price movements in the wheat market. Latter on by making some modifications
these contracts transformed in to an instrument to protect involved parties against
adverse factors such as unexpected price movements and unfavorable climatic factors.
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This promoted traders entry in futures market, which had no intentions to buy or sell
wheat but would purely speculate on price movements in market to earn profit.
Trading of wheat in futures became very profitable which encouraged the entry of
other commodities in futures market. This created a platform for establishment of a body
to regulate and supervise these contracts. Thats why Chicago Board of Trade (CBOT)
was established in 1848. In 1870 and 1880s the New York Coffee, Cotton and Produce
Exchanges were born. Agricultural commodities were mostly traded but as long as there
are buyers and sellers, any commodity can be traded. In 1872, a group of Manhattan
dairy merchants got together to bring chaotic condition in New York market to a system
in terms of storage, pricing, and transfer of agricultural products. In 1933, during the
Great Depression, the Commodity Exchange, Inc. was established in New York through
the merger of four small exchanges the National Metal Exchange, the Rubber
Exchange of New York, the National Raw Silk Exchange, and the New York Hide
Exchange.
The largest commodity exchange in USA is Chicago Board of Trade, The Chicago
Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity
Exchange and New York Coffee, sugar and cocoa Exchange. Worldwide there are
major futures trading exchanges in over twenty countries including Canada, England,
India, France, Singapore, Japan, Australia and New Zealand.
History of Commodity Market in IndiaThe history of organized commodity derivatives in India goes back to the nineteenth
century when Cotton Trade Association started futures trading in 1875, about a decade
after they started in Chicago. Over the time derivatives market developed in several
commodities in India. Following Cotton, derivatives trading started in oilseed in Bombay
(1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in
Bombay (1920).However many feared that derivatives fuelled unnecessary speculation
and were detrimental to the healthy functioning of the market for the underlying
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commodities, resulting in to banning of commodity options trading and cash settlement
of commodities futures after independence in 1952. The parliament passed the Forward
Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the
India. The act prohibited options trading in Goods along with cash settlement of forward
trades, rendering a crushing blow to the commodity derivatives market. Under the act
only those associations/exchanges, which are granted reorganization from the
Government, are allowed to organize forward trading in regulated commodities.
The act envisages three tire regulations: (i) Exchange which organizes forward trading
in commodities can regulate trading on day-to-day basis; (ii) Forward Markets
Commission provides regulatory oversight under the powers delegated to it by the
central Government. (iii) The Central Government- Department of Consumer Affairs,
Ministry of Consumer Affairs, Food and Public Distribution- is the ultimate regulatory
authority. The commodities future market remained dismantled and remained dormant
for about four decades until the new millennium when the Government, in a complete
change in a policy, started actively encouraging commodity market. After Liberalization
and Globalization in 1990, the Government set up a committee (1993) to examine the
role of futures trading.
The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in
17 commodity groups. The Committee which submitted its report in September 1994
recommended that futures trading be introduced in the following commodities:
Basmati Rice
Cotton, Kapas, Raw Jute and Jute Goods
Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed,
safflower seed, copra and soybean and oils and oilcakes
Rice bran oil
Castor oil and its oilcake
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Linseed
Silver
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.
It also recommended strengthening Forward Markets Commission, and certain
amendments to Forward Contracts (Regulation) Act 1952, particularly allowing option
trading in goods and registration of brokers with Forward Markets Commission.
The Government accepted most of these recommendations and futures trading was
permitted in all recommended commodities.
Since 2002, the commodities future market in India has experienced an unexpected
boom in terms of modern exchanges, number of commodities allowed for derivatives
trading as well as the value of futures trading in commodities, which crossed $ 1 trillion
mark in 2006. Since 1952 till 2002 commodity datives market was virtually non- existent,
except some negligible activities on OTC basis.
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Chapter 3. Indian Commodity ExchangesThere are more than 20 recognized commodity futures exchanges in India under the
purview of the Forward Markets Commission (FMC). The country's commodity futures
exchanges are divided majorly into two categories:
National exchanges
The four exchanges operating at the national level (as on 1st January 2010) are:
i) National Commodity and Derivatives Exchange of India Ltd. (NCDEX)
ii) National Multi Commodity Exchange of India Ltd. (NMCE)iii) Multi Commodity Exchange of India Ltd. (MCX)
iv) Indian Commodity Exchange Ltd. (ICEX)
Regional exchanges
The leading regional exchange is the National Board of Trade (NBOT) located at Indore.
There are more than 15 regional commodity exchanges in India.
Indian exchangesThe following are the list of exchange and commodities in which futures contracts are
traded in India are as follows
sr.no Exchanges Commodity
1 India pepper & Spice Trade
Association , Kochi(IPSTA)
Pepper (both domestic
and international
contracts)2 Vijay Beopar chamber Ltd.,
Muzaffarnagar Gur
3Rajdhani oil & oilseed exchange Gur, Mustard seed its
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ltd, Delhi oil & oilcake
4 Bhatinda Om & oil exchange ltd
,Bhantada Gur
5
The chamber of commerce ,Hapur
Gur , potatoes and
Mustard seed
6 The Meerut Agro Commodity
Exchange ltd., Meerut Oilseed complex
7
The Bombay Commodity Exchange
Ltd., Bombay
Castrol seed, Ground
nut, its oil & cake,
cottonseed its oil
&cake, cotton & RBD
Palmolein
8
Rajkot seeds, oil & Bullion
Merchants Association , Rajkot
Castrol seed,
cottonseed , its oil and
oilcake
9 The Ahmedabad Commodity
Exchange, Ahmedabad Hessian & sacking
10 The East India Jute & Hussian
Exchange Ltd., Calcutta Cotton
11 The East India cotton Association
Ltd., Calcutta Turmeric
12 The Spices & Oilseeds Exchange
Ltd, Sangli
Rapeseed/Mustard
seed, its oil and cake
13
Kanpur Commodity Exchange Ltd.,
Kanpur
Soya seed, Soya oil
and Soya meals.
Rapeseed/Mustard
seed its oil and oilcake
and RBD Palmolien
14 National Board of trade, Indore Copra/Coconut, its oil&
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oilcake
15 The First Commodities Exchange of
India Ltd., Kochi Gur and Mustard Seed
16 Central India Commerce Exchange
Ltd., Gwalior Sugar
17
E-Sugar India Ltd., Mumbai
Oilseed complex and
Rubber , sugar,
Aluminum, nickel ,Zinc,
Copper, Lead. tin
,pepper, Gram and
Sacking18 National MultiCommodity
Exchange of India Ltd., Ahmedabad Coffee
19 Coffee Futures Exchange India
Ltd.,Bangalore
Cotton,.Cotton seed,
Kapas
20 Surendranagar Cotton oil &
Oilseeds, Surendranagar Sugar
21
E-Commodities Ltd.,New Delhi
Mustard seed its oil &
oilcake
22 Bullion Merchants Association ,
Bikaner
Metals & Agri
Commodities
23 Multi Commodity Exchange (MCX),
Mumbai
Metals & Agri
Commodities
24 National Commodity and Derivation
Exchange ( NCDEX), Mumbai
Metals & Agri
Commodities
25 National Multi Commodity
Exchange (NMCE)
Metals & Agri
Commodities
26
India Commodity Exchange ( ICEX)
Metals & Agri
Commodities
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National Commodity
Exchange
Regional commodity exchange
There is compulsory online
trading
There is no compulsion for online trading
It should be demutualised
exchange.It need not be demutualised exchange
This exchange is recognized on
a permanent basis.
This Exchange is recognized for a fixed period, after
which it has to apply for re-registration.
All commodities permitted by
government for futures trading
can be traded here.
Exchange has to apply for each commodity for
futures trading. Sensitive commodities like gold and
silver, rice and wheat are not permitted for trading
here.
Trade Performance of leading Indian Commodity Exchanges for January 2010
Traded
Value
(Rs Crore)
MCX NCDEX NMCE ICEX NBOT
January2010
5,62,703 87,824 16,990 32,901 4,245
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National Commodities & Derivatives Exchange Limited (NCDEX)National Commodities & Derivatives Exchange Limited (NCDEX) promoted by ICICI
Bank Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank of
Agriculture and Rural Development (NABARD) and National Stock Exchange of India
Limited (NSC). Punjab National Bank (PNB), Credit Rating Information Service of India
Limited (CRISIL), Indian Farmers Fertilizer Cooperative Limited (IFFCO), Canada Bank
and Goldman Sachs by subscribing to the equity shares have joined the promoters as a
share holder of exchange. NCDEX is the only Commodity Exchange in the country
promoted by national level institutions.National Commodity & Derivatives Exchange Limited (NCDEX), a national level online
multicommodity exchange, commenced operations on December 15, 2003.It is a
national level technology driven on line Commodity Exchange with an independent
Board of Directors and professionals not having any vested interest in Commodity
Markets.
It is committed to provide a world class commodity exchange platform for market
participants to trade in a wide spectrum of commodity derivatives driven by best global
practices, professionalism and transparency.
The Exchange has received a permanent recognition from the Ministry of Consumer
Affairs, Food and Public Distribution, Government of India as a national level exchange
NCDEX is regulated by Forward Markets Commission (FMC). NCDEX is also subjected
to the various laws of land like the Companies Act, Stamp Act, Contracts Act, Forward
Contracts Regulation Act and various other legislations.
The Exchange, in 2005 posted an average daily turnover (one-way volume) of around
Rs 4500- 5000 crore a day (over USD 1 billion). The major share of the volumes comes
from agricultural commodities and the balance from bullion, metals, energy and other
products. Trading is facilitated through over 850 Members located across around 700
centers (having ~20000 trading terminals) across the country. Most of these terminals
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are located in the semi-urban and rural regions of the country. Trading is facilitated
through VSATs, leased lines and the Internet.
Commodities Traded at NCDEX
Bullion:- Gold KG, Silver, Brent
Minerals:- Electrolytic Copper Cathode, Aluminum Ingot, Nickel
Cathode, Zinc Metal Ingot, Mild steel Ingots
Oil and Oil seeds:-Cotton seed, Oil cake, Crude Palm Oil, Groundnut (in
shell), Groundnut expeller Oil, Cotton, Mentha oil, RBD Pamolein, RM Seed
oil cake, refined soya oil, Rape seeds, Mustard seeds, Caster seed, Yellow
soybean, Meal
Pluses:- Urad, Yellow peas, Chana, Tur, Masoor,
Grain:- Wheat, Indian Pusa Basmati Rice, Indian parboiled Rice (IR- 36/IR-
64), Indian raw Rice (ParmalPR-106), Barley, Yellow Red maize
Spices:-Jeera, Turmeric, Pepper
Plantation:-Cashew, Coffee Arabica, Coffee Robusta
Fibers and other:- Guar Gum, Guar seeds, Guar, Jute sacking bags, Indian
28 mm cotton, Indian 31mm cotton, Lemon, Grain Bold, Medium Staple,
Mulberry, Green Cottons, , , Potato, Raw JuteMulberry raw Silk, V-797 Kapas,
Sugar, Chilli LCA334
Energy:- Crude Oil, Furnace oil
Multi Commodity Exchange of India Limited (MCX)Multi Commodity Exchange of India Limited (MCX) is an independent and de-mutulized
exchange with permanent reorganization from Government of India, having Head
Quarter in Mumbai. Key share holders of MCX are Financial Technologies (India)
Limited, State Bank of India, Union Bank of India, Corporation Bank of India, Bank of
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India and Canada Bank. MCX facilitates online trading, clearing and settlement
operations for commodity futures market across the country.
MCX started of trade in Nov 2003 and has built strategic alliance with Bombay Bullion
Association, Bombay Metal Exchange, Solvent Extractors Association of India, pulses
Importers Association and Shetkari Sanghatana.
MCX deals with about 100 commodities.
Commodities Traded at MCX:-
Bullion:-Gold, Silver, Silver Coins,
Minerals:-Aluminum, Copper, Nickel, Iron/steel, Tin, Zinc, Lead
Oil and Oil seeds:-Castor oil/castor seeds, Crude Palm oil/ RBD Pamolein,
Groundnut oil, Mustard/ Rapeseed oil, Soy seeds/Soy meal/Refined Soy Oil,
Coconut Oil Cake, Copra, Sunflower oil, Sunflower Oil cake, Tamarind seed
oil,
Pluses:- Chana, Masur, Tur, Urad, Yellow peas
Grains:- Rice/ Basmati Rice, Wheat, Maize, Bajara, Barley,
Spices:-Pepper, Red Chili, Jeera, Cardamom, Cinnamon, Clove, Ginger,
Plantation:- Cashew Kernel, Rubber, Areca nut, Betel nuts, Coconut, Coffee,
Fiber and others:- Kapas, Kapas Khalli, Cotton (long staple, medium staple,
Short staple), Cotton Cloth, Cotton Yarn, Gaur seed and Guargum, Gur and
Sugar, Khandsari, Mentha Oil, Potato, Art Silk Yarn, Chara or Berseem, Raw
Jute, Jute Goods, Jute Sacking,
Petrochemicals:-High Density Polyethylene (HDPE), Polypropylene (PP),
Poly
Vinyl Chloride (PVC)
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Energy:-Brent Crude Oil, Crude Oil, Furnace Oil, Middle East Sour Crude Oil,
Natural Gas
National Multi Commodity Exchange of India Limited(NMCEIL)National Multi Commodity Exchange of India Limited (NMCEIL) is the first de-
mutualised Electronic Multi Commodity Exchange in India. On 25th July 2001 it
was granted approval by Government to organize trading in edible oil complex. It
is being supported by Central warehousing Corporation Limited, Gujarat State
Agricultural Marketing Board and Neptune Overseas Limited. It got reorganization
in Oct 2002. NMCEIL Head Quarter is at Ahmadabad.
INTERNATIONAL COMMODITY EXCHANGEWorlds MajorCommodity Exchanges
Futures trading is a result of solution to a problem related to the maintenance of a
year round supply of commodities/ products that are seasonal as is the case of
agricultural produce. The United States, Japan, United Kingdom, Brazil, Australia,Singapore are homes to leading commodity futures exchanges in the world.
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The New York Mercantile Exchange (NYMEX)
The New York Mercantile Exchange is the worlds biggest exchange for trading in
physical commodity futures. It is a primary trading forum for energy products and
precious metals. The exchange is in existence since last 132 years and performs trades
trough two divisions, the NYMEX division, which deals in energy and platinum and the
COMEX division, which trades in all the other metals.
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 worlds premier non -ferrous market, with
highly liquid contracts. The exchange was formed in 1877 as a direct consequence of
the industrial revolution witnessed in the 19th century. The primary focus of LME is in
providing a market for participants from non-ferrous based metals related industry to
safeguard against risk due to movement 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 a 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 Chicago Board of Trade
The first commodity exchange established in the world was the Chicago Board of Trade
(CBOT) during 1848 by group of Chicago merchants who were keen to establish a
central market place for trade. Presently, the Chicago Board of Trade is one of the
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leading exchanges in the world for trading futures and options. More than 50 contracts
on futures and options are being offered by CBOT currently through open outcry and/or
electronically. CBOT initially dealt only in Agricultural commodities like corn, wheat, non
storable agricultural commodities and non-agricultural products like gold and silver.
Commodities Traded: - Corn, Soybean, Oil, Soybean meal, Wheat, Oats, Ethanol,
Rough Rice, Gold, and Silver etc.
Tokyo Commodity Exchange (TOCOM)
The Tokyo Commodity Exchange (TOCOM) is the second largest commodity futures
exchange in the world. It trades in to metals and energy contracts. It has made rapid
advancement in commodity trading globally since its inception 20 years back. One of
the biggest reasons for that 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. TOCOMs recent tie up with the MCX to explore cooperation and
business opportunities is seen as one of the steps towards providing platform for futures
price discovery in Asia for Asian players in Crude Oil since the demand-supply situation
in U.S. that drives NYMEX is different from demand-supply situation in Asia. In Jan
2003, in a major overhaul of its computerized trading system, TOCOM fortified itsclearing system in June by being first commodity exchange in Japan to introduce an in-
house clearing system. TOCOM launched options on gold futures, the first option
contract in Japanese market, in May 2004.
Commodities traded: Gasoline, Kerosene, Crude Oil, Gold, Silver, Platinum,
Aluminum, Rubber, etc
Chicago Mercantile Exchange
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 rates
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futures, stock indices and foreign exchange futures. Its products often serves as a
financial benchmark and witnesses the largest open interest in futures profile of CME
consists of livestock, dairy and forest products and enables small family farms to large
Agri-business to manage their price risks. Trading in 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
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Chapter 4Current Scenario in Indian Commodity MarketAs on (September 21st, 2010)
Current Scenario in Indian Commodity Market
Need of Commodity Derivatives for India
India is among top 5 producers of most of the Commodities, in addition to being a major
consumer of bullion and energy products.
Agriculture contributes about 22% GDP of Indian economy. It employees around 57% of
the labor force on total of 163 million hectors of land Agriculture sector is an important
factor in achieving a GDP growth of 8-10%. All this indicates that India can be promoted
as a major centre for trading of commodity derivatives.
Trends in volume contribution on the three National Exchanges:-
Pattern on Multi Commodity Exchange (MCX)
MCX is currently largest commodity exchange in the country in terms of trade volumes,
further it has even become the third largest in bullion and second largest in silver future
trading in the world.
Coming to trade pattern, though there are about 100 commodities traded on MCX, only
3 or 4 commodities contribute for more than 80 percent of total trade volume. As per
recent data the largely traded commodities are Gold, Silver, Energy and base Metals.
Incidentally the futures trends of these commodities are mainly driven by international
futures prices rather than the changes in domestic demand-supply and hence, the price
signals largely reflect international scenario.
Among Agricultural commodities major volume contributors include Gur, Urad, Mentha
Oil etc.
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Pattern on National Commodity & Derivatives Exchange (NCDEX)
NCDEX is the second largest commodity exchange in the country after MCX. However
the major volume contributors on NCDEX are agricultural commodities.
But, most of them have common inherent problem of small market size, which is making
them vulnerable to market manipulations and over speculation. About 60 percent trade
on NCDEX comes from guar seed, chana and Urad (narrow commodities as specified
by FMC).
Pattern on National Multi Commodity Exchange (NMCE)
NMCE is third national level futures exchange that has been largely trading in
Agricultural Commodities.
Trade on NMCE had considerable proportion of commodities with big market size as
jute rubber etc. But, in subsequent period, the pattern has changed and slowly moved
towards commodities with small market size or narrow commodities.
Analysis of volume contributions on three major national commodity exchanges reveled
the following pattern, Major volume contributors: -
Majority of trade has been concentrated in few commodities that are
Non Agricultural Commodities (bullion, metals and energy) Agricultural commodities with small market size (or narrow commodities) like guar,
Urad, Mentha etc.
Latest DevelopmentsAgriculture commodity futures staged a remarkable recovery after steady decline over
the last two years, recording a trading value of Rs 10.88 lakh crore in 2009, signifying
growth of 48 per cent over the previous year.
During the year 2009, a new National Commodity Exchange called Indian Commodity
Exchange (ICEX) became operational.
Besides, a scheme of upgradation of Ahmadabad Commodity Exchange to National
Commodity Exchange status has been approved. Development of Electronic Spot
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Exchanges v/s Electronic spot exchanges is an emerging phenomenon in the country
these spot exchanges provide real time, online, transparent and vibrant spot platform for
commodities. The contracts allow participants from all over the country to buy and sell,
thereby enabling producers and users to discover best price.
The Government has allowed the National Commodity Exchanges to set up three spot
exchanges in the country, namely the National Spot Exchange Ltd. (NSEL), NCDEX
Spot Exchange Ltd. (NSPOT) and National Agriculture Produce Marketing Company of
India Ltd. (NAPMC).
During 2009, there was significant expansion of spot exchanges' trading facilities in
India. These spot exchanges have created an avenue for direct market linkage among
farmers, processors, exporters and end users with a view to reducing the cost ofintermediation and enhancing 29 price realizations by farmers.
They will also provide the most efficient spot price inputs to the futures exchanges. The
spot exchanges will encompass the entire spectrum of commodities across the country
and will bring home the advantages of an electronic spot trading platform to all market
participants in the agricultural and nonagricultural segments. On the agricultural side,
the exchanges would enable farmers to trade seamlessly on the platform by providing
simultaneous access to the exchanges and be able to procure at the best possible
price.
Therefore, the efficiency levels attained as a result of such seamless spot transactions
would result in major benefits for both producers and consumers.
In order to overcome current inefficiencies in the commodities spot market and to bring
transparency in trading in commodity spot markets, National Commodity and
Derivatives Exchange Limited (NCDEX) has set up an electronic spot exchange real-
time access to price information and a simplified delivery process, thereby ensuring the
best possible price. On the buy side, all users of the commodities in the commodity
value chain would have called NCDEX Spot Exchange Limited.
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CHAPTER 5.TradingCommodities Futures Trading SystemThe trading system on the NCDEX provides a fully automated screen-based trading for
futures on commodities on a nationwide basis as well as an online monitoring and
surveillance mechanism. It supports an order driven market and provides complete
transparency of trading operations.
The NCDEX system supports an order driven market, where orders match
automatically. Order matching is essentially on the basis of commodity, its price, time
and quantity. All quantity fields are in units and price in rupees. The Exchange specifies
the unit of trading and the delivery unit for futures contracts on various commodities.
The Exchange notifies the regular lot size and tick size for each of the contracts traded
from time to time. When any order enters the trading system, it is an active order. It tries
to find a match on the other side of the book.
If it finds a match, a trade is generated. If it does not find a match, the order becomes
passive and gets queued in the respective outstanding order book in the system. Time
stamping is done for each trade and provides the possibility for a complete audit trail if
required.
Entities in the Trading SystemThere are following entities in the trading system of NCDEX
1. Trading cum Clearing Member (TCM) :
Trading cum Clearing Members can carry out the transactions (trading, clearing and
settling) on their own account and also on their clients' accounts. The Exchange assignsan ID to each TCM. Each TCM can have more than one user. The number of users
allowed for each trading member is notified by the Exchange from time to time. Each
user of a TCM must be registered with the Exchange and is assigned an unique user
ID. The unique TCM ID functions as a reference for all orders/trades of different users.
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It is the responsibility of the TCM to maintain adequate control over persons having
access to the firm's User IDs.
2. Professional Clearing Member (PCM):
These members can carry out the settlement and clearing for their clients who have
traded through TCMs or traded as TMs.
3. Trading Member (TM):
Member who can only trade through their account or on account of their clients and will
however clear their trade through PCMs/STCMs.
4. Strategic Trading cum Clearing Member (STCM):
This is up gradation from the TCM to STCM. Such member can trade on their own
account, also on account of their clients. They can clear and settle these trades and
also clear and settle trades of other trading members who are only allowed to trade and
are not allowed to settle and clear.
Commodity Futures Trading CycleNCDEX trades commodity futures contracts having one-month, two-month, three-month
and more (not more than 12 months) expiry cycles. Most of the futures contracts (mainly
agro commodities contract) expire on the 20th of the expiry month. Some contracts
traded on the Exchange expire on the day other than 20th of the month. New contracts
for most of the commodities on NCDEX are introduced on 10th of every month. Base PriceOn introduction of new contracts, the base price is the previous days' closing price of
the underlying commodity in the prevailing spot markets. These spot prices are polled
across multiple centers and a single spot price is determined by the bootstrapping
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method. The base price of the contracts on all subsequent trading days is the daily
settlement price of the futures contracts on the previous trading day. Price Ranges of ContractsTo control wide swings in prices, an intra-day price limit is fixed for commodity futures
contract. The maximum price movement during the day can be +/- x% of the previous
day's settlement price for each commodity. If the price hits the first intra-day price limit
(at upper side or lower side), there will be a cooling period of 15 minutes. Then price
band is revised further and in case the prices reach that revised level, no trade is
permitted during the day beyond the revised limit.
Take an example of Guar Seed- Daily price fluctuation limit is (+/-) 4% (3% +1%). If the
trade hits the prescribed first daily price limit of 3 %, there will be a cooling off period for
15 minutes. Trade will be allowed during this cooling off period within the price band.
Thereafter, the price band would be raised by (+/-) 1% and trade will be resumed. If the
price hits the revised price band (4%) during the day, trade will only be allowed within
the revised price band. No trade / order shall be permitted during the day beyond the
limit of (+/-) 4%.
In order to prevent erroneous order entry by trading members, operating price ranges
on the NCDEX are pre-decided for individual contracts from the base price. Presently,
the price ranges for agricultural commodities is (+/-) 4 % from the base price for the day,
and upto (+/-) 9 % for non-agricultural commodities. Orders, exceeding the range
specified for a day's trade for the respective commodities are not executed
Margins for Trading In Futures
Margin is the deposit money that needs to be paid to buy or sell each contract. The
margin required for a futures contract is better described as performance bond or good
faith money.
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The margin levels are set by the exchanges based on volatility (market conditions) and
can be changed at any time. The margin requirements for most futures contracts range
from 5% to15% of the value of the contract, with a minimum of 5%, except for Gold
where the minimum margin is 4%.
In the futures market, there are different types of margins that a trader has to maintain.
Initial margin
The amount that must be deposited by a customer at the time of entering into a
contract is called initial margin. This margin is meant to cover the potential loss in one
day. The margin is a mandatory requirement for parties who are entering into the
contract. The exchange levies initial margin on derivatives contracts using the concept
of Value at Risk (VaR) or any other concept as the Exchange may decide periodically.
The margin is charged so as to cover one-day loss that can be encountered on the
position on 99.95% confidence-interval VaR methodology.
Exposure & Mark-to-Market Margin
Exposure margin is charged taking into consideration the back testing results of the
VaR model. For all outstanding exposure in the market, the Exchange also collectsmark-to-market margin which are positions restated at the daily settlement prices
(DSP). At the end of each trading day, the margin account is adjusted to reflect the
trader's gain or loss. This is known as marking to market the account of each trader. All
futures contracts are settled daily reducing the credit exposure to one day's movement.
Based on the settlement price, the value of all positions is marked-to-market each day
after the official close. i.e. the accounts are either debited or credited based on how well
the positions fared in that day's trading session. If the account falls below the required
margin level the clearing member needs to replenish the account by giving additional
funds or closing positions either partially/ fully. On the other hand, if the position
generates a gain, the funds can be withdrawn (those funds above the required initial
margin) or can be used to fund additional trades.
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Additional margin
In case of sudden higher than expected volatility, the Exchange calls for an additional
margin, this is a preemptive move to prevent potential default. This is imposed when the
Exchange/ regulator has view that that the markets have become too volatile and may
result in some adverse situation to the integrity of the market/ Exchange.
Pre-expiry margin
This margin is charged as additional margin for most commodities expiring during the
current/near month contract. It is charged on a cumulative basis from typically 3 to 5
days prior to the expiry date (including the expiry date). This is done to ensure that only
interested parties remain in the market and speculators roll over their positions to
subsequent months and ensure better convergence of the futures and spot market
prices.
Delivery Margin
This margin is charged only in the case of positions materializing into delivery. Members
are informed about the delivery margin payable. Margins for delivery are to be paid the
day following expiry of contract.
Special Margin
This margin is levied when there is more than 20% uni-directional movement in the
price from a pre-determined base and is typically related to the underlying spot price.
The base could be the closing price on the day of launch of the contract or the 90 days
prior settlement price. This is mentioned in the respective contract specification. Some
contracts also have an as-deemed-fit clause for levying of Special margins. It can also
be levied by market regulator if market exhibits excess volatility. If required by the
regulator, it has to be settled by cash. This is collected as extra margin over and above
normal margin requirement.
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Margin for Calendar Spread positions
Calendar spread is defined as the purchase of one delivery month of a given futures
contract and simultaneous sale of another delivery month of the same commodity by a
client/ member. At NCDEX, for calendar spread positions, margins are imposed as one
half of the initial margin (inclusive of the exposure margin). Such benefit will be given
only of there is positive correlation in the prices of the months under consideration and
the far month contracts are sufficiently liquid. No benefit of calendar spread is given in
the case of additional and special margins. However, calendar spread positions in the
far month contract are considered as naked position three days before expiry of near
month contract. Gradual reduction of the spread position is done at the rate of 33.3%
per day from 3 days prior to expiry. Just as a trader is required to maintain a margin
account with a broker, a clearing house member is required to maintain
collaterals/deposits with the clearing house against which the positions are allowed to
be taken.
ChargesMembers are liable to pay transaction charges for the trade done through the Exchange
during the previous month. The important provisions are listed below. The billing for the
all trades done during the previous month will be raised in the succeeding month.
1. Transaction charges
The transaction charges are payable at the rate of Rs. 4 per Rs.100,000 worth of
trade done. This rate is charged for average daily turnover of Rs. 20 crores.
Reduced rate is charged for increase in daily turnover. This rate is subject to
change from time to time. The average daily turnover is calculated by taking thetotal value traded by the member in a month and dividing it by number of trading
days in the month including Saturdays
2. Due date
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The transaction charges are payable on the 10th day of every month in respect
of the trade done in the previous month.
3. Collection
Members keep the Exchange Dues Account opened with the respective Clearing
Banks for meeting the commitment on account of transaction charges.
4. Adjustment against advances transaction charges
In terms of the regulations, members are required to remit Rs.50,000 as
advance transaction charges on registration. The transaction charges due first
will be adjusted against the advance transaction charges already paid asadvance and members need to pay transaction charges only after exhausting the
balance lying in advance transaction.
5. Penalty for delayed payments
If the transaction charges are not paid on or before the due date, a penal interest
is levied as specified by the Exchange.
Finally, the futures market is a zero sum game i.e. the total number of long in anycontract always equals the total number of short in any contract. The total number of
outstanding contracts (long/ short) at any point in time is called the 'Open interest'. This
Open interest figure is a good indicator of the liquidity in every contract. Based on
studies carried out in international Exchanges, it is found that open interest is maximum
in near month expiry contracts.
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Chapter 6 Clearing and SettlementIntroductionMost futures contracts do not lead to the actual physical delivery of the underlying
asset. The settlement is done by closing out open positions, physical delivery or cash
settlement. All these settlement functions are taken care of by an entity called clearing
house or clearing corporation. National Commodity Clearing Limited (NCCL) undertakes
clearing of trades executed on the NCDEX.ClearingClearing of trades that take place on an Exchange happens through the Exchange
clearing house. A clearing house is a system by which Exchanges guarantee the faithful
compliance of all trade commitments undertaken on the trading floor or electronically
over the electronic trading systems. The main task of the clearing house is to keep track
of all the transactions that take place during a day so that the net position of each of its
members can be calculated. It guarantees the performance of the parties to each
transaction. Typically it is responsible for the following:
1. Effecting timely settlement.
2. Trade registration and follow up.
3. Control of the open interest.
4. Financial clearing of the payment flow.
5. Physical settlement (by delivery) or financial settlement (by price difference) of
contracts.
6. Administration of financial guarantees demanded by the participants.
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The clearing house has a number of members, who are responsible for the clearing and
settlement of commodities traded on the Exchange. The margin accounts for the
clearing house members are adjusted for gains and losses at the end of each day (in
the same way as the individual traders keep margin accounts with the broker). Everyday
the account balance for each contract must be maintained at an amount equal to the
original margin times the number of contracts outstanding. Thus depending on a day's
transactions and price movement, the members either need to add funds or can
withdraw funds from their margin accounts at the end of the day.
The brokers who are not the clearing members need to maintain a margin account with
the clearing house member through whom they trade.
Clearing Mechanism
Only clearing members including professional clearing members (PCMs) are entitled to
clear and settle contracts through the clearing house.
The clearing mechanism essentially involves working out open positions and
obligations of clearing members. This position is considered for exposure and daily
margin purposes. The open positions of PCMs are arrived at by aggregating the open
positions of all the Trading Members clearing through him, in contracts in which they
have traded. A Trading-cum-Clearing Member's (TCM) open position is arrived at by the
summation of his clients' open positions, in the contracts in which they have traded.
Client positions are netted at the level of individual client and grossed across all clients,
at the member level without any set-offs between clients. Proprietary positions are
netted at member level without any set-offs between client and proprietary positions.
After the trading hours on the expiry date, based on the available information, the
matching for deliveries takes place firstly, on the basis of locations and then randomly,
keeping in view the factors such as available capacity of the vault/ warehouse,
commodities already deposited and dematerialized and offered for delivery etc.
Matching done by this process is binding on the clearing members. After completion of
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the matching process, clearing members are informed of the deliverable/ receivable
positions and the unmatched positions. Unmatched positions have to be settled in cash.
The cash settlement is only for the incremental gain/ loss as determined on the basis of
final settlement price.
Clearing Banks
Each exchange has designated clearing banks through whom funds to be paid and/ or
to be received must be settled. Every clearing member is required to maintain and
operate a clearing account with any one of the designated clearing bank branches. The
clearing account is to be used exclusively for clearing operations i.e., for settling funds
and other obligations to each exchange including payments of margins and penalcharges. A clearing member having funds obligation to pay is required to have clear
balance in his clearing account on or before the stipulated pay-in day and the stipulated
time. Clearing members must authorize their clearing bank to access their clearing
account for debiting and crediting their accounts as per the instructions of each
exchange, reporting of balances and other operations as may be required by each
exchange from time to time. The clearing bank will debit/ credit the clearing account of
clearing members as per instructions received from the exchange.
Depository participantsEvery clearing member is required to maintain and operate two CM pool account each
at NSDL and CDSL through any one of the empanelled depository participants. The CM
pool account is to be used exclusively for clearing operations i.e., for effecting and
receiving deliveries from NCDEX.
SettlementFutures contracts have two types of settlements, the Mark-to-Market (MTM) settlement
which happens on a continuous basis at the end of each day, and the final settlement
which happens on the last trading day of the futures contract. On, commodity exchange
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MTM settlement and final MTM settlement in respect of admitted deals in futures
contracts are cash settled by debiting/ crediting the clearing accounts of CMs with the
respective clearing bank. All positions of a CM, either brought forward, created during
the day or closed out during the day, are marked to market at the daily settlement price
or the final settlement price at the close of trading hours on a day.
Daily settlement price: Daily settlement price is the consensus closing price as
arrived after closing session of the relevant futures contract for the trading day.
However, in the absence of trading for a contract during closing session, daily
settlement price is computed as per the methods prescribed by the Exchange from time
to time.
Final settlement price: Final settlement price is the polled spot price of the underlying
commodity in the spot market on the last trading day of the futures contract. All open
positions in a futures contract cease to exist after its expiration day. Settlement involves
payments (Pay-Ins) and receipts (Pay-Outs) for all the transactions done by the
members. Trades are settled through the Exchange's settlement system.
Settlement Mechanism
Settlement of commodity futures contracts is a little different from settlement of financial
futures which are mostly cash settled. The possibility of physical settlement makes the
process a little more complicated.
Daily mark to market settlement
Daily mark to market settlement is done till the date of the contract expiry. This is done
to take care of daily price fluctuations for all trades. All the open positions of the
members are marked to market at the end of the day and the profit/ loss is determinedas below:
On the day of entering into the contract, it is the difference between the entry value
and daily settlement price for that day.
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On any intervening days, when the member holds an open position, it is the difference
between the daily settlement price for that day and the previous day's settlement price.
On the expiry date if the member has an open position, it is the difference between the
final settlement price and the previous day's settlement price.
Final settlement
On the date of expiry, the final settlement price is the closing price of the underlying
commodity in the spot market on the date of expiry (last trading day) of the futures
contract. The spot prices are collected from polling participants from base centre as well
as other locations. The poll prices are bootstrapped and the mid-point of the two boot
strapped prices is the final settlement price. The responsibility of settlement is on a
trading cum clearing member for all trades done on his own account and his client's
trades.
A professional clearing member is responsible for settling all the participants' trades
which he has confirmed to the Exchange. Members are required to submit delivery
information through delivery request window on the trader workstations provided by
commodity exchange or all open positions for a commodity for all constituents
individually. This information can be provided within the time notified by Exchange
separately for each contracts. Commodity exchange on receipt of such information
matches the information and arrives at a delivery position for a member for a
commodity. A detailed report containing all matched and unmatched requests is
provided to members through the extranet.
Pursuant to regulations relating to submission of delivery information, failure to submit
delivery information for open positions attracts penal charges as stipulated by
commodity exchange from time to time. Commodity exchange also adds all such open
positions for a member, for which no delivery information is submitted with final
settlement obligations of the member concerned and settled in cash as the case may
be.
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Non-fulfillment of either the whole or part of the settlement obligations is treated as a
violation of the rules, bye-laws and regulations of commodity exchange and attracts
penal charges as stipulated by commodity exchange from time to time. In addition,
commodity exchange can withdraw any or all of the membership rights of clearing
member including the withdrawal of trading facilities of all trading members clearing
through such clearing members, without any notice. Further, the outstanding positions
of such clearing member and/ or trading members and/ or constituents, clearing and
settling through such clearing member, may be closed out forthwith or any time
thereafter by the Exchange to the extent possible, by placing at the Exchange, counter
orders in respect of the outstanding position of clearing member without any notice to
the clearing member and/ or trading member and/ or constituent. Commodity exchangecan also initiate such other risk containment measures as it deems appropriate with
respect to the open positions of the clearing members. It can also take additional
measures like, imposing penalties, collecting appropriate deposits, invoking bank
guarantees or fixed deposit receipts, realizing money by disposing off the securities and
exercising such other risk containment measures as it deems fit or take further
disciplinary action.
Settlement Methods
Settlement of futures contracts on the NCDEX can be done in two ways - by physical
delivery of the underlying asset and by closing out open positions. All contracts
materializing into deliveries are settled in a period as notified by the Exchange
separately for each contract. The exact settlement day for each commodity is specified
by the Exchange through circulars known as 'Settlement Calendar'.
a) Physical delivery of the underlying asset
If the buyer/seller is interested in physical delivery of the underlying asset, he must
complete the delivery marking for all the contracts within the time notified by the
Exchange.
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b) Closing out by offsetting positions
Most of the contracts are settled by closing out open positions. In closing out, the
opposite transaction is effected to close out the original futures position. A buy contract
is closed out by a sale and a sale contract is closed out by a buy. For example, an
investor who took a long position in two gold futures contracts on the January 30 at
Rs.16090 per 10 grams, can close his position by selling two gold futures contracts on
February 13, at Rs.15928. In this case, over the period of holding the position, he has
suffered a loss of Rs.162 per 10 grams. This loss would have been debited from his
account over the holding period by way of MTM at the end of each day, and finally at
the price that he closes his position, that is Rs.15928, in this case.
c) Cash settlement
In the case of intention matching contracts, if the trader does not want to take/ give
physical delivery, all open positions held till the last day of trading are settled in cash at
the final settlement price. Similarly any unmatched, rejected or excess intention is also
settled in cash. When a contract is settled in cash, it is marked to the market at the end
of the last trading day and all positions are declared closed.
For example, Paul took a short position in five Silver 5kg futures contracts of July expiry
on June 15 at Rs.21500 per kg. At the end of 20th July, the last trading day of the
contract, he continued to hold the open position, without announcing delivery intention.
The closing spot price of silver on that day was Rs.20500 per kg. This was the
settlement price for his contract.
Though Paul was holding a short position on silver, he did not have to actually deliver
the underlying silver. The transaction was settled in cash and he earned profit of Rs.
5000 per trading lot of silver.
Unmatched positions of contracts, for which the intentions for delivery were submitted,
are also settled in cash. In case of commodity exchange, all contracts being settled in
cash are settled on the day after the contract expiry date. If the cash settlement day
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happens to be a Saturday, a Sunday or a holiday at the exchange, clearing banks or
any of the service providers, Pay-in and Pay-out would be effected on the next working
day.
Entities involved in Physical Settlement
Physical settlement of commodities involves the following three entities - an accredited
warehouse, registrar & transfer agent and an assayer. We will briefly look at the
functions of each.
Accredited warehouse
Commodity exchange specifies accredited warehouses through which delivery of a
specific commodity can be affected and which will facilitate for storage of commodities.
For the services provided by them, warehouses charge a fee that constitutes storage
and other charges such as insurance, assaying and handling charges or any other
incidental charges.
Following are the functions of an accredited warehouse:
1. Earmark separate storage area as specified by the Exchange for the purpose of
storing commodities to be delivered against deals made on the Exchange. The
warehouses are required to meet the specifications prescribed by the Exchange for
storage of commodities.
2. Ensure and co-ordinate the grading of the commodities received at the warehouse
before they are