Acknowledgment

A project is never the sole product of a person whose name has appeared on the cover. Even the best effort may not prove successful without proper guidance. For a best project one needs proper time, energy, efforts, patience, and knowledge and how to use all these things. But without any guidance it remains unsuccessful. I have done this project with the best of my ability and hope that it will serve its purpose.

At the onset I would like to express my deepest gratitude to Mr.Sushil Sinha, Country Head, Karvy Comtrade Ltd. for giving me the opportunity of conducting out my summer internship project in Karvy Comtrade Ltd. It was really a great learning experience and I would really express my special and profound gratitude to my guide Ms. Priya Chaudhary who not only helped me in the successful completion of this report but also spread his precious and valuable time in expanding my knowledge base, I take immense pleasure in thanking them for supporting at all stages of this project. After the completion of this Project I feel myself as a well aware person about the procedure and the complexities that can arose during the process. Also I get an insight of the commodity markets and its working. Finally, I am also grateful to all those personalities who have helped me directly or indirectly in bringing up this project report, my colleagues.

- Abha Mahapatra

Mr. Sushil Sinha

VP & Country Head Karvy Comtrade Ltd.

Certificate

This is to certify that the project report entitled “Challenges to Commodity Markets in India” prepared by Ms. Abha Mahapatra (Roll no. 75003),student at Shaheed Sukhdev College of Business Studies, Delhi University, in fulfillment of summer internship project at Karvy Comtrade Ltd., Hyderabad, Andhra Pradesh is a record of work done under my guidance and supervision.She has successfully completed her summer internship project of one and half months starting from 28 May 2012 to 8 July 2012.As an intern she has successfully completed all assigned task during the period of internship. An overview of tasks :

Worked in a software driven trading environment. Dishcharged customer relation management functions.

Banjara Hills, Hyderabad (Mr. Sushil Sinha) Andhra Pradesh Supervisor 8th July 2012

Executive SummaryCommodity exchanges in Indian are still at a nascent stage, and there are numerous bottlenecks in the growth of the commodity futures market. The challenges facing the Indian Commodity markets are very serious in nature and cannot be ignored as they can paralyze the agricultural futures markets, much against the objective of agricultural liberalization. The main problem is that the commodity markets are under the control of Government.

Commodity derivatives have achieved one of the fastest growth rates, probably the highest among any other developmental initiatives undertaken either in agricultural sector or in financial sector of a developing economy like India. But certainly this achievement is not just erecting a castle in air. Reasons are deep-rooted. Indian traders have century old experiences in trading commodity derivatives. Permitting commodity exchanges to set up an anonymous electronic trading platform accessible across the nation has given all the required mileage for commodity trading to scale new heights.

Compared to the 130 years old stock market, the commodity market is in its nascent stage. It is very much in consensus that by the advent of commodity derivatives trading, a silent revolution is building up in the economy. Though trading volumes in this new market is gradually catching up that in the stock market, yet commodity exchanges are facing challenges that need to be addressed now. There are certain set of challenges where commodity exchanges require regulatory amendments to make this market vibrant and some other set of challenges, where commodity exchanges have to take up the initiatives.

This project is focused on highlighting those challenges which create bottlenecks in the smooth operations of commodity markets and can slow down its growth. At the end it suggests measures for creating a free and well regulated market.

Table of Contents

Serial No.

Topic Page No.

1. Introduction to Commodity MarketsSpot MarketsFuture MarketsCommodity as Asset ClassCommodities: Unique Points of Diversification

2. History of Commodity Markets in IndiaBrief HistoryChange in government policy

3. Performance of Commodity Markets4. Evolution of Forward Market Commission

Forward Contracts (Regulation) ActRegulatory toolsMajor initiatives taken by the GOVT/Commission since liberalization of the marketsMajor initiatives taken by FMC during 2010-11Collaboration with international regulatorsDevelopmental initiatives taken by FMCCurrent Scenario

5. Challenges faced by Commodity Markets CurrentlyLegal ChallengesRegulatory ChallengesInfrastructural ChallengesAwareness among investors and producersOther Challenges

Introduction to Commodity Markets

India, a commodity based economy where two-third of the one billion population depends on agricultural commodities, surprisingly has an underdeveloped commodity 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 stock. A commodity is any physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts. The term is sometimes used more generally to include any product which trades on a commodity exchange; this would also include foreign currencies and financial instruments and indexes. The price of the commodity is subject to supply and demand factors. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be. A speculator can pay the farmer or anyone else producing commodities because the speculator wants to make a profit. This is called trading in futures.

The following is a list of commodities available for futures trading: Agricultural: grains, oils, livestock,

wood, textiles, food products Metallurgical: metals, petroleum,

chemicals Interest Bearing Assets: T-bills, bonds,

notes Stock Indices Currencies

Most of these contracts are used by corporations to hedge positions taken elsewhere. Some futures contracts, notably those for stock indices, are settled in cash because they are not deliverable goods. The contracts also vary in terms of the transaction date and the quality level of goods to be bought and sold. New futures contracts are created continuously, but many are not liquid enough to trade regularly and are used only as hedges.

SPOT MARKETS

Spot markets are organized exchanges where commodity products can daily be traded (by large amounts, even). Typical examples are the CME (Chicago Mercantile Exchange), the MCE (Mid America Commodity Exchange).

FUTURES MARKETS At their very early stage, commodity markets futures trading exchanges, served the purpose of hedging against price fluctuations in agricultural commodities. Sellers (farmers) and buyers would commit themselves to future exchanges of grain for a certain amount of cash. Nowadays, the rationale for trading futures is threefold:

Hedging against price fluctuations. Both producers, refiners (in the case of oil) and consumers would look to it. For example, a producer, that is a participant who wants to sell the physical

commodity, will hedge by selling futures. On the other hand, a consumer will try to be long futures, once she decided to buy the commodity in question.

Speculation: trading futures, as compared to spot assets, presents many advantages, as futuresare more leveraged than the spot instruments

because of the low margin requirement, are cheaper in term of transaction costs and finally do not require storage during the lifetime of the contract.Arbitrage between spot and futures markets: for commodities, the cash and carry arbitrage is more difficult to realize because of storage and delivery costs. Commodity as Asset ClassA group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations. The three main asset classes are equities (stocks), fixed-income (bonds) and cash equivalents (money market instruments).

While the 1980s and the 1990s witnessed above-average returns on the equity and bond markets, the 2000s (until 2008) were clearly the decade of the forgotten asset class. Commodities have experienced a renaissance, with several driving forces at work. The strong demand for commodities from the developing countries, as well as from emerging countries (especially from China),

has pulled prices significantly higher. At the same time, supply was limited by nature and bottlenecks in the production appeared due to negligence of investments.

Additionally, investors also rediscovered the forgotten asset class. Investments in commodities not only offer the possibility of expected price increases but also reduce the risk in a portfolio since commodity returns have historically shown a very low or a negative correlation with the traditional asset classes of equities and bonds, although the correlation between asset classes increased in 2008. This diversification effect can be amplified by investments in different commodities since the price of each commodity reacts differently to economic forces and commodity returns appear to display a low correlation to each other.

Against the background of the financial turmoil in 2008, commodity prices have corrected sharply. One of the biggest corrections has been observed in the oil price. After reaching a record high in July 2008 at $147, the price of the "black gold" dropped to $32, a fall of almost 80% within just five months. On a broader basis, the CRB Commodity Index, one of the most recognized indices to track commodity prices, has also shown a significant loss of 58% after reaching a record high in July 2008 as well.

The main reasons for the sharp correction were global recession, a stronger dollar and rising risk aversion among financial investors. As everyone was discussing the sharp fall in equities, commodities slumped even more. Considering the recent strong equity rally, some people have started to look at equities again. It might also make sense to rethink commodities, as after reaching the bottom late in 2008 most of them could recover from their multi-year lows.

In financial parlance, assets are economic resources that are capable of being owned or controlled to produce value. Commodity too has gained importance currently as independent asset class. Commodities, being the natural goods are independent of other asset classes

Assets Classes

Equities: Performer during economic expansion & an out performer over very long term.Fixed Income: Performs at the later stage of recession.Real Estate: Performs during early expansion.Commodities: Performance spread evenly over the economic cycle.

Commodities: Unique points of Diversification

Seasonality A major force in the commodities marketsCorrelation Unlike other asset class, commodities are positively and negatively correlated

within & outside the group which is unique to commodities onlyWeather No other asset class are so much influenced by weather patternsHedge Provides natural hedge against war, inflation, other asset portfolios, recession etc. example -GOLD

Below is a guide to various macro-economic or fundamental factors affecting commodity price.

Inflation : Commodities has long been viewed as a hedge against inflation, some more than others.

Supply & Demand : Learn what all online commodity traders should know about the commodity markets balance of supply and demand .

Exchange rates : Do you know the most important exchange rates to keep track on and why and when you should do it?

Business cycle : Most commodities follow a cyclical behavior. Interest Rates : See the current interest rates for the major countries and currencies, and

learn why it impacts commodity prices.

History of Commodity Markets in India

The commodity futures market in India dates back to more than a century. The first organized futures market was established in 1875, under the name and style of 'Bombay Cotton Trade Association' to trade in cotton derivative contracts. This was followed by institutions for futures trading in oilseeds, food grains, etc. The futures market in India underwent rapid growth

between the period of First and Second World Wars. As a result, before the outbreak of the Second World War, a large number of commodity exchanges trading futures contracts in several commodities like cotton, groundnut, groundnut oil, raw jute, jute goods, Castor seed, wheat, rice, sugar, precious metals like gold and silver were flourishing throughout the country. In view of the delicate supply situation of major

commodities in the backdrop of war efforts mobilization, futures trading came to be prohibited during the Second World War under the Defence of India Act. After independence, especially in the second half of the 1950s and first half of 1960s, the commodity futures trading again picked up and there were thriving commodity markets. However, in mid-1960s, commodity futures trading in most of the commodities came to be banned and futures trading continued only in two minor commodities, viz, pepper and turmeric. In the 1980s, the futures trading in some commodities like potato, Castor seed, and gur (jaggery) was permitted. In 1992, futures trading in hessian were permitted; in April 1999 futures trading in various edible oilseed complexes were permitted and in May 2001 futures trading in Sugar were permitted. The National Agricultural Policy announced in July 2000 recognized the positive role of forward and futures market in price discovery and price risk management. In pursuance thereof, Government of India, by a notification dated 1.4.2003, permitted additional 54 commodities for futures trading. With the issue of this notification, prohibition on futures trading has been completely withdrawn. The mechanism of forward trading has actually developed and advanced considerably in the major trading nations of the world, like USA, UK, France, Japan, etc. In these countries, forward trading has been permitted in many new items/services including financial futures, shipping freights and interest rates etc. In comparison, commodity futures markets in India are much simpler and are at present dealing in single futures contracts in commodities.

Change in Government Policy

After the Indian economy embarked upon the process of liberalization and globalization in 1990, the Government set up a Committee in 1993 to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also recommended strengthening of the Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing options 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.

Commodity futures trading in India remained in a state of hibernation for nearly four decades, mainly due to doubts about the benefits of derivatives. Finally a realization that derivatives do perform a role in risk management led the government to change its stance. The policy changes favoring commodity derivatives were also facilitated by the enhanced role assigned to free market forces under the new liberalization policy of the Government. Indeed, it was a timely decision too, since internationally the commodity cycle is on the upswing and the next decade is being touted as the decade of commodities.

Performance of Commodity Markets in

The Indian Commodity Futures Markets continued to grow, despite the suspension of futures trading in a few agricultural commodities. During the year, 113 commodities were regulated under the auspices of the recognized Exchanges. During 2010-11, 21 recognized exchanges were functioning. Out of the 113 commodities, regulated by the FMC, in terms of value of trade, Silver, Gold, Copper, Nickel, Zinc, Lead, Soy Oil, Guarseed, Chana, Pepper, and Jeera were the prominently traded commodities.

The table below indicates the commodity wise/group wise volume and value of trade in the commodity market during the year.

Volume of Trading and Value of Trade during the year 2010-11 in Major Commodities Volume of Trading – In lakh tonneValue - In ` CroreSr.No Name of the

Commodity2010-11

Volume ValueA Bullion i Gold 0.14 2700607.00ii Silver 7.24 2793280.23 iii Platinum 0.0000002 4.89 Total for A 7.38 5493892.12B Metals other than

Bullion

i Aluminum 110.17 114081.70ii Copper 335.36 1239261.20iii Lead 356.88 366422.24iv Nickel 44.83 478789.31v Steel 86.66 22759.03Vi Tin 0.002 18.35Vii Zinc 463.25 465375.27

Volume of Trading and Value of Trade during the year 2010-11 in Major Commodities Volume of Trading – In lakh tonneValue - In ` CroreSr.No Name of the

Commodity2010-11

Volume Valueviii Iron 12.56 965.89 Total for B 1409.72 2687672.99C Agricultural

commodities

i Chana/Gram 523.59 126158.29ii Wheat 26.78 3316.88iii Maize 16.36 1730.06iv Soy Oil 617.15 345286.26v Mentha Oil 6.21 60527.10vi Guarseed 1056.04 254690.88vii Guar Gum 83.15 49942.57viii Potato 269.22 14428.17ix Chilies 11.31 8493.79x Jeera(Cumin seed) 42.53 60864.48xi Cardamom 0.77 10882.04xii Pepper 42.25 84786.09xiii Rubber 11.78 23846.92

xiv other agri 1461.21 411436i.10 Total for C 4168.35 1456389.62D Energy 7220.12 2310958.58E Other 0.00 29.04Grand Total (A+B+C+D+E) 12805.57 11948942.3

5Note: Natural Gas, Heating Oil & Gasoline Volumes are not included in the Total Volume.

The share of various Exchanges in the total value of trade in 2010-11.

Value of the recognized Exchanges during 2010-11

Name of the Exchanges Value in ` Cr. % share to the total value of the commodities traded during 2010-11.

MCX 98,41,502.90 82.36 NCDEX, Mumbai 14,10,602.21 11.81

NMCE, Ahmadabad 2,18,410.90 1.83 ICEX, Gurgaon 3,77,729.88 3.16ACE, Ahmadabad @ 30,059.63 0.25 NBOT, Indore 51,662.06 0.43

Total of six Exchanges 1,19,29,967.58 99.84 Others 18,974.77 0.16 Grand Total 1,19,48,942.35 100

% share of the commodity exchanges to the total value of trade during the year 2010-11

(April-March) NBOT0.43%

ACE0.25% ICEX

3.16%

MCX82.36%

Others0.16%NMCE

1.83%

NCDEX11.81%

MCX NCDEX NMCE ICEX ACE NBOT Others

Source: Annual Report of FMC, 2010-11

Source: Report of the UNCTAD Study Group on Emerging Commodity Exchanges

Evolution of Forward Market Commission

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. A Bill on forward contracts was referred to an expert committee headed by Prof. A.D.Shroff and Select Committees of two successive Parliaments and finally in December 1952 Forward Contracts (Regulation) Act, 1952, was enacted. The Act provided for 3-tier regulatory system;

a) An association recognized by the Government of India on the recommendation of Forward Markets Commission,

b) The Forward Markets Commission (it was set up in September 1953) and The Central Government.

c) 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

MCX and warehousing expansion“It is in the warehousing sector that India is witnessing another boom these days. Warehouse companies in India are increasing capacity thanks to huge demand for various agricultural products because of the increasing delivery system in futures market and the retail boom that is taking place across the country.

“The Indian farmer will get a much better price for his produce, if he is able to store them well,” says Managing Director Anil Choudhary of National Bulk Handling Corp Ltd (NBHC). He said with over 40 commodities being traded and more additions likely, greater investment in warehousing facilities is needed from the farm gate to the delivery point. Choudhary said NBHC, a subsidiary of the leading commodity bourse—the Multi Commodity Exchange of India—will add 5 million tonnes of warehousing capacity in 3-5 years.”Source: Commodity Online. “India to witness warehousing boom” (Monday, 9 July 2007).

association organized in such free commodities is required to obtain the Certificate of Registration from the Forward Markets Commission.

In the seventies, most of the registered associations became inactive, as futures as well as forward trading in the commodities for which they were registered came to be either suspended or prohibited altogether.

The Khusro Committee (June 1980) had recommended reintroduction of futures trading in most of the major commodities , including cotton, kapas, raw jute and jute goods and suggested that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at appropriate time. The government, accordingly initiated futures trading in Potato during the latter half of 1980 in quite a few markets in Punjab and Uttar Pradesh.

After the introduction of economic reforms since June 1991 and the consequent gradual trade and industry liberalization in both the domestic and external sectors, the Govt. of India appointed in June 1993 one more committee on Forward Markets under Chairmanship of Prof. K.N. Kabra. The Committee submitted its report in September 1994. The majority report of the Committee recommended that futures trading be introduced in

1) Basmati Rice 2) Cotton and Kapas3) Raw Jute and Jute Goods4) Groundnut , rapeseed/mustard seed , cottonseed , sesame seed , sunflower seed , safflower seed , copra and soybean , and oils and oilcakes of all of them.5) Rice bran oil 6) Castor oil and its oilcake7) Linseed8) Silver and9) Onions.

The committee also recommended that some of the existing commodity exchanges particularly the ones in pepper and castor seed, may be upgraded to the level of international futures markets.

The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement and distribution channel necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management.The National Agriculture Policy announced in July 2000 and the announcements of Hon'ble Finance Minister in the Budget Speech for 2002-2003 were indicative of the Governments resolve to put in place a mechanism of futures trade/market. As a follow up the Government issued notifications on 1.4.2003 permitting futures trading in the commodities, with the issue of

these notifications futures trading is not prohibited in any commodity. Options’ trading in commodity is, however presently prohibited.

Regulation of forward trading is done through a three tier regulatory structure, viz., the Central Government, Forward Markets Commission and the Recognized Commodity Exchanges / Associations.

The Central Government has the powers to legislate on the subject of forward trading in commodities. Presently, the subject is dealt with by the Ministry of Consumer Affairs, Food and public Distribution in the Central Government. The Central Government broadly determines the policy relating to areas such as identification of commodities as well as the territorial area in which futures / forward trading can be permitted and giving recognition to the Exchange / Association through which such trading is to be permitted.

The Forward Markets Commission performs the role of approving the Rules and Regulations of the Exchange accordance to which trading is to be conducted, accords permission for commencement of trading in different contracts, monitors market conditions continuously and takes remedial measures wherever necessary.

The Recognized Exchange / Associations provide the framework of Rules and Regulations for conduct of trading, indicate the place where the trading can be conducted, report, record, execute & settle contracts, provide forum for exchange of documents and payments, etc.

Forward Contracts (Regulation) ActThe Commodity Future Markets are regulated according to the provisions of Forward Contracts (Regulation) Act 1952. The Act broadly divides commodities into 3 categories, i.e. commodities in which forward trading is prohibited, commodities in which forward trading is regulated and residuary commodities. Under Section 17 of the FC(R) Act, 1952, the Government has powers to notify commodities, in which forward trading is prohibited in whole or part of India. Any forward trading in such commodities in the notified area is illegal and any person who contravenes the provisions of section 17 shall be liable to penal action. Under Section 15, Government has powers to notify commodities in which forward trading is regulated as also the area in which such regulation will be in force. Once a commodity is notified under section 15, the forward trading in such contracts (other than Non-transferable Specific Delivery Contracts) can be entered into only between members of the recognized association or through or with any such member. Contracts other than these are illegal. Section 6 of the Act provides powers to the Central Government to grant recognition to an association for organizing forward contracts in the commodity which is notified under Section 15. Such recognition may be for a specified period or may remain in force till revoked under Section 7 of the Act. Section 18(1) exempts the Non-Transferable Specific Delivery Contracts from the purview of regulation. However, under Section 18(3) of the Act, the Government has powers to prohibit or regulate the non-transferable specific delivery contracts in commodities also by issue of a notification. Such notifications may apply for the whole of the country or the specified part of the country. Trading in commodities where non-transferable specific delivery

contracts are prohibited is illegal and any person who does such illegal trading shall be liable to penal action. Trading in non-transferable specific delivery contracts in respect of regulated commodities has to be through recognized associations just as in the case of other forward contracts. The commodities that are notified neither under section 15 nor under section 17 of the Act are in common parlance referred to as free commodities. For organized forward trading in such commodities, the concerned Association or Exchange has to get a certificate of registration under Section 14B of the Act from the Forward Markets Commission.

The Act defines three types of contracts i.e. ready delivery contracts, forward contracts and options in goods.

Ready delivery contracts are contracts for delivery of goods and payment of price therefore where both the delivery and payment are completed within 11 days from the date of the contract. Such contracts are outside the purview of the Act.

Forward Contracts, on the other hand, are contracts for delivery of goods where delivery or payment or both takes place after 11 days from the date of contract or where the contract is performed by any other means as a result of which actual tendering of goods for the payment of the full price therefore is dispensed with.

The forward contracts are further of two types, viz., specific delivery contracts and 'other than specific delivery contracts'. The specific delivery contracts are those where delivery of goods is mandatory though delivery takes place after a period longer than 11 days. Specific delivery contracts are essentially merchandising contracts entered into by the parties for actual transactions in the underlying commodity and terms of contract may be drawn to meet specific needs of parties as against standardized contracts like terms in futures contracts.

The specific delivery contracts are again of two sub-types viz., the transferable variety where rights and obligations under the contracts are capable of being transferred and the non-transferable variety where rights and obligations are not transferable.

Forward contracts other than specific delivery contracts are what are generally known as 'futures contracts' though the Act does not specifically define the futures contracts.

Such contracts can be performed either by delivery of goods and payment thereof or by entering into offsetting contracts resulting into payment or receipt of amount based on the difference between the rate of entering into contract and the rate of offsetting contract. Futures contracts are usually standardized contracts where the quantity, quality, date of maturity, place of delivery are all standardized and the parties

to the contract only decide on the price and the number of units to be traded. Futures contracts are entered into through the Commodity Exchanges.

‘Options’ in goods means an agreement, by whatever name called, for the purchase or sale of a right to buy or sell, or a right to buy and sell, goods in future and includes a put, a call, or a put and call in goods. Options in goods are prohibited under the present Act. An option contract is the right (but not the obligation) to purchase or sell a certain commodity at a pre-arranged price (the "strike price") on or before a specified date. For this contract, the buyer or seller of the option has to pay a price to his counterpart at the time of contracting, which is called the "premium; if the option is not used, the premium is the maximum cost involved. When prices move unfavorably, this right will not be exercised, and therefore, the purchase of options provides protection against unfavorable price movements, while permitting to profit from favorable ones. Option can give the right to buy or sell a certain amount of physical commodity, or, more commonly, they can give the right to buy or sell a futures contract.

Working of Forward Markets Commission:

Forward Markets Commission is a statutory body set up under Forward Contracts (Regulation) Act, 1952. The Commission functions under the administrative control of the Ministry of Consumer Affairs, Food & Public Distribution, Department of Consumer Affairs, and Government of India. The functions of the FMC are dealt with in section 4 of the Forward Contracts (Regulation) Act, 1952 [F.C(R) Act, 1952] which is given below:

i. 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 the FC(R) Act, 1952.

ii. to keep forward markets under observation and to take such action, in relation to them as it may consider necessary, in exercise of the powers assigned to it by or under the FC(R) Act, 1952.

iii. 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 the Act, and the working of forward markets relating to such goods.

iv. to make recommendations generally, with a view to improving the organization and the working of forward markets.

v. 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 and

vi. to perform such other duties and exercise such other powers as may be assigned to the Commission by or under the FC(R) Act, 1952 or as may be prescribed.

Section 4A of the FC (R) Act, 1952 deals with the powers of the Commission which are as follows:

The Commission have all the powers of a civil court under the Code of Civil Procedure 1908 (5 of 1908) while trying a suit in respect of the following matters:

● Summoning and enforcing the attendance of any person and examining him on oath;

● Requiring the discovery and production of any documents;

● Receiving evidence on affidavits;

● Requisitioning any public record or copy thereof from any office;

● Any other matter which may be prescribed.

The Commission, thus, is a statutory authority entrusted with regulatory functions under the Act. The Commission consists of a Chairman and two members. Presently, Shri. Ramesh Abhishek, IAS is officiating as the Chairman of the Commission. Shri. D. S. Kolamkar, IES is the Member of the Commission. It has its headquarters at Mumbai and a Regional Office at Kolkata. Forward Markets Commission has 5 Divisions to carry out various tasks. These Divisions were formed on 1st August 2005 in order to streamline the work on a functional basis.

i) Markets, Trading and Development (Market Division)ii) Market Intelligence, Monitoring & Surveillance ( M & S Division )iii) Awareness, Training and Intermediary Registration and IT

(IR Division)iv) Investigation, Vigilance and Legal Affairs (Legal Affairs Division)v) Commission Secretariat including HR, Administration and Finance, Grievances

(Administration Division)

Each Division is headed by a Director, assisted by Deputy Directors, Assistant Directors, Economic Officers and Junior Research Assistants.

Regulatory Tools

1.10 Futures trading has the risk of being misused by unscrupulous elements. In order to safeguard the market against such elements, regulatory measures as under are prescribed by the Forward Markets Commission:-

(a) Limit on open position of an individual operator as well as member, to prevent over trading;

(b) Limit on daily price fluctuation, to prevent abrupt upswing or downswing in prices;(c) Additional Margins payable on outstanding purchases and sales to contain high

volatility in prices;(d) Special margin deposits to be collected on outstanding purchases or sales, to curb

excessive concentration of position; (e) During times of shortages, the Commission

may even take more stringent 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.

COMMISSION

Major Initiatives taken by the Government / Commission since liberalization of the market

Prohibition on futures trading lifted in all the commodities on 1st April 2003.

Three Multi-Commodity electronic Exchanges, i.e., National Multi Commodity Exchange, Ahmedabad (10.1.2003), Multi Commodity Exchange, Mumbai (26.9.2003) and National Commodity and Derivative Exchange, Mumbai (20.11.2003) were granted recognition as 'National' Exchanges during 2003.

Fourth National Exchange viz. Indian Commodity Exchange Limited (ICEX) was granted recognition on the 9th October 2009 on permanent basis.

On 14th May 2008, the Commission issued guidelines on setting up of new National Multi Commodity Exchanges to further strengthen the infrastructure in Commodity Derivative Market. Inter alia, it prescribed the framework for share holding pattern of a new National Multi Commodity Exchang e. A fifth National Exchanges namely, ACE Commodity and Derivative Exchanges was granted recognition on 10.8.2010. ACE became a National Exchange by upgrading itself from a Regional Exchange.

Improvement of Regulatory Framework and Re-structuring of Forward Markets Commission. The F.C (R) Act enacted in 1952 does not fully meet the regulatory needs of a modern electronic market. Hence, the regulatory framework needs to be overhauled to bring it on par with those of similar regulators like SEBI, etc. and also to restructure and strengthen the Forward Markets Commission to meet the regulatory challenges. Hence, a Bill proposing amendments to F.C (R) Act has been introduced in the Parliament which, inter alia, provides for –

Defining forward contract so as to include other commodity derivatives, and defining of intermediaries, etc.

Revised composition and mandate of FMC. Financial and administrative autonomy of the Commission so as to

provide for recruitment of its officers and its employees, management of the affairs to vest with the Chairman, accounts and audits, and creation of an ‘FMC General Fund’ to which all receivables except penalties will be credited. The FMC General Fund shall be used for the management of the affairs of the Commission and to enforce the provisions of the F.C(R) Act, 1952.

Levying of fees on intermediaries to finance the Commission’s activities.

Allowing trading of options and other derivatives in goods.

Provide for corporatization and demutualization of commodity exchanges.

Strengthening the penal provisions. Constitution of Forward Markets Appellate Tribunal. Provision for grant by the Central Government to meet

transitional financial needs of FMC.

Major Initiatives taken by Forward Markets Commission during 2010-11

The Commodity Futures Market has witnessed rapid growth since the opening of the market in 2002. National Commodity Exchanges have completed 7 years of their operation in Commodity Derivatives market. The Commission from time to time reviewed the market and suggested some amendments to the bye-laws of the Exchanges; issued guidelines and directives to these Exchanges for better governance, transparency and investor confidence.

Notified ‘Iron Ore’ u/s 15 of the Forward Contracts (Regulation) Act, 1952 vide notification dated 29th September, 2010.

The Government amended the guidelines on the equity structure of Multi Commodity Exchanges to be adopted after completing five years of their operation. With this amendment, any single Stock Exchange along with the persons acting in concert shall not hold more than 5% of the subscribed and paid up equity capital of the said National Exchange.

Amended guidelines for granting recognition to new Commodity Exchanges under the Forward Contracts (Regulation) Act, 1952 putting restriction on sharholding of single stock exchange to 5% of the subscribed and paid up equity capital of national commodity exchange. The cumulative shareholding of Stock Exchanges in the relevant National Commodity Exchange shall not be more than 10%.

Issued guidelines for members of the Commodity Exchanges on 21st June 2010 for setting up Joint Ventures/ wholly owned subsidiaries abroad.

In order to streamline regulation of intermediaries, the Commission issued directives to the Exchanges to discontinue the system of sub-brokers and switch over to the system of Authorised Person (AP), for giving market access to clients trading in these markets through APs.

To ensure market and financial integrity, the Commission issued directives to the National Exchanges not to allow execution of trades without uploading the Unique Client Code (UCC) details.

Issued revised directives to the exchanges exempting delivery margins for the market participants who have moved their goods to the Exchange warehouse.

Issued revised directives to the National Exchanges for fixing the price limit on the first day of the contract.

Issued Directives on fixing Price limit on the first day of new contracts. Issued guidelines on fixation of Due Date Rates. On the recommendations of the Forward Markets Commission, the Ministry of

Consumer Affairs, Food and Public Distribution, Government of India, vide Notification dated 10th August 2010, granted recognition to the Ahmedabad Commodity Exchange, now rechristened as ACE Derivatives & Commodity Exchange Limited (ACE) as a Nationwide Multi Commodity Exchange on permanent basis in respect of forward contracts in all the commodities to which Section 15 of the Forward Contracts (Regulation) Act, is applicable. With the grant of recognition to this exchange the total number of national exchanges has become Five. These exchanges can offer futures contracts in all the commodities subject to the approval of the Commission. Besides these, 16 other exchanges generally referred to as Regional Exchanges, are recognized for futures trading in specific commodities.

The Central Government granted in-principle approval to the Universal Commodity Exchange Limited (UCX), Mumbai, on 25th August 2010 as a Nationwide Multi Commodity Exchange, subject to the fulfilling of commitments made / undertakings given to the Commission within the stipulated time.

Collaboration with International Regulators:

In order to strengthen co-operation with international regulators, the FMC took steps for collaborating with regulators in other countries. FMC is also an associate member of IOSCO, an international organization of Security and Commodities Market Regulators. In addition, FMC has also signed Memorandum of Understanding with the United States Commodity Futures Trading Commission (USCFTC) and the China Securities Regulatory Commission (CSRC). The Commission, in January 2010, had signed MOU with the Commissao de Valores Mobiliarios – CVM (Securities and Exchange Commission of Brazil), Brazil.

Developmental Initiatives taken by Forward Markets Commission

The Commission has taken the following steps in recent years to ensure that the markets are broad based and its benefits reach all the stakeholders of the Commodity Markets.

Increasing the awareness level of different categories of stakeholders especially farmers to make them aware of the existence of as well as benefits from the futures markets, sensitization of policy makers and capacity building in the commodity sector.

Working on various models of “Aggregation” to enable the farmers to take the benefit of actual hedging on the Commodity Exchanges to manage their price risks.

Working on a project of Price Dissemination through APMCs and other centers to empower the farmers with price information.

Meeting with various stakeholders to understand their difficulties, problems and felt needs so as to align/ design policies to feasible/ desirable objectives.

Current ScenarioCurrently 5 national exchanges, viz. Multi Commodity Exchange, Mumbai; National Commodity and Derivatives Exchange, Mumbai and National Multi Commodity Exchange, Ahmedabad, Indian Commodity Exchange Ltd., Mumbai (ICEX) and ACE Derivatives and Commodity Exchange, regulate forward trading in 113 commodities. Besides, there are 16 Commodity specific exchanges recognized for regulating trading in various commodities approved by the Commission under the Forward Contracts (Regulation) Act, 1952.The commodities traded at these exchanges comprise the following:

Edible oilseeds complexes like Groundnut, Mustard seed, Cottonseed, Sunflower, Rice bran oil, Soy oil etc.

Food grains – Wheat, Gram, Dals, Bajra, Maize etc. Metals – Gold, Silver, Copper, Zinc etc. Spices – Turmeric, Pepper, Jeera etc. Fibres – Cotton, Jute etc. Others – Gur, Rubber, Natural Gas, Crude Oil etc. Out of 21 recognized exchanges, Multi Commodity Exchange (MCX), Mumbai, National

Commodity and Derivatives Exchange (NCDEX), Mumbai, National Board of Trade (NBOT), Indore, National Multi Commodities Exchange, (NMCE), Ahmedabad, and the ACE Derivatives & Commodity Exchange Ltd., contributed 99% of the total value of the commodities traded during the year 2011-12. Out of the 113 commodities, regulated by the FMC, in terms of value of trade, Gold, Silver, Copper, Zinc, Guarseed, Soy Oil, Jeera, Pepper and Chana are the prominently traded commodities. The total volume of trade across all Exchanges in 2011-12 was 14,025.74 lakh MT at a value of Rs.181,26,103.78 Crores.The total of deliveries of all commodities on Commodity Exchange platform is 8,88,250 MT during the year 2010-11.

The different intermediaries and clients registered at these recognized national exchanges are,

Members - 4081, Other intermediary - 234, Warehouse service provider / warehouse - 35 and Clients - 33, 75,123 as on 31.1.2012.

Challenges faced by Commodity Markets currently

Despite a long history of commodity markets, the Indian commodity markets remained underdeveloped, partially due to intermediate ban on commodity trading and more due to the policy interventions by the government. Being agriculture-based economy, commodity markets play a vital role in the economic development of the country. While the agricultural liberalization has paved way for commodity trading, India has to still go a long way in achieving the benefits of commodity markets. Towards the development of the commodity markets, it is important to understand the growth constraints and address these issues in the right perspective.

Commodity markets play an important role in the development of an economy, especially those economies that are dependent to a large extent on the agriculture sector. Owing to its dependence on agriculture sector, Indian economy to a large extent would benefit from commodity markets. Despite the fact, that Indian economy has witnessed robust growth in the last decade on account of services sector; agricultural sector still remains the backbone of Indian economy. Roughly around 60% of the Indian population is dependent on agriculture. Vibrant commodity markets in India will not only benefit the farmers but also the manufacturing sector that is dependent on it to gain significant price gains.

The following are the challenges faced by Indian Commodity Markets currently. These are explained and also the conclusion is provided at the end of it:

Legal challenges Regulatory challenges Infrastructural challenges Awareness among investors and producers Other challenges regarding trading

Legal Challenges

Right from the beginning of commodity markets there has been several bottlenecks regarding the products being in the essential commodities list because of which they often get banned. Also there were times when because of hoarding and black marketing there were famines for a very long time, so the market needed an efficient regulator which lead to the formation of FMC. Moreover, many efficient institutions like banks and mutual funds are not allowed to participate in commodity markets. Also weather and rainfall indexes are also banned from trading on the commodity exchanges because of the clauses of the Banking regulations act, which defines that anything that could be obtained in physical form only can be traded at the exchanges. These inefficiencies must be eradicated by amending these cats. Several amendments have been introduced in these acts and also accepted by the government but only some of them have been passed. Rests are in the queue. Let’s have a look at those amendments:

Forwards contracts (Regulation) Amendment Act, 2010

Under the existing FCRA, hedging products like options, indices and weather derivatives, which can be tailored to the risk appetite of hedgers, are currently not permissible. This leaves less scope for innovation. On the regulatory front, the current law leaves the market regulator, FMC, dependent on the government — financially and for day-to-day operations. This lack of autonomy does not render enough teeth to the regulator of the commodity derivatives markets — a phenomenon quite unlike than that of the regulators of the equity markets (Sebi) or insurance (IRDA).

As is evident in the rapid growth and overall size of the commodity derivatives market in India, participants use sophisticated trading systems and world-class technology. In this context, the regulatory system too needs a major upgrade to keep up with its regulated entities. Thus, a stronger and autonomous regulatory body is required to properly to develop strong monitoring systems to oversee the regulated entities on a real-time basis. FMC is short on human and technological resources, and needs to ramp up its capacity. It needs powers and autonomy equivalent to its capital market counterpart, the Sebi, to fulfill this role.

Such empowerment of the regulator is provided for in the FCRA Amendment Bill, placing powers and resources at the disposal of FMC. The FCRA Amendment Bill was first placed on the floor of Parliament in 2006.

The need for regulatory empowerment and new derivative products has increased manifold since then. Thus, there is an immediate need for the government to ensure passage of the Bill.

The FMC needs to operate under a regulatory framework that enables it to: Protect market integrity. To preserve the economic functions of the commodity markets to shift commercial price

risk and aid in price discovery. Ensure market fairness. Ensure financial safety and soundness by guarding against systemic risk. key component required for the development of commodities market in India is the

infrastructure. Though there are number of exchanges in India, they lack in infrastructure exception to a few large exchanges like National Commodity Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX). Infrastructure requirements like warehousing facilities, clearing house and modern trading ring are absent in majority of the exchanges. As a result, majority of the exchanges have to depend on a few commodities and consequently, the turnover is low.

The Standing Committee on Food, Consumer Affairs and Public Distribution, chaired by Vilas Muttemwar, had on December 22 last year, submitted its report on FCRA Bill, which was introduced in the Lok Sabha in December 2010.

Objectives of the FC(R) Amendment Bill 2010 The main objectives of the FC(R) Amendment Bill 2010 are as follows: I. Strengthening of the regulatory framework including enforcement and penal provisions for the commodity derivatives markets.

II. Functional and Financial Autonomy for the market regulator, the Forward Markets Commission (FMC) to better regulate the commodity derivatives market.

III. Permitting new products, viz., options in the commodity derivative market which are more suitable for participants like farmers to cover their price-risks.

G. Important Amendments Proposed to the FC(R) Act 1952: The Forward Contracts (Regulation) Amendment Bill, 2010, inter alia, seeks to make amendments to the Forward Contracts (Regulation) Act, 1952, in respect of the following:– (a) to redefine the expression ―forward contract so as to include therein ―commodity derivative and also to define new expressions such as ―commodity derivative, ―corporatization, ―demutualization and ―intermediary which have been used in the Bill;

(b) To increase the maximum number of members of the Forward Markets Commission from four, as at present, to nine out of which at least three would be whole-time members besides the Chairman;

(c) To confer power upon the Commission to levy fees;

(d) to provide for constitution of a fund called the ―Forward Markets Commission General Fund‖ to which all grants, fees and all sums received by the Commission except penalty shall be credited, and apply the funds for meeting its expenses;

(e) To confer power upon the Central Government to issue directions to the Commission on matters of policy and to supersede it in certain extreme circumstances;

(f) To make provisions for corporatization and demutualization of recognized associations in accordance with the scheme to be approved by the Commission;

(g) To make provisions for registration of members and intermediaries;

(h) To allow trading in options in goods and commodity derivatives;

(i) To make provision for investigation, enforcement and penalty in case of contravention of the provisions of the Act;

(j) To make provision for transfer of the duties and functions of a clearing house of an exchange to a clearing corporation;

(k) To make provisions for exemption from payment of tax on wealth, income and profits or gains of the Commission; and

(l) to make provision for appeals from the orders of the Forward Markets Commission and Adjudicating Officer to the Securities Appellate Tribunal for the purposes of the Act and from the order of the Securities Appellate Tribunal under the Forward Contracts (Regulation) Act, 1952 to the Supreme Court;

(m) To make consequential changes in the Securities and Exchange Board of India Act, 1992.

Essential Commodities Act, 1955 The Essential Commodities Act, 1955 was enacted to ensure easy availability of essential commodities to the consumers and to protect them from exploitation by unscrupulous traders. The Act provides for regulation and control of production, distribution and pricing of commodities, which are declared as essential for maintaining or increasing supplies or for securing their equitable distribution and availability at fair prices. Most of the powers under the Act have been delegated to the State Governments. Using the powers under the Act, various Ministries/Departments of the Central Governments have issued Control Orders for regulating production/distribution/quality aspects/movement etc. pertaining to the commodities which are essential and administered by them. The Essential Commodities Act is being implemented by the State Governments/UT Administrations by availing of the delegated powers under the Act. The State Governments/UT Administrations have issued various Control Orders to regulate various aspects of trading in Essential Commodities such as food grains, edible oils, pulses kerosene, sugar etc. The Central Government regularly monitors the action taken by State Governments/UT Administrations to implement the provisions of the Essential Commodities Act, 1955. The items declared as essential commodities under the Essential Commodities Act, 1955 are reviewed from time to time in the light of liberalized economic policies in consultation with the Ministries/Departments administering the essential commodities and particularly with regard to their production, demand, and supply. From 15 February 2002, the Government removed 11 classes of commodities in full and one in part from the list of essential commodities declared earlier. In order to accelerate economic growth and to benefit consumers, two more commodities have been deleted from the list from 31 March 2004. At present the list of essential commodities contains 15 items.

List of commodities declared essential under the Essential Commodities Act, 1955: Declared under Clause (a) of Section 2 of the Act

1. Cattle fodder, including oilcakes and other concentrates. 2. Coal, including coke and other derivatives. 3. Component parts and accessories of automobiles. 4. Cotton and woolen textiles. 5. Drugs. 6. Foodstuffs, including edible oilseeds and oils. 7. Iron and Steel, including manufactured products of Iron & Steel. 8. Paper, including newsprint, paperboard and strawboard. 9. Petroleum and Petroleum products. 10 Raw Cotton either ginned or unginned and cotton seed. 11. Raw Jute. 12. Jute textiles. 13. Fertilizer, whether inorganic, organic or mixed. 14. Yarn made wholly from cotton. 15. (i) seeds of food crops and seeds of fruits and vegetables, (ii) seeds of cattle fodder and (iii) jute seeds In the context of liberalization of Indian economy, it was decided that the Essential Commodities Act, 1944 might continue as umbrella legislation for the Centre and the States to use when warranted allowing, however, a progressive dismantling of the control and restrictions. Accordingly, the Central Government issued the Removal of Licensing requirements, Stock limits and Movement Restrictions on Specified Foodstuffs Order, 2002 on 15 February 2002 under the Essential Commodities Act, 1955 allowing dealers to freely buy, stock, sell, transport, distribute, dispose, etc., any quantity in respect of wheat, paddy/rice, coarse grains, sugar, edible oilseeds and edible oils without requiring any license or permit therefore under any order issued under the Act. In 2006, considering the shortage of wheat, this order of removal of licensing requirements, stock limits and movement restrictions has been kept in abeyance for wheat and pulses for 6 months starting from 29th August 2006.

ESSENTIAL COMMODITIES ACT, 1980 In order to prevent unethical trade practices like hoarding and black-marketing etc., the Prevention of Black-marketing of Supplies of Essential Commodities, Act, 1980 is being Implemented by the State Governments to detain persons whose activities are found to be prejudicial to the maintenance of supplies of commodities essential to the community.

Banking Regulations ActAmendment in Banking Regulations Act. According to the Banking Regulations Act, banks are not allowed to trade in the commodity derivatives. But contradictorily, banks have a big role to play in the development of the commodity market. As they have exposure to agriculture, they would be better off in case they were able to hedge their positions. Since banks have a strong rural reach and financial expertise, they can become aggregators and take an aggregative position on behalf of farmers.

There is stark contrast between capital markets and commodity markets. In the commodity market, statutes today keep out a huge section of the financial players, like, banks, insurance companies, mutual funds, and pension funds. There is therefore an urgent need to change the regulations relating to mutual fund, insurance and pension funds. Hedge funds should also be allowed in the commodity futures market with the same tax benefits that the mutual fund industry has in the securities market. Also banks are quintessential financial intermediaries and derivatives can play an important part in the risk-management strategies employed by banks and financial institutions and their customers. The Banking Regulation Act prohibits banks from dealing in goods. RBI has interpreted this to imply that banks are prohibited from dealing in derivatives on goods. This prevents banks from fully engaging in the agricultural economy. For example, a bank could give a loan to a farmer, and hedge itself against price fluctuations, so as to deliver a loan with a variable rate of interest - whereby lower interest rates are charged in the event that output prices are higher. However, such sophisticated product development is prohibited by the existing regulatory regime. In the spirit of convergence, we need to find solutions through which the banking system can embrace commodity derivatives exactly as is the case with derivatives on currency, equity or debt. Also, market making is necessary to ensure initial liquidity. Banks and financial institutions are historically considered stable institutions to provide market-making services, all over the world. In India, when NSE launched these in 2000, for nearly two years, ICICI Ltd acted as the market maker and provided up to 60 per cent of the volumes on both sell and buy sides; once the market5s took off in 2002, ICICI Ltd, scaled down its support. A similar role was played in corporate debt paper market. Market makers add to depth, liquidity and stability of markets. Of course, there is a need to develop supervisory guidance to ensure that these activities are conducted safely and soundly. The RBI could assemble a talented staff with outstanding expertise, who understand this business and take a risk-focused approach to applying that guidance to the banks they supervise. Banks could be required to demonstrate that they have established appropriate risk measurement and management processes – including board supervision, managerial and staff expertise, comprehensive policies and operating procedures, risk identification and measurement, and

management information systems as well as an effective risk control function. Currently Banking Regulation Act does not permit banks to participate in the commodity markets.The restrictions on participation of banking institutions in commodities markets, at least for hedging purpose, for a start, should be removed by amending section 6 of the Banking Regulation Act.

Even though the commodity derivatives market has made good progress in the last few years, the real issues facing the future of the market have not been resolved. Agreed, the number of commodities allowed for derivative trading have increased, the volume and the value of business has zoomed, but the objectives of setting up commodity derivative exchanges may not be achieved and the growth rates witnessed may not be sustainable unless these real issues are sorted out as soon as possible. Some of the main unresolved issues are discussed below.

Regulatory Challenges:

The RegulatorAs the market activity pick-up and the volumes rise, the market will definitely need a strong and independent regular; similar to the Securities and Exchange Board of India (SEBI) that regulates the securities markets. Unlike SEBI which is an independent body, the Forwards Markets Commission (FMC) is under the Department of Consumer Affairs (Ministry of Consumer Affairs, Food and Public Distribution) and depends on it for funds. It is imperative that the Government should grant more powers to the FMC to ensure an orderly development of the commodity markets. The SEBI and FMC also need to work closely with each other due to the inter-relationship between the two markets.

Infrastructural Challenges:

(a) The Warehousing and Standardization:For commodity derivatives market to work efficiently, it is necessary to have a sophisticated, cost-effective, reliable and convenient warehousing system in the country. The Habibullah (2003) task force admitted, “A sophisticated warehousing industry has yet to come about”. Further, independent labs or quality testing centers should be set up in each region to certify the quality, grade and quantity of commodities so that they are appropriately standardized and there are no shocks waiting for the ultimate buyer who takes the physical delivery. Warehouses also need to be conveniently located.Central Warehousing Corporation of India (CWC: www.fieo.com) is operating 500Warehouses across the country with a storage capacity of 10.4 million tonnes. This is obviously not adequate for a vast country. To resolve the problem, a Gramin Bhandaran Yojana (Rural Warehousing Plan) has been introduced to construct new and expand the existing rural godowns. Large scale privatization of state warehouses is also being examined.iii.

(b) Cash versus Physical Settlement:It is probably due to the inefficiencies in the present warehousing system that only about 1% to 5% of the total commodity derivatives trade in the country is settled in physical delivery. Therefore the warehousing problem obviously has to be handled on a war footing, as a good delivery system is the backbone of any commodity trade. A particularly difficult problem in cash settlement of commodity derivative contracts is that at present, under the Forward Contracts (Regulation) Act 1952, cash settlement of outstanding contracts at maturity is not allowed. In other words, all outstanding contracts at maturity should be settled in physical delivery. To avoid this, participants square off their positions before maturity. So, in practice, most contracts are settled in cash but before maturity. There is a need to modify the law to bring it closer to the widespread practice and save the participants from unnecessary hassles. (c)Lack of Economy of Scale:There are too many (3 national level and 21regional) commodity exchanges. Though over 80 commodities are allowed for derivatives trading, in practice derivatives are popular for only a few commodities. Again, most of the trade takes place only on a few exchanges. All this splits volumes and makes some exchanges unviable. This problem can possibly be addressed by consolidating some exchanges. Also, the question of convergence of securities and commodities derivatives markets has been debated for a long time now. The Government of India has announced its intention to integrate the two markets. It is felt that convergence of these derivative markets would bring in economies of scale and scope without having to duplicate the efforts, thereby giving a boost to the growth of commodity derivatives market. It would also help in resolving some of the issues concerning regulation of the derivative markets. However, this would necessitate complete coordination among various regulating authorities such as Reserve Bank of India, Forward Markets commission, the Securities and Exchange Board of India, and the Department of Company affairsetc.vi. (d)Tax and Legal bottlenecks:There are at present restrictions on the movement of certain goods from one state to another. These need to be removed so that a truly national market could develop for commodities and derivatives. Also, regulatory changes are required to bring about uniformity in octroi and sales taxes etc. VAT has been introduced in the country in 2005, but has not yet been uniformly implemented by all states. With the gradual withdrawal of the Govt. from various sectors in the post liberalization era, the need has been left that various operators in the commodities market be provided with a mechanism to hedge and transfer their risk. India’s obligation under WTO to open agriculture sector to world trade require future trade in a wide variety of primary commodities and their product to enable divers market functionaries to cope with the price volatility prevailing n the world markets. Following are some of applications, which can utilize the power of the commodity market and create a win-win situation for all the involved parties.

Awareness among investors and producers:

Creation of Awareness:

Creation of awareness amongst the farmers, related bodies and organizations including the ones which could be potential hedgers / aggregators and other market constituents has been one of the major activities of the Commission. During 2010-11, 829 awareness programmes were organized for various stakeholders of the commodity futures market. Of this, 486 programmes were held exclusively for farmers. In the previous year, (2009-10) 515 awareness programmes were held, of which 423 were exclusively for the farmers. The programmes were conducted at different locations all over the country. These awareness programmes were attended by different category of market participants ranging from farmers, traders and members of Commodity exchanges to bankers, cooperative personnel staff and students of Universities, Government functionaries, warehouse professionals, agricultural extension workers, makers etc. These awareness programmes have resulted in creating awareness among the various constituents about commodity futures trading and the benefits thereof. The programmes were organized in association with various organizations/universities having connectivity with the farmers, viz. agricultural universities, NABCONS , farmer cooperatives and federations, GSKs, National & Regional Base Commodity Exchanges, etc.

Other challenges regarding trading in Commodity Markets:

(a) Size of contracts too big for small traders and producers:

Towards the growth of any market, the trading conditions or the terms and conditions of contracts play a crucial role. The contracts should be market friendly in terms of attracting both the big and small traders alike. In majority of the contract specifications, it was found that the size is too big for small traders and producers to trade. Unless such finer aspects are dealt with proper attention at the regulatory level and the exchange level, attracting small traders and farmers into commodity futures trading becomes impossible. Especially in a country like India, where corporate farming is absent and predominant section of the farmers own small agricultural lands, meeting the specifications of the contract becomes difficult. Such farmers prefer spot markets rather than commodity markets for trading. Even the small traders refrain from trading owing to the capital constraints.

(b)Mutual funds and FIIs should be allowed to trade on exchanges

Indian commodity market players are seeking entry of banks, funds and foreign brokers in the

futures market in the forthcoming budget, but analysts fear spiralling food prices may hinder policy moves. Banks and fund's entry will push volumes up exponentially giving them increased opportunity as an asset class.India which opened commodity futures trade seven years ago has not allowed foreigners, banks and funds to trade. It also doesn't allow options and indices trading which are volume generators across the world's bourses.

(c) Lack of economies of scaleThere are too many (3 national level and 21 regional) commodity exchanges. Though over 80 commodities are allowed for derivatives trading, in practice derivatives are popular for only a few commodities. Again, most of the trade takes place only on a few exchanges. All this splits volumes and makes some exchanges unviable. This problem can possibly be addressed by consolidating some exchanges. Also, the question of convergence of securities and commodities derivatives markets has been debated for a long time now. The Government of India has announced its intention to integrate the two markets. It is felt that convergence of these derivative markets would bring in economies of scale and scope without having to duplicate the efforts, thereby giving a boost to the growth of commodity derivatives market. It would also help in resolving some of the issues concerning regulation of the derivative markets. However, this would necessitate complete coordination among various regulating authorities such as Reserve Bank of India, Forward Markets commission, the Securities and Exchange Board of India, and the Department of Company affairs etc.

(d) Issues on warehouse receipts Currently, WR is not an instrument, against which banks lend comfortably. There are number of risks associated with it. Some of them are like fraud WR, credit risk with the warehouse owner, and financial strength of the warehouse, quality of the warehouse and of course the credibility of the goods valuation. Closely analyzing the problem, NCDEX in particular has taken some initiatives to bring banks closer to the farmer in the field of structured finance. Farmers can get finance through a pledged dematerialized warehouse receipt of an accredited warehouse of the Exchange. This instrument is pledged by borrowers against the loan. Since they sell forward the underlying on the Exchange's platform, the value of the collateral is fixed in a futuristic perspective, which mitigates the default risk for the banks. This value addition can boost up agri-lending, thereby strengthening the agricultural development process. At the same time, it will mean a better business for the banks too which are lending around Rs 9000 cr as lending against commodities. The potential can be seen to be in the region of at least Rs 150,000 cr. But there are certain issues which need to be resolved. If dematerialized WRs issued by the commodity exchanges are recognized by the Depository Act, it will give credibility to the receipt and will provide an ease for banks to lend against WRs. At the same time, WR should be allowed to become negotiable under the Negotiable Instrument Act.

(e) Cash versus physical settlement It is probably due to the inefficiencies in the present warehousing system that only about 1% to 5% of the total commodity derivatives trade in the country are settled in physical delivery. Therefore the warehousing problem obviously has to be handled on a war footing, as a good delivery system is the backbone of any commodity trade. A particularly difficult problem in cash settlement of commodity derivative contracts is that at present, under the Forward Contracts (Regulation) Act 1952, cash settlement of outstanding contracts at maturity is not allowed. In other words, all outstanding contracts at maturity should be settled in physical delivery. To avoid this, participants square off their positions before maturity. So, in practice, most contracts are settled in cash but before maturity. There is a need to modify the law to bring it closer to the widespread practice and save the participants from unnecessary hassles.

(f)The Warehousing and Standardization: For commodity derivatives market to work efficiently, it is necessary to have a sophisticated, cost-effective, reliable and convenient warehousing system in the country. The Habibullah (2003) task force admitted, “A sophisticated warehousing industry has yet to come about”. Further, independent labs or quality testing centers should be set up in each region to certify the quality, grade and quantity of commodities so that they are appropriately standardized and there are no shocks waiting for the ultimate buyer who takes the physical delivery. Warehouses also need to be conveniently located. Central Warehousing Corporation of India (CWC: www.fieo.com) is operating 500 Warehouses across the country with a storage capacity of 10.4 million tonnes. This is obviously not adequate for a vast country. To resolve the problem, a Gramin Bhandaran Yojana (Rural Warehousing Plan) has been introduced to construct new and expand the existing rural godowns. Large scale privatization of state warehouses is also being examined.

(g)Commodity Options: Trading in commodity options contracts has been banned since 1952. The market for commodity derivatives cannot be called complete without the presence of this important derivative. Both futures and options are necessary for the healthy growth of the market. While futures contracts help a participant (say a farmer) to hedge against downside price movements, it does not allow him to reap the benefits of an increase in prices. No doubt there is an immediate need to bring about the necessary legal and regulatory changes to introduce commodity options trading in the country. The matter is said to be under the active consideration of the Government and the options trading may be introduced in the near future.There are at present restrictions on the movement of certain goods from one state to another. These need to be removed so that a truly national market could develop for commodities and derivatives. Also, regulatory changes are required to bring about uniformity in octroi and sales taxes etc. VAT has been introduced in the country in 2005, but has not yet been uniformly implemented by all states.

Conclusion

India is one of the top producers of a 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 seem to have finally arrived now. The market has made enormous progress in terms of technology, transparency and the trading activity. Interestingly, this has happened only after the Government protection was removed from a number of commodities, and market forces were allowed to play their role. This should act as a major lesson for the policy makers in developing countries, that pricing and price risk management should be left to the market forces rather than trying to achieve these through administered price mechanisms. The management of price risk is going to assume even greater importance in future with the promotion of free trade and removal of trade barriers in the world. All this augurs well for the commodities.