COVER STORYBy Sagar Tamrakar

Commodity marketWaiting on the sidelines

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42 the boss 15 Mar - 14 Apr 2011

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old was in use as a form of money, in one form or another, at least from 2560 BC. It has been used as a store of value both by individuals and countries since

then. The central banks still use gold as an international trading and swapping currency. It is still considered by many as a store of value and a safe bet in times of crisis. Gold and other precious metals are assets that are both tangible and liquid. However, over time, people began to consider any commodity, chiefly agro products, as a form of finance, and the first modern organised futures exchange began in 1710 at the Dojima Rice Exchange in Osaka, Japan; a century later, the US followed suit with a similar set-up in Chicago, which is located at the base of the Great Lakes, close to

the farmlands and cattle belt of the US Midwest, making it a natural centre for transportation, distribution and trading of agricultural produce. The glut and shortage of these products were causing chaotic fluctuations in price, and this is what led to the development of a market enabling the grain merchants, processors, and agriculture companies to trade in ‘to arrive’ or ‘cash forward’ contracts so as to insulate them from the risk of adverse price change while at the same time enabling them to hedge.

Forward contracts were standard at the time. However, most forward contracts weren’t honoured by both the buyer and the seller. For instance, if the buyer of a corn forward contract made an agreement to buy corn, and at the time of delivery the price of corn differed dramatically from the original contract price, either the buyer or the seller would back out. Additionally, the forward contracts market was very illiquid and an exchange was needed that would bring together a market to find potential

As far as the seminars/sessions that CEs offer

are concerned, those are inadequate to effectively

educate the investors and brokers.

buyers and sellers of a commodity instead of making the people bear the burden of finding a buyer or seller; thus, was born the commodity exchange (CE).

CE entered the Nepali market only in 2006, but has not been able to grab a major chunk of investors. However, in the past three years, the number of brokers has grown five-fold, investors 60-fold, and CEs five-fold; yet the size of investment has not witnessed a similar growth rate—the growth is merely divided into many shares of the same pie entering the market. Yes,

there was a big boom in the initial period as many investors rushed in enamoured by the glamour of testing the new market, but most of them did not elect to return to it as they found no substantial returns on their investments. Vijay Satyal, CEO, Commodities and Metal Exchange Nepal (COMEN), the pioneer CE of Nepal, says, “Those who came to invest/trade were less informed; they were less aware about the CE they were associated with and are still uneducated about the trade mechanism.” He adds, “The brokers ought to have a good R&D and should be particular in informing their clients. The CEs have rules that stipulate the training of brokers about R&D; here at COMEN, we have conducted a lot of symposiums and seminars for our brokers to inform them about international markets, international monetary policies, and about the influences of the prices of different commodities.” However, Bijesh Shrestha, president, Association of Commodity Brokers Nepal (ACBN), is not at all happy with the infrastructure and

human resources. He says, “There is a lack of basic infrastructure and human resource; the businesses are being run without adequate market survey, growth analysis, and policies to fit the business atmosphere. As far as the seminars/sessions that CEs offer are concerned, those are inadequate to effectively educate the investors and brokers, which is evident from the market with a lot of investors incurring losses. There really is a horrendous lack of experts in the market. The CEs or the government ought to focus on this issue—they could even hire people from abroad.” Shrestha warns that if the required human resource is not culled within two years, the business would hit a stumbling block.

Meanwhile, ACBN has been holding talks with the Global Exposition and Management Services regarding a book fair on commodity market (CM); the fair is aimed at exposing the market to the public at large and to educate them about it. Shrestha says, “This is how we are aiming to be a medium for promoting CM in the coming five to six months. All the initiative towards these goals are being taken by the private sector alone; the government representatives are there only to collect taxes and participate in various inaugural programmes as chief guests. The government is ignoring issues like awareness development, infrastructure development, pol icy formulat ion, human resource development, capital management, etc. “If experts are available, the CM can take a giant leap. However, expertise generation is a costly affair beyond the capacity of broking agencies; that said, the issue can be addressed through mutual efforts, and the ACBN has been working on it along with our backers.”

regulation or the laCk of it

As there’s a blatant lack of a central regulatory authority for CM, the investors have been diffident about joining in. CEO Satyal says, “We are a self-regulated organisation. Even though we are an exchange, we regulate our members—trading members, clearing members, cleansing members, and market makers. Ultimately, we will start facilitating the market when the government starts regulating CM. The compliances that the government has laid out in the committee

COVER STORY

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Bijesh Shresthapresident, ACBN

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and the rules and bylaws that it has formulated show that the Securities Board of Nepal (SEBON) is the most feasible and practical body to regulate the derivative market (DM). A proposal to this effect has already been forwarded to the Ministry of Finance.” Dr Nabaraj Adhikari, head, Planning and Development Department, SEBON, says, “We have not really reviewed the data and statistics of derivative trading. Yet, we have come to hear from the participants in the DM, particularly the investors, that they are not confident enough on the clarity of the DM perspective in the country. But then the CEs are doing

their best to develop the market in the country and are building a good network with their counterpart markets.” Satyal points out, “The DM in other countries are regulated by stock market regulators except in India where the DM is regulated by the Forward Market Commission. As we have reviewed Indian CEs’ arguments, they are also not satisfied with the ministry-run commission.” Adhikari elaborates, “SEBON feels that as commodities are also financial products, they need to be regulated properly. After all, any market without regulation cannot run for a long time. The global financial crisis has also underscored the importance of a strict and proper regulatory mechanism.” And he thinks SEBON can play the role of the regulatory authority when it comes to DM, but he is looking for more structural autonomy. He says, “We think SEBON should be assigned the responsibility of handling the regulation of DM as we have the experience of regulating the stock market. But to regulate DM, we have not

become fully autonomous operationally; we also lag far behind in terms of our institutional capability to even regulate the stock market fully. If the responsibility of the DM is given to SEBON, it should be along with operational autonomy and enhancement of its institutional capability; otherwise, it won’t be effective.”

Shrestha says, “We anticipate that the government will formulate business-friendly regulations and a scientific tax framework. Tax is something that is payable after someone has gained and not something that a person keeps paying regardless of gains or losses. Because of

policy discrepancies, genuine brokers and/or investors have not showed up in this market. This has been hampering the overall business of genuine stakeholders. To avoid these circumstances, there has to be a system of regulation that defines the criteria for investors, brokers, CEs, capital, etc. Only then will there be enough liquidity.” Satyal points to another crucial aspect: the absence of a Commodity Act. He says, “We don’t have a Commodity Act. The government, in fact, has drafted it, but it has not been made into an Act. The government has formed a committee to formulate a Public Warehouse Act which will compel the demutualised commodities to be traded only through the commodity exchange; only if that works out can the market come into good shape. As of now, the CEs are simply providing a platform where some arbitragers, hedgers and some speculators come and trade to gain short-term profits/benefits, and even among them only some are well informed and the rest come for the glamour of it.”

Adhikari elaborates on SEBON and what it has to evolve into before becoming the regulatory authority for DM. He says, “SEBON has a long way to go before it regulates DM. Currently, it is under the jurisdiction of the Ministry of Finance; the finance minister guides the operations of SEBON. Its composition of a seven-member board involves four government representatives, a majority, which should be reformed. In a way, major professional participation should be encouraged at SEBON rather than bureaucratic participation. Along with the board, the whole organisational structure should be changed. As of now, SEBON is acquiring technical assistance from the Securities Board of India, and its Institution Reform Committee is formulating a five-year master plan under the technical assistance of the World Bank. But the assignment of regulating DM is not covered in this master plan and it only covers the formation of a Central Securities Depository, monetary fund and enforcement departments.” Amidst these issues, Shrestha raises a concern, “ACBN is not in a position to pinpoint any party because any step it takes will impact the whole market; therefore, it chooses to keep the market safe and promote it as much as it can. Actually, solutions do not seem to be evolving from any direction, and they need to come about within the next two to three years.”

Spot exChangeS, warehouSeS…

Talking about the objectives of CEs, Satyal points out, “CEs shall supply investors with the commodities they require. They have an alternative to invest rather than in other investment instruments so that the national investment liquidity has an added advantage. Secondly, there are places where investment is required in a real sense for the growth of the GDP. We say agro is one of our economy’s major resources; the thing is how many people in the urban territory are interested to invest in paddy, wheat or other agro products? If via the CEs, some of the financial liquidity is thrown into the agro industry, ultimately the development of these commodities, producers, market, and the pools of the liquidity on their part will also become the financial pool of the economy, and a new collateral will be developed by which the rural people will also have an approach to the mainstream financial system/services of the country.”

If the responsibility of the DM is given

to SEBON, it should be along with operational

autonomy and enhancement of its

institutional capability; otherwise, it won’t be

effective.

Nabaraj Adhikarihead, Planning and Development

Department, SEBON

44 the boss 15 Mar - 14 Apr 2011

A few months back, COMEN started the wheat market, but could not carry it forward. Satyal says, “There are a lot of problems related to unions, pricing, grading; we will never know which price is formal as long as there’s a lack of an apex regulatory body, and until there is regulation.” But in what seems as a challenge to Satyal’s contention, two companies—Nepal Spot Exchange (NSE) and Wealth Exchange Nepal—have approached the market to run spot exchanges. Tejaswi Sharma, CEO, NSE, explains, “We are promoting two kinds of market segments—rollover and spot. The rollover segment is similar to the existing market scenario and thus we are running it in a full-fledged manner—chiefly exchanging gold, mini gold, silver, mini silver, copper, mini copper, corn, coffee, wheat and sugar, based on international prices. We have not been able to introduce local pricing; we are not dealing in futures price, but the spot price. The response of the farming community to the spot segment has been overwhelming. Actually, people are excited about this because they are likely to get the delivery of the commodities they trade in, quote the price on their own, edit prices on order matching basis, without taking into consideration volatility/liquidity; thus, we are in the process of entering the spot segment. We will be launching a few products in the spot segment very soon.” As it prepares for the venture, NSE has been carrying out massive awareness programmes from the west of Nepal to the east, chiefly in the agro sector, for the farmers and farmer cooperatives.

The spot exchange mechanism demands that some entities need to be in the system besides exchange, clearing member, broker member, clients, ie, warehouse vendors of designated warehouses. Sharma elaborates, “The warehouses that can maintain the standard for the commodities

With our warehouse financing initiatives,

the financial institutions can reach out to certain groups

of farmers, which they would not be able to reach

via branching out no matter how extensively.

that we are launching and that can abide by our agreement, will be designated. We will designate a few of the warehouses at different locations based on the production area, the facilities that the warehouses deliver and the feasibility of the warehouse itself.” Having warehouses increase the holding capacity of the producers (farmers), and they can retain their prices for a long term. This way the producers can break the long chain of supply of their products. Sharma says, “The farmer’s cooperatives, which have been facilitating the producers in distributing their products, have shown a positive response to our initiative because we can tie up with them so that they can also benefit from the alternative market. As of now, we are not looking at international standard warehouses. We

have been designing contracts by collecting the views of experts who have been in the field for a long time and who can judge the moisture-oil content of agro products and the time of retention-degradation. We have lined up agro products that include cash crops as well as a few food crops—to be specifically revealed once we finally launch the spot segment.” Pointing out the challenges, she says, “The producers fear losing their clients once they deal with spot exchanges. As CSR, we design programmes to educate the farmer groups in the rural areas rather than being city-centric. We are even approaching the regions which do not have an organised market or where the pricing mechanism is totally in ruins. In the process, we have had chances of interacting with different I/NGOs who have been working in the sector of agro production, but without being able to provide a market. We aim to fix the chain of supply throughout the country.”

Besides ordinary warehouse use, NSE is introducing the concept of warehouse receipt financing. Sharma says, “Regarding warehouse receipt, we are having talks with different financial institutions that it can be pledged for loan, provided the regulations support it. With our warehouse financing initiatives, the financial institutions can reach out to certain groups of farmers, which they would not be able to reach via branching out no matter how extensively, and thus there’s benefit. The formation of a committee to formulate the Public Warehouse Act is good news because we can move ahead further and it will be an efficient way for us once we can proceed in a regulated framework and make people aware of it.”

If via the CEs, some of the financial liquidity is thrown into the agro industry, ultimately the development of these commodities, producers, market, and the pools of the liquidity on their part will also become the financial pool of the economy.Vijay SatyalCEO, COMEN

Tejaswi SharmaCEO, NSE

COVER STORY