Commodity derivatives market has seen an upheaving progress in the last few years and supporting the fact is the geometrically growing numbers in the terms of value and the volume of the business along with an increase in the number of commodities allowed for derivative trading. But still there are a lot of issues which are lurking in the background and hindering the actual progress of the commodity derivative markets. The current growth rate may not sustain unless steps are taken to resolve these crucial issues. The idea behind setting up the commodity index may fail to realize its objective if the issues remain unresolved. Some of the crucial unresolved issues are
Commodity Options: Option trading in commodity market is banned by the government since a long time. Options in goods are presently prohibited under Section 19 of the Forward Contracts (Regulation) Act, 1952. No exchange or person can organize or enter into or make or perform options in goods. Futures and options together are necessary for a healthy growing market & the absence of commodity options in the market make them incomplete. The futures contracts are targeted only to be used as hedging instruments and protect the downsides of one's portfolio. The restriction on & unavailability of options trading restricts the players to make capital gains in the markets. For e.g. although futures contracts help a farmer to hedge against downside price movements, it does not permit him to reap the benefits of an increase in prices. All the major market players support that 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 under the active consideration of the Government and the options trading may be introduced in the near future.
The Warehousing and Standardization: A cost-effective, convenient, sophisticated, and reliable warehousing system is necessary for efficient working and proper functioning of the commodity derivative market in the country. The government set up the Habibullah task force in 2003 on convergence of regulatory work for proper development of the commodity futures market. The task force admitted that, "A sophisticated warehousing industry has yet to come about." As the trade volumes are increasing it is important to set up and maintain independent quality testing centers in all the regions to certify the quality, grade and quantity of the commodities during settlement. These standardized practices will reduce the delivery risk of the buyer of the commodity. The location of the warehouse is of critical importance and it should be conveniently located and easily approachable. According to latest figures Central Warehousing Corporation of India, A premier Warehousing Agency in India, established during 1957 providing logistics support to the agricultural sector, is one of the biggest public warehouse operators in the country offering logistics services to a diverse group of clients. CWC is operating 487 Warehouses across the country with a storage capacity of 10.6 million tonnes providing warehousing services for a wide range of products ranging from agricultural produce to sophisticated industrial products. Warehousing activities of CWC include food grain warehouses, industrial warehousing, custom bonded warehouses, container freight stations, inland clearance depots and air cargo complexes. Apart from storage and handling, CWC also offers services in the area of clearing & forwarding, handling & transportation, procurement & distribution, disinfestation services, fumigation services and other ancillary activities. Obviously there is much scope for improvement in capacity and locations and the current facility is not sufficient for a vast country like India. Large scale privatization and Gramin Bhandar Yojana (Rural Warehousing Scheme) are a few steps taken in the direction.
Cash versus Physical Settlement: A probable reason for very low volumes of trade being settled by physical delivery of the underlying may be an inefficient warehousing system in the country. Only about 5% of the total commodity derivatives traded in the country are settled through physical delivery. Hence the warehousing facilities need to be improved to increase the efficiency of the system and enhance the incidences of settlement through physical delivery. Steps should be taken to improve the delivery system as it is the pillar of any commodity trade. Under the Forward Contracts (Regulation) Act 1952, cash settlement of outstanding contracts at maturity is not allowed, in other words all the outstanding contracts at maturity needs to be settled through physical delivery. This is a serious issue in the commodities market as to avoid the physical delivery the participants have to square off the deal before maturity. This leads to majority of contracts being settled in cash but prior to maturity dates to avoid the physical settlement. Steps need to be taken to change the laws and save participants from unnecessary hassles.
The Regulator: To match the standards of global markets a strong and independent regulator is the need of the hour. Also the increasing market activity in terms of volumes of trade being executed is ever increasing. The commodity market needs a regulator similar to the Securities and Exchange Board of India (SEBI) that regulates the securities markets. While SEBI functions independently, the Forwards Markets Commission (FMC) is under the Department of Consumer Affairs (Ministry of Consumer Affairs, Food and Public Distribution) and depends on the ministry for regular funding. To ensure the development of the commodity market the Government should grant more powers to the FMC. The SEBI and FMC can work closely with each other due to the inter-relationship between the two markets.
Lack of Economy of Scale: Commodities are traded at number of exchanges which are spread across the country. A large number of commodities are traded in the commodity derivative market but in practice only a few commodities futures are popular among the players. All these trades if carried on a few number of central exchange would lead to an efficient market for the traders and would bring economies of scale and scope. This would reduce duplication of efforts and improve the growth prospects of the market. The notion of combining the securities market and the commodities market has been discussed by the policy makers and market players since a long time. It would also improve the regulation of the commodity market. However integration of the two markets would require complete synchronization among the regulatory authorities such as Reserve Bank of India, Forwards Markets Commission, Securities and Exchange Board of India and the Department of Company affairs etc.
Legal Bottlenecks: Restrictions on the movement of goods across the states negatively impacts the functioning of the commodity markets. To develop a national market for commodities and derivatives these bottlenecks need to be removed and free flow of goods should be allowed.
Future Prospects & Conclusion
Commodity exchanges in the country are expected to play a significant role in the economic growth of the country and strengthen the Indian economy to face the challenges posed by globalization. India boasts of huge amount of commodity production in the country and has a long history in future trading of commodity. An improvement in the transparency, technology and trading regulation have significantly contributed to the progress of the commodity derivative market. Options on commodity index are being considered, once implemented these would provide market players with better risk management techniques. Further developments in the warehousing system would facilitate in seamless countrywide commodities market. Commodity future trading provides the players with an opportunity to diversify their portfolios. An integration of equity, commodity, forex and debt market would lead to better business opportunities for the market players. This convergence would result in better services for the players like India's corporate and trading community in terms of risk management solutions.
Future market in commodities needs to be better regulated and treated with caution to avoid giving a large playing ground to the speculators.
