Commodity Connect Booklet'_Single Page View

CONTENTS

Module 1 - Introduction and Genesis of Commodity

Derivatives Market

Module 2 - Economic Utility of Commodity Derivatives Market

Module 3 - Basic Concepts of Commodity Derivatives Market

Module 4 - Relevance of Commodity Derivatives Ecosystem

to Stakeholders

Module 5 - Global and Indian Commodity Market

Module 6 - Career Opportunity in Commodities Derivatives

Ecosystem

MODULE-1

Introduction and Genesis of

Commodity Derivatives

Market

What is defined as Commodity?

From an economic perspective, the word commodity is a broad term for

economic goods that are fungible, i.e., interchangeable with other goods

of the same type. Commodities may be either naturally occurring or agriculturally

grown materials that can be bought and sold.

Commodities can broadly be classified into two categories: hard commodities and

soft commodities. While natural resources that are mined or extracted, e.g. Gold,

Silver, Crude Oil, Metal ores, Rubber, etc., form a part of hard commodities,

agricultural produce and livestock fall under soft commodities, e.g., Wheat,

Coffee, Soybean, etc. Processed products or finished products are also known as

commodities in business parlance, e.g., processed foods like refined soybean oil

for human consumption, cotton seed oilcake used as an animal feed, soybean meal

as poultry feed, etc. In the modern world, even cryptos are called

commodities.Hence, one can say that the word “Commodity” by itself has a broad

definition or usage.

It goes without saying that Commodities are crucial in our everyday lives, which

explains why there is lot of value in trading them. The widespread availability of

commodities usually results in low profit margins, which in turn renders price to

be the single most important aspect of a commodity in economic Buy/ Sell

decisions.

1

History of Commodity Derivatives Market in

India

Commodity markets have existed for centuries around the world.

After Barter[1] trade, when formal currencies came into circulation, cash

transactions became common. History cites existence of forward agreements

related to the rice markets in Japan as long back as in the 17th Century. Gradually

forward agreements started appearing in the early 19th Century in Chicago, which

on account of its location became the hub for grain trades in the USA. The

concerns of grain merchants to ensure that there were buyers and sellers for

commodities led to forward contracts to sell and buy commodities. Credit

(default) risk nevertheless remained a serious problem and often resulted into

disputes which led to violent clashes in Chicago grain markets.

The CBOT (Chicago Board of Trade) was then formed to provide a centralized

location, where buyers and sellers could meet to negotiate and formalize forward

contracts.

Unlike non-agricultural commodities like metals and energy products, the

production and therefore, supply, of agricultural commodities is largely seasonal

in nature and is subject to several risks and uncertainties. On the other hand, the

demand for these commodities is obviously perennial (as consumption takes place

round the year). The evolution of forward/ futures contracts[1] in commodities

was therefore, a significant human innovation in the context of this supply

demand mismatch.

[1] Any exchange of goods and services for other goods and services without exchanging any form of money is

known as Barter trade.

2

Genesis/ Origin of Commodity Trading

(Global Context)

Commodity markets have existed for centuries around the world. After Barter[1]

trade, when formal currencies came into circulation, cash transactions became

common. History cites existence of forward agreements related to the rice markets

in Japan as long back as in the 17th Century. Gradually forward agreements

started appearing in the early 19th Century in Chicago, which on account of its

location became the hub for grain trades in the USA. The concerns of grain

merchants to ensure that there were buyers and sellers for commodities led to

forward contracts to sell and buy commodities. Credit (default) risk nevertheless

remained a serious problem and often resulted into disputes which led to violent

clashes in Chicago grain markets. The CBOT (Chicago Board of Trade) was then

formed to provide a centralized location, where buyers and sellers could meet to

negotiate and formalize forward contracts.

Unlike non-agricultural commodities like metals and energy products, the

production and therefore, supply, of agricultural commodities is largely seasonal

in nature and is subject to several risks and uncertainties. On the other hand, the

demand for these commodities is obviously perennial (as consumption takes place

round the year). The evolution of forward/ futures contracts[2] in commodities

was therefore, a significant human innovation in the context of this supply

demand mismatch.

[2] Explained in detailed in subsequent section/s 3

Genesis/ Origin of Commodity Trading

(Global Context)

At this stage, it may be pertinent to understand the meaning of the word

‘Commodity Derivatives’ before proceeding with the history of such trading

across the world. In simple words, commodity derivatives are standardized

contracts or agreements that are linked to an underlying commodity. These

contracts can be traded on Commodity Derivatives Exchanges (CDE). Two of the

most popular derivatives contracts traded on exchange platforms are Futures

Contracts and Options Contracts. Forward contracts are also a form of derivatives

contract, however they are customized contracts entered between two parties and

are not traded on Exchange platforms. These terms would be explained in more

detail in subsequent sections.

In 1864, the CBOT listed the first ever standardized "exchange traded" forward

contracts, which were called Futures Contracts. In 1919, the Chicago Butter and

Egg Board, was reorganized to enable member traders to allow future trading, and

its name was changed to Chicago Mercantile Exchange (CME). The twentieth

century and earlier part of this century saw evolution of many exchanges in

different counties – like NYMEX, COMEX, LME, ICE, Tokyo Commodity

Exchange, Dalian Exchange (China) to name a few.

The evolution of futures derivatives markets in the US economy had been

characterized by concerns of linking futures contracts to price rise, price falls and/

or price manipulation. In the initial days of the evolution, derivatives markets

witnessed a significant struggle for legitimacy as the 19th century America was

both fascinated and appalled by futures trading. The US markets witnessed

various stages of launch of forward contracts, futures contracts, the attack on

futures contracts by vested interests with allegations of inflationary and

manipulative tendencies of such contracts, and finally a series of legislative

actions leading to the current regulated and well developed futures derivatives

markets.

4


India

There are historical evidences to indicate

that forward trading in commodities

existed in India from ancient times. Commodity derivative markets have been

there in our country, in one form or the other, since the nineteenth century. We

have been having commodity specific exchanges in many parts of the country –

first being organized trading in cotton through the Cotton Trade Association in

1875 known as “Bombay Cotton Trading Association”, Jute forward trading in

Kolkata in 1912, Wheat forward trading in Hapur in 1913, Bombay Bullion

Exchange in 1923, etc. By the Second World War, i.e., between 1920s & 1940s,

derivatives trading in organized form commenced in a number of commodities,

such as cotton, groundnut, groundnut oil, raw jute, jute goods, castor seed, wheat,

rice, sugar, precious metals like gold and silver.

The derivatives trading in India, did not have smooth sailing as there were several

disruptions. During the Second World War, futures trading was prohibited under

Defense of India Rules. After Independence, the subject of futures trading was

placed in the Union list, and Forward Contracts (Regulation) Act, 1952 was

enacted. Futures trading in commodities, particularly cotton, oilseeds and bullion,

was at its peak during this period. However, following the scarcity

in various commodities, futures trading in most commodities were

prohibited in mid-sixties. Deregulation and liberalization following

the forex crisis in early 1990s also triggered policy changes leading

to reintroduction of futures trading in commodities in India.

The growing awareness of imminent globalization under the WTO

regime and non-sustainability of Government support to commodity

sector, led the Government to explore the alternative of market-based

mechanism, viz., futures markets, to protect the commodity sector

from price volatility.

5


India

In April 1999, the Government took a

landmark decision to remove all the

commodities from the restrictive list. Food grains, pulses and bullion were not

exceptions. The long spell of prohibition had stunted the growth and

modernization of the surviving traditional commodity exchanges. Therefore,

along with liberalization of commodity futures, the Government initiated steps to

persuade and incentivize the existing exchanges to modernize their systems and

structures.

The Watershed moment came in 2003 when permissions were granted for starting

the first three national level commodity exchanges - National Multi Commodity

Exchange of India Ltd (NMCE), The National Commodity and Derivatives

Exchange Ltd (NCDEX) and the Multi Commodity Exchange Ltd (MCX). These

exchanges were regulated by erstwhile Forward Market Commission (FMC)

under FCRA (Forward Contract Regulation Act).

In 2015, with the merger of FMC with SEBI, the regulatory

oversight of commodity derivatives was brought under Security

Exchange Board of India (SEBI). Later SEBI brought the

concept of universal exchanges – thereby permitting Equity

Exchanges like National Stock Exchange (NSE) and Bombay

Stock Exchange (BSE) to launch derivatives contracts in

commodities as well. Initially, Indian commodity exchanges

were permitted to launch trading in Futures Contracts only;

SEBI granted approval for introduction of Options[3] contracts

in September 2016 and the first Options Contract of non-agri

commodity (Gold) was launched by MCX in October 2017 and

first Options Contract of agri-commodity (Guarseed) was

launched by NCDEX in January 2018.

[3] Explained in detailed in subsequent section/s. 6

Commodities trade cycle/ flow in the physical (spot)

market in India

In a spot markets, physical commodities

are sold or bought at prices negotiated

between the buyers and sellers. Physical Market (Spot/ Cash market) is one, in

which buyer agrees to make payment and

seller agrees to deliver the commodity

immediately.

In India spot/ physical markets for agriculture commodities are also known as

Mandis. There are spot markets for individual consumers (retail market) and the

business-to-business (wholesale market). Spot markets also include traditional

markets like APMC (Agriculture Produce Market Committees). Such physical

commodity markets are highly fragmented where trading happens in a set of

primary commodities specific to the region. Moreover, the APMCs are regulated

by various state governments. In few states like Bihar, the APMC Act itself has

been abolished.

The farm produce typically goes through multiple middlemen, starting from

kaccha arthias (commission agents) to pakka arthias, who in turn sell to

processors/ wholesalers, who sell it to the retailers and finally the consumers, with

a ‘dami’ or a commission fee being charged at every stage. This ultimately leads

to a huge gap between the farm gate price and the consumer price. More the

intermediaries, wider is the gap between the price we as a consumer pay and what

the farmers/producers get.

7

Commodities trade cycle/ flow in the physical (spot)

market in India

In a Mandi, the price is decided mutually between the farmer/ producers and the

trader or in an open outcry auction. However, cartelization by middlemen and

traders prevents transparent price discovery mechanisms leading to lopsided price

discovery. This also impedes the process of taking any informed decision based

on price signals emanating from such trades.

If we look at non-agri commodities, like Gold for which India is major consumer,

India is a price taker as the prices are determined in the global market. In fact, if

we look at many non-agri commodities, India is a price taker for most of them,

such as base metals, crude oil, etc.

In case of Gold, big traders buy gold directly from miners and overseas gold hubs

like Dubai. Medium and small jewellers are often forced to rely on large players,

which puts them at a price disadvantage. This system is inefficient and raises costs

for jewellers as well as the customers.

End consumers go to jewellry shops established in Sarafa/ Zaveri Bazaars or any

other jewellry showrooms in different towns and cities to buy Gold or Gold

Jewelry.

8

Commodity Derivatives Market

Ecosystem in India

Unlike the physical commodity markets which

are fragmented in nature and regulated by

different state governments, the Commodity

Derivatives Market Ecosystem in India is highly

regulated with centralized regulators like SEBI/

WDRA. As indicated above, organized

commodity derivatives markets was originally

regulated by the Forward Markets Commission

(FMC). In the Union Budget for 2015-16, the

Hon’ble Union Finance Minister proposed a

merger of FMC with the Securities and Exchange

Board of India (SEBI), “to strengthen regulation

of commodity forward markets and reduce wild

speculation”.

9


Ecosystem in India

To enable the same, the Finance Act, 2015

provided for amending the Securities Contracts

(Regulation) Act, 1956 (SCRA) and the Forward

Contracts (Regulation) Act, 1952 (FCRA). SEBI

commenced regulation of the Commodity

Derivatives Market from Sep 28, 2015. As a

regulator, SEBI is responsible to protect the

interests of investors in securities[4] and to

promote the development of, and to regulate the

securities market, by such measures as it thinks

fit.

For the purpose of trade and delivery through

Exchanges, commodities are stored in

warehouses which are required to be approved

by the Warehousing Development and

Regulatory Authority (WDRA[5]). The role of

WDRA is to regulate and ensure implementation

of the provisions of the Warehousing

(Development and Regulation) Act, 2007, for the

development and regulation of warehouses,

regulations of negotiability of Warehouse

Receipts and promote orderly growth of the

warehousing business.

[4] Section 133 of the Finance Act, 2015 had amended Securities Contracts (Regulation) Act, 1956 to include “Commodity Derivatives” as securities.

[5]Warehousing Development and Regulatory Authority (WDRA) was formed in October 2010 with an intent to develop and regulate of warehouses and

promote orderly growth of warehousing business. In October 2016, WDRA issued guidelines for creation and management of Electronic Negotiable

Warehouse Receipts (eNWRs) which enabled establishing of a system for creation and management of eNWRs through registered Repositories.

10


Ecosystem in India

Exchanges provide an electronic platform where

buyer and seller come together and trade in

derivatives instruments available on the

Exchange platform. Clearing Corporation (of the

Exchange) is the counter-party for both buyer

and seller. All trades taking place on the

Exchange platform are also settled through the

Clearing Corporation.

Exchanges have arrangements with Warehouse

Service Providers (WSP) to ensure that

farmers/producers get scientific storage facilities

in Warehousing Development and Regulatory

Authority (WDRA) accredited warehouses. Such

infrastructures are beneficial for the

purchasers/consumers of the commodity as it

ensures that the commodities that they purchase

meet the quality standards. Warehousing

facilities are made available at several delivery

centers at convenient locations (specific to

various commodities traded on the exchanges).

Along with storage, assaying services are also

provided by these WSPs which ensures that

commodity stored in warehouses meets the

Exchange quality standards.

11


Ecosystem in India

A Repository is an electronic storehouse of

commodities stored in warehouses.The

warehouse receipts that are issued against such

commodities are issued in electronic form and

are called ENWRs (Electronic Negotiable

Warehouse Receipts). In the Repository system,

ENWRs are held in repository accounts, which is

more or less similar to holding funds in bank

accounts. Transfer of ownership of ENWRs is

done through simple repository account transfers.

This method does away with all the risks and

hassles normally associated with paperwork.

Consequently, the cost of transacting in a

repository environment is considerably lower as

compared to transacting in physical warehouse

receipts. Repository in commodity derivatives

market plays a similar role as Depositories in

Equity market.

Brokers/ Members act as a facilitator between

clients and the Exchange. Anyone who wants to

participate in Commodity Derivatives Market

has to open an account through a registered

Broker/ Member of the Exchange. Further,

clearing member is responsible to clear all the

trades of the member associated with itself.

12


Ecosystem in India

The chart below provides the graphical

representation of the interaction between the

entities involved right from the placing of order

by the client through member to the final

settlement through delivery (in case of physical

delivery):

13

Participants in Commodity Derivatives Ecosystem

Participants in the commodity derivatives market ecosystem constitute all

members of the value chain ranging from farmers or Farmer Producer

Organizations, processors, importers/ exporters, traders, stockists, government

agencies to the end consumer which in some cases can also be an Eligible Foreign

Entity (EFE). Other participants include financial participants, quant and

proprietary traders, arbitrageurs, proprietary traders, retail and institutional

investors, Alternative investment funds, etc.

14

MODULE-2

Economic Utility

of Commodity

Derivatives

Market

Economic utility of the commodity derivatives market revolves around two key

functions performed by these markets, viz., fair and transparent price discovery

and market driven mechanism for price risk management (hedging). The

nationwide price dissemination done by these markets also helps in reducing the

information asymmetry in the commodity ecosystem.

Amongst the various tradable asset classes, commodity prices generally tend to be

more volatile compared to say, currencies or equities. Commodity price risk is the

risk of loss arising from the volatility in commodity prices. It affects different

participants in the commodity value chain differently and largely depends on the

extent to which unfavorable price movements can be passed on to the consumer or

the next participant in the value chain.

Mining, crude oil extraction / farming, are all economic activities that require

upfront capital investment and in most cases, particularly farming, the realizable

price is not a controllable factor making the farmer (or any other value chain

participant) highly vulnerable to unfavorable price movement. Increase in raw

material costs and production costs are often unrelated to the selling price with the

result that, if increasing raw material costs coincide with decreasing sales prices, a

margin squeeze is inevitable.Such kind of price volatility can greatly endanger the

success of a business.

Similarly, in the case of farming activity, the farmer

is often influenced by prevailing prices while sowing

a crop at which time prices are generally high as it is

the end of the season and the previous year’s supply

would have dwindled. By the time the crop is ready

for harvest, if there is a bumper crop, the prices

would crash and the farmer may not be able to

recover even his cost of production or may realize

far less than what he expected at the time of

cultivating the crop.

15

Further, with the advent of globalization, all countries are so interlinked and

dependent on each other that several global events including global demand

supply, influences domestic prices thereby aggravating the price volatility. Take

the example of crude oil: during the Covid-19 pandemic, when countries across

the globe witnessed demand destruction and economic activities came to a

standstill, the sharp fall in prices of commodities led to negative prices in Crude

Oil trading in April-2020 - an unprecedented incidence for this generation. The reopening

of economies, return to normalcy and restocking of inventories led to a

surge in global demand which caused the Crude Oil prices to rise up sharply.

The Geo-political tension in the backdrop of Russia-Ukraine led to further rise in

Crude Oil price and it touched USD 140 per barrel in March-2022. So, within a

span of 2 years, the crude oil price witnessed sharp swings ranging from trading

even at negative price to such highs. This kind of uncertainty and price volatility

makes it very difficult for businesses to plan strategically and concentrate on their

core business.

16

Apart from the price risk, there are several other risks involved in commodity

business such as:

Risk -

Volumetric Risk

This risk is felt when buyers are not sure that adequate quantity would be

available for their requirements at later dates and sellers apprehend that enough

numbers of buyers may not be there to buy the quantity that is available for sale.

Uncertainty of yield in the case of agricultural produce also creates this kind of

risk.

Government Policy

Changes

Policy changes like restrictions imposed on stocking of goods (Stock holding

Limits) by State Governments or Central Government, export/ import policy

change such as increase/ decrease in import/ export duties and/ or putting

quantitative restrictions on import/ export of certain goods, interstate movement of

goods, GST rates etc., affect the market sentiments. An importing country is also

impacted if a major exporting country imposes a ban on export for a particular

commodity. This can lead to an unfavorable price movement for the consumers of

importing country.

Commodity derivatives play a vital role

in combating/ mitigating the risks

mentioned above.

17

Economic Functions of Commodity Derivatives

Market

·Price discovery

Price discovery happens when a large number of

buyers and sellers congregate at a market place and

offer to buy or sell (trade), based on their views on

expected supply and demand fundamentals, leading to

the discovery (determination) of prices. While in a

physical market these trades happen at a designated

market place called mandi, in a derivatives market,

buyers and sellers place their bids and offer on a

centralized electronic exchange platform, which are

then matched on the trading system leading to

nationwide and centralized price discovery.ince the

buyers and sellers on an exchange platform are spread

across locations, the prices are freely and

competitively derived.

Futures prices are, therefore, considered to be more efficient and

realistic than the administered prices or prices that are determined

privately. As a result of this free flow of information, the market

determines the best estimate of future prices and it act as a

barometer for supply and demand situation of various commodities

and as a focal point for the collection and dissemination of statistics

on supplies, transportation, storage, purchases, exports, imports,

currency values, interest rates and other pertinent information.

Thus, price discovered transparently in the derivatives markets also

provides advance price signals to market participants.

18

Economic Functions of Commodity Derivatives

Market

·Price risk management

Commodity price risk is the uncertainty that arises from changing prices.

Producers/ Processors/ Manufactures and other value chain participants can

protect themselves from the price risk by taking offsetting positions on

commodities derivatives exchanges. This will help the participants to lock in the

price of the input / output and thereby protect their margins. We will be learning

more about the mechanics of this procedure in subsequent chapters. In effect, this

results in transfer of the price risk inherent in any economic activity to the market

place, where it is absorbed by market participants who are willing and able to take

these risks.

When the price risk is hedged by the value chain participant, it helps him to

concentrate on his core activity - crushing in case of the oilseed industry,

processing in the case of pulses, cultivation in the case of farmer, etc.

19

Apart from the two major economic functions of the Commodity Derivatives

Market listed above, i.e., Price Discovery and Price Risk Management, the market

offers several more tangible benefits, few of which are listed below:

·Price Dissemination -

Reducing Information

Gaps

Price discovered transparently on the

Exchange’s platform are disseminated

through various means such as Exchange

Website, trading terminals, SMSs, ticker

boards at physical mandis and other

prominent locations, etc.

This gives a constant flow of

information about spot prices as well

as futures prices for various products

and for different time periods. Thus,

a farmer can decide which crop to

cultivate or for that matter whether

to sell his produce on an immediate

basis or to hold back the stock for

sale at a later date depending on the

futures prices.

In fact, the commodity derivative

ecosystem provides solution to a related

problem, i.e., how to hold on to the crop

for longer periods through pledge

financing, warehousing, etc., which are

explained later.

20

In the process, the ecosystem indirectly actually helps the farmers get better prices

from intermediaries even in the physical Mandis.

Such advance price signals and dissemination helps the government and the

private sector to make plans for timely imports, instead of having to resort to last

minute imports in the case of crisis arising from shortages, at time when prices

may be already high. This ensures availability of adequate supplies and prevents

sudden spurt in prices. Similarly, in the case of a bumper crop, the early price

signals emitted by futures market help the importers to defer or stagger their

imports and exporters to plan exports, which protect the producers against unremunerative

prices. At the same time, it enables the exporters and importers to

hedge their position against commitments made for export/ import. This leads to

better management of import and exports leading to improvement in the balance

of payments situation.

Thus, price information disseminated by the Exchange is of crucial importance,

not only for buyers/ sellers spread across geographies, but can be of immense

benefit to Government agencies / policy makers to take an informed decision.

21

Physical deliveries in the commodity derivatives market has had a positive effect

on the development of infrastructure in warehousing, assaying and grading.

Assaying and grading not only ensures better return to farmers, but also

incentivizes them to cultivate better crop varieties.

·Development of

Infrastructure

The use of eNWR[1] that is

generated for all stocks

deposited in such warehouses

lends transparency and

traceability in the system as

these stocks are reported on a

daily basis and also available for

online viewing by interested

stakeholders. This not only

makes it easier and safer for

lenders to extend pledge finance

against commodities stored in

such warehouses but, also helps

the Government to collect and

collate information on the stock

of the commodity available at

different locations across the

country, which again aids in

appropriate policy decisions.

Derivatives market has helped in

development of quality infrastructure

especially on the warehousing side. It

may be noted that major delivery centres

of exchange have witnessed a boom in

the WDRA approved warehousing

infrastructure over the years. As

physical deliveries on exchange

platforms can be made only at WDRA

approved warehouses who are in turn

associated only with NABL[6] approved

Labs, the development of commodity

derivative markets leads to a

proliferation of such approved

warehouses/ Labs.

[6] National Accreditation Board for Testing and Calibration Laboratories (NABL) is an accreditation body, with

its accreditation system established in accordance with ISO/ IEC 17011

22

The use of eNWR[7] that is generated for all

stocks deposited in such warehouses lends

transparency and traceability in the system as

these stocks are reported on a daily basis and

also available for online viewing by interested

stakeholders. This not only makes it easier and

safer for lenders to extend pledge finance

against commodities stored in such warehouses

but, also helps the Government to collect and

collate information on the stock of the

commodity available at different locations

across the country, which again aids in

appropriate policy decisions.

A notable example of how the derivatives

market helped in infrastructure development is

the case of Gulabbagh (a small town around

300 kms away from Patna) in Bihar. Gulabbagh

which was a key centre for Maize trade was

long ignored by trade participants on account of

poor infrastructure. However, after it was

notified as a delivery centre for maize futures

trading in 2013, there has been a substantial rise

in total storage capacity in the region. Farmers

were able to get better prices due to increase in

the number of buyers for maize (as the market

place was extended nationwide) and cost of

intermediation came down significantly due to

more competition and greater efficiency.

[7] eNWR – Electronic negotiable warehouse receipt against the commodity stored in warehouse 23

·Adherence to

Quality Standards

Goods deposited in Exchange approved warehouses undergo various tests and

have to meet the quality standards prescribed by the Exchange. This helps in

ensuring that the goods meet standards / benchmarks such as FSSAI and

AGMARK. Exchange warehouses may be the largest source of tested

commodities in the country. Adherence to quality standards leads to better

practices pre and post-harvest, and in the long term, results in better realizations

for the farmer and better quality of commodity to the end user.

·Recognition for India as

Global benchmark price

setter

Over the years, India has seen a huge increase in production of several

commodities. This has helped India to move from deficit to surplus in case of

many commodities. Our country is the largest producer of pulses, spices, milk and

jute and the second largest producer of wheat, rice, fruits and vegetables,

groundnut, onions and potatoes. India is also one of the leading producer of

rapeseed, cereals and eggs. The country’s production of few other commodities

such as Rice, Wheat, Maize, Barley, Gram, Urad, Rapeseed and Sugarcane has

reached all-time highs. Despite this, India is a price taker for most of the

commodities, except for few commodities. This is because of the absence of

derivative markets for such commodities with the result that the fragmented

markets spread across the country leads to the incidence of several prices across

local and regional markets instead of having one central national price.

24

If there was one central market place and one central price across the country,

India could be recognized as the global price setter for these commodities because

of the sheer quantity produced in the country. Take the case of spices such as

Turmeric, Coriander, Jeera or for that matter Castor Seed, Guar Seed, for which

India is largest producer. Availability of the derivatives market for these

commodities has helped India to become the price setter for the global markets in

these commodities. Contrast this with Sugar: although India is one of the largest

producers and consumers of Sugar, as there is no transparent and fair price

discovery owing to the price controls, the price discovered on the Intercontinental

Exchange (ICE Europe[8]) is considered as the global benchmark.

·Enabling access to

cheaper sources of finance

especially for Farmers

Post-harvest credit in the form of warehouse receipt finance has proved to be a

critical component for the growth of the agricultural sector. Electronic Negotiable

Warehouse Receipts (eNWR) infuses the required efficiency and transparency in

the pledge financing by restricting the chances of tempering, mutilation, loss or

damage associated with paper warehouse receipts.

Pledge financing is provided by banks and other financial intermediaries to help

the farmer tide over temporary financial difficulties and avoid distress selling of

crops at the time of harvest when there is surplus supply.

[8] eNWR – An American company that owns and operates financial and commodity marketplaces and exchanges in

the U.S., U.K., EU, Canada, Singapore and Abu Dhabi.

25

Commodity financing forms one of the

largest components of banks’ loan book. We

have seen in the foregoing paragraphs that

commodities are prone to a high risk of price

volatility. How does this affect banks?

Banks lend to farmers, processors and

manufacturers against the security of

commodities pledged/ hypothecated to the

banks.

·Improvement in Asset

Quality of banks

It is obvious that when the price of the underlying commodity falls, the value of

the banks’ collateral reduces substantially. Further, the incidence of falling prices

would reduce the borrower’s profitability and ability to repay the bank loan.

Similarly, the incidence of rising prices would result in increase in raw material

cost and lead to fall in profitability and ability to repay.

Thus, whether the price rises or falls, one or other category of borrowers’ ability

to repay would be adversely impacted and ultimately the bank may be exposed to

risk of such assets (loans) becoming NPA (Non-performing Assets). As NPA have

to be provided for out of the banks’ profits, the banks’ profitability and thereby

capital adequacy would be adversely impacted.

The Commodity Derivatives Ecosystem provides a solution to the above problem.

If the borrower who avails finance against commodities arranges to hedge the

price risk on derivative platforms, he would be protected from the price risk; this

would ensure that his profitability and ability to repay the bank loan is not

adversely impacted and thus the banks’ interests would be safeguarded. The

banks’ capital and capital adequacy are important indicators of their soundness

and financial health and the Government, particularly the Ministry of Finance and

RBI are keen on maintaining and enhancing the same. It may be concluded from

the foregoing paragraphs that the Commodity Derivative Ecosystem is of

immense economic significance not only to the micro economic stakeholders like

farmers/ processors/ SME, etc., but also has enormous macro-economic

significance to Government and policy makers.

26

MODULE-3

Basic Concepts of

Commodity

Derivatives Market

Commodity Derivative Markets are co

a good understanding of several b

concepts. In this chapter, we will in

terminology followed by a glimpse

instruments in India. This will be follo

technical concepts and finally also pro

of commodity vs equity markets.

27

mplex markets that call for

asic terms and technical

ntroduce you to the basic

at the types of derivative

wed by explaining various

vide an insightful analysis

28

I.Basic Terminology

1.1. Commodity Market

A Commodity Market is a market place for buying/ selling/ trading commodities

(or goods). The market may be physical like a retail outlet or a mandi where

people meet face-to-face, or electronic (virtual) like an online market, where there

is no direct physical contact between buyers and sellers.

Markets may be Spot Markets or Derivative Markets. Spot Markets involve

immediate delivery and settlement while derivative markets involve delivery and

settlement at specified future dates. A Commodity Derivative Market is a market

where commodities are traded through financial instruments like futures and

forwards.

1.2. Derivative Contract

A derivative contract is an enforceable agreement between two parties based upon

the asset or assets. The value of this contract or agreement is determined by

fluctuations in the underlying asset. The underlying asset may include

commodities, currencies, equities, bonds, Index etc.

29

I.Basic Terminology

1.3. Commodity Derivatives

A derivative contract which has the underlying asset as a commodity is called

Commodity Derivative.

1.4. Contract specification

Contract Specifications is a term referring to the set of standards or parameters of

a derivative contract. All the standards/ parameters for a particular commodity is

defined in the contract specification. These parameters includes Name, Ticker

Symbol, Basis centre, Additional Delivery centre/s, unit of trading (lot size), price

quotation unit (Rs./Quintal, Rs./Tonne, etc.), Tick size, acceptable commodity

quality specification, trading hours, delivery logic (compulsory delivery, intention

matching, sellers’ option), expiry date, daily price limit, position limits, final

settlement price, etc. A sample copy of contract specification is provided in

Annexure.

30

I.Basic Terminology

1.5. Exchange

An Exchange is an organized and regulated market that provides a platform to

trade in securities (including stocks and commodities). As of September 2022,

there are four Exchanges in India that provide the platform for trading in

Commodity Derivatives:

·National Commodity & Derivatives Exchange Limited

·Multi Commodity Exchange of India Limited

·National Stock Exchange of India Limited

·Bombay Stock Exchange of India Limited

These exchanges are regulated by the Securities and Exchange Board of India

(SEBI) which functions under the control of the Ministry of Finance.

1.6. Repository in the Commodity Derivatives

Market

A Repository is an electronic storehouse of commodities stored in warehouses.

From commodity derivatives segment perspective, a Repository maintains the

records of goods stored in warehouses which can be used for clearing and

settlement of trades executed on stock exchange platform through Clearing

Corporations. Repositories are regulated by WDRA.

31

I.Basic Terminology

Physical deliveries in the commodity derivatives market has had a positive effect

on the development of infrastructure in warehousing, assaying and grading.

Assaying and grading not only ensures better return to farmers, but also

incentivizes them to cultivate better crop varieties.

The role of repository is somewhat similar to that of depository in equity market,

but far wider for the commodity ecosystem. A Repository serves several

important functions, including

Creation and storage of eNWRs

Transfer of e-NWRs between users of the repository

Ensuring security and authenticity of eNWR information

Providing secure access to manage and view the eNWRs

Providing controlled infrastructure to avoid duplication of eNWRs

Allowing pledging and sales of eNWR

Providing real time notification to the holder of eNWR and any pledge

holders and the warehouse service providers

Displaying any regulatory information that WDRA may require for

dissemination to users of the repository

1.7. Clearing Corporation and its Role

Clearing Corporation is an entity that undertake the post-trade activity of clearing

and settlement of trades undertaken on a recognized stock exchange, and

facilitates risk management. The Clearing Corporation is the entity which is

responsible for the settlement of trades executed on the Exchange. It also acts as a

counter party to all trades, i.e., it becomes a seller to every buyer and a buyer to

every seller; thus helps to minimize counter party defaults and in effect,

guarantees the performance of the contracts executed on the exchange platform.

This function of Clearing Corporation is known as ‘Novation’.

32

I.Basic Terminology

The clearing corporation, inter alia:

collects different types of margins

computes obligations of members

arranges for pay-in and pay-out of funds

takes care of physical settlement (delivery of goods), wherever applicable

1.8. Commodity Index / Indices

1.7. Clearing Corporation and its Role

A Commodity Index is an index that tracks the price of a basket of commodities.

The value of these indices fluctuates based on their underlying commodities.

Commodity indices vary in the way they are weighted and the commodities that

they are composed of. Example of commodity index can be Oils and Oilseeds

Index (comprising of Soybean, Soya Oil, Mustard Seed, Mustard Oil, etc.), or

Energy Index (which may comprise of Crude Oil and Natural Gas) or Precious

Metal Index (Gold and Silver as a component), etc

33

I.Basic Terminology

1.8. Commodity Index / Indices

Trading in commodity derivatives can be undertaken only through a SEBI

registered stock broker. For this purpose, these are some of the important steps to

be followed to start participating:

Choose a Broker (Member) - Open Trading Account with a SEBI registered

stock broker and complete the process of Know Your Client (KYC)

Understand the contents of Risk Disclosure Document (RDD)

Allotment of Unique Client Code (UCC) by the Broker (Member)

Open Bank account for funds transfer/receipt

Deposit required Margin with the Broker (Member) only through Bank.

Based on margin deposited broker (member) allocates limit for client to

participate.

Open account with Repository to facilitate delivery

34

II. Types of derivatives contract available in India

2.1. Forward Contracts

[9]

These are customized over the counter (OTC) contracts for buying or selling a

commodity at a future date, on terms and conditions agreed between the

contracting parties, whose names are mentioned in the contract. These are traded

outside the exchange framework. Such contracts can only be settled with physical

delivery of the commodity.

2.1. Future Contracts

Like forwards, a commodity futures contract is an agreement between parties to

buy or sell a commodity at a predetermined price agreed today, for delivery at a

specified time in the future (called expiry day). Unlike forwards, futures contracts

are highly standardized in terms of quality, quantity and delivery date of

commodities. Such strict specifications facilitate fair price discovery and also

reduces scope for disputes on quality related aspects. Futures Contracts are highly

regulated and permitted only on exchange platforms.

Holder of Futures contract may unwind the position (by squaring-off the position)

before the expiry or may held the position till maturity (or expiry) of the contract.

If position is held till expiry, holder must either physically give or take delivery of

the underlying asset (depending on settlement type[1] of the contract)

[9] Forwards contracts are not available on Exchange platforms and hence do not come under the purview of regulatory ambit

of SEBI.

[10] Covered in later part of this module.

35

The chart below provides the pay-off diagram of long and short futures position:

From the above pay-off diagram, it may be observed that in case of long/buy

position, one makes profit when prices rise, whereas in case of short/sell position,

profit is made when prices fall.

2.3. Options

‘Options’, as the word suggests, refers to choices or alternatives. A commodity

option is a derivative contract which gives the buyer the right, but not the

obligation, to buy or sell a commodity at a specified price called ‘Strike Price’.

The option buyer is also referred to as the ‘option holder’ while the seller of the

option is referred to as the ‘option writer’. The price that the option buyer pays to

the option seller for owning this right is called ‘option premium’.

Options are of two types, viz., Call Option and Put Option. Call Options gives the

right to the buyer to buy the underlying commodity while a Put Option gives the

option buyer the right to sell the underlying commodity.

36

As the option buyer has the choice (right) to buy or sell, he will obviously

exercise such right when the price of the underlying commodity moves in his

favour. For instance, if he buys a Call Option, if the market price falls below the

strike price, he may choose not to exercise his option as he can anyway buy the

commodity in the market at the lower price. But if the price rises beyond the strike

price, he will choose to exercise his option and buy the commodity. The option

seller, on the other hand, has no choice and has the obligation to honour the

contract, if and whenever the buyer chooses to exercise the option. The option

buyer will exercise his option only when the price of the underlying is favourable

to him, otherwise he will let the option expire worthless.

The table below provides the difference between the Call and Put Option:

Buyer or Seller Call Option Put Option

Buyer

Seller (Writer)

Right to Buy, and not obligation

(Limited Loss, Unlimited Profit)

Obligation of buying

(Limited Profit, Unlimited Loss)

Right to Sell, and not obligation

(Limited Loss, Unlimited Profit)

Obligation of Selling

(Limited Profit, Unlimited Loss)

Based on the timing of the exercise of the option, options can be of two types:

American

The buyer can choose to exercise the option at

any time before and including on the expiry date

of the option contract.

The buyer can choose to exercise the option only

on the date of expiration of the contract.

European

As per current regulatory norms, only European style commodity options are

available in India, i.e., the option can be exercised only at expiry.

37

Depending on the market price of the underlying commodity vis-a-vis the strike

price[11], options may be In the money (ITM), At the money (ATM), or Out of

the money (OTM).

The Option contract is said to be ‘In the Money’ (ITM) when it gives its

holder a positive cash flow, if exercised. A call option where the market price

(spot price) is above the strike price and a put option where the market price

(spot price) is less than the strike price is said to be ITM.

When the Option contract does not give any cash flow to the holder, if

exercised, i.e., when both market prices (spot price) and strike prices are

nearly equal, it is known as ATM option.

The Option contract is said to be ‘Out of the Money’ (OTM) when gives its

holder a negative cash flow, if exercised. A call option where the market price

(spot price) is below the strike price and a put option where the market price

(spot price) is above the strike price is said to be OTM.

The charts below provide the pay-off of different option variants:

[11]Strike price is the price at which the underlying commodity in an options contract can be bought or sold 38

Arranging the Payoff diagrams in the above fashion helps us understand a few

things better. Let us list them:

Let us start from the left side – if you notice the pay-off diagram of Call

Option (buy) and Call option (sell) are stacked one below the other. If

you look at the pay-off diagram carefully, they both look like a mirror

image. The mirror image of the pay-off emphases the fact that the riskreward

characteristics of an option buyer and seller are opposite. The

maximum loss of the call option buyer is the maximum profit of the call

option seller. Likewise, the call option buyer has unlimited profit

potential, mirroring this the call option seller has maximum loss

potential.

Pay-off of Call Option (buy) and Put Option (sell) are placed next to each

other. This is to emphasize that both these option variants make money

only when the market is expected to go higher. In other words, do not

buy a call option or do not sell a put option when you sense there is a

chance for the markets to go down. You will not make money doing so,

or in other words, you will certainly lose money in such circumstances.

Finally, on the right, the pay-off diagram of Put Option (sell) and the Put

Option (buy) are stacked one below the other. Clearly, the pay-off

diagrams looks like the mirror image of one another. The mirror image of

the payoff emphasizes the fact that the maximum loss of the put option

buyer is the maximum profit of the put option seller. Likewise, the put

option buyer has unlimited profit potential, mirroring this the put option

seller has maximum loss potential.

39

III. Technical Concepts relating to Commodity

Derivatives

3.1. Positions -

Long & Short

Long Position means a person has bought futures or

option contracts. A futures contract is bought if one

thinks that prices may increase. In case of option

contracts, a call option is bought when one wants to take

advantage of upward movement in prices or wants to

secure oneself from rising prices. Contrary to this, a put

option is bought when one feels that prices may fall and

wants to take advantage of falling prices or wants to

secure oneself from falling prices.

A hedger will hedge through long futures when he/ she

is exposed to price risk from the upward movement of

prices. For e.g., for the airline industry, the major cost is

the cost of Aviation Turbine Fuel (ATF) that is required

to power the aircraft. ATF prices closely follow the price

trend of crude oil, so an airline company may hedge its

price risk by buying a crude oil futures contract, in

which case they are said to have got a long position in

crude oil.

Short position means a person has sold futures or option

contracts. A futures contract is sold if one thinks that

prices might fall in future. A hedger will hedge through

short futures when he/ she is exposed to price risk from

the downward movement of prices. E.g., a farmer

cultivating Chana and who expects to have his harvest

ready in few months’ time, may enter into a ‘Sell’

futures contract of Chana and thereby protects himself

from the risk of falling price of chana.

40


Derivatives

3.2. Hedging

Hedging is a strategy to protect profits or limit losses. It involves taking equal and

opposite positions in two different markets (such as physical and futures market),

with the objective of protecting profits or reducing / limiting losses which may

occur with price change. It is a two-step process, where a gain or loss in the

physical position due to changes in price will be offset by changes in the value on

the futures platform, thereby reducing or limiting risks associated with

unpredictable changes in price.

3.3. Type of Settlement of Contract

Derivatives contract could either be cash settled or through delivery of underlying

commodity at the expiry of the contract. Brief explanation of different type of

settlement is provided below:

Compulsory Delivery

As the name indicates the Seller with an open interest at the expiry of the contract

has to arrange for delivery and the allocated buyer has to accept the same. Almost

all the major commodities available for Futures trading in India have compulsory

delivery logic, which mean open position on expiry of the contract has to be

settled through delivery/ receipt of underlying physical commodity (unless buyer/

seller squares-off the position before expiry/ maturity of the contract).

41


Derivatives

Intention matching

Under this mode of delivery only when both the buyer and the seller mark an

intention to take/ give delivery, settlement takes place through actual delivery of

underlying commodity.

Sellers Option

Under Sellers option, as the name indicates, delivery will take place only when the

Seller intends to give delivery. In case the Seller does mark an intention to deliver,

the buyer to whom that delivery has been allocated, will have to accept the same

Cash Settled

As the name indicates, open position at the expiry of the contract is cash settled.

Type of settlement of the contract is defined in the contract specification.

3.4. Delivery Centre – Basis and Additional

The price of a commodity differs from location to location. Moreover, price of the

same commodity also varies depending on the grade/ quality. Hence, each

commodity futures contract is tethered to a specific delivery center which is called

Basis centre. This provides clarity for market participants while taking a position

in derivatives contract, as they know the specific location where delivery can be

tendered/ received.

For the convenience of the market participants, there are additional delivery

centres (ADCs) defined for most commodities, from where delivery of a

commodity can also take place. Both, basis centre and additional delivery centre

are defined in the contract specification at the time of launch of the contract itself.

42

The identified basis and additional delivery centres for each commodity are

normally those centres which are major production/ consumption / trading centres.

For example, Indore (Madhya Pradesh) may be the basis centre for Soybean

contract while Akola (Maharashtra), Kota (Rajasthan), etc., may be identified as

additional delivery centres.

3.5. Expiry date of a contract

Expiry date is the last date till which a particular contract would available for

trading. Contract expires or cease to exist after the expiry date. Expiry Date of a

contract is one of the parameters defined in the contract specification of

commodity derivatives contracts. E.g., NCDEX has specified the 20th day of the

delivery month as the futures contract expiry date for most commodities. If this

happens to be a Saturday, or a Sunday or any other trading holiday, the expiry

date will be the immediately preceding trading day.

For example, if a Soybean futures contract expiring in November has an expiry

date as November 20, 2022, participants can trade in this contract till 20th

November 2022, post which this contract cease to exist.

Near Month, Mid Month and Far Month contracts

It may also be noted that at any given point of time, there would be several

contracts expiring in different months available for trading for a particular

commodity, and as such, there would be as many expiry dates (usually 3 to 4

contracts for the same commodity, each having different expiry date/month).

So if there are three contracts available, the contract having expiry nearest or

closest is known as near month or front month contract, the contract having expiry

next is known as next month or mid month contract and the contract which is have

the expiry farthest is known as far month contract.

43

For instance, suppose we are at 1st January and following contracts having expiry

date as 20th January, 20th February and 20th March are available for trading. So

in this case near month, mid month and far month contract would be as follows:

Expiry Date

Contract

20th January

Near Month or Front Month

20th February

Mid-Month or Next Month

20th March

Far Month

3.6. Lot Size

Lot size in commodity derivatives contracts refer to the minimum quantity

allowed for trading in a contract. E. g., lot size of NCDEX Maize futures is 10 MT

and that of NCDEX Jeera futures is 3 MT. The lot size is normally defined based

on the trade practice in the physical market for that particular commodity.

3.7. Open Interest

The total number of outstanding futures or options contracts of a given

commodity that are held by market participants at the end of the day. It is also

defined as the total number of contracts that have not been squared off, expired or

fulfilled by delivery. Open interest is normally expressed in terms of quantity. For

eg. Total open interest or outstanding position in a Commodity A is 10,000

tonnes. Now suppose the size of one contract or lot is 10 tonnes, then in terms of

number of contracts open interest would become 1,000 contracts.

44

It may be noted that Open Interest and Traded Volumes are totally different terms.

Traded Volume refers to the total quantity traded on a particular day or over a

specific period, while open interest refers to the outstanding positions at a

particular point of time.

3.8. Position Limits

Position limits are the maximum quantity of open positions that are permitted for

each commodity. These limits are prescribed by the Regulator (SEBI) and

monitored/ enforced by exchanges / clearing corporations. These limits are

prescribed in order to protect market integrity and prevent market manipulation or

market abuse and also act as a risk mitigating measure for individual

traders.Position limits are based on “deliverable supply” of that commodity.

Violations of position limits are monitored on a real time basis and attract stiff

penalties including monetary penalty and being placed in square-off mode (where

they cannot take any fresh position or increase their position till they square off

their excess position and come within permissible limits).

3.9. Daily Price Limit

The Daily Price Limit (DPL) in commodity futures market serve an important

function of defining the maximum range within which the price of a commodity

futures contract can move in one trading session. The defined daily price limits

protect investors from sudden and extreme price movements and provides

cooling-off period to re-assess the information and fundamentals impacting the

price of the commodity futures contract. DPL is prescribed in the contract

specification and it varies from commodity to commodity. Such limits are within a

reasonable range, i.e., neither too narrow nor too wide, so as not to impede the

market function of facilitating fair price discovery.

45

3.10. Daily Price Limit

Daily Settlement Price is the official daily closing price for a contract that is

calculated and announced by the Clearing Corporation at the end of each trading

day. The DSP is used to compute the daily profits / losses and arrive at MTM

(Mark To Market) profits/ losses for all open positions.There are regulatory

prescriptions for determining and notifying the DSP that has to be followed by all

Clearing Corporations.

3.11. Final Settlement Price (FSP)

The Final Settlement Price is the official closing price for a contract that is

calculated and announced at the expiry of a futures contract. The FSP is the price

that is used to settle all open positions at expiry of a futures contract. As per

current regulatory guidelines, the FSP shall be arrived at by taking the simple

average of the last polled spot prices of the last three trading days viz., E0 (expiry

day), E-1 and E-2. In the event the spot price for any one or both of E- 1 and E-2

is not available; the simple average of the last polled spot price of E0, E-1, E-2

and E-3, whichever available, shall be taken as FSP. Thus, the FSP under various

scenarios of non-availability of polled spot prices shall be as under:

Scenario

1

2

3

4

5

6

7

Polled spot price availability on

E-0 E-1 E-2 E-3

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes/No

Yes No

Yes

No

Yes Yes

No

Yes

No

No

No

Yes

No

No

Yes

No

No

No

FSP shall be simple average of

last polled spot prices on

FSP shall be simple average

E0, E-1, E-2

of last polled spot prices on:

E0, E-1, E-3

E0, E-2, E-3

E0, E-3

E0, E-1

E0, E-2

E0

46

3.12. Polling of Spot Prices

As final settlement price (FSP) of the contract is arrived at by taking the simple

average spot prices, spot prices have to be ‘polled’ for a specific grade (as defined

in contract specification) at identified centres from physical market participants.

Polling is the process of eliciting information from a cross section of market

players about the prevailing spot price of the commodity in the market. Polling is

a process that is undertaken by the Exchange for which they have empaneled

polling participants. Such empanelment is done by a careful process of selecting

participants who are representative of the value chain comprising various user

classes, viz., traders/ brokers, processors, importers/ exporters and other users.

Active players in the market belonging to different segments in the value chain are

chosen as polling participants to ensure that they are aware of the prevailing

prices. Primarily the data on spot prices is captured at the identified centers of a

commodity, by inviting price quotes from the empaneled polling participants.

3.13. Polling of Spot Prices

Spot prices and futures prices of a commodity normally tend to move up and

down in tandem, and it is this behavior of prices that makes the concept of

effective hedging possible. But businesses involved in buying or selling of

physical commodities are aware of the fact that the spot price in their own local

market, or the price their supplier quotes for a given commodity, usually differs

from the price that is quoted in the futures market.

It is because, price in the local markets is arrived at taking into consideration

variables such as local demand and supply situation in that particular region as

well as quality, storage, insurance, transportation and handling charges. The

difference between the spot price and futures price is known as Basis.

Putting it in a form of an equation, basis can be defined as:

Basis = Spot Price – Futures Price

47

Basis can either be positive or negative. Basis is important because it affects the

final outcome of a hedge in terms of the ultimate price either paid or received.

Example 1: Computation of Basis

Scenario Spot Price (A) Futures Price (B) Basis (C = A-B) Basis (+ or -)

1

Rs.5,000

Rs.5,100

(- Rs. 100)

Negative

2

Rs.5,000

Rs.4,900

(+ Rs. 100)

Positive

One can actually think of basis as “localizing” a futures price. The futures market

price is used as a benchmark in determining a local spot price.

3.14. Contango & Backwardation

Contango is a market situation in which either futures prices of far month

contracts exceed those of the near month contracts, or futures prices are higher

than spot prices. On the other hand, backwardation is a market situation in which

either futures prices of far month contracts are lower than those of the near month

contracts, or futures prices are below spot prices. Backwardation situation is

generally observed in Agri Commodities due to seasonality and cropping pattern

of commodities. During arrival season, due to supply being more than demand,

spot prices get depressed resulting in spot prices in the lean month being more

than future prices of contract expiring in arrival months, unless the crop is

expected to be poor.

48

3.15. Margins applicable in Derivatives market

Margins represents the minimum amount of money that a market participant must

pay to the Exchange / Clearing Corporation in order to start trading in commodity

derivatives. Margins are partly prescribed by SEBI and partly notified by Clearing

Corporations as a risk mitigating measure in order to maintain overall market

integrity.The Clearing Corporation imposes several types of margins for the trades

done by the members and their clients, like initial margin, extreme loss margin,

pre-expiry margin, delivery margin etc., Sometimes special margins (based on

evolving market conditions), keeping in mind overall safety of the market are

imposed by either exchanges/ clearing corporations or SEBI. Margin percentage is

computed using on-line state-of-art scenario-based Risk Management System

(RMS). The objective of RMS is to identify overall risk in a portfolio of all

contracts for each member. Its purpose is to determine the largest possible loss

that a portfolio might reasonably be expected to suffer from one day to the next,

based on appropriate Value at Risk (VaR) methodology.

IV. Classification of participants in Commodity

Derivatives Market

Based on the objectives of trading, participants in the derivatives markets can be

segregated into three broad categories, viz., Hedger, Arbitrager and Risk Taker.

49

4.1.

Hedgers

Hedgers are participants or traders who wish to

protect themselves from the risk arising from price movements. They look for

opportunities to pass on this risk to those who are willing to bear it. In order to

avoid the uncertainty associated with adverse price movements, they are prepared

to pay the related cost (like an insurance contract where one pays a premium to

avoid the monetary loss arising from certain incidents). To hedge their position,

participant takes an off-setting (opposite) position in the commodity derivatives

market. For example, if a value chain participant is long (holding stock) in

physical markets, he/ she would take a short/ sell position in derivatives market.

Arbitrageur 4.2.

Arbitrageurs are participants who identify and take

advantage of imperfections in the pricing of a commodity across

different markets / different month expiry contracts. The nature of their trading

helps reduce/ eliminate price distortions from the market across locations/ time

periods.

In commodity market participants can use different type of arbitrage strategies

such as:

Cash-n-carry: Cash-n-carry arbitrage can be used between spot/ physical and

future prices of a commodity. This strategy is often used by commodity

traders who have linkages with physical markets. In this case, arbitrageurs set

up a trade in the physical market and, simultaneously, take a position in the

futures market, in order to gain from the price disparity between the spot and

futures prices.

Spread: In case of spread, arbitrageurs trade only in the futures contracts on

exchanges to benefit from the price differentiation between various contracts

(having different expiry dates) of the same commodity. They buy a futures

contract of a specific month and sell another futures contract of a different

month of the same underlying commodity on the exchange to profit from the

price difference.

50

Inter-commodity: When one considers a different commodity on the same

exchange having the same cash flow or in the same category, then an intercommodity

arbitrage can be created. For instance, an arbitrage between

cotton, cottonseed, cotton oilseed cake and Kapas can be created in order to

benefit from the price difference.

Inter-exchange: The price difference for the same commodity on various

exchanges with the same contract expiry can be exploited as an interexchange

arbitrage opportunity. The price difference for the same commodity in the two

exchanges can arise due to volatility, liquidity and contract specifications,

among other reasons.

4.3.

Risk Taker OR

Speculator

These are participants who are ready to take

risk for the chance to earn a profit (reward for risk). Since risk and return always

go hand in hand, this category of participants, unlike hedgers, look for

opportunities to take on risk in the hope of making higher returns. This set of

participants may not produce or use a commodity or have any kind of stake in the

commodity, but are willing to risk his/ her own capital for trading in that

commodity in the hope of making a profit on price changes (Volatility). This class

of participants are also called ‘Speculators’. While many people consider that

speculation is not good for the markets, it must be recognized that speculators do

help the markets as they represent the risk takers in the market. As we have seen,

the hedgers want to transfer their risk, and if there were no risk takers, to whom

would they transfer the risk? The number of hedgers on the other side (long or

short as the case may be) may not be enough to create a liquid derivatives market

by themselves.

51

For example, the farmer wants to sell futures contract to protect himself from

price fall and the processor wants to buy a futures contract to protect himself from

price rise, but the timing and quantity offered by these participants may not

necessarily match. This is called a liquidity problem and it is the speculators

willing to take different positions, who can provide the liquidity, or the ability to

buy and sell derivatives contracts without materially affecting the prices.

This set of participants may also include investors, who invest in commodity

derivatives markets to earn a return similar to the investor in Securities/ Forex/

Equity markets.

V. Commodity Markets vs. Equity Markets

Commodity Markets are by nature much more complex with far reaching

economic significance as compared to equity markets. Due to the physicality of

the underlying commodity and linkage to the fundamental or primary economy,

this market is not just more complex but also impacts the equity markets; i.e., the

incidents and events in the commodity markets will influence equity markets

though the reverse may not be true at least to the same extent. For this reason, an

understanding of these markets will be of immense help in any economic activity

or field. Therefore, having understood the basics of commodity derivatives, let us

now have a brief look at the distinctive features of commodity markets vs equity

markets.

52

Parameter Comodity Market Equity Market

Multiple regulators, viz.,

Regualator

Exchanges and

Clearing

SEBI

Corporations: SEBI

Repository:WDRA

Spot Markets:

Respective State

Government (APMC

Instruments/Segment

available for

trading

on the Exchange

Futures & Options

Cash, Futures & Options

platform

Domestic Exchanges

NCDEX, MCX, NSE, BSE NSE, BSE, MSE

(as at Sep-2022)

Agri Commodities -

09.00 to 17.00

Trading Hours

Internationally

Referenceable Agri

09:15 to 15:30

Commodities / Non-Agri

- 09:00 am to

21:00/23:30

53


Fragmented – spread

Organised, electronic

Underlying Market across the country, with

national level Stock

bulk of trading

Exchanges with

concentrated in major

continuous, transparent

production /

price availability

consumption centers

Opaque

Underlying Supply

Uncertain & Estimated Certain and available

Changes every year in Public domain

Retail Investor which may

Kinds of Participants include Traders/

NSE, BSE, MSE

Manufacturers/ Processors,

Commission Agents/

Brokers

Institutional Participants –

AIF, Mutual Funds, FPIs

Farmers/FPOs

As defined in contract

Basis centre

specification.

Not applicable

E.g., Chana: Bikaner

Soybean: Indore

54


Spot Market: Commodity

are normally perishable in

nature. It has a shelf life

which may differ for each

commodity

Derivatives Segment:

Contracts have expiry

date. Even commodity date

Duration/ Expiry

deposited in warehouse

for tendering delivery

through the Exchange

ecosystem have a defined

shelf life, after which

same may not be

tenderable through

Exchange ecosystem.

Cash segment:

Perpetual. One can

buy a share of the

company and hold

for infinite period.

Derivative Segment:

Have contract expiry

Delivery and

Physical delivery of Demat settlement; no

Settlement commodities requires physical delivery

warehouses, vaults, etc

Factors affecting price Demand and Supply,

Company results,

movement

Climatic changes, etc.

News, Economic

factors, etc.

55

A further dimension to the commodity trade is the several points of distinction

between the commodity spot/ physical market and commodity derivatives market,

the major highlights of which are listed below:

Particulars Spot/Physical Market Commodity Derivatives

Regulator Respective state government

Party to party contract (buyer and

seller may be known to each other). Trade takes place anonymously

Nature

of trades

Trade may be between farmer and between two parties through

trader/ commission agent/ broker or Exchange platform

between trader and processor, etc.

Nature of contracts Customized Standardized

Mostly no collaterals, works on Initial margin has to be paid before

Prerequisites

trust and mutual understanding

trading

At the end of the day, i.e., mark

to market settlement in cash

Physical Settlement

Instantaneously or within 11 days of

Type of settlement

the deal Final settlement – Cash /

Physical, at the expiry of the

contract

Clearing corporation ensures

Guarantee of the trades On trust /mutual understanding

performance guarantee of the

contract

50 56

Annexure:

Illustrative Sample of Contract Specifications of Jeera

Futures Contract

57

58

Tolerance Limits for Outbound Deliveries of Jeera

59

Note:

Tolerance limit is applicable only for outbound deliveries. Variation in quality

parameters within the prescribed tolerance limit as above will be treated as good

delivery when members/clients lift the materials from warehouse. These

permissible variations shall be based on the parameters found as per the

immediate preceding test certificate given by NCCL empaneled assayer.

Disclaimer

Members and market participants who enter into buy and sell transactions may

please note that they need to be aware of all the factors that go into the

mechanism of trading and clearing, as well as all provisions of the Exchange's

Bye Laws, Rules, Regulations, Product Notes, circulars, directives, notifications

of the Exchange as well as of the Regulators, Governments and other authorities.

It is clarified that it is the sole obligation and responsibility of the Members and

market participants to ensure that apart from the approved quality standards

stipulated by the Exchange, the commodity deposited / traded / delivered through

the approved warehouses of the Clearing Corporation either on their own or on

their behalf by any third party is in due compliance with the applicable

regulations laid down by authorities like Food Safety Standard Authority of India

(FSSAI), AGMARK, Warehousing Development and Regulatory Authority

(WDRA), Orders under Packaging and Labelling etc. and other State/Central

laws and authorities issuing such regulations in this behalf from time to time,

including but not limited to compliance of provisions and rates relating to GST,

APMC Tax, Mandi Tax, LBT, Stamp Duty, etc. as applicable from time to time on

the underlying commodity of any contract offered for deposit / trading / delivery

and the Exchange / Clearing Corporation shall not be responsible or liable on

account of any non-compliance thereof.

60

MODULE-4

Relevance of Commodity

Derivatives Ecosystem to

Stakeholders

As we have seen in Chapter 2, Commodity Derivative Markets perform two major

economic functions viz., Transparent and Fair Price Discovery and Price Risk

Management. In addition to such macroeconomic functions, this market offers

several tangible benefits to the various Value Chain Participants (VCP)/

stakeholders in different ways depending on nature of their business/activities.

This chapter covers the relevance of Commodity Derivatives Market and

Ecosystem to different stakeholders.

So, who are the various VCP/ stakeholders who benefit directly and indirectly

from this market?

A. Farmers / Farmers Producers Organization (FPOs)

B. Processors and traders including stockists

C. Corporates/ SMEs using commodities as raw materials

D. Banking system

E. Government Agencies (involved in procurement like, FCI/ MMTC/ NAFED/

HAFED)

F. Government and Policy Makers (an important stakeholder in this ecosystem)

G. Retail Participants

Now, let us see how this ecosystem benefits each of the above.

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A. Farmers / Farmers Producers

Organization (FPOs)

Farmer’s income is a function of Yield and Price of the

commodity produced by the farmer. Over a period of time,

production related uncertainties have become manageable

due to various Government interventions/ policies, improved

farm practices and crop insurance available to farmers.

However, price uncertainty (mainly owing to price fall during

sowing to harvesting period or at the time of harvesting), is

still a concern and despite various initiative and schemes, it is

still a major challenge for farmers looking for a minimum

income from their crops. Hence, farmers need to be educated

and made aware of appropriate price risk management

techniques to lock-in their price at the time of sowing.

Before proceeding, let us understand the unique characteristic

of farm produce, viz., seasonal production accompanied by

perennial consumption which leads to demand supply mismatch

and resultant price volatility. Agriculture is a seasonal

activity and as such, the supply or availability of crops is

highest during the harvest season; but as the demand for the

produce is perennial and constant throughout the year, the

supply gradually dwindles and becomes very low by the time

the next sowing season starts. Most farmers make sowing

decisions based on prevailing prices at that time. But as the

harvest sets in, the supply of the crop increases with resultant

price falls, thereby leading to less than anticipated price for

the farmer. Of course, the cycle will be repeated and the price

will gradually rise in the succeeding months as the supply

falls with increasing consumption, but our farmer rarely has

the holding power to hold his stocks till that time.

62

Let us understand this with an example. It may be observed in the chart of Chana

below that in most years, prices during peak arrival period have been low as

compared to the sowing /pre harvesting stage. It may also be seen that prices have

moved up in later months (post peak-arrival period) in a few years, but the farmers

may not be able to hold on to the stocks till that time as they would generally need

funds immediately, i.e., they do not have holding capacity.

It would greatly benefit the farmer if he could ‘lock in’ the prices at the time of

sowing itself so that he is not exposed to the price volatility during the sowing to

harvest period.

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How can this ‘lock in’ of prices be done? In the following paragraphs, we shall

see how it is possible for the farmers to use market based instruments to ‘lock-in’

prices at specific levels and protect themselves from price uncertainty (risk).

Three such instruments are Forward Contracts, Futures Contracts and Put Options,

about which we have already learnt in a previous chapter.

A Forward Contract as we have seen is a private one to one agreement between

two parties to buy and sell specified goods at specified prices. These contracts are

exposed to what is called ‘counter party default risk’, i.e., the risk of default by

either party. If the buyer fails to honor his commitment to buy at the time of

harvest (which he may well do if the price falls sharply), the farmer may not have

any recourse and will have to sell in the open market at lower prices. This takes us

to the next instrument, viz., Futures Contract.

Futures Contract, as we have seen are exchange traded contracts that are regulated

by SEBI and as such, the risk of counter party default is low. So, the farmer can

enter into a ‘sell’ contract to sell specified quantity at specified prices (thereby

locking their selling price) at a future date and be assured that the Clearing House

of the Exchange will protect him from counter party default and ensure that he

will be able to realize the specified price. Of course, it can be readily seen that if

the price moves upwards, the farmers will lose the opportunity to sell at such

higher price as they are also contract bound to sell at the specified price. Another

disadvantage of Futures Contracts is that these require upfront margins and daily

Mark to Market (MTM) margin maintenance, which may adversely impact

Farmers’ cash flows when prices are moving against the hedged position. This

brings us to the third alternative instrument available to the farmer to lock in the

prices.

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Put Options: The limitations of hedging through Futures contracts can be

overcome with the help of Options contracts. As we have seen, Put Options gives

the Option Buyer (in our case, the farmer) the right, but not the obligation, to sell

at a pre-fixed price on a given date. Put Option gives the right to the farmer to sell

goods, but there is no obligation to deliver. In case the price moves up in the

physical market, the farmer has a discretion to not exercise the option. In such a

case, the farmer can sell goods in the physical market. Hence, he retains the

upside benefit too, which is not possible when price is locked-in (hedged) through

Futures contract.

The cost of buying a Put Option is called ‘option Premium’. This premium has

to be paid upfront at the time of entering into the Option contract and is fixed cost

regardless of whether the option is exercised or not. Option contract, therefore,

acts like a pseudo-insurance contract wherein the buyer of the contract buys the

right to sell, by paying a fixed premium to the seller of the Option or Option

writers, who act like an insurer.

65

Choices/alternatives available to farmers while availing Price Protection through

Put Option

Up to Expiry – Put Option buyer can square-off the Put Option at any time

before the expiry of the Put option contract and sell the produce in the

physical market. This square off the put option position would be at the

prevalent market premium.

Upon Expiry – Option is exercisable only upon the expiry of the option. If

the final settlement price is less than or close to the strike price the Farmer

can exercise such options contract and deliver the goods on the Exchange

platform and realize the delivery consideration which is equal to the Strike

price of the contract.

If the final settlement price is higher than the Strike Price, farmers can sell their

produce in the open market and need not deposit their goods in exchange

warehouses. Put option positions in such a case will expire worthless.

Thus Put Options in commodities gives the farmer the choice to sell his produce

either on the exchange platform at a pre-decided price or in the spot market

/mandi by squaring off the option position at prevailing market price. This

flexibility comes at the cost of premium to be paid for buying the Put Option.

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Role of FPOs in helping farmers to hedge their price risk

What is FPO ?

The term ‘FPO’ refers to ‘Farmer Producer

Organization’, which is a collective or

aggregation of farmers. FPO is recognized as

a separate and distinct legal entity. The Indian

agricultural sector is dominated by small and

marginal farmers who have very small land

holdings. Such small farmers may not have

the volume individually (both inputs and

produce) to benefit from the economies of

scale.

Besides, in agricultural

marketing, there is a long chain

of intermediaries resulting in a

situation where the farmer

receives only a small part of the

value that the ultimate

consumer pays. Through

aggregation, the farmers can

avail the benefit of economies

of scale. They will also have

better bargaining power vis-àvis

the bulk buyers of produce

and bulk suppliers of inputs.

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Farmer Producer Organizations (FPOs) are the way forward to overcome the

challenges / constraints faced by small and medium farmers, as they derive the

benefits of scale through aggregation. FPOs can also be seen as hybrids between

private companies and cooperative societies. The FPO or producer company

concept is aimed to combine the efficiency of a company with the `spirit' of

traditional cooperatives. They integrate smallholders into modern supply

networks, minimizing transaction and coordination costs, while benefiting from

economies of scale. Organization and collective action can help to enhance

farmers' competitiveness and increase their advantage in emerging market

opportunities. In the past few years, FPOs have been using Exchange traded

instruments such as Futures contracts and Put Options on exchange platforms to

hedge the price risk of its Farmer members.

It is pertinent to note here that NCDEX (the leading agricultural exchange in the

country) has been actively working with FPOs to increase awareness on this

subject. SEBI as the market regulator has also been actively helping the exchanges

in spreading such awareness. NCDEX with active support from SEBI, launched a

pilot program of Price Protection through Put Option for FPOs in November-

2020, which was highly successful and helped large number of farmers to benefit

from Put Options for price risk management. Details of the same is provided in

Annexure 1.

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B. Processors and Traders including stockists:

Similar to farmers/ FPOs, processors or manufacturers can also use commodity

derivatives contract to hedge their price risk. In fact, processor can take a benefit

of hedging on both legs, i.e., for sourcing of raw material as well as for selling

finished product.

For example, Soybean processor who crushes Soybean to produce Soya Oil and

Soyameal faces the risk of Soybean (raw material) price rising and prices of Soya

Oil and Soyameal falling (processed products). Hence, it could use commodity

derivatives market to hedge its price risk by buying Soybean (raw material) and

selling Soya Oil and Soyameal (processed products) futures contracts of different

months depending on its processing capacity.

Traders/ Stockists of commodities

A stockiest is a participant who procures physical commodity in bulk and keeps

on off-loading the same depending on the demand and prices. He bears the risk of

fall in the price. Hence, to hedge his price risk, he could sell futures contract

expiring after few months. E.g., a stockist enters into a sell futures contract

expiring after 2 months. Till the date of expiry, he may continue off-loading the

stock in the physical market depending on the demand and at the same time

unwinds his futures position (square-off by buying

back futures). At the expiry of the contract after 2

months, he partly sells the quantity in the physical

market along with squaring-up of the position (for

the quantum sold in the physical market) and

partly delivers it through the Exchange platform.

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C. Corporate / SMEs using commodities as raw material

Corporates or SME who use commodities as raw material also face the risk of

price of raw material rising. Hence, they can also hedge their price risk through

commodity derivatives market.

For example, for a company producing biscuits using wheat flour, wheat is the

primary raw material. If the price of wheat rises, it would impact the company’s

profitability (unless, ofcourse the rise can be passed on the consumer). Taking an

another example of airlines industry for which fuel cost forms a major part of

operating expenses. If the crude oil prices rise, Aviation Turbine Fuel price also

rises, which impacts the margins of the airline companies. To mitigate this risk,

airline companies may hedge their price risk by buying futures contracts of crude

oil.

To understand the relevance of commodity derivatives market to processor in a

better way an example of chana dal miller named ABC Corporation is provided in

Annexure 2.An excerpt from the news article providing details of how Starbucks,

a world’s largest coffeehouse chain, buys coffee beans using a method called

hedging is also provided Annexure 3.

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D. Banking System

Banks lend to farmers, processors and manufacturers against the security of

commodities pledged/ hypothecated to the banks.It is obvious that when the price

of the underlying commodity falls, the value of the banks’ collateral reduces

substantially. The incidence of falling prices would reduce the borrower’s

profitability and ability to repay the bank loan. Similarly, the incidence of rising

prices would result in increase in raw material cost and lead to fall in profitability

and ability to repay. Thus, whether the price rises or falls, one or other category of

borrowers’ ability to repay would be adversely impacted and ultimately the bank

may be exposed to risk of such assets (loans) becoming NPA (Non-performing

Assets). As NPA have to be provided for out of the banks’ profits, the banks’

profitability and thereby capital adequacy would be adversely impacted.

There have been instances of commodity firms/ companies getting bankrupt or

defaulting due to losses arising from unmanageable commodity risks. One of the

largest makers of edible oils, which had taken loans worth over Rs. 10,000 crores

defaulted few years back.

The Reserve Bank of India (RBI) mandates banks to lend 40% of their overall

credit to the priority sector, including agriculture, MSME, education, housing,

social infrastructure, renewable energy and export credit. A majority of such

loans are commodity based and banks could suffer a huge loss if these loans

become NPA. Recognizing the importance of price risk management for such

borrowers, RBI (vide its circular “DBR.No.BP.BC.96 /21.04.157/2014-15” dated

May 28, 2015), issued guidelines advising banks to encourage hedging by large

agricultural borrowers by creating awareness.

71

D. Government Agencies (involved in procurement -

FCI/ MMTC/ NAFED/ HAFED)

Our Government plays a crucial role in the commodity ecosystem. In an effort to

provide remunerative prices of their farm produce to the farmers, the Government

undertakes to procure the farm produce from farmers at a specified price called

Minimum Support Price (MSP). Such produce is used partly in the Public

Distribution System (PDS) and partly as a buffer stock to meet future

requirements of the nation as part of Food Security Program.

Government agencies undertake the procurement and distribution of many

agricultural commodities like rice, wheat, chana, soybean, mustard seed, cotton

etc. The cost of such procurement is quite large and the Government spends

additional amounts on storage and maintenance of such stocks. These activities

(procurement, storage and distribution) are carried out by the Government through

PSU like FCI and MMTC, PEC and NAFED. Such agencies could use the

domestic commodity exchanges effectively for various purposes discussed below.

Price support

Price stabilization

Hedging procured stocks

Government participation through Options

Subsidizing premium paid by farmers

72

Price stabilization

The Government through various agencies could also use the Derivatives platform

to provide stability in times of volatility by accordingly participating on the

platform. In times of price bullishness, the Government could consider liquidating

the accumulated buffer stocks through the Derivatives platform which would have

an effect of cooling down prices. Thus just as the RBI through its Monetary Policy

manages macro level inflation, the Government though an appropriate

Commodity Procurement Policy can manage commodity inflation particularly

Food Inflation.

Price stabilization

Various Government agencies such as FCI, NAFED, MMTC, PEC, State

Government Agencies etc., are involved in the procurement of stocks. Normally,

stocks are procured during the arrival season and thereafter gradually released

during the year. In commodities such as Paddy and Wheat, the release may be for

PDS as well as with a view to stabilize prices at times of shortages. In

commodities such as Pulses and Cotton, the Government procures to provide

support in times of weakness in prices and releases the same at appropriate times

depending on the prevailing price scenario. In the intervening period these

agencies are carrying the risk of adverse price movements. The Government can

hedge this risk by taking short positions on the derivatives platforms. These

positions may be unwound upon liquidation of stocks. Alternatively, these

agencies could also release the stocks via the Exchange platform by delivering on

the Exchange.

73

Taking a short hedge can be a most suitable strategy for any Government agency

which is carrying huge stock and exposed to price volatility. For example, during

MSP procurement operations, FCI buys excess Wheat which they release through

Open market sale scheme (OMSS) operation on or above a pre-defined base price.

Frequently, due to national and international demand supply dynamics, local

prices remain below OMSS prices and FCI is unable to sell allocated quantity. In

this scenario, FCI is exposed to adverse price risk and huge inventory cost for the

additional quantity; such large quantities of excess stocks are also vulnerable to

quality issues.

These issues could be addressed if FCI hedge their extra stock in far month

futures contracts. By doing this FCI can limit their loss up to a certain price point

and also can ensure smoothen supply to market during lean season. A graphical

representation how a government procurement agency can hedge its position

through derivatives market is provided in Annexure 5.

Government participation through Options

MSP through Put Options: Writing Put Options for farmers is an effective way of

helping the farmers as they could buy such options to protect themselves from

falling prices at the time of harvest. This could be a more optimal intervention

than procurement at MSP, as the latter may be costlier on account of physical

procurement/ storage, etc. It would at the same time serve the objective of an

assured return to farmer. Therefore, except for the actual quantity necessary to be

procured for PDS and a certain buffer for price stabilization, the Government

could evaluate writing options to absorb the excess quantity of farm produce

available in the market.

Subsidizing premium paid by farmers

Alternatively, the Government could subsidize the premium paid by the farmers to

buy a Put Option. This will reduce the cost for farmers and encourage them to

hedge their price risk through Options on the Exchange platform. Both the above

alternatives could result in huge savings for the Government, both in terms

monetary resources as well as physical storage space which is required when

actual procurement is undertaken.

7743

F. Government and Policy Makers (an important

stakeholder in this ecosystem)

Government uses various policy measures like export-import duty rationalization,

keeping quantitative restrictions on import/ exports and putting stock holding

limits on traders, etc. These policy measures are aimed at balancing supply and

demand equilibrium so that prices do not escalate beyond a certain level. These

policy measures do not always succeed because they use artificially determined

prices that could disrupt pure market functioning. Resultantly, there are frequent

incidences of sharp rise/ fall in prices, both of which scenarios hurt one or other

important section of the economy, viz., falling prices are detrimental to farmers’

interest while rising prices hurt consumer interest.

Derivatives markets offer a window into the future. Commodity derivatives

provide invaluable signals on the future trajectory of price movements and predict

future demand / supply mismatches. These early warning signals can serve as lead

indicators or advance guideposts for policy makers in decision making and

managing the supply bottlenecks or absorbing the excess supplies whatever the

case may be. In this way, efficient and advance supply chain management can be

done.

G. Retail Participants/ Investors

Retail participants or investors represent that set

of market participants who use commodity

derivatives as an additional asset class and trade

in these instruments with the objective of

making profits. They invest in commodity

derivatives markets to earn a return as is done

in securities/ forex/ equity markets.

75

This set of participant plays an important role of providing the liquidity to the

market. They are the ‘Risk Takers’ in the market as the hedger transfers their risk

to such participants.

Since risk and return always go hand in hand, this category of participants, unlike

hedgers, look for opportunities to take on risk in the hope of making higher

returns. This set of participants may not produce or use a commodity or have any

kind of stake in the commodity, but are willing to risk his/ her own capital for

trading in that commodity in the hope of making a profit on price changes

(Volatility). This class of participants are also called ‘Speculators’. While many

people consider that speculation is not good for the markets, it must be recognized

and appreciated that speculators do help the markets as they represent the risk

takers in the market. As we have seen, the hedgers want to transfer their risk, and

if there were no risk takers, to whom would they transfer the risk? The number of

hedgers on the other side (long or short as the case may be) may not be enough to

create a liquid derivatives market by themselves. For example, the farmer wants to

sell futures contract to protect himself from price fall and the processor wants to

buy a futures contract to protect himself from price rise, but the timing and

quantity offered by these participants may not necessarily match. This is called a

liquidity problem and it is the speculators willing to take different positions, who

can provide the liquidity, or the ability to buy and sell derivatives contracts

without materially affecting the prices.

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Annexure 1 -

Price Protection through Put Option Program for

FPOs by NCDEX

Farming is subject to both Yield Uncertainty and Price Uncertainty. There are

several schemes like Crop Insurance to protect the farmers from Yield

Uncertainty.Crop Insurance like any other Insurance, is a scheme whereby the

farmers pay a premium to the insurance company and buy a Crop Insurance

Policy in terms of which the farmer is compensated with a monetary pay out if the

crop fails. In order to make the crop insurance scheme popular among the farmers,

government has been subsidizing the premium amount.

But what about the Price Uncertainty.As we have seen, Put Options are a market

(exchange traded) instrument, that provides price protection to the farmer.

77

Put Option Contracts are like a pseudo-insurance contract, wherein the farmer

(option buyer) has to pay a small amount (called option premium) to the option

writers, who play the role of the Insurer. However, as Put Options are a relatively

new concept, farmers/ FPOs were hesitant to use them as they were reluctant to

pay the upfront premium cost. SEBI along with NCDEX recognized that there

was a need to subsidize this premium cost either fully or partially for FPOs, and

encourage them to use such market based instruments and inculcate the habit of

price locking through Put Options.

Accordingly, NCDEX with support from SEBI launched a ‘Price Protect through

Put Option Program’ in November 2020, in which FPOs by registering as a client

with a member of NCDEX could buy a Put Option and lock-in a price in Chana

and Mustard seed. Under this Program, the Premium cost paid by the FPOs for

buying the Put Options was reimbursed by NCDEX. The Program was found to

be highly successful. 41 FPOs (including 2 consortiums of FPOs), participated in

the Program and locked-in price on behalf of their farmer members for 1,030 MT

Chana and 1,980 MT Mustard Seed. Around Rs.83 lakhs of premium cost for

buying the put options was subsidized under this program to protect the produce

worth around Rs.15 crores from fall in prices between sowing and harvesting

period.

The program was carried out to incentivize the participation of FPOs in the

Options in Goods contract and give FPOs first-hand experience of the benefits of

locking in the future prices by using market based instruments at the time of

planting itself. Based on learnings and benefits derived in Options Familiarization

Program, few FPOs bought Put Option of Soybean and Maize on their own in

2021 (without any premium subsidy).

78

Annexure 2 -

Example of processor hedging his price risk

In the month of January, ABC Corporation sells 1000 tonnes chana dal to be

delivered in March.

Company would require chana to process it to a dal

Books a forward contract to buy 500 tonnes chana at Rs.4000 per quintal

which would be delivered to it in March

It is still short of 500 tonnes chana and prices starts rising owing to lower

supply

On account of lack of seller in the physical market, it buys (Hedges) 500

tonnes in NCDEX March chana futures contract at Rs.4050 per quintal.

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Annexure 3

An excerpt from the news article[13] providing details of how Starbucks, a

world’s largest coffeehouse chain, buys coffee beans using a method called

hedging is provided below:

Starbucks is immune to the recent spike in coffee prices thanks to a common yet

brilliant business strategy

Prices are going up for ingredients and food across the

retail industry, but Starbucks says it has coffee prices locked

in for months.

Starbucks buys coffee beans using a method called hedging.

Basically, Starbucks locks in a price to buy coffee beans

over an agreed-upon future period, "hedging" against risk.

The contract acts almost like insurance, protecting

Starbucks from paying higher prices if coffee beans spike

due to a weather event, shortage, or some other issue.

[13] The excerpt is taken from article published in Business Insider. https://www-businessinsiderin.cdn.ampproject.org/c/s/www.businessinsider.in/retail/news/starbucks-is-immune-to-the-recent-spike-in-coffee-prices-thanks-to-acommon-yet-brilliant-business-strategy/amp_articleshow/84922915.cms

80

Over the years we've created a very thoughtful approach to how we source,

warehouse, and use hedging techniques to ensure we always have supply of

premium Arabica green coffee at an attractive cost basis," Starbucks CEO Kevin

Johnson told investors in an earnings call in July. "In fact, we purchase green

coffee 12 to 18 months in advance, and we never stopped buying green coffee

through the pandemic."

Coffee bean prices just hit a six-year high as Brazil, a major coffee producer, was

hit by a drought followed by the worst frost in over 20 years. The full effect won't

be realized until the 2022 crop is harvested, meaning coffee prices could remain

inflated for months or longer.

Starbucks is insulated from those price increases for a while, though.

"We currently have over 14 months of price-forward coverage, which means we

have price locked on our coverage for the next 14 months, which gets us through

the rest of fiscal year 2021 and most of fiscal year 2022," Johnson said in the

earnings call.

Starbucks declined to comment further on how it buys coffee beans.

Starbucks' buying strategy "looks really smart right now," Edward Jones analyst

Brian Yarbrough told Insider. "They've been doing it for years."

Hedging coffee beans is working out well for Starbucks right now, but it can also

go the other way, for example if the chain bought coffee beans at a high price

before the rate dropped. For now, though, Starbucks can avoid price increases for

customers if the price of coffee beans spikes in the coming months and goes back

down.

Hedging is a common strategy in other industries. "Most international companies

hedge commodities and raw materials," Yarbrough told Insider. "A lot more

companies than you think hedge."

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Annexure 4

A hypothetical case study featuring benefits of hedging to farmers as well as the

lending bank is provided below for better understanding on relevance of hedging

to banks and financial institutions.

Raja is a farmer in Bikaner. It was September 2015 and the prevailing price of

Chana was Rs.5000/ - per MT. Raja felt that this price was very attractive as his

cost of cultivation would be about Rs.4000/- per MT. So he decided to sow a

substantial Chana crop and expected a harvest of about 1000 MT by February/

March 2016. Raja also decided to take a crop loan from SBI for this. He

approached the nearby SBI Branch and made his loan application.The SBI Field

Officer, Ms.Shoba was a young officer who was doing her rural assignment. She

examined Raja’s proposal and was quite happy to consider extending the loan as

it would help the branch to fulfil their priority sector lending. But she was

apprehensive about one thing. The Branch had a large portfolio of crop loans and

many of these loans had become NPA (non-performing assets) as the borrower

was unable to make the repayments as per the schedule. Shoba felt that somehow

she had to ensure this loan did not suffer the same fate.

She had been reading about hedging and commodity derivatives and

she was also aware that RBI had recently issued a circular encouraging

the use of hedging to cover commodity based lendings.

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She informed Raja about this and advised him to hedge his exposure by entering

into futures contract. Now Raja was apprehensive about the additional cost of

hedging and further was quite confident of the price that he would be able to

realize and therefore declined to do the hedging. Just that morning, the Branch

Manager Alka had called for a meeting of the field officers and informed them

that the branch was lagging behind in priority sector targets and were also short

on overall Advances budgets.With business targets and priority sector lending

targets looming large in their mind, Alka and Shoba felt compelled to extend the

loan to Raja without the hedging.

Raja availed the loan and sowed the chana and happily looked forward to making

a substantial profit after the harvest season. In October 2015, Raja’s nephew Ajay

came to visit him. Raja took him around his farm and proudly told him about his

expectations.Now Ajay was a student at an agricultural university and he had an

understanding of the economics of farming. He realized that prices prevailing at

the start of the sowing season (when the stock of that commodity is at an all-time

low resulting in high prices) are not reliable and that Raja may not get such

prices at the time of harvest. He therefore urged his uncle to go for the Hedging.

So Raja entered into the March Futures contract on NCDEX platform

where the price was 4850 per MT. This meant that regardless of the

actual price prevailing in the physical market at harvest time, Raja would

be able to get the contracted price of Rs.4850 per MT on NCDEX

platform on the date of expiry of the contract.

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As the harvesting season began and crop started arriving at mandis, the price of

chana started falling from February onwards.By March, Raja had harvested his

crop and got about 1050 MT (his actual yield was slightly more than his

expectation of 1000 MT) and was ready to sell; however, by end March, the price

had fallen to 3800 per MT as many farmers had been able to get good harvests.

But Raja having entered into the futures contract on NCDEX platform he was

able to get the contracted price of Rs.4850 per MT for 1000 MT. Raja decided to

keep the balance 50 MT for his personal consumption for family and relatives

rather than sell in the local mandi at Rs.3800 per MT. He realized sale proceeds

of Rs.48.50 lacs, paid off all his local dues and proudly went to deposit the

balance amount in his bank and repay the outstanding bank loan. Alka and Shoba

were very happy that Raja’s loan was repaid in full.

During the preceding few months, Alka had several times reviewed the branch

loan portfolio and asked her officers to try and find out how many of the

borrowers had hedged their crops.They were able to find out that out of 18 crop

loans granted against the Chana crop, 6 farmers had gone in for hedging and 12

farmers had not followed the bank’s advice to hedge their crops.The day Raja

came to repay his loan, that afternoon, the bank officers had another meeting to

review the outstanding loans and examine the position of NPAs. They found that 3

other farmer borrowers had also repaid their loans during the past one week.

These 3 farmers had also hedged their crops. They were quite confident that the

other 2 borrowers who had also done the hedging would repay the amounts within

next one week. But they were quite concerned about the fate of the loan to the 12

farmers who had not hedged, and felt that at least half of them would fail to repay

the bank’s dues.

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Some of them, felt Alka, may even feel constrained to borrow from local money

lenders at usurious rates to fulfil their loan obligations, though that may be

unlikely. Alka was extremely worried about the rising NPAs and aslo quite

anguished about the fate of these farmers too and for the hundredth time,

wondered how to make the farmer borrowers do the hedging and protect their

prices and in the process, protect the bank’s asset quality too. Later in the week,

Alka had a meeting with her Regional Manager and had to apprise her bosses of

the NPA position and expectations in that regard. At that meeting Alka told the

story of her branch and lamented – “if only our bank could introduce a policy of

mandating hedging for all commodity loans, we could achieve substantial

improvement in repayment standards and our NPA position would be so much

better.” The Regional Manager was highly impressed by her arguments and

promised to take up the case with the policy making bodies at higher levels.

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Annexure 2 -

Example of processor hedging his price risk

Case 1.

Case 2.

Above diagrams represent that a timely hedge position helps to manage risk at certain price points. It is clear from the above example that after

prices fall, FCI is compensated for spot market loss through its position on Futures and vice versa in case of price increase. Considering the

huge quantum of procurement, it is important to limit the loss through hedging (as explained above).

86

MODULE-5

Global and Indian Commodity

Market

Global Commodity Markets

Globally, the growth of commodities derivatives market is positively correlated

with the economic growth of major countries: economic growth and development

is inevitably accompanied by sizeable growth of both domestic and international

trade in commodities. But as we have already seen, commodities are characterized

by high price volatility and requires effective price risk management for the

market participants. We have also seen how commodity derivative markets

provide sound risk management tools that are absolutely essential for the survival

and growth of the participants in this market. Thus, it is not surprising that high

growth economies will have mature and thriving commodity derivatives markets.

China is a classic example of this phenomenon: as the country has seen a massive

boom in their commodities market in the last 15 years, their derivatives markets

have grown immensely. In fact, such superlative growth in commodities market

helped the country to become price setter in a number of commodities such as

metals, iron ore, egg, polymers, etc., where they were either a major consumer or

producer or both. Smaller countries such as Nepal, Myanmar, etc., have also

realized the importance of derivatives market and hedging and have been setting

up the Exchanges.

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Brief History of Futures Trading in developed

countries:

Evolution of commodity derivatives market in US

In early 19th century, grains were produced across US were traded through

tributaries of the Ohio and Mississippi Rivers and east-west overland routes. Then

the Great Lakes provided a natural water route east to Buffalo. By 1835 the

mouths of rivers and streams throughout the East North Central States had

become the hubs or port cities for grain trades.

In 1848 the Illinois-Michigan Canal connected the Illinois River to Lake Michigan

that enabled farmers in the hinterlands along the Illinois river to ship their

produce. With this, commercial activities grew significantly and Chicago emerged

as a dominant grain hub.

A system to finance the commodity trade was developed consisting of a network

of banks, grain dealers, merchants, millers and commission houses. A 60 to 90

days’ line of credit got evolved. Warehouse receipts based finance and trade was

introduced. High volume grain storage and shipment required that inventoried

grains be fungible. Merchants were able to secure larger loans more easily and at

relatively lower rates if they obtained price and quantity commitments from

their buyers. So, merchants began to engage in forward (not futures) contracts.

However, credit risk still remained as a serious problem.

To solve this, the Chicago Board of Trade (CBOT) came into

existence on April 3, 1848.

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countries:


It began as a voluntary association of prominent Chicago grain merchants. At

first, grain was sold by sample, but soon a system of inspection and grading was

introduced to standardize the market. A system of staple grades, standards and

inspections was established which facilitated the fungibility of grains. By the

1850s traders sold and resold forward contracts prior to actual delivery. By 1864,

the CBOT began to transform actively traded and reasonably homogeneous

forward contracts into futures contracts. CBOT standardized contract

specifications, necessitated traders to deposit margins, specified formally contract

settlement, including payments and deliveries, and grievance procedures.

Simultaneously to grain trades, forward contracts for cotton were traded in New

York (and Liverpool, England) by the 1850s. Like Chicago, organized trading in

cotton futures began on the New York Cotton Exchange in about 1870. Futures

trading on the New Orleans Cotton Exchange began around 1882.Futures

exchanges in the mid-1870s lacked modern clearinghouses. CBOT started its

clearinghouse in 1884 and mandatory clearing system was adopted by 1925. The

earliest formal clearing and offset procedures were established by the Minneapolis

Grain Exchange in 1891.

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countries:


In nineteenth century America was both fascinated and appalled by futures

trading. Many agricultural producers, and at times, legislatures and the courts,

believed trading in futures was identical to gambling. Many Americans believed

that futures traders frequently manipulated prices. This is apparent from the

litigation and many public debates surrounding its legitimacy. By 1892 thousands

of petitions to Congress called for the prohibition of “speculative gambling in

grain”. Several restrictions came from across the state legislatures. For example,

in 1879 California’s constitution invalidated futures contracts, in 1882 an Ohio

law tried to restrict cash settlement of futures contracts; and, in 1882, 1883 and

1885, Mississippi, Arkansas, and Texas, respectively, passed laws that equated

futures trading with gambling thus making the futures trading a crime. By 1892,

anti-Option Bill was introduced in Congress though failed on technical grounds.

In 1922 the U.S. Congress enacted the Grain Futures Act, which required

exchanges to be licensed, limited market manipulation and publicized trading

information. However, regulators could rarely enforce the act because it enabled

them to discipline exchanges, rather than individual traders. The Commodity

Exchange Act of 1936 enabled the government to deal directly with

traders rather than exchanges.

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countries:


It established the Commodity Exchange Authority (CEA), a bureau of the U.S.

Department of Agriculture, to monitor and investigate trading activities and

prosecute price manipulation as a criminal offense. The act also limited

speculators’ trading activities and the sizes of their positions; regulated futures

commission merchants; banned options trading on domestic agricultural

commodities; and restricted futures trading, designated which commodities were

to be traded on which licensed exchanges.

In 1974 Congress passed the Commodity Futures Trading Act, which created farreaching

federal oversight of U.S. futures trading and established the Commodity

Futures Trading Commission (CFTC). CFTC was given broad regulator powers

over all futures trading and related exchange activities throughout the U.S.A new

Futures Trading Act of 1982 passed which legalized options trading on

agricultural commodities and identified more clearly the jurisdictions of the CFTC

and Securities and Exchange Commission (SEC). Thus, CFTC was given

regulation of all futures contracts and options on futures contracts traded on U.S.

futures exchanges whereas the SEC regulates all financial instrument cash

markets as well as all other options markets.

CBOT, after more than a century of trading exclusively in agricultural products

Futures trading extended beyond physical commodities to currency futures in

1972; interest rate futures in 1975; and stock index futures in 1982. In 2007 the

CBOT was merged with Chicago Mercantile Exchange Holdings Inc. In 2015 the

CME Group closed most of its trading pits for futures contracts, replacing the era

of open outcry trading with online trading systems.

91


countries:


The above account of the history of futures trading in the United States is

strikingly similar to what is currently happening in our country – the long history

of unregulated trading followed by successive bans following the erroneous belief

that futures trading is linked to price rise or price fall. In the initial days,

derivatives market in United States also witnessed a significant struggle for

legitimacy as the 19th century America was both fascinated and appalled by

futures trading. Even, the US markets witnessed various stages of launch of

forward contracts, futures contracts, the attack on futures contracts by vested

interests with allegations of inflationary and manipulative tendencies of such

contracts before finally coming to the realization that appropriately regulated

futures markets are essential for the economic growth and development of the

country.

The story is no different for China. In an attempt to facilitate its market evolution

in 1990, China set up its first commodity exchange in Zhengzhou. As per some

literature by late 1994 there were more than sixty registered and unregistered

futures markets throughout China, featuring such diverse commodities as mung

beans, copper, refined oil, wire rods, and treasury bonds futures. Given the

thriving Chinese economy and the ambiguous regulatory climate, there was an

immediate and enthusiastic response from state-owned enterprises (SOEs) and

speculating investors who poured money into futures contracts and other

derivatives on the numerous exchanges.

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countries:


As futures trading intensified, prices began fluctuating wildly, causing widespread

trading losses. Fearing inflationary impacts, the Chinese government responded

rapidly by banning trade in the overheated and speculative markets, product by

product, in ad hoc succession. However, improved regulation and active

participation from state owned enterprises in commodity derivatives market soon

helped the Chinese commodities derivatives market to grow at a rapid pace. This

provides the valuable lesson that active government participation in such markets

can fast track the development of robust markets and overall economic

development besides imparting the prestigious status of being global price setters

for major commodities.

93

The table below provides the comparison among derivatives market in India, USA

and China on broad parameters (as of September 2022):

94

Major exchange providing commodity derivatives trading around the world:

95

Commodity derivatives exchanges are an important part of economic landscape

globally. Some of the major commodity exchanges globally and key commodities

traded on those exchanges are given below:

96

Commodity derivatives exchanges are an important part of economic landscape

globally. Some of the major commodity exchanges globally and key commodities

traded on those exchanges are given below:

*Note: Commodities listed in the above table are illustrative and does not

necessarily include all commodities that may be traded on these.

97

It may be observed from above table that in most countries there are multiple

commodity exchanges wherein the same commodity is available for trading on the

different exchanges within the country. However, in China one commodity is

available for trading on any one exchange only.

Price Setter vs. Price Takers

It may be observed that the same commodity is available on different exchanges

across many countries. For example, Soybean is available for trading on different

exchanges in USA, China, Brazil, India, etc. However, only one or at times a

maximum of two countries/ exchanges are recognized as global benchmark price

setter based on the price determined through trading on the platform of the

respective exchange. This recognition is highly advantageous for both the

respective exchange and the country: from the exchange perspective, it adds to the

attractiveness of their platform for the rest of the world thereby providing an

opportunity for increasing the liquidity and depth of the markets; from the

country’s perspective, it has macro-economic implications from a balance of

trade/ balance of payments perspective.

98

The table below provides details of which exchange is known as a global

benchmark price setter for different commodities:

99

Now let us have a look at how the above phenomenon occurs. In other words, how

does one exchange/ country manage to acquire this status of being recognized as

global benchmark price setters?

This is possible on account of two simple reasons – the country being major

producer or consumer and also presence of conducive government policies

promoting derivatives market. For e.g., China has become benchmark price setter

in certain commodities on account of active participation from state owned

enterprises in commodity derivatives market.

However, it is opposite in India. As we know, India is globally one of the largest

producers/ consumers of many agricultural commodities. But sadly, our country

does not at all feature in the above table; For e.g., India is the major producer of

Wheat, Paddy, Pulses, but despite that it is not a benchmark price setter.

Time-zones in global commodity markets

Commodity markets is almost a 24-hour

market as it remains open in different parts of

the world due to different time-zones.

Commodity exchanges across the world open

as the day begins in the respective country. Of

the major markets in the world, the first to open

are the countries nearest the International Date

Line. The International Date Line (IDL) is an

internationally accepted demarcation on the

surface of Earth, running between the South

Pole and North Pole and serving as the

boundary between one calendar day and the

next. Crossing the date line eastbound

decreases, the date by one day (24 hours),

while crossing the date line westbound

increases the date.

100

MODULE-6

Career Opportunity in Commodities

Derivatives Ecosystem

Employability in commodities ecosystem

Commodity Derivatives Markets offer attractive opportunities for employment in

several sectors like banking, Government agencies/ PSUs (like FCI/ MMTC),

trading firms, export organizations, etc.Basically, individuals having a basic

understanding of the physical market and / or qualifications like graduates in any

discipline, post graduate in economics, MBAs, chartered accountants, and also

individuals with some experience in financial markets can opt for a career in

commodities market.

How is this market different from the equity or currency market?There are several

fundamental differences arising from the sheer ‘physicality’ of a

‘commodity’.Commodity is a physical asset that requires storage, quality control

and transportation. Further, there is a concept of seasonality attached to

commodities that affects the demand, supply and prices. Lastly, it should also be

noted that when someone buys a share in an equity/ stock market, he or she

becomes one of the owners of the company in which the share is bought.

However, when one purchases a commodity, the buyer alone owns the whole of

that commodity.

Therefore, in addition to academic

qualification, it would be desirable for one

who wishes to make a career in commodity

markets to also possess a basic understanding

of the commodities, their fundamentals and

also the functioning of the physical and

derivatives markets.

101

Employability in commodities ecosystem

Although the specific skill sets for different areas of commodity ecosystem can

vary, some general skill sets include having sound fundamental knowledge,

analytical skills, number crunching and report making skills, good communication

skills and last but not least willingness to travel to places including interiors or

rural areas of the country, especially for the agri-commodity markets.

Different avenues to develop a career in commodities

Indian commodity market is an emerging sector and has significant growth

potential with the ability to benefit from rapid economic growth, government

initiatives and widening market participation. This in turn, has the potential to

create additional employment in different areas. Individuals opting for a career in

commodities can look forward to rewarding career opportunities in commodity

markets. Some of the areas that can be explored in commodity market are

explained below:

102

Commodity Trading companies

The world of commodity trading has changed over the years. Corporate

concentration has long been a defining feature of this sector. These companies buy

and sell agricultural and non-agricultural commodities, and also undertake a range

of activities from finance to production to processing and distribution. For

example, the four commodity conglomerates - also called as the ABCDs (ADM,

Bunge, Cargill and Louis-Dreyfus) have big stakes in Indian commodity market.

There are several other companies such as Glencore, Olam Agro, ETG, Trafigura,

ITC, and Adani among others. Not only these, there are hundreds of other smaller

companies spread across the country. These companies have their operation in

several countries and do often require skilled manpower for their operations.

Fast moving consumer goods

(FMCG) companies

FMCG is one of the largest contributing sectors to the

Indian economy. The FMCG market in India is

expected to increase at a CAGR of 14.9% to reach US$

220 billion by 2025, from US$ 110 billion in 2020.

Rising digital connectivity in cities and rural areas is

driving the demand for FMCG. Companies such as

HUL, ITC, Nestle, Britannia, Godrej, Patanjali, Dabur,

Marico etc., do also require skilled manpower in

commodity segment from time to time.

103

Commodity exchanges

A commodity exchange is a regulated electronic trading platform where buyers

and sellers interact to trade commodity-based derivatives contracts. The platform

is largely used for price risk management by physical market participants. Such

exchanges require skilled people in compliance, research, regulatory operations,

product research and business development, technology, etc.

Market Infrastructure Institutions

There are various market infrastructure institutions associated with the derivatives

trade on commodity exchanges. They are Clearing Corporations, Custodial

Service Providers, Repository, Trading & clearing members of Exchange,

knowledge management subsidiaries to perform research and a range of functions

related to the derivatives trading. Besides, the emergence of online, electronic

auction platforms in agricultural and allied sectors such as dairy and poultry, nonagricultural

and bullion spot and international exchange in GIFT City has also

created a significant demand for skilled professional in various areas.

Warehousing/ Collateral

Management

Warehousing is the backbone of commodity

market infrastructure. India is going through a

number of reforms and massive expansion in

warehousing sector with a mandate to digitize and

promote the electronic negotiable warehouse

receipt (e-NWR) system in the country under the

regulation of WDRA. This will only increase the

demand for professionals in testing labs and

assaying facilities, grading, sorting and packing

units, retail financing platforms including banks

and NBFCs.

104

In the retails pledge finance space, collateral management companies are at times

used to manage the quantity and quality of the collateral as part of the risk

mitigation endeavors of banks/ financial institutions. These organizations also

have a healthy demand for commodity finance professionals.

Broking House

Brokerage houses/ firms act as a link between retail clients and the stock/

commodity exchange. Their primary function is to buy and sell commodities on

behalf of their clients. These broking firms have different departments like dealing

desk, advisory desk, research desk, risk management, and business development

among others. They also do require skilled human resources for their operations.

Banks/ NBFCs

Banks and non-banking financial institutions play an important role in

facilitating the smooth functioning of the commodity markets.

Commodity producers,

manufacturers and end

users raise capital in a

variety of ways, including

bank finance. Often

commodities stored in

warehouses are financed

by banks.

105

Commodity based lendings form a large proportion of total bank finance and risk

management for such loans is a critical aspect for banks. As such, banks / NBFCs

also have career opportunities for commodity professionals in the field of risk

management and also business development.Further, banks (clearing banks) are

an integral part of the commodity derivative ecosystem and offer attractive

employment opportunity. In India, over 25 major banks and NBFC are currently

offering their services in commodity market and all of them add to employment

opportunities at times.

CONCLUSION

Over the last two decades, commodity derivatives market has been growing at a

steady pace and hence the employability in these sectors is also expected to grow.

Learning the basics of commodity derivatives will enable students not only to

have basic understanding and interest in commodity market but also open up

career opportunities in future.

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