Introduction to Commodity Market

What is “Commodity”?

Any product that can be used for commerce or an article of commerce

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 actionable claims, money and securities”.

“The term refers to a whole range of natural resources that are used to create the

goods that people buy and the food they eat.” Says Jeremy Baker, USB's Zurich-

based head of Commodity Research'.

A commodity may be defined as an article, a product or material that is bought

and sold. It can be classified as every kind of movable property, except Actionable

Claims, Money & Securities. Commodities actually offer immense potential to become a

separate asset class for market-savvy investors, arbitrageurs and speculators.

Retail investors, who claim to understand the equity markets, may find commodities an

unfathomable market. But commodities are easy to understand as far as fundamentals

of demand and supply are concerned. Retail investors should understand the, risks and

advantages of trading in commodities futures before taking a leap. Historically, pricing in

commodities futures has been less volatile compared with equity and bonds, thus

providing an efficient portfolio diversification option.

What is a commodity Market?

Commodity market is a place where trading in commodities takes place.

Markets where raw or primary products are exchanged. These raw commodities are

traded on regulated commodities exchanges, in which they are bought and sold in

standardized Contracts. It is similar to an Equity market, but instead of buying or selling

shares one buys or sells commodities.

Commodity market is an important constituent of the financial markets of any

country. It is the market where a wide range of products, viz., precious metals, base

metals, crude oil, energy and soft commodities like palm oil, coffee etc. are traded. It is

important to develop a vibrant, active and liquid commodity market. This would help

investors hedge their commodity risk, take speculative positions in commodities and

exploit arbitrage opportunities in the market.

In fact, the size of the commodities markets in India is also quite significant. Of

the country's GDP of Rs 13, 20,730 crores (Rs 13,207.3 billion), commodities related

(and dependent) industries constitute about 58 per cent. Currently, the various

commodities across the country clock an annual turnover of Rs 1, 40,000 crores (Rs

1,400 billion). With the introduction of futures trading, the size of the commodities

market grows many folds here on.

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.

History of Evolution of commodity markets

Historically, dating from ancient Sumerian use of sheep or goats, or other

peoples using pigs, rare seashells, or other items as commodity money, people have

sought ways to standardize and trade contracts in the delivery of such items, to render

trade itself more smooth and predictable.

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 as 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 Futures

Commodities futures trading have evolved from the need for ensuring continuous

supply of seasonal agricultural crops. In Japan, merchants stored rice in warehouse for

future use. In order to raise case warehouse holders sold receipts against the stored

rice. These were known as rice tickets.

Eventually such rice tickets became accepted as a kind of general commercial

currency Rules came into being, to standardize the trading in rice tickets. The futures

contract, as we know it today, evolved as farmers (sellers) and dealers (buyers) began

to commit to future exchanges of grain for cash. For instance, the farmer would agree

with the dealer on a price to deliver to him 5,000 bushels of wheat at the end of June.

The bargain suited both parties. The farmer knew how much he would be paid for his

wheat, and the dealer knew his costs in advance. The two parties may have exchanged

a written contract to this effect and even a small amount of money representing a

"guarantee."

Such contracts became common and were even used as collateral for bank

loans. They also began to change hands before the delivery date. If the dealer decided

he didn't want the wheat, he would sell the contract to someone who did. Or, the farmer

who didn't want to deliver his wheat might pass his obligation on to another farmer. The

price would go up and down depending on what was happening in the wheat market. If

bad weather had come, the people who had contracted to sell wheat would hold more

valuable contracts because the supply would be lower; if the harvest were bigger than

expected, the seller's contract would become less valuable. It wasn't long before people

who had no intention of ever buying or selling wheat began trading the contracts. They

were speculators, hoping to buy low and sell high or sell high and buy low.

In the early 20th century, advanced communication & transportation, centralized

warehouses built in the principal markets, to distribute goods more economically, paved

the way to expanded interstate and international trade. Agricultural commodities were

the most commonly traded, but it led to the fact that a market can flourish for any

underlying a long as there is an active pool of buyers and sellers

The Indian Perspective

History of Commodity Market in India:-

The 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 datives 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

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. 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. It is timely decision since

internationally the commodity cycle is on upswing and the next decade being touched

as the decade of Commodities. Commodity exchange in India plays an important role

where the prices of any commodity are not fixed, in an organized way. Earlier only the

buyer of produce and its seller in the market judged upon the prices. Others never had a

say.

Today, commodity exchanges are purely speculative in nature. Before

discovering the price, they reach to the producers, end-users, and even the retail

investors, at a grassroots level. It brings a price transparency and risk management in

the vital market. A big difference between a typical auction, where a single auctioneer

announces the bids and the Exchange is that people are not only competing to buy but

also to sell. By Exchange rules and by law, no one can bid under a higher bid, and no

one can offer to sell higher than someone else’s lower offer. That keeps the market as

efficient as possible, and keeps the traders on their toes to make sure no one gets the

purchase or sale before they do.

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.

In 2002-03, Prime Minister, Shri. A. B. Vajpayee, in his Independence Day

address to the nation on 15th August 2002, demonstrated its commitment to revive the

Indian agriculture sector and commodity futures markets. The GOI in that very year took

two steps that gave a fillip to the commodity markets. The first one was setting up of

nation wide multi commodity exchanges and the second one was expansion of list of

commodities permitted for trading under (FC(R) A).

In India there are 25 recognized future exchanges, of which there are

three national level multi-commodity exchanges. After a gap of almost three decades,

Government of India has allowed forward transactions in commodities through Online

Commodity Exchanges, a modification of traditional business known as Adhat and

Vayda Vyapar to facilitate better risk coverage and delivery of commodities. The three

exchanges are: National Commodity & Derivatives Exchange Limited (NCDEX) Mumbai, Multi Commodity Exchange of India Limited (MCX) Mumbai and National Multi-

Commodity Exchange of India Limited (NMCEIL) Ahmedabad. There are other regional

commodity exchanges situated in different parts of India.

mmodity Markets – Key Characteristics

Nature of Commodities –

Commodities are real assets that are produced and consumed in an

industrial or other process. In contrast, other asset classes of interest rates,

currency or equity represent financial claims on different aspects of real assets.

This aspect of commodities ha a number of dimensions, including:

1. Consumption goods – commodities are primarily consumption goods

rather than investment products. This means that demand is not purely price

dependent. In addition, some commodities may display characteristics not

normally found in financial assets.

For example, zero or negative price may occur in electricity markets where

generators seek to ensure that their plants are dispatched for contiguous blocks

of time longer than a simple slot for which separate time bids are accepted. This

is driven by the desire of the generator to shed excess output as electricity

cannot be stored.

2. Non standard structure – commodities are generally not standardized.

This reflects the heterogeneous nature of commodity production in terms of

quality or grade. This contrasts with other financial assets that are homogenous.

This dictates that the commodity market has two layers.

The physical or cash market that trades a range of commodities of varying

quality, location and structure, and a commodity derivatives market that trades a

range of instruments on (artificially) standardized commodities. This is driven by

the need to facilitate trading. It creates basis risk in commodity derivatives.

3. Cost of production – commodity prices frequently gravitate towards

the cost of production. This is because the market will adjust over time. If prices

are significantly above or below the cost of production (including a "normal" profit

component), then supply will adjust in the longer term.

4. Price behavior – commodity prices display seasonality and may

change over different phases of the commodity life. Seasonal patterns in

consumption and production are manifested in recurring behavior of prices and

volatility. Forward prices of commodities will generally change as time to maturity

changes.

Commodity Markets – Participants

The structure of commodity markets dictates that there are several types

of participants active in the trading of commodities and commodity derivatives.

The structure of the participants and the nature of their activities/motivations are

more complex than in other asset classes.

The major participants in commodity markets include:

Commodity Producers/Consumers: These participants have natural

underlying outright 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 in 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 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 (including debt service). 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 hedges 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 long term 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 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 or provider 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.

Commodity Exchange Definition

A commodities exchange is an exchange where various commodities and derivatives

products are traded. Most commodity markets across the world trade in agricultural

products and other raw materials (like wheat, barley, sugar, maize, cotton, cocoa,

coffee, milk products, pork bellies, oil, metals, etc.) and contracts based on them. These

contracts can include spots, forwards, futures and options on futures. Other

sophisticated products may include interest rates, environmental instruments, swaps, or

ocean freight contracts.

C o m m o d i t y e x c h a n g e s a r e i n s t i t u t i o n s w h i c h p r o v i d e a p l a t f o r m f o r t r a d i n g i n

‘commodity futures’ just as how stock markets provide space for trading in equities and

their derivatives. They thus play a critical role in robust price discovery where several

buyers and sellers interact and determine the most efficient price for the product.

In India there are 21 regional exchanges and three national level multi-

commodity exchanges.

STRUCTURE OF COMMODITY MARKET IN INDIA

After a gap of almost three decades, Government of India has allowed

forward transactions in commodities through Online Commodity Exchanges, a

modification of traditional business known as Adhat and Vayda Vyapar to facilitate

better risk coverage and delivery of commodities. The three exchanges are:

(1) 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 Ratting Information Service of

India Limited (CRISIL), Indian Farmers Fertilizer Cooperative Limited (IFFCO), Canara

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.

NCDEX is a public limited company incorporated on 23 April 2003.

NCDEX 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.

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.

NCDEX is located in Mumbai and offers facilities to its members in more

than 550 centers through out India. NCDEX currently facilitates trading of 57

commodities.

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

Pulses:- 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 Jute,

Mulberry raw Silk, V-797 Kapas, Sugar, Chilli LCA334

Energy:- Crude Oil, Furnace oil

(2) 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

India and Canara 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 wit 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 ,

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

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

Tamarind seed oil,

Pulses:- 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)

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

Crude Oil, Natural Gas

The exchanges follow best international risk management practices and

provide a financially secure environment by putting in place a suitable risk management

mechanism (system of upfront margining based on the Value at Risk margining system,

daily mark to market and special intra-day clearing and settlement in the event of high

volatility in prices). The performance of the contracts registered by the exchange are

guaranteed either by the exchange or its clearing house.

Clearing Houses put in place a sound risk-management system to be able

to discharge their role as counter-party to all participants. Clearing Houses interpose

between buyers and sellers as a legal counter-party, i.e., the clearing house becomes

the buyer to every seller and vice versa (novation). Novation thus obviates the need for

ascertaining the credit-worthiness of each counter-party and the only credit risk that the

participants face is the risk of clearing house committing a default.

The exchanges also maintain their own Trade/Settlement Guarantee Fund,

which can be used in case of any default. Some exchanges have also prescribed

certain minimum capital adequacy norms.

(3) 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 25 th 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 Ahmedabad.

Regulatory authority for commodity Market

Forward Markets Commission (FMC)

The Forward Markets Commission (FMC) headquartered at Mumbai, is

the regulatory authority for commodity derivatives in India. It is a statutory body set up in

1953 under the Forward Contracts (Regulation) Act, 1952. FMC is in turn supervised by

the Ministry of Consumer Affairs, Food and Public Distribution, Govt. of India.

The act provides that the commission shall consist of not less than two but

not exceeding four members appointed by the Central Govt. out of them being

nominated by the Central Govt. be the chairman thereof.

The functions of the Forward Markets Commission are as follows:

1. To advise the Central Government in respect of the recognition or the withdrawal

of recognition from any association or in respect of any other matter arising out of

the administration of the Forward Contracts (Regulation) Act 1952.

2. To keep forward markets under observation and to take such action in relation to

them, as it may consider necessary, in exercise of the powers assigned to it by or

under the Act.

3. To collect and whenever the Commission thinks it necessary, to publish

information regarding the trading conditions in respect of goods to which any of

the provisions of the act is made applicable, including information regarding

supply, demand and prices, and to submit to the Central Government, periodical

reports on the working of forward markets relating to such goods;

4. To make recommendations generally with a view to improving the organization

and working of forward markets;

5. To undertake the inspection of the accounts and other documents of any

recognized association or registered association or any member of such

association whenever it considerers it necessary.

Regulatory Measures Evolved By FMC

1. Limit on open position of an individual operator to prevent over-trading

2. Limit on price fluctuation to prevent abrupt upswing or downswing in prices

3. Special Margin deposits to be collected on outstanding purchases or sales to

curb excessive speculators activity through financial restraints.

4. Minimum / Maximum prices to be prescribed to prevent futures prices from falling

below the levels that are not remunerative and from rising below the levels not

warranted by genuine supply and demand factors.

5. During shortages, extreme steps like skipping trading in certain deliveries of the

contracts, closing the markets for a specified period and even closing out the

contracts to overcome the emergency situations are taken

International Commodity Exchanges

Recent years have witnessed a steep rise in the creation of the commodity

exchanges along with a consistent expansion of the existing ones. The United States,

Japan, United Kingdom, Brazil, Australia, Singapore are homes to leading commodity

futures exchanges in the world.

Worlds Major Commodity Exchanges:

The New York Mercantile Exchange (NYMEX)

The New York Mercantile Exchange is the world's biggest exchange for trading in

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

precious metals. The Exchange has been in existence for 132 years and performs

trades through two divisions, the NYMEX divisions, which deals in energy and platinum

and the COMEX division which trades in all the other metals.

A major contribution of the Exchange has been to develop and launch energy futures

and options contract in 1978 to facilitate price transparency and risk management in this

key market. Exchange has become a significant part of the commercial, civic and

cultural life of New York. Exchange also clears trades for market participants who which

to avoid counter-party credit risk by using standardized contracts for Natural Gas, Crude

Oil, Refined products and Electricity.

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 (LME)

The London Metal Exchange (LME) is the world's premier non-ferrous

market, with highly liquid contracts. It is an innovative exchange that has maintained its

traditional strengths in a modern business environment by remaining close to its core

users by ensuring that its contracts continue to meet the high expectations of a

demanding industry. It has become highly successful with a trading turnover value of

more than US$2000 billion per annum and contributes substantially to the invisible

earnings.

The Exchange was formed in 1877 as a direct consequence of the industrial revolution

witnessed in Britain in the 19th Century. The primary focus of LME is providing a market

for participants from the non-ferrous base metals related industry to safe guard against

risk due to movements 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 an 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 LME metal futures contracts run a daily basis for a period of three months, unlike

other commodity markets that are primarily based on a monthly prompt dates. The

Exchange thus combines the convenience of settlement dates tailored to individual

needs with the security of a clearinghouse for its clearing members, The LME also

offers options contracts based on each of these futures contracts together with Traded

Average Price Options contracts (TAPOs) based on the monthly average settlement

price (MASP) for all metals futures contracts.

The Chicago Board of Trade (CBOT)

The first commodity exchange established on the world was the Chicago

Board of Trade (CBOT). During the year 1848 by a group of Chicago merchants who

were keen to establish a central market place for trade. This was situated in the

premises of a flour store during its first four years, Prior to this farmers often found no

buyers for the grain they had transported to Chicago. Given the high transport cost, they

have been left with little choice but to dump the unsold produce in the near by lake.

Presently, the Chicago Board of Trade is one of the leading exchanges in

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

options are been offered by CBOT. Currently through open-outcry and/or electronically.

CBOT is the oldest existing commodity exchange in the world having established in the

year 1848. Initially, CBOT dealt only in agricultural commodities like corn, wheat,

soybeans, and oats. Futures contracts in CBOT evolved over a period of time to

facilitate trading in non-storable agricultural commodities and non-agricultural products

like gold and silver. The first electronic trading system in CBOT was introduced in 1994

after more than 150 years of open auction trading where traders used to meet to buy

and sell futures contracts.

Commodities traded Corn, Soybeans, Soybean Oil, Soybean Meal, Wheat, Oats,

Ethanol, Rough Rice, Gold, and Silver etc.

]Like any other commodity exchange the primary role of CBOT is to provide

transparency and liquidity in its contracts to its members, clients and market participants

like farmers, corporate, small business men, financial service providers, international

trading firms and speculators for price delivery, risk management and investment.

Tokyo Commodity Exchange (TOCOM)

The Tokyo Commodity Exchange (TOCOM) is the second largest

commodity futures exchange in the world with trade in metals and energy contracts. It

has made rapid advancements in commodity trading globally since inception 20 years

back. One of the biggest reasons for this 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. TOCOM's recent tie-up with the MCX to

explore cooperation and business opportunities is seen as one of the steps towards

providing a platform for futures price discovery in Asia for Asian players in Crude Oil

since the demand-supply situation in US that drives the MYMEX is different from the

demand-supply in Asia.

In January 2003, in a major overhaul over its computerized trading system, TOCOM

fortified its clearing system in June by being the first commodity Exchange in Japan to

introduce an in-house clearing system. TOCOM launched options on gold futures, the

first options contract in Japanese market, in May 2004.

Commodities Traded. Gasoline, Kerosene, Crude Oil, Gold, Silver, Platinum,

Palladium, Aluminum, Rubber, Etc.

Chicago Mercantile Exchange (CME)

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

in interest rate futures, Stock indices and foreign exchange futures. Its products often

serve as a financial benchmark and witness the larges the open interest in futures

contracts compared to any other exchange in the world. The commodities futures profile

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

to large agri-businesses to manage their price risks. Trading in the 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.

How Commodity market works?

There are two kinds of trades in commodities. The first is the spot trade,

in which one pays cash and carries away the goods. The second is futures trade. The

underpinning for futures is the warehouse receipt. A person deposits certain amount of

say, good X in a ware house and gets a warehouse receipt which allows him to ask for

physical delivery of the good from the warehouse but some one trading in commodity

futures need not necessarily posses such a receipt to strike a deal.

A person can buy or sale a commodity future on an exchange based on

his expectation of where the price will go. Futures have something called an expiry date,

by when the buyer or seller either closes (square off) his account or give/take delivery of

the commodity. The broker maintains an account of all dealing parties in which the daily

profit or loss due to changes in the futures price is recorded. Squiring off is done by

taking an opposite contract so that the net outstanding is nil.

For

commodity futures to work, the seller should be able to deposit the commodity at

warehouse nearest to him and collect the warehouse receipt. The buyer should be able

to take physical delivery at a location of his choice on presenting the warehouse receipt.

But at present in India very few warehouses provide delivery for specific commodities.

Following diagram gives a fair idea about working of the Commodity market.

Today Commodity trading system is fully computerized. Traders need not

visit a commodity market to speculate. With online commodity trading they could sit in

the confines of their home or office and call the shots.

The commodity trading system consists of certain prescribed steps or

stages as follows:

I. Trading: - At this stage the following is the system implemented-

- Order receiving

- Execution

- Matching

- Reporting

- Supervision

- Price limits

- Position limits

II. Clearing: - This stage has following system in place-

- Matching

- Registration

- Clearing

- Clearing limits

- Notation

- Margining

- Price limits

- Position limits

- Clearing house.

III. Settlement: - This stage has following system followed as follows-

- Marking to market

- Receipts and payments

- Reporting

- Delivery upon expiration or maturity.

The NCDEX System

Every market transaction consists of three components i.e. trading, clearing and settlement.

A brief overview of how transactions happen on the NCDEX’s market.

TRADING

The trading system on the NCDEX provides a fully automated screen

based trading for futures on commodities on a nationwide basis as well as online

monitoring and surveillance mechanism. It supports an order driven market and

provides complete transparency of trading operations. Order matching is essential 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 finds 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. NCDEX trades commodity futures contracts having one

month, two month and three month expiry cycles.

All contracts expire on the 20th of the expiry month. Thus a January

expiration contract would expire on the 20th of January and a February expiry contract

would cease trading on the 20th of February. If the 20th of the expiry month is a trading

holiday, the contracts shall expire on the previous trading day. New contracts will be

introduced on the trading day following the expiry of the near month contract.

The figure shows the contract cycle for futures contracts on NCDEX

CLEARING

National Securities Clearing Corporation Limited (NSCCL) undertakes clearing of trades

executed on the NCDEX. The settlement guarantee fund is maintained and managed by

NCDEX. Only clearing members including professional clearing members (PCMs) only

are entitled to clear and settle contracts through the clearing house. At NCDEX, 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 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.

SETTLEMENT

Futures contracts have two types of settlements, the 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 the NCDEX, daily

MTM settlement and the 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, brought forward, created during the day

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

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

On the date of expiry, the final settlement price is the spot price on the

expiry day. 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. On the expiry date of a futures contract, members submit delivery

information through delivery request window on the trader workstations provided by

NCDEX for all open positions for a commodity for all constituents individually. NCDEX

on receipt of such information matches the information and arrives at delivery position

for a member for a commodity. The seller intending to make delivery takes the

commodities to the designated warehouse.

These commodities have to be assayed by the exchange specified

assayer. The commodities have to meet the contract specifications with allowed

variances. If the commodities meet the specifications, the warehouse accepts them.

Warehouse then ensures that the receipts get updated in the depository system giving a

credit in the depositor’s electronic account. The seller the gives the invoice to his

clearing member, who would courier the same to the buyer’s clearing member. On an

appointed date, the buyer goes to the warehouse and takes physical possession of the

commodities.

The Present Status

Presently futures’ trading is permitted in all the commodities.  Trading is

taking place in about 78 commodities through 25 Exchanges/Associations as given in

the table below:-

No. Exchange Commodity

1.India Pepper & Spice Trade

Association, Kochi (IPSTA)

Pepper (both domestic and

international contracts)

2.Vijai Beopar Chambers Ltd.,

Muzaffarnagar

Gur, Mustard seed

3.Rajdhani Oils & Oilseeds Exchange

Ltd., Delhi

Gur, Mustard seed its oil & oilcake

4.Bhatinda Om & Oil Exchange Ltd.,

Bhatinda

Gur

5. The Chamber of Commerce, Hapur Gur, Potatoes and Mustard seed

6.The Meerut Agro Commodities

Exchange Ltd., Meerut

Gur

7.The Bombay Commodity Exchange

Ltd., Mumbai

Oilseed Complex, Castor oil

international contracts

8.

Rajkot Seeds, Oil & Bullion Merchants

Association, Rajkot

Castor seed, Groundnut, its oil &

cake, cottonseed, its oil & cake,

cotton (kapas) and RBD

Palmolein.

9.The Ahmedabad Commodity

Exchange, Ahmedabad

Castorseed, cottonseed, its oil and

oilcake

10.The East India Jute & Hessian

Exchange Ltd., Calcutta

Hessian & Sacking

11. The East India Cotton Association Ltd., Cotton

Mumbai

12.The Spices & Oilseeds Exchange Ltd.,

Sangli.

Turmeric

13.National Board of Trade, Indore

Soya seed, Soya oil and Soya

meals, Rapeseed/Mustard seed

its oil and oilcake  and RBD

Palmolien

14.The First Commodities Exchange of

India Ltd., Kochi

Copra/coconut, its oil & oilcake

15.Central India Commercial Exchange

Ltd., Gwalior

Gur and Mustard seed

16. E-sugar India Ltd., Mumbai Sugar

17.National Multi-Commodity Exchange of

India Ltd., Ahmedabad

Several Commodities

18.Coffee Futures Exchange India Ltd.,

Bangalore

Coffee

19.Surendranagar Cotton Oil & Oilseeds,

Surendranagar

Cotton, Cottonseed, Kapas

20. E-Commodities Ltd., New Delhi Sugar (trading yet to commence)

21.National Commodity & Derivatives,

Exchange Ltd., Mumbai

Several Commodities

22.Multi Commodity Exchange Ltd.,

Mumbai

Several Commodities

23.Bikaner commodity Exchange Ltd.,

Bikaner

Mustard seeds its oil & oilcake,

Gram. Guar seed. Guar Gum

24. Haryana Commodities Ltd., Hissar Mustard seed complex

25. Bullion Association Ltd., Jaipur Mustard seed Complex

How to invest in a Commodity Market?

With whom investor can transact a business?

An investor can transact a business with the approved clearing member of previously

mentioned Commodity Exchanges. The investor can ask for the details from the

Commodity Exchanges about the list of approved members.

What is Identity Proof?

When investor approaches Clearing Member, the member will ask for identity proof.

For which Xerox copy of any one of the following can be given

a) PAN card Number

b) Driving License

c) Vote ID

d) Passport

What statements should be given for Bank Proof?

The front page of Bank Pass Book and a canceled cheque of a concerned bank.

Otherwise the Bank Statement containing details can be given.

What are the particulars to be given for address proof?

In order to ascertain the address of investor, the clearing member will insist on

Xerox copy of Ration card or the Pass Book/ Bank Statement where the address of

investor is given.

What are the other forms to be signed by the investor?

The clearing member will ask the client to sign

a) Know your client form

b) Risk Discloser Document

The above things are only procedure in character and the risk involved and only

after understanding the business, he wants to transact business.

What aspects should be considered while selecting a commodity broker?

While selecting a commodity broker investor should ideally keep certain aspects

in mind to ensure that they are not being missed in any which way. These factors

include

Net worth of the broker of brokerage firm.

The clientele.

The number of franchises/branches.

The market credibility.

The references.

The kind of service provided- back office functioning being most important.

Credit facility.

The research team.

These are amongst the most important factors to calculate the credibility of

commodity broker.

Broker:-

The Broker is essentially a person of firm that liaisons between individual

traders and the commodity exchange. In other words the Commodity Broker is the

member of Commodity Exchange, having direct connection with the exchange to carry

out all trades legally. He is also known as the authorized dealer.

Types of Traders:-

Hedgers

Hedging involves buying or selling of a standardized futures contract

against the corresponding sale or purchase respectively of the equivalent physical

commodity. The benefits of hedging flow from the relationship between the prices of

contracts (either ready or forward) for physical delivery and those of futures contracts.

So long as these two sets of prices move in close unison and display a parallel (or

closely parallel) relationship, losses in the physical market are offset, either fully or

substantially, by the gains in the futures market. Hedging thus performs the economic

function of helping to reduce significantly, if not eliminate altogether, the losses

emanating from the price risks in commodities.

Hedgers are those who protect themselves from the risk associated with

the price of an asset by using derivatives. A person keeps a close watch upon the

prices discovered in trading and when the comfortable price is reflected according to his

wants, he sells futures contracts. In this way he gets an assured fixed price of his

produce. In general, hedgers use futures for protection against adverse future price

movements in the underlying cash commodity.

Hedgers are often businesses, or individuals, who at one point or another

deal in the underlying cash commodity. Take an example: A Hedger pay more to the

farmer or dealer of a produce if its prices go up. For protection against higher prices of

the produce, he hedges the risk exposure by buying enough future contracts of the

produce to cover the amount of produce he expects to buy. Since cash and futures

prices do tend to move in tandem, the futures position will profit if the price of the

produce raises enough to offset cash loss on the produce.

Speculators

Speculators are some what like a middle man. They are never interested

in actual owing the commodity. They will just buy from one end and sell it to the other in

anticipation of future price movements. They actually bet on the future movement in the

price of an asset. They are the second major group of futures players. These

participants include independent floor traders and investors. They handle trades for their

personal clients or brokerage firms. Buying a futures contract in anticipation of price

increases is known as ‘going long’. Selling a futures contract in anticipation of a price

decrease is known as ‘going short’. Speculative participation in futures trading has

increased with the availability of alternative methods of participation.

Speculators have certain advantages over other investments they are as follows:

If the trader’s judgment is good, he can make more money in the futures

market faster because prices tend, on average, to change more quickly than real estate

or stock prices. Futures are highly leveraged investments. The trader puts up a small

fraction of the value of the underlying contract as margin, yet he can ride on the full

value of the contract as it moves up and down.

The money he puts up is not a down payment on the underlying contract,

but a performance bond. The actual value of the contract is only exchanged on those

rare occasions when delivery takes place.

Arbitrators

According to dictionary definition, a person who has been officially chosen

to make a decision between two people or groups who do not agree is known as

Arbitrator. In commodity market Arbitrators are the people who take the advantage of a

discrepancy between prices in two different markets. If he finds future prices of a

commodity edging out with the cash price, he will take offsetting positions in both the

markets to lock in a profit. Moreover the commodity futures investor is not charged

interest on the difference between margin and the full contract value.

How to become a Commodity Trader/Broker of Commodity Exchange?

To become a commodity trader one needs to complete certain legal and binding

obligations. There is routine process followed, which is stated by a unit of Government

that lays down the laws and acts with regards to commodity trading. A broker of

Commodities is also required to meet certain obligations to gain such a membership in

exchange. To become a member of Commodity Exchange the broker of brokerage firm

should have net worth amounting to Rs. 50 Lakhs. This sum has been determined by

Multi Commodity Exchange.

How to become a Member of Commodity Exchange?

To become member of Commodity Exchange the person should comply with

the following Eligibility Criteria.

1. He should be Citizen of India.

2. He should have completed 21 years of his age.

3. He should be Graduate or having equivalent qualification.

4. He should not be bankrupt.

5. He has not been debarred from trading in Commodities by statutory/regulatory

authority,

There are following three types of Memberships of Commodity Exchanges.

Trading-cum-Clearing Member (TCM):-

A TCM is entitled to trade on his own account as well as on account of his

clients, and clear and settle trades himself. A sole proprietor, Partnership firm, a joint

Hindu Undivided Family (HUF), a corporate entity, a cooperative society, a public sector

organization or any other Government or non-Government entity can become a TCM.

There are two types of TCM, TCM-1 and TCM-2. TCM-1 refers to

transferable non-deposit based membership and TCM-2 refers to non-transferable

deposit based membership.

A person desired to register as TCM is required to submit an application as

per the format prescribed under the business rules, along with all enclosures, fee and

other documents specified therein. He is required to go through interview by

Membership Admission Committee and committee is also empowered to frame rules or

criteria relating to selection or rejection of a member.

Institutional Trading-cum-clearing Member (ITCM):-

Only an Institution/ Corporate can be admitted by the Exchange as a member,

conferring upon them the right to trade and clear through the clearing house of

exchange as an Institutional Trading-cum-clearing Member (ITCM). The member may

be allowed to make deals for himself as well as on behalf of his clients and clear and

settle such deals. ITCMs can also appoint sub-brokers, authorized persons and Trading

Members who would be registered as trading members.

Professional Clearing Member (PCM):-

A PCM entitled to clear and settle trades executed by other members of the

exchange. A corporate entity and an institution only can apply for PCM. The member

would be allowed to clear and settle trades of such members of the Exchange who

choose to clear and settle their trades through such PCM.

Membership Details for NCDEX:-

Trading-cum-clearing Member: - TCM

Sr.No. Particulars NCDEX: TCM

1 Interest Free Cash Security Deposit 15.00 Lakhs

2 Collateral Security Deposit 15.00 Lakhs

3 Admission Fee 5.00 Lakhs

4 Annual Membership Fees 0.50 Lakhs

5 Advance Minimum Transaction Charges 0.50 Lakhs

6 Net worth Requirement 50.00 Lakhs

Professional Clearing Membership: - PCM

Sr. No. Particulars NCDEX: PCM

1 Interest Free Cash Security Deposit 25.00 Lakhs

2 Collateral Security Deposit 25.00 Lakhs

3 Annual Subscription Charges 1.00 Lakhs

4 Advance Minimum Transaction Charges 1.00 Lakhs

5 Net worth Requirement 5000.00 Lakhs

Membership Details for MCX:-

CategoryAdmission

Fees

Initial

Security

Deposit

Annual

Subscription

Net worth Criteria

Corporate Partnership Individual

TCM-1Rs.10 Lakhs

Rs. 15 Lakhs Rs 50,000

Rs 50 Lakhs

Rs. 50 Lakhs

Rs. 50 Lakhs

TCM-2Rs.5 Lakhs

Rs. 50 Lakhs Rs 50,000

Rs. 50 Lakhs

Rs. 50 Lakhs

Rs. 50 Lakhs

ITCMRs. 10 Lakhs

Rs. 50 Lakhs Rs 50,000

Rs. 50 Lakhs N.A. N.A.

PCMNil

Rs. 50 Lakhs Rs 1,00,000

Rs. 5Crores N.A. N.A.

Dematerialization and Rematerialization in commodity markets

Introduction

The Indian commodity futures market has grown exponentially in the

recent times. With the increase in trade volume at the Commodity Exchanges; the need

to have a vibrant and efficient settlement system was felt. This led to the concept of

dematerialization of warehouse receipts. Demat of warehouse receipt eliminates the

difficulties arising out of the use of physical warehouse receipts. Dematerialization

refers to the process of conversion of the physical paper (i.e. share certificates,

warehouse receipts, etc.) into the electronic balances. In this process the physical paper

is destroyed and electronic balance is credited in the demat account owner of the

physical document. The concept of demat has been in vogue in the securities market

from the year 1996 with the setting up of the first depository i.e. National Securities

Depository Limited (NSDL) to remove the difficulties arising out of the use of physical

(paper) certificates for settlement of trades on stock exchanges and for improving

settlement efficiency.

What is a Warehouse Receipt?

Warehouse receipts are title documents issued by the warehouse to the

depositors against commodities deposited in warehouses. These receipts are

transferable by endorsement and delivery. Either the original depositor or the holder in

due course (transferee) can claim the commodities from the warehouse. According to

Sec.32 of the Bombay Warehouse Act, 1959, a receipt issued by a warehouseman

shall, unless otherwise specified on the receipt, be transferable by endorsement, and

shall entitle its lawful holder to receive the goods specified in it on the same terms and

conditions on which the person who originally deposited the goods would have been

entitles to receive them. The physical warehouse receipt suffers from the following

deficiencies being the paper form of title documents.

Need for splitting the warehouse receipt in case the depositor has an obligation

to transfer only a part of the commodities. A single warehouse receipt is

generally issued to the depositor for the goods deposited by him at one time

hence he faces this difficulty in case of part transfer.

Need to physically move the warehouse receipt from one place to another with

the risk of theft, mutilation, loss in transit etc. if the transferor and the transferee

are at two different locations.

Risk of fake / forged warehouse receipt with the introduction of dematerialization

of warehouse receipt the above deficiencies are taken care of.

Entities involved in the demat process

Issuer: The issuer is an entity, which floats the physical paper document. It

would be a company in case of the share certificate or warehouse in case of

warehouse receipt.

The Registrar and Transfer Agents: It acts on behalf of the issuer as an

interface between the issuer and the depository for converting the physical

warehouse receipt in the demat form.

The Depository: The Depository maintains the records of the beneficial owner in

its books. Presently there are two depositories in India i.e. National Securities

Depository Limited (NSDL) and Central Depository Services Limited (CDSL)

Types of Demat Account

Beneficiary Owner Account is used to hold and transact in commodity

balances. The depositor is required to quote this account number at the time of

depositing commodity in the warehouse. The commodity balances are credited in this

type of account. All the investors trading in the commodity markets are required to

separately open beneficiary owner account for commodity. The existing demat account

for securities cannot be used for the purpose of holding and transacting in the

commodity. Unlike the securities demat account, the investors need to open the

commodity demat account with both the depositories i.e. NSDL and CDSL. The basic

reason behind opening the account in both the depositories is that the Depositories

have not yet started Inter-Depository transfer in case of commodities.

Clearing Member Pool Account is used for the purpose of settlement of

delivery obligation. The account is used by the member for giving or receiving delivery

of commodity to or from the Clearing House of the Exchange. In short the pay-in and

pay-out of the exchange is settled through this account. All the members of the

exchange are required to open the CM Pool Account with both the depositories. This

cannot be used for holding the commodity.

Process of Demat Commodity

The depositor at the time of deposit of commodity contacts the Exchange

approved Quality Certifying Agency (QCA) to get the quality of goods assayed in order

to ascertain whether the goods confirms to the quality specification norms of the

Exchange. After receipt of the quality certificate from the QCA the depositor is required

to fill Commodity Deposit Form (CDF) which contains the details of the quality, quantity,

validity dates of both for a commodity, demat account number of the depositor, etc. The

depositor is required to ensure that all these details are properly filled in the form to

avoid any kind of delays or errors. The depositor submits the CDF, quality certificate

and warehouse receipt to the warehouse and receives acknowledgement of the same.

The warehouse management then initiates the process of demat credit in co-ordination

with the Exchange, Registrar and Transfer Agent and the Depository. The depositor is

required to check the holding statement (which can be obtained from his depository

participant) after a day or two to see whether the commodity deposited has been

credited to his account under proper Commodities Identifier – ICIN.

Concept of International Commodity Identification Number (ICIN)

ICIN refers to International Commodity Identification Number. Commodities that have

been dematerialized are identified by its unique code (i.e. ICIN) allotted by depository.

ICIN is generated on the uniqueness of the following 4 parameters:

Commodity.

Warehouse Location.

Grade / Fineness of the commodity.

Validity date of the commodity.

Change in any of the above parameters will result in the generation of new ICIN. For

example, suppose there are four designated Vaults for Gold delivery and 2 qualities of

gold are tendered for delivery then a total of 8 ICINs will be generated for Gold. The

ICIN description provides the name of the commodity, grade of goods, the unit of

measurement and the validity date of the ICIN.

Process of Demat Delivery

If the futures contract on its expiry results into delivery, then the member having delivery

obligation is required to give delivery of the commodity to the exchange on or before the

respective pay-in date. This is done by transferring commodity from the Clearing

Member Pool Account to the Clearing House Account of the Exchange; the member is

required to give the delivery instruction to his Depository Participant before the pay-in

deadline. On Payout, the exchange credits the commodity to the Buying Member Pool

Account.

Rematerialization / Withdrawal / Revalidation of Commodities

The depositor approaches the DP and makes request for withdrawal of commodity in

the prescribed form called Remat Request Form (RRF). The acknowledgement copy of

RRF is given to the depositor. The depositor will approach the vault / warehouse along

with the following documents for withdrawal of commodity.

Original copy of acknowledgement issued by DP on which RRN is written

Authority letter from the depositor (in case agent)

Proof of identification of the agent person.

All agricultural commodities have a shelf life and cannot be stored indefinitely. The “final

expiry” of commodity refers to the maximum time period for which the particular

commodity has shelf-life. "Validity / Revalidity Duration" refers to the number of times

and the corresponding duration for which the quality certification is valid. After the

validity date, ICIN is considered to have expired and the same would not be acceptable

as good delivery at the exchange.

The depositor has two options after the validity date:

The depositor can withdraw the goods from the warehouse.

The depositor can go for revalidation of the commodity.

Thus in case of revalidation of commodity, the depositor needs to submit the fresh

quality certificate as revalidation form. The relevant quantity will be credited on the new

ICIN.

Participation of FII and Mutual Funds in Commodity Markets

Mutual Funds and Foreign Institutional Investors are presently not allowed

to trade in commodity markets. The Government is considering the proposal to allow

these entities to trade in commodity future markets.

For commodity markets to grow rapidly, retail participation is essential as

has been the experience in developed countries. But the extent of knowledge

dissemination of commodity futures among the mass market is at an abysmal level.

Unlike the financial derivatives market, one can enter the commodity

derivatives market with a much lower investment, since margins are lower in the range

of 5-10%. The leverage that can be obtained in the commodity futures market is much

higher. In case mutual funds are allowed to participate in commodity markets by

structuring commodity funds for retail investors, this would prove to be an added

advantage for the lay investor, who may not have the knowledge and wherewithal to

trade in such markets. The commodity futures exchange remain largely in the shadows

of the booming equity market exchanges due to low awareness levels.

Tracking commodity prices is not just a balance sheet analysis or a

company specific study. Global factors and rather macro factors play a much important

role in it. That demands domain expertise in commodities, market dynamics and price

forecasting. This is the reason for mutual funds to participate in commodity markets

since, they are equipped with qualified analysts and fund management who undertake

value investing and boost up the reliability for the retail investors.

Globally, commodity markets are being acknowledged as an effective

market to hedge against the vagaries of the equity markets. The presence of foreign

funds in the securities market has been found to have correlation with the interest as

well as activity in equity segment. A similar scenario is expected to be replicated in the

commodity market, in case regulation permits the entry of Foreign Institutional Investors

into this market.

Yet the other set of challenges in front of the exchanges are creating

awareness and information dissemination. While volumes are important for commodity

exchanges, what is probably more critical is awareness. There is a need for exchanges

to keep relentlessly pursuing an awareness creation strategy. Awareness at the

grassroots will be essential to materialize and sustain the success it is foreseeing.

Disseminating market discovered prices to the farmer level calls for a mammoth

structural framework and massive investments.