100 Marks Commodity Project

7/29/2019 100 Marks Commodity Project

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COMMODITY MARKETSBACHELOR OF COMMERCE

FINANCIAL MARKETSSEMESTER V

(2011)SUBMITTED

BY:LAVINA PRADEEP CHANDALIA

ROLL NO. 02UNDER THE GUIDANCE OFMr mandar khandkar

SIES COLLEGE OF COMMERCE AND ECONOMICS,Plot No. 71/72, Sion Matunga Estate

T.V. Chidambaram Marg,Sion (East), Mumbai 400022.


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COMMODITY MARKETSBACHELOR OF COMMERCE

FINANCIAL MARKETSSEMESTER V

(2011)SUBMITTED

In Partial Fulfillment of the requirementsFor the Award of Degree of

Bachelor of Commerce Financial MarketsBY:

LAVINA PRADEEP CHANDALIAROLL NO. 02

UNDER THE GUIDANCE OFMr mandar khandkar

SIES COLLEGE OF COMMERCE AND ECONOMICS,Sion (East), Mumbai 400022.


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CERTIFICATEThis is to certify that Miss._________________________________ of

B.Com Financial Markets Semester V (2011) has successfully

completed the project on 30-09-2011 under the guidance ofMr.mandar khandkar

________________ ________Course Coordinator Principal_______________Project Guide/ Internal Examiner

________________External Examiner

DATE: PLACE:


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DECLARATION

I, ________________________________, the student of B.com(Financial Markets) semester V (2011) hereby declare that Ihave completed the project on 30-09-2011. The informationpresented through this project is true and original to thebest of my knowledge.

Date:

Place:

________________StudentS Signature

LAVINA CHANDALIAROLL NO: 02


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ACKNOWLEDGEMENT

With great pleasure I would like to thankMr mandarkhandkar and my course CoordinatorMR. TAMBE of South

Indian Education Society College of Commerce and Economics,

for giving me the opportunity to do this project on COMMODITYMARKETS. I would also like to thank him for being an

inspiration in the completion of this project. He gave me his

invaluable advice and help without which this project would

not have materialized.


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Objective

To give a basic introduction of exchange tradedcommodity future markets in India

To understand the difference between commodity &financial derivative

To understand merits & demerits of Indian exchangetraded commodity markets

To understand basics of trading, clearing & settlementon Indian commodity exchange

To understand how risk is managed in Indian commodityexchange

To understand the regulatory framework of Indiancommodity markets

To gain theoretical knowledge of gold as a commodity


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Summary

Trading in commodities existed in India since a long decade. But it has been organized

only few years ago. India is one of the top producers of large number of commodities

and also has a long history of trading in commodities and related derivatives. The

Commodities Derivatives market has seen ups and downs, but seems to have finally

arrived now.

The market has made enormous progress in terms of Technology, transparency and

trading activity. Interestingly, this has happened only after the Government protection

was removed from a number of Commodities, and market force was allowed to play

their role.

Transparent trading & clearing settlement mechanism has helped commodity markets

to gain popularity.Possibility of default by the participating players is minimized through

proper monitoring of the market, strong surveillance systems and implementation ofstrong risk management procedures.

Long term fundamentals of commodity markets appear bright given the supply demand

mismatch.

Gold as a trading commodity has been of great advantage to individuals & corporate.

The recent introduction of gold petal has made gold our traditional investment, within

the reach of common man, who otherwise finds it difficult to buy gold with ease

because of its rising price.


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Index

Sr no. Topic Page no

1 Introduction to commodity markets 9-212 Evolution of commodity markets 22-253 Indian commodity exchanges 26-364 Current Scenario in Indian Commodity Market 37-395 Trading 40-466 Clearing & settlement 47-567 Risk management 57-598 Regulatory framework 60-649 case study ; gold 65-68

10 Bibliography 69-69


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CHAPTER 1 INTRODUCTION TO COMMODITY MARKETCOMMODITYA commodity is a product, which is of uniform quality and traded across various

markets. There are generally two types of commodities, hard commodities and soft

commodities. Hard commodities include crude oil, iron ore, gold, and silver and have a

long shelf life. Agricultural products such as soybean, rice or wheat, are considered soft

commodities since they have a limited shelf life. These commodities have to be similar

and interchangeable. For example, soybean from one country or market should be of

the same quality wise as soybean from another, or gold in one country should be of the

same purity as gold from another. Consumer products like televisions or computers vary

from manufacturer to manufacturer and hence cannot be traded as commodities.

Hence, any product which is traded on an authorized commodity exchange is known as

commodity. The article should be movable of value, something which is bought or sold

and which is produced or used as the subject or barter or sale. In short commodity

includes all kinds of goods. Indian Forward Contracts (Regulation) Act (FCRA), 1952

defines goods as every kind of movable property other than act ionable claims, money

and securities.

In current situation, all goods and products of agricultural (including plantation), mineral

and fossil origin are allowed for commodity trading recognized under the FCRA. The

national commodity exchanges, recognized by the Central Government, permits

commodities which include precious (gold and silver) and non-ferrous metals, cereals

and pulses, ginned and un-ginned cotton, oilseeds, oils and oilcakes, raw jute and jute

goods, sugar and gur, potatoes and onions, coffee and tea, rubber and spices. Etc.


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Spot MarketThe spot commodity market is governed by State Agricultural Marketing Boards

(SAMB), MandiBoard (Farmers, Traders, State). There are more than 7000 Mandis

trading in about 140 crops. Participants in this market are Farmers, Licensed Traders,

and Brokers & Wholesale Dealers. Mandi Inspectors issue type & quantity certificate.

Mandifees: Transaction fee, Taxes; total varies between 4% and 12% Trading, Clearing

and Settlement.

Derivatives MarketA derivative is a product whose value is derived from the value of one or more

underlying variables or assets in a contractual manner. The underlying asset can be

equity, forex, commodity or any other asset.

The Forward Contracts (Regulation) Act, 1952, regulates the forward/ futures contracts

in commodities all over India. As per this Act, the Forward Markets Commission (FMC)

continues to have jurisdiction over commodity forward/ futures contracts. However,

when derivatives trading in securities was introduced in 2001, the term 'security' in the

Securities Contracts (Regulation) Act, 1956 (SC(R) A), was amended to include

derivative contracts in securities. Consequently, regulation of derivatives came under

the purview of Securities Exchange Board of India (SEBI). We thus have separate

regulatory authorities for securities and commodity derivative markets. Derivatives are

securities under the SC(R) A and hence the trading of derivatives is governed by the

2 ways of tradingin commodity

markets

Spot market Derivative market


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regulatory framework under the SC(R) A. The Securities Contracts (Regulation) Act,

1956 defines 'derivative' to include

1. A security derived from a debt instrument, share, loan whether secured or unsecured,

risk instrument or contract for differences or any other form of security.

2. A contract which derives its value from the prices, or index of prices, of underlying

securities.

COMMODITY EXCHANGEA commodity exchange is an association or a company or any other body corporate

organizing futures trading in commodities for which license has been granted by

regulating authority.Commodity Futures

A Commodity futures is an agreement between two parties to buy or sell a specified

and standardized quantity of a commodity at a certain time in future at a price agreed

upon at the time of entering into the contract on the commodity futures exchange. The

need for a futures market arises mainly due to the hedging function that it can perform.

Commodity markets, like any other financial instrument, involve risk associated with

frequent price volatility.

The loss due to price volatility can be attributed to the following reasons:

Consumer Preferences: - In the short-term, their influence on price volatility is small

since it is a slow process permitting manufacturers, dealers and wholesalers to adjust

their inventory in advance.

Changes in supply: - They are abrupt and unpredictable bringing about wild

fluctuations in prices. This can especially noticed in agricultural commodities where the

weather plays a major role in affecting the fortunes of people involved in this industry.

The futures market has evolved to neutralize such risks through a mechanism; namely

hedging.


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The objectives of Commodity futures Hedging with the objective of transferring risk related to the possession of

physical assets through any adverse moments in price. Liquidity and Price

discovery to ensure base minimum volume in trading of a commodity through

market information and demand and supply factors that facilitates a regular price

discovery mechanism.

Price stabilization along with balancing demand and supply position. Futures

trading leads to predictability in assessing the domestic prices, which maintains

stability, thus safeguarding against any short term adverse price movements.

Liquidity in Contracts of the commodities traded also ensures in maintaining the

equilibrium between demand and supply.

Flexibility, certainty and transparency in purchasing commodities facilitate bank

financing. Predictability in prices of commodity would lead to stability, which in

turn would eliminate the risks associated with running the business of trading

commodities. This would make funding easier and less stringent for banks to

commodity market players.

The major participants in commodity markets include1. Commodity Producers/Consumers

These participants are long (producers) and short (consumers) positions in the relevant

commodity. The inherent risk-exposure drives the use of commodity derivatives by

producers and users.

The application of commodity derivatives is frequently driven by the pattern of cash

flows. Producers must generally make significant capital investments (sometime

significant in scale) to undertake the production of the commodity. This investment must


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generally be made in advance of production and sale of the commodity. This means

that the producer is exposed to the price fluctuations in the commodity.

If prices decline sharply, then revenues may be insufficient to cover the cost of servicing

the capital investment .This means that there is a natural tendency for producers to

hedge at levels that ensure adequate returns without seeking to optimize the potential

returns from higher returns. This may also be necessitated by the need to secure

financing for the project.

Consumer hedging behavior is more complex. Consumer desire to undertake hedging is

influenced by availability of substitute products and the ability to pass on higher input

costs in its own product market. In many commodities, producer and consumer deal

directly with each other. The form of arrangement may include negotiated bilateral longterm supply or purchase contracts between the producers and consumers. The

contracts may include fixed price arrangements to reduce the price risk for both parties.

These arrangements create a number of difficulties. These include lack of transparency,

low liquidity and exposure to counterparty credit risk. The bilateral structure also creates

potential adverse performance incentives. This reflects the fact that the contracts

combine supply/purchase obligations and price risk elements in a single contract.

2. Commodity Processors

These participants have limited outright price exposure. This reflects the fact the

processors have a spread exposure to the price differential between the cost of the

input and the cost of the output. For example, oil refiners are exposed to the differential

between the price of the crude oil and the price of the refined oil products (diesel,

gasoline, heating oil, aviation fuel, etc.). The nature of the exposure drives the types of

hedging activity and the instruments used.

3. Commodity Traders

Commodity markets have complex trading arrangements. This may include the

involvement of trading companies (such as the Japanese trading companies and

specialized commodity traders). Where involved, the traders act as an agent or principal


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to secure the sale/purchase of the commodity. Traders increasingly seek to add value to

pure trading relationship by providing derivative/risk management expertise. Traders

also occasionally provide financing and other services. Commodity traders have

complex hedging requirements, depending on the nature of their activities.

A trader as a pure agent will generally have no price exposure. Where a trader acts as a

principal, it will generally have outright commodity price risk that requires hedging.

Where traders provide ancillary services such as commodity derivatives as the principal,

the market risk assumed will need to be hedged or managed.

4. Financial Institution/Dealers

Dealer participation in commodity markets is primarily as a provider of finance orprovider of risk management products. The dealers role is similar to that in the

derivative market in other asset classes. The dealers provide credit enhancement,

speed, immediacy of execution and structural flexibility. Dealers frequently bundle risk

management products with other financial services such as provision of finance.

5. Investors

This covers financial investors seeking to invest in commodities as a distinct and

a separate asset class of financial investment. The gradual recognition of

commodities as a specific class of investment assets is an important factor that

has influenced the structure of commodity derivatives markets.

Difference between Commodity and Financial DerivativesThe basic concept of a derivative contract remains the same whether the underlying

happens to be a commodity or a financial asset. However, there are some features

which are very peculiar to commodity derivative markets. In the case of financial

derivatives, most of these contracts are cash settled. Since financial assets are not

bulky, they do not need special facility for storage even in case of physical settlement.

On the other hand, due to the bulky nature of the underlying assets, physical settlement


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in commodity derivatives creates the need for warehousing. Similarly, the concept of

varying quality of asset does not really exist as far as financial underlings are

concerned. However, in the case of commodities, the quality of the asset underlying a

contract can vary largely. This becomes an important issue to be managed.

1 .Physical Settlement

Physical settlement involves the physical delivery of the underlying commodity, typically

at an accredited warehouse. The seller intending to make delivery would have to take

the commodities to the designated warehouse and the buyer intending to take delivery

would have to go to the designated warehouse and pick up the commodity. This may

sound simple, but the physical settlement of commodities is a complex process. Theissues faced in physical settlement are enormous. There are limits on storage facilities

in different states. There are restrictions on interest rate movement of commodities.

Besides state level octroi and duties have an impact on the cost of movement of goods

across locations. The process of taking physical delivery in commodities is quite

different from the process of taking physical delivery in financial assets.

1. a. Delivery notice period

Unlike in the case of equity futures, typically a seller of commodity futures has the

option to give notice of delivery. This option is given during a period identified as

`delivery notice period'.

1. b. Assignment

Whenever delivery notices are given by the seller, the clearing house of the Exchange

identifies the buyer to whom this notice may be assigned. Exchanges follow different

practices for the assignment process.


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1. c. Delivery

The procedure for buyer and seller regarding the physical settlement for different types

of contracts is clearly specified by the Exchange. The period available for the buyer to

take physical delivery is stipulated by the Exchange. Buyer or his authorized

representative in the presence of seller or his representative takes the physical stocks

against the delivery order.

Proof of physical delivery having been affected is forwarded by the seller to the clearing

house and the invoice amount is credited to the seller's account.

The clearing house decides on the delivery order rate at which delivery will be settled.

Delivery rate depends on the spot rate of the underlying adjusted for discount/ premium

for quality and freight costs. The discount/ premium for quality and freight costs are

published by the clearing house before introduction of the contract. The most active

spot market is normally taken as the benchmark for deciding spot prices.

2. Warehousing

One of the main differences between financial and commodity derivative is the need for

warehousing. In case of most exchange-traded financial derivatives, all the positions arecash settled. Cash settlement involves paying up the difference in prices between the

time the contract was entered into and the time the contract was closed. For instance, if

a trader buys futures on a stock at Rs.100 and on the day of expiration, the futures on

that stock close at Rs.120, he does not really have to buy the underlying stock. All he

does is take the difference of Rs.20 in cash. Similarly, the person who sold this futures

contract at Rs.100 does not have to deliver the underlying stock. All he has to do is pay

up the loss of Rs.20 in cash.

In case of commodity derivatives however, there is a possibility of physical settlement. It

means that if the seller chooses to hand over the commodity instead of the difference in

cash, the buyer must take physical delivery of the underlying asset. This requires the

Exchange to make an arrangement with warehouses to handle the settlements. The


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efficacy of the commodities settlements depends on the warehousing system available.

Such warehouses have to perform the following functions:

Earmark separate storage areas as specified by the Exchange for storing

commodities;

Ensure proper grading of commodities before they are stored;

Store commodities according to their grade specifications and validity period; and

Ensure that necessary steps and precautions are taken to ensure that the quantity and

grade of commodity, as certified in the warehouse receipt, are maintained during the

storage period. This receipt can also be used as collateral for financing.

In India, NCDEX has accredited over 775 delivery centers which meet the requirements

for the physical holding of goods that are to be delivered on the platform. As future

trading is delivery based, it is necessary to create the logistics support for the same.

3. Quality of Underlying Assets

A derivatives contract is written on a given underlying. Variance in quality is not an issue

in case of financial derivatives as the physical attribute is missing. When the underlyingasset is a commodity, the quality of the underlying asset is of prime importance. There

may be quite some variation in the quality of what is available in the marketplace. When

the asset is specified, it is therefore important that the Exchange stipulate the grade or

grades of the commodity that are acceptable. Commodity derivatives demand good

standards and quality assurance/ certification procedures. A good grading system

allows commodities to be traded by specification.

Trading in commodity derivatives also requires quality assurance and certifications fromspecialized agencies. In India, for example, the Bureau of Indian Standards (BIS) under

the Department of Consumer Affairs specifies standards for processed agricultural

commodities. AGMARK, another certifying body under the Department of Agriculture

and Cooperation, specifies standards for basic agricultural commodities.


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Benefits of Commodity Futures MarketsThe primary objectives of any futures exchange are authentic price discovery

and an efficient price risk management. The beneficiaries include those who trade in the

commodities being offered in the exchange as well as those who have nothing to do

with futures trading. It is because of price discovery and risk management through the

existence of futures exchanges that a lot of businesses and services are able to function

smoothly.

1. Price Discovery

Based on inputs regarding specific market information, the demand and supply

equilibrium, weather forecasts, expert views and comments, inflation rates,

Government policies, market dynamics, hopes and fears, buyers and sellers conduct

trading at futures exchanges. This transforms in to continuous price discovery

mechanism. The execution of trade between buyers and sellers leads to assessment

of fair value of a particular commodity that is immediately disseminated on the

trading terminal.

2. Price Risk ManagementHedging is the most common method of price risk management. It is strategy of

offering price risk that is inherent in spot market by taking an equal but opposite

position in the futures market. Futures markets are used as a mode by hedgers to

protect their business from adverse price change. This could dent the profitability of

their business. Hedging benefits who are involved in trading of commodities like

farmers, processors, merchandisers, manufacturers, exporters, importers etc.

3. Import- Export competitiveness

The exporters can hedge their price risk and improve their competitiveness by

making use of futures market. A majority of traders which are involved in physical

trade internationally intend to buy forwards. The purchases made from the physical


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market might expose them to the risk of price risk resulting to losses. The existence

of futures market would allow the exporters to hedge their proposed purchase by

temporarily substituting for actual purchase till the time is ripe to buy in physical

market. In the absence of futures market it will be meticulous, time consuming and

costly physical transactions.

4. Predictable Pricing

The demand for certain commodities is highly price elastic. The manufacturers have

to ensure that the prices should be stable in order to protect their market share with

the free entry of imports. Futures contracts will enable predictability in domestic

prices. The manufacturers can, as a result, smooth out the influence of changes intheir input prices very easily. With no futures market, the manufacturer can be

caught between severe short-term price movements of oils and necessity to

maintain price stability, which could only be possible through sufficient financial

reserves that could otherwise be utilized for making other profitable investments.

5. Benefits for farmers/Agriculturalists

Price instability has a direct bearing on farmers in the absence of futures market.

There would be no need to have large reserves to cover against unfavorable price

fluctuations. This would reduce the risk premiums associated with the marketing or

processing margins enabling more returns on produce. Storing more and being more

active in the markets. The price information accessible to the farmers determines the

extent to which traders/processors increase price to them. Since one of the

objectives of futures exchange is to make available these prices as far as possible, it

is very likely to benefit the farmers. Also, due to the time lag between planning and

production, the market-determined price information disseminated by futures

exchanges would be crucial for their production decisions.


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6. Credit accessibility

The absence of proper risk management tools would attract the marketing and

processing of commodities to high-risk exposure making it risky business activity to

fund. Even a small movement in prices can eat up a huge proportion of capital owned

by traders, at times making it virtually impossible to payback the loan. There is a high

degree of reluctance among banks to fund commodity traders, especially those who do

not manage price risks. If in case they do, the interest rate is likely to be high and terms

and conditions very stringent. This posses a huge obstacle in the smooth functioning

and competition of commodities market. Hedging, which is possible through futures

markets, would cut down the discount rate in commodity lending.

7. Improved product quality

The existence of warehouses for facilitating delivery with grading facilities along with

other related benefits provides a very strong reason to upgrade and enhance the

quality of the commodity to grade that is acceptable by the exchange. It ensures

uniform standardization of commodity trade, including the terms of quality standard:

the quality certificates that are issued by the exchange-certified warehouses have

the potential to become the norm for physical trade.

Disadvantages of commodity markets1. PRINCIPLE IS NOT GUARENTEED

Like trading stocks, there is no guarantee of your initial investment. However, in buying

stock in a company, your loss is limited to the amount you paid for the stock. In

commodity future trading, losses can mount to a greater amount then your initial marginused to open the position and additional capital through margin calls may be necessary

if the market goes against your position.


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2. High risk due to leverage

Using leverage only requires a small amount of initial capital to initiate a new position

and price volatility can lead to big profits or big losses. That is why many people

suggest using stop orders to limit potential losses.

3. High price volatility could lead to margin call

A margin call is when the market is going your position additional capital is required. At

this time, additional margin will be deducted from your account balance. If there are

insufficient funds in your account, your broker will notify you of the additional amount

that is required .if these additional funds are not promptly deposited into traders

account, their positions will be automatically liquidated by the broker.


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Chapter 2. Evolution of commodity marketsHistory of commodity markets globally

Commodities future trading was evolved from need of assured continuous supply of

seasonal agricultural crops. The concept of organized trading in commodities evolved in

Chicago, in 1848. But one can trace its roots in Japan. In Japan merchants used to

store Rice in warehouses for future use. To raise cash warehouse holders sold receipts

against the stored rice. These were known as rice tickets. Eventually, these rice tickets

become accepted as a kind of commercial currency. Latter on rules came in to being, to

standardize the trading in rice tickets. In 19 th century Chicago in United States had

emerged as a major commercial hub. So that wheat producers from Mid-west attracted

here to sell their produce to dealers & distributors. Due to lack of organized storage

facilities, absence of uniform weighing & grading mechanisms producers often confined

to the mercy of dealers discretion. These situations lead to need of establishing a

common meeting place for farmers and dealers to transact in spot grain to deliver wheat

and receive cash in return.

Gradually sellers & buyers started making commitments to exchange the

produce for cash in future and thus contract for futures trading evolved. Whereby the

producer would agree to sell his produce to the buyer at a future delivery date at an

agreed upon price. In this way producer was aware of what price he would fetch for his

produce and dealer would know about his cost involved, in advance. This kind of

agreement proved beneficial to both of them. As if dealer is not interested in taking

delivery of the produce, he could sell his contract to someone who needs the same.

Similarly producer who not intended to deliver his produce to dealer could pass on the

same responsibility to someone else. The price of such contract would dependent on

the price movements in the wheat market. Latter on by making some modifications

these contracts transformed in to an instrument to protect involved parties against

adverse factors such as unexpected price movements and unfavorable climatic factors.


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This promoted traders entry in futures market, which had no intentions to buy or sell

wheat but would purely speculate on price movements in market to earn profit.

Trading of wheat in futures became very profitable which encouraged the entry of

other commodities in futures market. This created a platform for establishment of a body

to regulate and supervise these contracts. Thats why Chicago Board of Trade (CBOT)

was established in 1848. In 1870 and 1880s the New York Coffee, Cotton and Produce

Exchanges were born. Agricultural commodities were mostly traded but as long as there

are buyers and sellers, any commodity can be traded. In 1872, a group of Manhattan

dairy merchants got together to bring chaotic condition in New York market to a system

in terms of storage, pricing, and transfer of agricultural products. In 1933, during the

Great Depression, the Commodity Exchange, Inc. was established in New York through

the merger of four small exchanges the National Metal Exchange, the Rubber

Exchange of New York, the National Raw Silk Exchange, and the New York Hide

Exchange.

The largest commodity exchange in USA is Chicago Board of Trade, The Chicago

Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity

Exchange and New York Coffee, sugar and cocoa Exchange. Worldwide there are

major futures trading exchanges in over twenty countries including Canada, England,

India, France, Singapore, Japan, Australia and New Zealand.

History of Commodity Market in IndiaThe history of organized commodity derivatives in India goes back to the nineteenth

century when Cotton Trade Association started futures trading in 1875, about a decade

after they started in Chicago. Over the time derivatives market developed in several

commodities in India. Following Cotton, derivatives trading started in oilseed in Bombay

(1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in

Bombay (1920).However many feared that derivatives fuelled unnecessary speculation

and were detrimental to the healthy functioning of the market for the underlying


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commodities, resulting in to banning of commodity options trading and cash settlement

of commodities futures after independence in 1952. The parliament passed the Forward

Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the

India. The act prohibited options trading in Goods along with cash settlement of forward

trades, rendering a crushing blow to the commodity derivatives market. Under the act

only those associations/exchanges, which are granted reorganization from the

Government, are allowed to organize forward trading in regulated commodities.

The act envisages three tire regulations: (i) Exchange which organizes forward trading

in commodities can regulate trading on day-to-day basis; (ii) Forward Markets

Commission provides regulatory oversight under the powers delegated to it by the

central Government. (iii) The Central Government- Department of Consumer Affairs,

Ministry of Consumer Affairs, Food and Public Distribution- is the ultimate regulatory

authority. The commodities future market remained dismantled and remained dormant

for about four decades until the new millennium when the Government, in a complete

change in a policy, started actively encouraging commodity market. After Liberalization

and Globalization in 1990, the Government set up a committee (1993) to examine the

role of futures trading.

The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in

17 commodity groups. The Committee which submitted its report in September 1994

recommended that futures trading be introduced in the following commodities:

Basmati Rice

Cotton, Kapas, Raw Jute and Jute Goods

Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed,

safflower seed, copra and soybean and oils and oilcakes

Rice bran oil

Castor oil and its oilcake


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Linseed

Silver

Onions

The committee also recommended that some of the existing commodity exchanges

particularly the ones in pepper and castor seed, may be upgraded to the level of

international futures markets.

It also recommended strengthening Forward Markets Commission, and certain

amendments to Forward Contracts (Regulation) Act 1952, particularly allowing option

trading in goods and registration of brokers with Forward Markets Commission.

The Government accepted most of these recommendations and futures trading was

permitted in all recommended commodities.

Since 2002, the commodities future market in India has experienced an unexpected

boom in terms of modern exchanges, number of commodities allowed for derivatives

trading as well as the value of futures trading in commodities, which crossed $ 1 trillion

mark in 2006. Since 1952 till 2002 commodity datives market was virtually non- existent,

except some negligible activities on OTC basis.


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Chapter 3. Indian Commodity ExchangesThere are more than 20 recognized commodity futures exchanges in India under the

purview of the Forward Markets Commission (FMC). The country's commodity futures

exchanges are divided majorly into two categories:

National exchanges

The four exchanges operating at the national level (as on 1st January 2010) are:

i) National Commodity and Derivatives Exchange of India Ltd. (NCDEX)

ii) National Multi Commodity Exchange of India Ltd. (NMCE)iii) Multi Commodity Exchange of India Ltd. (MCX)

iv) Indian Commodity Exchange Ltd. (ICEX)

Regional exchanges

The leading regional exchange is the National Board of Trade (NBOT) located at Indore.

There are more than 15 regional commodity exchanges in India.

Indian exchangesThe following are the list of exchange and commodities in which futures contracts are

traded in India are as follows

sr.no Exchanges Commodity

1 India pepper & Spice Trade

Association , Kochi(IPSTA)

Pepper (both domestic

and international

contracts)2 Vijay Beopar chamber Ltd.,

Muzaffarnagar Gur

3Rajdhani oil & oilseed exchange Gur, Mustard seed its


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ltd, Delhi oil & oilcake

4 Bhatinda Om & oil exchange ltd

,Bhantada Gur

5

The chamber of commerce ,Hapur

Gur , potatoes and

Mustard seed

6 The Meerut Agro Commodity

Exchange ltd., Meerut Oilseed complex

7

The Bombay Commodity Exchange

Ltd., Bombay

Castrol seed, Ground

nut, its oil & cake,

cottonseed its oil

&cake, cotton & RBD

Palmolein

8

Rajkot seeds, oil & Bullion

Merchants Association , Rajkot

Castrol seed,

cottonseed , its oil and

oilcake

9 The Ahmedabad Commodity

Exchange, Ahmedabad Hessian & sacking

10 The East India Jute & Hussian

Exchange Ltd., Calcutta Cotton

11 The East India cotton Association

Ltd., Calcutta Turmeric

12 The Spices & Oilseeds Exchange

Ltd, Sangli

Rapeseed/Mustard

seed, its oil and cake

13

Kanpur Commodity Exchange Ltd.,

Kanpur

Soya seed, Soya oil

and Soya meals.

Rapeseed/Mustard

seed its oil and oilcake

and RBD Palmolien

14 National Board of trade, Indore Copra/Coconut, its oil&


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oilcake

15 The First Commodities Exchange of

India Ltd., Kochi Gur and Mustard Seed

16 Central India Commerce Exchange

Ltd., Gwalior Sugar

17

E-Sugar India Ltd., Mumbai

Oilseed complex and

Rubber , sugar,

Aluminum, nickel ,Zinc,

Copper, Lead. tin

,pepper, Gram and

Sacking18 National MultiCommodity

Exchange of India Ltd., Ahmedabad Coffee

19 Coffee Futures Exchange India

Ltd.,Bangalore

Cotton,.Cotton seed,

Kapas

20 Surendranagar Cotton oil &

Oilseeds, Surendranagar Sugar

21

E-Commodities Ltd.,New Delhi

Mustard seed its oil &

oilcake

22 Bullion Merchants Association ,

Bikaner

Metals & Agri

Commodities

23 Multi Commodity Exchange (MCX),

Mumbai

Metals & Agri

Commodities

24 National Commodity and Derivation

Exchange ( NCDEX), Mumbai

Metals & Agri

Commodities

25 National Multi Commodity

Exchange (NMCE)

Metals & Agri

Commodities

26

India Commodity Exchange ( ICEX)

Metals & Agri

Commodities


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National Commodity

Exchange

Regional commodity exchange

There is compulsory online

trading

There is no compulsion for online trading

It should be demutualised

exchange.It need not be demutualised exchange

This exchange is recognized on

a permanent basis.

This Exchange is recognized for a fixed period, after

which it has to apply for re-registration.

All commodities permitted by

government for futures trading

can be traded here.

Exchange has to apply for each commodity for

futures trading. Sensitive commodities like gold and

silver, rice and wheat are not permitted for trading

here.

Trade Performance of leading Indian Commodity Exchanges for January 2010

Traded

Value

(Rs Crore)

MCX NCDEX NMCE ICEX NBOT

January2010

5,62,703 87,824 16,990 32,901 4,245


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National Commodities & Derivatives Exchange Limited (NCDEX)National Commodities & Derivatives Exchange Limited (NCDEX) promoted by ICICI

Bank Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank of

Agriculture and Rural Development (NABARD) and National Stock Exchange of India

Limited (NSC). Punjab National Bank (PNB), Credit Rating Information Service of India

Limited (CRISIL), Indian Farmers Fertilizer Cooperative Limited (IFFCO), Canada Bank

and Goldman Sachs by subscribing to the equity shares have joined the promoters as a

share holder of exchange. NCDEX is the only Commodity Exchange in the country

promoted by national level institutions.National Commodity & Derivatives Exchange Limited (NCDEX), a national level online

multicommodity exchange, commenced operations on December 15, 2003.It is a

national level technology driven on line Commodity Exchange with an independent

Board of Directors and professionals not having any vested interest in Commodity

Markets.

It is committed to provide a world class commodity exchange platform for market

participants to trade in a wide spectrum of commodity derivatives driven by best global

practices, professionalism and transparency.

The Exchange has received a permanent recognition from the Ministry of Consumer

Affairs, Food and Public Distribution, Government of India as a national level exchange

NCDEX is regulated by Forward Markets Commission (FMC). NCDEX is also subjected

to the various laws of land like the Companies Act, Stamp Act, Contracts Act, Forward

Contracts Regulation Act and various other legislations.

The Exchange, in 2005 posted an average daily turnover (one-way volume) of around

Rs 4500- 5000 crore a day (over USD 1 billion). The major share of the volumes comes

from agricultural commodities and the balance from bullion, metals, energy and other

products. Trading is facilitated through over 850 Members located across around 700

centers (having ~20000 trading terminals) across the country. Most of these terminals


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are located in the semi-urban and rural regions of the country. Trading is facilitated

through VSATs, leased lines and the Internet.

Commodities Traded at NCDEX

Bullion:- Gold KG, Silver, Brent

Minerals:- Electrolytic Copper Cathode, Aluminum Ingot, Nickel

Cathode, Zinc Metal Ingot, Mild steel Ingots

Oil and Oil seeds:-Cotton seed, Oil cake, Crude Palm Oil, Groundnut (in

shell), Groundnut expeller Oil, Cotton, Mentha oil, RBD Pamolein, RM Seed

oil cake, refined soya oil, Rape seeds, Mustard seeds, Caster seed, Yellow

soybean, Meal

Pluses:- Urad, Yellow peas, Chana, Tur, Masoor,

Grain:- Wheat, Indian Pusa Basmati Rice, Indian parboiled Rice (IR- 36/IR-

64), Indian raw Rice (ParmalPR-106), Barley, Yellow Red maize

Spices:-Jeera, Turmeric, Pepper

Plantation:-Cashew, Coffee Arabica, Coffee Robusta

Fibers and other:- Guar Gum, Guar seeds, Guar, Jute sacking bags, Indian

28 mm cotton, Indian 31mm cotton, Lemon, Grain Bold, Medium Staple,

Mulberry, Green Cottons, , , Potato, Raw JuteMulberry raw Silk, V-797 Kapas,

Sugar, Chilli LCA334

Energy:- Crude Oil, Furnace oil

Multi Commodity Exchange of India Limited (MCX)Multi Commodity Exchange of India Limited (MCX) is an independent and de-mutulized

exchange with permanent reorganization from Government of India, having Head

Quarter in Mumbai. Key share holders of MCX are Financial Technologies (India)

Limited, State Bank of India, Union Bank of India, Corporation Bank of India, Bank of


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India and Canada Bank. MCX facilitates online trading, clearing and settlement

operations for commodity futures market across the country.

MCX started of trade in Nov 2003 and has built strategic alliance with Bombay Bullion

Association, Bombay Metal Exchange, Solvent Extractors Association of India, pulses

Importers Association and Shetkari Sanghatana.

MCX deals with about 100 commodities.

Commodities Traded at MCX:-

Bullion:-Gold, Silver, Silver Coins,

Minerals:-Aluminum, Copper, Nickel, Iron/steel, Tin, Zinc, Lead

Oil and Oil seeds:-Castor oil/castor seeds, Crude Palm oil/ RBD Pamolein,

Groundnut oil, Mustard/ Rapeseed oil, Soy seeds/Soy meal/Refined Soy Oil,

Coconut Oil Cake, Copra, Sunflower oil, Sunflower Oil cake, Tamarind seed

oil,

Pluses:- Chana, Masur, Tur, Urad, Yellow peas

Grains:- Rice/ Basmati Rice, Wheat, Maize, Bajara, Barley,

Spices:-Pepper, Red Chili, Jeera, Cardamom, Cinnamon, Clove, Ginger,

Plantation:- Cashew Kernel, Rubber, Areca nut, Betel nuts, Coconut, Coffee,

Fiber and others:- Kapas, Kapas Khalli, Cotton (long staple, medium staple,

Short staple), Cotton Cloth, Cotton Yarn, Gaur seed and Guargum, Gur and

Sugar, Khandsari, Mentha Oil, Potato, Art Silk Yarn, Chara or Berseem, Raw

Jute, Jute Goods, Jute Sacking,

Petrochemicals:-High Density Polyethylene (HDPE), Polypropylene (PP),

Poly

Vinyl Chloride (PVC)


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Energy:-Brent Crude Oil, Crude Oil, Furnace Oil, Middle East Sour Crude Oil,

Natural Gas

National Multi Commodity Exchange of India Limited(NMCEIL)National Multi Commodity Exchange of India Limited (NMCEIL) is the first de-

mutualised Electronic Multi Commodity Exchange in India. On 25th July 2001 it

was granted approval by Government to organize trading in edible oil complex. It

is being supported by Central warehousing Corporation Limited, Gujarat State

Agricultural Marketing Board and Neptune Overseas Limited. It got reorganization

in Oct 2002. NMCEIL Head Quarter is at Ahmadabad.

INTERNATIONAL COMMODITY EXCHANGEWorlds MajorCommodity Exchanges

Futures trading is a result of solution to a problem related to the maintenance of a

year round supply of commodities/ products that are seasonal as is the case of

agricultural produce. The United States, Japan, United Kingdom, Brazil, Australia,Singapore are homes to leading commodity futures exchanges in the world.


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The New York Mercantile Exchange (NYMEX)

The New York Mercantile Exchange is the worlds biggest exchange for trading in

physical commodity futures. It is a primary trading forum for energy products and

precious metals. The exchange is in existence since last 132 years and performs trades

trough two divisions, the NYMEX division, which deals in energy and platinum and the

COMEX division, which trades in all the other metals.

Commodities traded: - Light sweet crude oil, Natural Gas, Heating Oil, Gasoline,

RBOB Gasoline, Electricity Propane, Gold, Silver, Copper, Aluminum, Platinum,

Palladium, etc.

London Metal Exchange

The London Metal Exchange (LME) is the worlds premier non -ferrous market, with

highly liquid contracts. The exchange was formed in 1877 as a direct consequence of

the industrial revolution witnessed in the 19th century. The primary focus of LME is in

providing a market for participants from non-ferrous based metals related industry to

safeguard against risk due to movement in base metal prices and also arrive at a price

that sets the benchmark globally. The exchange trades 24 hours a day through an inter

office telephone market and also through a electronic trading platform. It is famous for

its open-outcry trading between ring dealing members that takes place on the market

floor.

Commodities traded:- Aluminum, Copper, Nickel, Lead, Tin, Zinc, Aluminum Alloy,

North American Special Aluminum Alloy (NASAAC), Polypropylene, Linear Low Density

Polyethylene, etc.

The Chicago Board of Trade

The first commodity exchange established in the world was the Chicago Board of Trade

(CBOT) during 1848 by group of Chicago merchants who were keen to establish a

central market place for trade. Presently, the Chicago Board of Trade is one of the


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leading exchanges in the world for trading futures and options. More than 50 contracts

on futures and options are being offered by CBOT currently through open outcry and/or

electronically. CBOT initially dealt only in Agricultural commodities like corn, wheat, non

storable agricultural commodities and non-agricultural products like gold and silver.

Commodities Traded: - Corn, Soybean, Oil, Soybean meal, Wheat, Oats, Ethanol,

Rough Rice, Gold, and Silver etc.

Tokyo Commodity Exchange (TOCOM)

The Tokyo Commodity Exchange (TOCOM) is the second largest commodity futures

exchange in the world. It trades in to metals and energy contracts. It has made rapid

advancement in commodity trading globally since its inception 20 years back. One of

the biggest reasons for that is the initiative TOCOM took towards establishing Asia as

the benchmark for price discovery and risk management in commodities like the Middle

East Crude Oil. TOCOMs recent tie up with the MCX to explore cooperation and

business opportunities is seen as one of the steps towards providing platform for futures

price discovery in Asia for Asian players in Crude Oil since the demand-supply situation

in U.S. that drives NYMEX is different from demand-supply situation in Asia. In Jan

2003, in a major overhaul of its computerized trading system, TOCOM fortified itsclearing system in June by being first commodity exchange in Japan to introduce an in-

house clearing system. TOCOM launched options on gold futures, the first option

contract in Japanese market, in May 2004.

Commodities traded: Gasoline, Kerosene, Crude Oil, Gold, Silver, Platinum,

Aluminum, Rubber, etc

Chicago Mercantile Exchange

The Chicago Mercantile Exchange (CME) is the largest futures exchange in the US and

the largest futures clearing house in the world for futures and options trading. Formed in

1898 primarily to trade in Agricultural commodities, the CME introduced the world s first

financial futures more than 30 years ago. Today it trades heavily in interest rates


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futures, stock indices and foreign exchange futures. Its products often serves as a

financial benchmark and witnesses the largest open interest in futures profile of CME

consists of livestock, dairy and forest products and enables small family farms to large

Agri-business to manage their price risks. Trading in CME can be done either through

pit trading or electronically.

Commodities Traded: - Butter milk, Diammonium phosphate, Feeder cattle, frozen

pork bellies, Lean Hogs, Live cattle, Non-fat Dry Milk, Urea, Urea Ammonium Nitrate,

etc


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Chapter 4Current Scenario in Indian Commodity MarketAs on (September 21st, 2010)

Current Scenario in Indian Commodity Market

Need of Commodity Derivatives for India

India is among top 5 producers of most of the Commodities, in addition to being a major

consumer of bullion and energy products.

Agriculture contributes about 22% GDP of Indian economy. It employees around 57% of

the labor force on total of 163 million hectors of land Agriculture sector is an important

factor in achieving a GDP growth of 8-10%. All this indicates that India can be promoted

as a major centre for trading of commodity derivatives.

Trends in volume contribution on the three National Exchanges:-

Pattern on Multi Commodity Exchange (MCX)

MCX is currently largest commodity exchange in the country in terms of trade volumes,

further it has even become the third largest in bullion and second largest in silver future

trading in the world.

Coming to trade pattern, though there are about 100 commodities traded on MCX, only

3 or 4 commodities contribute for more than 80 percent of total trade volume. As per

recent data the largely traded commodities are Gold, Silver, Energy and base Metals.

Incidentally the futures trends of these commodities are mainly driven by international

futures prices rather than the changes in domestic demand-supply and hence, the price

signals largely reflect international scenario.

Among Agricultural commodities major volume contributors include Gur, Urad, Mentha

Oil etc.


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Pattern on National Commodity & Derivatives Exchange (NCDEX)

NCDEX is the second largest commodity exchange in the country after MCX. However

the major volume contributors on NCDEX are agricultural commodities.

But, most of them have common inherent problem of small market size, which is making

them vulnerable to market manipulations and over speculation. About 60 percent trade

on NCDEX comes from guar seed, chana and Urad (narrow commodities as specified

by FMC).

Pattern on National Multi Commodity Exchange (NMCE)

NMCE is third national level futures exchange that has been largely trading in

Agricultural Commodities.

Trade on NMCE had considerable proportion of commodities with big market size as

jute rubber etc. But, in subsequent period, the pattern has changed and slowly moved

towards commodities with small market size or narrow commodities.

Analysis of volume contributions on three major national commodity exchanges reveled

the following pattern, Major volume contributors: -

Majority of trade has been concentrated in few commodities that are

Non Agricultural Commodities (bullion, metals and energy) Agricultural commodities with small market size (or narrow commodities) like guar,

Urad, Mentha etc.

Latest DevelopmentsAgriculture commodity futures staged a remarkable recovery after steady decline over

the last two years, recording a trading value of Rs 10.88 lakh crore in 2009, signifying

growth of 48 per cent over the previous year.

During the year 2009, a new National Commodity Exchange called Indian Commodity

Exchange (ICEX) became operational.

Besides, a scheme of upgradation of Ahmadabad Commodity Exchange to National

Commodity Exchange status has been approved. Development of Electronic Spot


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Exchanges v/s Electronic spot exchanges is an emerging phenomenon in the country

these spot exchanges provide real time, online, transparent and vibrant spot platform for

commodities. The contracts allow participants from all over the country to buy and sell,

thereby enabling producers and users to discover best price.

The Government has allowed the National Commodity Exchanges to set up three spot

exchanges in the country, namely the National Spot Exchange Ltd. (NSEL), NCDEX

Spot Exchange Ltd. (NSPOT) and National Agriculture Produce Marketing Company of

India Ltd. (NAPMC).

During 2009, there was significant expansion of spot exchanges' trading facilities in

India. These spot exchanges have created an avenue for direct market linkage among

farmers, processors, exporters and end users with a view to reducing the cost ofintermediation and enhancing 29 price realizations by farmers.

They will also provide the most efficient spot price inputs to the futures exchanges. The

spot exchanges will encompass the entire spectrum of commodities across the country

and will bring home the advantages of an electronic spot trading platform to all market

participants in the agricultural and nonagricultural segments. On the agricultural side,

the exchanges would enable farmers to trade seamlessly on the platform by providing

simultaneous access to the exchanges and be able to procure at the best possible

price.

Therefore, the efficiency levels attained as a result of such seamless spot transactions

would result in major benefits for both producers and consumers.

In order to overcome current inefficiencies in the commodities spot market and to bring

transparency in trading in commodity spot markets, National Commodity and

Derivatives Exchange Limited (NCDEX) has set up an electronic spot exchange real-

time access to price information and a simplified delivery process, thereby ensuring the

best possible price. On the buy side, all users of the commodities in the commodity

value chain would have called NCDEX Spot Exchange Limited.


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CHAPTER 5.TradingCommodities Futures Trading SystemThe trading system on the NCDEX provides a fully automated screen-based trading for

futures on commodities on a nationwide basis as well as an online monitoring and

surveillance mechanism. It supports an order driven market and provides complete

transparency of trading operations.

The NCDEX system supports an order driven market, where orders match

automatically. Order matching is essentially on the basis of commodity, its price, time

and quantity. All quantity fields are in units and price in rupees. The Exchange specifies

the unit of trading and the delivery unit for futures contracts on various commodities.

The Exchange notifies the regular lot size and tick size for each of the contracts traded

from time to time. When any order enters the trading system, it is an active order. It tries

to find a match on the other side of the book.

If it finds a match, a trade is generated. If it does not find a match, the order becomes

passive and gets queued in the respective outstanding order book in the system. Time

stamping is done for each trade and provides the possibility for a complete audit trail if

required.

Entities in the Trading SystemThere are following entities in the trading system of NCDEX

1. Trading cum Clearing Member (TCM) :

Trading cum Clearing Members can carry out the transactions (trading, clearing and

settling) on their own account and also on their clients' accounts. The Exchange assignsan ID to each TCM. Each TCM can have more than one user. The number of users

allowed for each trading member is notified by the Exchange from time to time. Each

user of a TCM must be registered with the Exchange and is assigned an unique user

ID. The unique TCM ID functions as a reference for all orders/trades of different users.


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It is the responsibility of the TCM to maintain adequate control over persons having

access to the firm's User IDs.

2. Professional Clearing Member (PCM):

These members can carry out the settlement and clearing for their clients who have

traded through TCMs or traded as TMs.

3. Trading Member (TM):

Member who can only trade through their account or on account of their clients and will

however clear their trade through PCMs/STCMs.

4. Strategic Trading cum Clearing Member (STCM):

This is up gradation from the TCM to STCM. Such member can trade on their own

account, also on account of their clients. They can clear and settle these trades and

also clear and settle trades of other trading members who are only allowed to trade and

are not allowed to settle and clear.

Commodity Futures Trading CycleNCDEX trades commodity futures contracts having one-month, two-month, three-month

and more (not more than 12 months) expiry cycles. Most of the futures contracts (mainly

agro commodities contract) expire on the 20th of the expiry month. Some contracts

traded on the Exchange expire on the day other than 20th of the month. New contracts

for most of the commodities on NCDEX are introduced on 10th of every month. Base PriceOn introduction of new contracts, the base price is the previous days' closing price of

the underlying commodity in the prevailing spot markets. These spot prices are polled

across multiple centers and a single spot price is determined by the bootstrapping


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method. The base price of the contracts on all subsequent trading days is the daily

settlement price of the futures contracts on the previous trading day. Price Ranges of ContractsTo control wide swings in prices, an intra-day price limit is fixed for commodity futures

contract. The maximum price movement during the day can be +/- x% of the previous

day's settlement price for each commodity. If the price hits the first intra-day price limit

(at upper side or lower side), there will be a cooling period of 15 minutes. Then price

band is revised further and in case the prices reach that revised level, no trade is

permitted during the day beyond the revised limit.

Take an example of Guar Seed- Daily price fluctuation limit is (+/-) 4% (3% +1%). If the

trade hits the prescribed first daily price limit of 3 %, there will be a cooling off period for

15 minutes. Trade will be allowed during this cooling off period within the price band.

Thereafter, the price band would be raised by (+/-) 1% and trade will be resumed. If the

price hits the revised price band (4%) during the day, trade will only be allowed within

the revised price band. No trade / order shall be permitted during the day beyond the

limit of (+/-) 4%.

In order to prevent erroneous order entry by trading members, operating price ranges

on the NCDEX are pre-decided for individual contracts from the base price. Presently,

the price ranges for agricultural commodities is (+/-) 4 % from the base price for the day,

and upto (+/-) 9 % for non-agricultural commodities. Orders, exceeding the range

specified for a day's trade for the respective commodities are not executed

Margins for Trading In Futures

Margin is the deposit money that needs to be paid to buy or sell each contract. The

margin required for a futures contract is better described as performance bond or good

faith money.


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The margin levels are set by the exchanges based on volatility (market conditions) and

can be changed at any time. The margin requirements for most futures contracts range

from 5% to15% of the value of the contract, with a minimum of 5%, except for Gold

where the minimum margin is 4%.

In the futures market, there are different types of margins that a trader has to maintain.

Initial margin

The amount that must be deposited by a customer at the time of entering into a

contract is called initial margin. This margin is meant to cover the potential loss in one

day. The margin is a mandatory requirement for parties who are entering into the

contract. The exchange levies initial margin on derivatives contracts using the concept

of Value at Risk (VaR) or any other concept as the Exchange may decide periodically.

The margin is charged so as to cover one-day loss that can be encountered on the

position on 99.95% confidence-interval VaR methodology.

Exposure & Mark-to-Market Margin

Exposure margin is charged taking into consideration the back testing results of the

VaR model. For all outstanding exposure in the market, the Exchange also collectsmark-to-market margin which are positions restated at the daily settlement prices

(DSP). At the end of each trading day, the margin account is adjusted to reflect the

trader's gain or loss. This is known as marking to market the account of each trader. All

futures contracts are settled daily reducing the credit exposure to one day's movement.

Based on the settlement price, the value of all positions is marked-to-market each day

after the official close. i.e. the accounts are either debited or credited based on how well

the positions fared in that day's trading session. If the account falls below the required

margin level the clearing member needs to replenish the account by giving additional

funds or closing positions either partially/ fully. On the other hand, if the position

generates a gain, the funds can be withdrawn (those funds above the required initial

margin) or can be used to fund additional trades.


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Additional margin

In case of sudden higher than expected volatility, the Exchange calls for an additional

margin, this is a preemptive move to prevent potential default. This is imposed when the

Exchange/ regulator has view that that the markets have become too volatile and may

result in some adverse situation to the integrity of the market/ Exchange.

Pre-expiry margin

This margin is charged as additional margin for most commodities expiring during the

current/near month contract. It is charged on a cumulative basis from typically 3 to 5

days prior to the expiry date (including the expiry date). This is done to ensure that only

interested parties remain in the market and speculators roll over their positions to

subsequent months and ensure better convergence of the futures and spot market

prices.

Delivery Margin

This margin is charged only in the case of positions materializing into delivery. Members

are informed about the delivery margin payable. Margins for delivery are to be paid the

day following expiry of contract.

Special Margin

This margin is levied when there is more than 20% uni-directional movement in the

price from a pre-determined base and is typically related to the underlying spot price.

The base could be the closing price on the day of launch of the contract or the 90 days

prior settlement price. This is mentioned in the respective contract specification. Some

contracts also have an as-deemed-fit clause for levying of Special margins. It can also

be levied by market regulator if market exhibits excess volatility. If required by the

regulator, it has to be settled by cash. This is collected as extra margin over and above

normal margin requirement.


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Margin for Calendar Spread positions

Calendar spread is defined as the purchase of one delivery month of a given futures

contract and simultaneous sale of another delivery month of the same commodity by a

client/ member. At NCDEX, for calendar spread positions, margins are imposed as one

half of the initial margin (inclusive of the exposure margin). Such benefit will be given

only of there is positive correlation in the prices of the months under consideration and

the far month contracts are sufficiently liquid. No benefit of calendar spread is given in

the case of additional and special margins. However, calendar spread positions in the

far month contract are considered as naked position three days before expiry of near

month contract. Gradual reduction of the spread position is done at the rate of 33.3%

per day from 3 days prior to expiry. Just as a trader is required to maintain a margin

account with a broker, a clearing house member is required to maintain

collaterals/deposits with the clearing house against which the positions are allowed to

be taken.

ChargesMembers are liable to pay transaction charges for the trade done through the Exchange

during the previous month. The important provisions are listed below. The billing for the

all trades done during the previous month will be raised in the succeeding month.

1. Transaction charges

The transaction charges are payable at the rate of Rs. 4 per Rs.100,000 worth of

trade done. This rate is charged for average daily turnover of Rs. 20 crores.

Reduced rate is charged for increase in daily turnover. This rate is subject to

change from time to time. The average daily turnover is calculated by taking thetotal value traded by the member in a month and dividing it by number of trading

days in the month including Saturdays

2. Due date


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The transaction charges are payable on the 10th day of every month in respect

of the trade done in the previous month.

3. Collection

Members keep the Exchange Dues Account opened with the respective Clearing

Banks for meeting the commitment on account of transaction charges.

4. Adjustment against advances transaction charges

In terms of the regulations, members are required to remit Rs.50,000 as

advance transaction charges on registration. The transaction charges due first

will be adjusted against the advance transaction charges already paid asadvance and members need to pay transaction charges only after exhausting the

balance lying in advance transaction.

5. Penalty for delayed payments

If the transaction charges are not paid on or before the due date, a penal interest

is levied as specified by the Exchange.

Finally, the futures market is a zero sum game i.e. the total number of long in anycontract always equals the total number of short in any contract. The total number of

outstanding contracts (long/ short) at any point in time is called the 'Open interest'. This

Open interest figure is a good indicator of the liquidity in every contract. Based on

studies carried out in international Exchanges, it is found that open interest is maximum

in near month expiry contracts.


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Chapter 6 Clearing and SettlementIntroductionMost futures contracts do not lead to the actual physical delivery of the underlying

asset. The settlement is done by closing out open positions, physical delivery or cash

settlement. All these settlement functions are taken care of by an entity called clearing

house or clearing corporation. National Commodity Clearing Limited (NCCL) undertakes

clearing of trades executed on the NCDEX.ClearingClearing of trades that take place on an Exchange happens through the Exchange

clearing house. A clearing house is a system by which Exchanges guarantee the faithful

compliance of all trade commitments undertaken on the trading floor or electronically

over the electronic trading systems. The main task of the clearing house is to keep track

of all the transactions that take place during a day so that the net position of each of its

members can be calculated. It guarantees the performance of the parties to each

transaction. Typically it is responsible for the following:

1. Effecting timely settlement.

2. Trade registration and follow up.

3. Control of the open interest.

4. Financial clearing of the payment flow.

5. Physical settlement (by delivery) or financial settlement (by price difference) of

contracts.

6. Administration of financial guarantees demanded by the participants.


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The clearing house has a number of members, who are responsible for the clearing and

settlement of commodities traded on the Exchange. The margin accounts for the

clearing house members are adjusted for gains and losses at the end of each day (in

the same way as the individual traders keep margin accounts with the broker). Everyday

the account balance for each contract must be maintained at an amount equal to the

original margin times the number of contracts outstanding. Thus depending on a day's

transactions and price movement, the members either need to add funds or can

withdraw funds from their margin accounts at the end of the day.

The brokers who are not the clearing members need to maintain a margin account with

the clearing house member through whom they trade.

Clearing Mechanism

Only clearing members including professional clearing members (PCMs) are entitled to

clear and settle contracts through the clearing house.

The clearing mechanism essentially involves working out open positions and

obligations of clearing members. This position is considered for exposure and daily

margin purposes. The open positions of PCMs are arrived at by aggregating the open

positions of all the Trading Members clearing through him, in contracts in which they

have traded. A Trading-cum-Clearing Member's (TCM) open position is arrived at by the

summation of his clients' open positions, in the contracts in which they have traded.

Client positions are netted at the level of individual client and grossed across all clients,

at the member level without any set-offs between clients. Proprietary positions are

netted at member level without any set-offs between client and proprietary positions.

After the trading hours on the expiry date, based on the available information, the

matching for deliveries takes place firstly, on the basis of locations and then randomly,

keeping in view the factors such as available capacity of the vault/ warehouse,

commodities already deposited and dematerialized and offered for delivery etc.

Matching done by this process is binding on the clearing members. After completion of


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the matching process, clearing members are informed of the deliverable/ receivable

positions and the unmatched positions. Unmatched positions have to be settled in cash.

The cash settlement is only for the incremental gain/ loss as determined on the basis of

final settlement price.

Clearing Banks

Each exchange has designated clearing banks through whom funds to be paid and/ or

to be received must be settled. Every clearing member is required to maintain and

operate a clearing account with any one of the designated clearing bank branches. The

clearing account is to be used exclusively for clearing operations i.e., for settling funds

and other obligations to each exchange including payments of margins and penalcharges. A clearing member having funds obligation to pay is required to have clear

balance in his clearing account on or before the stipulated pay-in day and the stipulated

time. Clearing members must authorize their clearing bank to access their clearing

account for debiting and crediting their accounts as per the instructions of each

exchange, reporting of balances and other operations as may be required by each

exchange from time to time. The clearing bank will debit/ credit the clearing account of

clearing members as per instructions received from the exchange.

Depository participantsEvery clearing member is required to maintain and operate two CM pool account each

at NSDL and CDSL through any one of the empanelled depository participants. The CM

pool account is to be used exclusively for clearing operations i.e., for effecting and

receiving deliveries from NCDEX.

SettlementFutures contracts have two types of settlements, the Mark-to-Market (MTM) settlement

which happens on a continuous basis at the end of each day, and the final settlement

which happens on the last trading day of the futures contract. On, commodity exchange


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MTM settlement and final MTM settlement in respect of admitted deals in futures

contracts are cash settled by debiting/ crediting the clearing accounts of CMs with the

respective clearing bank. All positions of a CM, either brought forward, created during

the day or closed out during the day, are marked to market at the daily settlement price

or the final settlement price at the close of trading hours on a day.

Daily settlement price: Daily settlement price is the consensus closing price as

arrived after closing session of the relevant futures contract for the trading day.

However, in the absence of trading for a contract during closing session, daily

settlement price is computed as per the methods prescribed by the Exchange from time

to time.

Final settlement price: Final settlement price is the polled spot price of the underlying

commodity in the spot market on the last trading day of the futures contract. All open

positions in a futures contract cease to exist after its expiration day. Settlement involves

payments (Pay-Ins) and receipts (Pay-Outs) for all the transactions done by the

members. Trades are settled through the Exchange's settlement system.

Settlement Mechanism

Settlement of commodity futures contracts is a little different from settlement of financial

futures which are mostly cash settled. The possibility of physical settlement makes the

process a little more complicated.

Daily mark to market settlement

Daily mark to market settlement is done till the date of the contract expiry. This is done

to take care of daily price fluctuations for all trades. All the open positions of the

members are marked to market at the end of the day and the profit/ loss is determinedas below:

On the day of entering into the contract, it is the difference between the entry value

and daily settlement price for that day.


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On any intervening days, when the member holds an open position, it is the difference

between the daily settlement price for that day and the previous day's settlement price.

On the expiry date if the member has an open position, it is the difference between the

final settlement price and the previous day's settlement price.

Final settlement

On the date of expiry, the final settlement price is the closing price of the underlying

commodity in the spot market on the date of expiry (last trading day) of the futures

contract. The spot prices are collected from polling participants from base centre as well

as other locations. The poll prices are bootstrapped and the mid-point of the two boot

strapped prices is the final settlement price. The responsibility of settlement is on a

trading cum clearing member for all trades done on his own account and his client's

trades.

A professional clearing member is responsible for settling all the participants' trades

which he has confirmed to the Exchange. Members are required to submit delivery

information through delivery request window on the trader workstations provided by

commodity exchange or all open positions for a commodity for all constituents

individually. This information can be provided within the time notified by Exchange

separately for each contracts. Commodity exchange on receipt of such information

matches the information and arrives at a delivery position for a member for a

commodity. A detailed report containing all matched and unmatched requests is

provided to members through the extranet.

Pursuant to regulations relating to submission of delivery information, failure to submit

delivery information for open positions attracts penal charges as stipulated by

commodity exchange from time to time. Commodity exchange also adds all such open

positions for a member, for which no delivery information is submitted with final

settlement obligations of the member concerned and settled in cash as the case may

be.


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Non-fulfillment of either the whole or part of the settlement obligations is treated as a

violation of the rules, bye-laws and regulations of commodity exchange and attracts

penal charges as stipulated by commodity exchange from time to time. In addition,

commodity exchange can withdraw any or all of the membership rights of clearing

member including the withdrawal of trading facilities of all trading members clearing

through such clearing members, without any notice. Further, the outstanding positions

of such clearing member and/ or trading members and/ or constituents, clearing and

settling through such clearing member, may be closed out forthwith or any time

thereafter by the Exchange to the extent possible, by placing at the Exchange, counter

orders in respect of the outstanding position of clearing member without any notice to

the clearing member and/ or trading member and/ or constituent. Commodity exchangecan also initiate such other risk containment measures as it deems appropriate with

respect to the open positions of the clearing members. It can also take additional

measures like, imposing penalties, collecting appropriate deposits, invoking bank

guarantees or fixed deposit receipts, realizing money by disposing off the securities and

exercising such other risk containment measures as it deems fit or take further

disciplinary action.

Settlement Methods

Settlement of futures contracts on the NCDEX can be done in two ways - by physical

delivery of the underlying asset and by closing out open positions. All contracts

materializing into deliveries are settled in a period as notified by the Exchange

separately for each contract. The exact settlement day for each commodity is specified

by the Exchange through circulars known as 'Settlement Calendar'.

a) Physical delivery of the underlying asset

If the buyer/seller is interested in physical delivery of the underlying asset, he must

complete the delivery marking for all the contracts within the time notified by the

Exchange.


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b) Closing out by offsetting positions

Most of the contracts are settled by closing out open positions. In closing out, the

opposite transaction is effected to close out the original futures position. A buy contract

is closed out by a sale and a sale contract is closed out by a buy. For example, an

investor who took a long position in two gold futures contracts on the January 30 at

Rs.16090 per 10 grams, can close his position by selling two gold futures contracts on

February 13, at Rs.15928. In this case, over the period of holding the position, he has

suffered a loss of Rs.162 per 10 grams. This loss would have been debited from his

account over the holding period by way of MTM at the end of each day, and finally at

the price that he closes his position, that is Rs.15928, in this case.

c) Cash settlement

In the case of intention matching contracts, if the trader does not want to take/ give

physical delivery, all open positions held till the last day of trading are settled in cash at

the final settlement price. Similarly any unmatched, rejected or excess intention is also

settled in cash. When a contract is settled in cash, it is marked to the market at the end

of the last trading day and all positions are declared closed.

For example, Paul took a short position in five Silver 5kg futures contracts of July expiry

on June 15 at Rs.21500 per kg. At the end of 20th July, the last trading day of the

contract, he continued to hold the open position, without announcing delivery intention.

The closing spot price of silver on that day was Rs.20500 per kg. This was the

settlement price for his contract.

Though Paul was holding a short position on silver, he did not have to actually deliver

the underlying silver. The transaction was settled in cash and he earned profit of Rs.

5000 per trading lot of silver.

Unmatched positions of contracts, for which the intentions for delivery were submitted,

are also settled in cash. In case of commodity exchange, all contracts being settled in

cash are settled on the day after the contract expiry date. If the cash settlement day


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happens to be a Saturday, a Sunday or a holiday at the exchange, clearing banks or

any of the service providers, Pay-in and Pay-out would be effected on the next working

day.

Entities involved in Physical Settlement

Physical settlement of commodities involves the following three entities - an accredited

warehouse, registrar & transfer agent and an assayer. We will briefly look at the

functions of each.

Accredited warehouse

Commodity exchange specifies accredited warehouses through which delivery of a

specific commodity can be affected and which will facilitate for storage of commodities.

For the services provided by them, warehouses charge a fee that constitutes storage

and other charges such as insurance, assaying and handling charges or any other

incidental charges.

Following are the functions of an accredited warehouse:

1. Earmark separate storage area as specified by the Exchange for the purpose of

storing commodities to be delivered against deals made on the Exchange. The

warehouses are required to meet the specifications prescribed by the Exchange for

storage of commodities.

2. Ensure and co-ordinate the grading of the commodities received at the warehouse

before they are

100 Marks Commodity Project

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