1. COMMODITY MARKET
History of commodity market
Evolution of commodity market
Commodity futures trading have evolved from the need for ensuring
continuous supply of seasonal agricultural crops. In Japan, merchants stored rice
in warehouses for future use. In order to raise cash, warehouse holders sold
recipes 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 concept of organized trading in commodities evolved in the
middle of the 19th
century, in Chicago, United States. Chicago has emerged as a
major commercial hub with railroad & telegraph lines connecting it with the rest
of the world, thereby attracting wheat producers from mid-west to sell their
produce to the dealer and distributors. However, lack of organized storage
facilities & the absence of a uniform weighing/ grading mechanism often
confined them to the mercy of sealer’s discretion. This led to inherent need to
establish a common meeting place, both for farmers and dealers to transact in
“spot” grain- to deliver wheat and receive cash in return. This happened in
1848.
Gradually, the farmers (sellers) and dealers (buyers) started to make
commitment to exchange the produce for cash in futures. This is how the
contract for “futures” trading evolved whereby the producers would agree to
sell his produce (wheat) to the buyer at a future delivery date at an agreed upon
price. In this way the farmer knew in advance about what he would receive for
this produce and the dealer would know about his costs involved. This
arrangement was beneficial to both the producer and the trader.
These contracts became popular very quickly and started changing
hands even before the delivery date of the product. If a dealer is not interested in
taking delivery of the produce, he would sell his contract to some one who
needed the same. Similarly, the farmer who did not intend to deliver his crop
would pass on the responsibility to another. the price of the contract would
depend on the price movement in the wheat market.
1

2. COMMODITY MARKET
With some more modifications, such contracts gradually
transformed into an instrument to protect the parties involved against adverse
factors like unexpected price movements, unfavorable climatic factors etc. for
ex; during bad weather, people having contracts to sell wheat would be
interested to hold more valuable contract due to supply shortages. Conversely, if
there is over supply, the seller’s contract value would decline. This prompted
the entry of traders in the futures market who had no intentions to buy or sell
wheat but would purely speculate on price movements in the market to earn
profits.
Trading in futures as a result became a very profitable mode of
activity that encouraged the entry of other commodities in the futures market
thereby creating a platform to set up a body that can regulate and supervise this
contract. Thus, during 1848, the Chicago board of trade (CBOT) was
established. it was initially formed as a common location known both to the
buyers and sellers negotiate forward contracts. However the popularity of the
contracts and the success of CBOT in Chicago created interest in the other local
markets catering to specific commodities to establish trade bodies that would
facilitate dealing in futures contract.
In t the early 20th
century, as communication and transportation
became more advanced, centralized warehouses were built in the principal
market centers to distribute goods more economically. Agricultural
commodities were the most commonly traded, but it led to the fact that the
market can flourish for any underlying as long as therein an active pool of
buyers and sellers.
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3. COMMODITY MARKET
COMMODITY MARKETS IN INDIA
The Forward Markets Commission (FMC) headquartered at Mumbai, is
the .regulatory authority for Commodity Derivatives Markets 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 Government out of them
being nominated by the Central Government to be the Chairman thereof.
Currently the Commission comprises four members among whom Shri S.
Sundareshan, IAS, is the Chairman and Dr. Kewal Ram, lES, Dr. (Smt)
Jayashree Gupta, CSS, and Shri. Rajeev Kumar Agarwal, IRS, are the Members
of the Commission.
The functions of the Forward Markets Commission are as
follows:
a) 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.
b) To keep fonward 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

4. COMMODITY MARKET
c) To collect and whenever the Commission feels 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;
d) To make recommendations generally with a view to improving the
organization and working of forward markets;
e) 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 considers it necessary.
There are three National level Commodity Exchanges in India. They are
Multi Commodity exchange of India Ltd., Mumbai, National Commodity and
Derivatives Exchange (NCDEX), Mumbai and National Multi Commodity
Exchange (NMCE), Ahmadabad. There are 21 other "regional" commodity
exchanges situated in different parts of India.
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5. COMMODITY MARKET
INTERNATIONAL COMMODITY EXCHANGES
Futures trading are a direct consequence of the problems related to the
maintenance of a year-round supply of commodities / products that are seasonal
as is the case of agricultural produce. Trading on the futures market platform
provides the solution to these problems and opens up new opportunities as well.
The economic benefits of exchange traded futures and options include the
ability to shift and manage the price risk exposure of the market and tangible
positions. With the liberalization in international trade policies, there is a new
need felt in many countries for price discovery and the existence of a futures
trading mechanism. This need can be met through commodity exchanges.
As a result, recent years have witnessed a steep rise in the creation of
commodity exchanges along with a consistent expansion of the existing ones.
The United States, Japan, United Kingdom, Brazil, Australia and Singapore are
homes to leading commodity futures exchanges in the world.
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6. COMMODITY MARKET
World's 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 division,
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. The Exchange has
become a significant part of the commercial, civic and cultural life of New
York. The Exchange also clears trades for market participants who wish 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.
6

7. London Metal Exchange
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 in providing a market for
participants from the non-ferrous base metals related industry to safeguard
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 on a daily basis for a period of three
months, unlike other commodity markets that are primarily based on 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

8. on the monthly average settlement price (MASP) for all metals futures
contracts.
The Chicago Board of Trade
The first commodity exchange established in 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 costs, they had been left with little choice but to dump the unsold
produce in the nearby 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 being 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, 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

9. participants like farmers, corporate, small businessmen, financial service
providers, international trading firms and speculators for price discovery, 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 advancement 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
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 U.S.
that drives the NYMEX is different from the demand-supply situation in Asia.
In January 2003, in a major overhaul of 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, Aluminium, Rubber, etc.

10. Chicago Mercantile Exchange (CME)
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 rate futures, stock indices and foreign
exchange futures. Its products often serve as a financial benchmark and witness
the largest open interest in futures contracts compared to any other exchange in
the world. The commodity 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.

11. Some Major International Commodity Derivatives Exchanges
Sr.
No
Name and Address Contract Traded
1. Chicago Mercantile
Exchange
(CME)
Butter, Milk, Diammonium
Phosphate, Feeder cattle, Frozen Pork
bellies, Lean Hogs, Live Cattle, Non-fat
Dry Milk, Urea, Urea Ammonium
Nitrate, etc.
2. New York Mercantile
Exchange
(NYMEX)
Light Sweet Crude Oil, Natural Gas,
Heating Oil, Gasoline, RBOB Gasoline,
Electricity, Propane, Gold, Silver,
Copper, Aluminum, Platinum,
Palladium, etc.
3. London International
Financial Futures and
Options Exchange
(LIFFE)
Cocoa, Robusta Coffee, Corn, Potato,
Rapeseed, White Sugar, Feed Wheat,
Milling Wheat, etc.
4. Chicago Board of Trade
(CBOT)
Corn, Soybeans, Soybean Oil,
Soybean meal. Wheat, Oats, Ethanol,
Rough Rice, Gold, Silver, etc.
5. London Metal Exchange
(LME)
Aluminum, Copper, Nickel, Lead,
Tin, Zinc, Aluminum Alloy, North
American Special Aluminum Alloy
(NASAAC), Polypropylene, Linear Low
Density Polyethylene, etc.
6. New York Board of
Trade (NYBOT)
Cocoa, Coffee, Cotton, Ethanol,
Sugar, Frozen Concentrated
Orange Juice, Pulp etc.

12. 7. Tokyo Commodity
Exchange (TOCOM)
Gasoline, Kerosene, Crude Oil,
Gold, Silver, Platinum, Palladium,
Aluminum, Rubber, etc.
8. Sydney Futures Exchange
(SFE)
Greasy Wool, Fine Wool, Broad
Wool, Cattle, etc.
9. Dubai Gold and
Commodities Exchange
(DGCX)
Gold, Silver, Fuel Oil, Steel, Freight
Rates, Cotton, etc.
10. Bursa Malaysia Berhad Refined Bleached Deodorized
Palmolein, Crude Palm Oil, Palm Kernel
Oil, etc.
11. Winnipeg Commodity
Exchange
Canola, feed Wheat, Western Barley,
etc.
12. Dalian Commodity
Exchange
Corn, Soybean, Soybean Meal, Soy
Oil, etc.
13. Zheng Zhou Commodity
Exchange (CZCE)
Wheat, Cotton, Sugar, etc.
14. Central Japan
Commodity Exchange
Gasoline, Kerosene, Gas Oil, Eggs,
Ferrous Scrap, etc.
15. Shanghai Futures
Exchange (SHFE)
Copper, Aluminum, Natural Rubber,
Plywood & Long Grained Rice
16. Brazilian Mercantile and
Futures Exchange
Anhydrous Fuel Alcohol, Arabica
Coffee, Robusta-Conillon Coffee, Corn,
Cotton, Feeder cattle. Live Cattle,
Soybean, Crystal Sugar, Gold, etc.
17. Kansai Commodity
Exchange
Soybean, Raw Sugar, Raw Silk,
Shrimp (frozen). Coffee, Corn, Azuki
beans (Red), etc.
18. Osaka Mercantile
Exchange
(Ribbed Smoked Sheets) RSS3,
(Technically Specified Rubber) TSR20,
Nickel, Aluminum, Rubber Index

13. 19. Singapore Commodity
Exchange
Coffee, Rubber (RSS1, 2, 3)
20. Tokyo Grain Exchange
(TGE)
Corn, Soybean Meal, Soybeans, Red
Beans, Coffee, Sugar, Raw Silk,
Vegetables, etc.
21. Intercontinental
Exchange (ICE)
Brent Crude Oil, Coal, Electricity,
Emissions, Gas Oil, Heating Oil,
Gasoline (RBOB), Natural Gas, WTI
and all the futures contracts of its
subsidiary - The international Petroleum
Exchange (IPE)

14. COMMODITY FUTURES IN INDIA AND ITS REGULATIONS
Evolution of Commodity futures in India
The history of futures trading in commodities in India is almost as old as that
of US. It has, however, passed through a turbulent past. India's first organized
futures market was the Bombay Cotton Trade Association Ltd., which was set
up in 1875. Futures trading in oilseeds started with the setting up of Gujarati
Vyapari Mandali in 1900. Gold futures trading began in Mumbai in 1920.
During the first half of the 20th century, there were several commodity futures
exchanges trading in jute, pepper, turmeric, potatoes, sugar, etc.
However, during the 1940s to 1960s, trading in forwards and futures became
difficult as a result of price controls. Major policy decisions taken after
Independence, mainly because of the then prevailing scarcity situation,
adversely affected the development of futures and forwards markets in the
country. In 1952, the Forward Contract Regulation Act was passed which
controls all transferable forward and futures contracts. This again put restriction
on futures trading. During the 1960s and 70s, the Government of India
suspended trading in several commodities like cotton, jute, edible oilseeds, etc.
as the government felt that these markets were increasing the prices of
commodities.
The government's twin policies of offering to buy agricultural produce at a
"minimum support price" (MSP) and gaining a monopoly in
storage/transportation/distribution of agricultural produce along with a ban on

15. futures and options trading were the major factors that weakened the agro-
commodity markets in the country.
The government appointed two committees to study this sector i.e. the
Dantwala Committee in 1966, and the Khusro Committee in 1980, which
recommended the reintroduction of futures trading in major commodities. The
government finally brought back forward trading in agricultural commodities In
the early 1980's. But, it was done for commodities that did not have a very
significant role in the economy - such as castor seed and castor oil, jaggery,
jute, pepper, potato and turmeric. Several localized exchanges started trading in
the same commodity, each of them with a local broker/wholesale-merchandiser.
But, even after a decade, none of the markets achieved the levels of liquidity
that existed prior to the ban on commodity futures trading.
Once futures trading became operational, in spite of liberalization, it has
been difficult for trade to be transferred from illegal black markets, which have
zero tax liability and no reporting requirements to the legal authorities as
compared to the regulated markets, where taxes & reporting are part of the legal
procedures. Further, responding to the need for commodity futures in India, in
1993, a committee was set-up for assessing the scope for forwards and futures
trading in commodities and for recommending steps to be taken for
development of futures trading in India. The Committee so instituted was
known as the Kabra Committee and much of its recommendations have been
implemented.
Whereas, with the current initiatives of the regulators, these markets have
shown revolutionary changes in the last few years, with the National-level multi
commodity exchanges in India showing tremendous potential to tap the
commodity derivatives market.

16. Before the advent of nationwide, online, multi commodity
exchanges, the low volume in the regionalized exchanges in India
were attributed to the following reasons:
1. Excessive government intervention in the form of subsidies, price control,
compulsory purchasing and rationing in the agricultural markets. This led
to inefficient functioning of the markets & lower yield in terms of income
to the farmers.
2. Influential & large commodity producers / traders acting as members /
brokers of commodity exchanges & manipulation in the prices of
commodities.
3. Imperfect mechanisms & lack of standardization for physical delivery,
settlement, documentation and warehousing arrangements.
4. Absence of organized interconnected spot markets, which resulted in
flawed price discovery mechanisms and no means to arbitrage to achieve
price efficiency in geographically separated markets.
This resulted in fragmenting the volumes across the local exchanges.
The following suggestions were made to improve the commodities futures market
1. Allow commodity futures exchanges to be run by independent
professionals, rather than by brokers.
2. Allow trading of short-term futures contracts in commodities, which has
an existing cash market to enable hedgers to protect themselves against
adverse price fluctuations.

17. 3. To change the working of the Forward Markets Commission from micro
management to macro management
4. Introduce commodity futures contracts with different grades for trading.
5. Eliminate price manipulation & circular trading.
6. Use of latest technology & systems that have been developed for the
financial derivative markets
7. Introduce options contracts to augment futures.
Currently the multi commodity exchanges in India, which started their
operations in 2003, have done well in terms of nation wide reach, online trading
and efficient and effective risk management and thereby generating appreciable
volumes in the first year of their operations.
With Commodity Ecosystem much bigger than the stock markets, we have
witnessed how fast commodity futures have picked up compared to the stock
futures when they were introduced. The permission granted to the stock broking
community to participate in the commodity markets has further increased the
scope of creating more liquid and vibrant contracts. Further liberalization, de-
regulation of markets, WTO implications, and technological and informational
changes are going to add more fuel to the markets in the coming years.
A preview of the Committee Report would help understand the markets that
existed then and what needs to be done in developing these markets. Most of the
recommendations have already been implemented.

18. Regulatory Framework
Forward Contracts (Regulation) Act, 1952
The Constitution of India brought the subject of stock exchanges and futures
MARKET in Union list. As a result, the responsibility for regulation of
commodity futures markets devolved on Govt of India. The Commodity
Exchanges in India are governed and regulated under the Forward Contracts
(Regulation) Act, 1952 and Rules framed there under.
It provides for a 3 tier regulatory system, namely;
• an association recognized by the Government of India on
recommendation of Forward Markets Commission (FMC)
• the Forward Markets Commission (it was set up in Sept 1953) and
• the Central Government
Forward Markets Commission
The Forward Markets Commission, under the Ministry of Consumer Affairs,
Food and Public Distribution, Government of India is the regulating authority
for all Commodity Futures Exchanges in India.

19. Functions of the Forward Markets Commission - Statutory
a) To advise the Central Government in respect of the recognition of or the
withdrawal of recognition from any association or in respect of any other
matter arising out of the administration of this Act;
b) To keep forward markets under observation and to take such action in
relation to them as it ma) consider necessary, in exercise of the powers
assigned to it by or under this Act;
c) To collect and whenever the Commission thinks it necessary, publish
information regarding the trading conditions in respect of goods to which
any of the provisions of this Act is made applicable, including
information regarding supply, demand and prices and to submit to the
Central Government periodical reports on the operation of this Act and on
the working of forward market! relating to such goods;
d) To make recommendations generally with a view to improving the
organization and working o forward markets;
e) To undertake the inspection of accounts and other documents of any
recognized association o registered association or any member of such
association whenever it considers it necessary; and
f) To perform such other duties and exercise such other powers as may be
assigned to the Commission by or under this Act, or as may be
prescribed. Principal Features of the FC(R)Act 1952 are as follows:
• The act enables the regulating authority to take such action as may be
considered desirable respect of specified commodities and specified
area without automatically applying the entire provisions of the act to
all commodities in all areas in sec 15

20. • The act prohibits option trading in all commodities
• The act ordinarily exempted non transferable specific delivery contracts
from regulation: sec18{1)
• The act ordinarily covers transferable specific delivery contract as well
as hedge contracts
• The act empowers the Govt to prohibit forward contracts in particular
commodity by notification sec 17
• The act provides for grant of recognition to associations concerned with
forward tradio: sec 6
• The act provides that the regulation of forward markets should
ordinarily take place thought governing bodies of recognized
associations sec 11
• The act empowers the Central Govt to appoint not more than four
members on k governing bodies of recognized associations sec 6{2b)
• It provides for a machinery for the supervision and regulation of the
governing bodies from point of public interest this machinery is the
forward markets commission
Regulatory measures evolved by the Commission.
a) Limit on open positions of an individual operator to prevent overtrading.
b) Limit on price fluctuations to prevent abrupt upswing or downswing in
prices.
c) Special margin deposits to be collected on outstanding purchases or sales
to curb excessive speculative activity through financial restraints.

21. d) Minimum / maximum prices to be prescribed to prevent futures prices
from falling below) levels that are not remunerative and from rising
above the levels not warranted by genuine supply and demand factors.
e) During shortages, extreme steps like skipping trading in certain deliveries
of the contract, closing the markets for a specified period and even
closing out the contract to overcome emergency situations are taken.
Organizational Structures of Forward Market Commission
The Organizational Structures of Forward Market Commission is classified
as follows:
• Commodity Division
• Enforcement Division
• Administrative Division
Proposed amendments to the FC(R) Act, 1952
The government has proposed certain amendments to the Forward Contracts
(Regulation) Act, 1952. The amendments include setting up of a separate
Clearing Corporation, registration of intermediaries and enhancement of penal
provisions in the FC(R) Act. Exempting FMC from payment of tax on wealth,
income and profits or gains; conferring powers upon the Centre to regulate
forward contracts and options in goods.
The Cabinet cleared the decks for the Forward Market Commission (FMC)
to become an independent regulator for the commodities futures market. A Bill

22. will be introduced in Parliament during the next parliament session to amend
the Forward Contracts (Regulations) Act of 1952. Once the Bill is passed, the
FMC would be able to generate its own resources and have the powers to
recognize or derecognize futures commodities exchanges. The amendments will
allow trading in options in goods and registration of intermediaries with the
FMC and redefine commodities to include energy, weather and other exotic
products and also push forth demutualization of regional exchanges.
With the FMC having recommended to thegovernmentto allow banks,
Foreign Institutional Investors(FII) and Mutual Funds (MF) to participate in
commodity futures market, it is expected that the daily trade volume to go up to
Rs 25,000-30,000 crore in the coming years. Option trading is all set to play a
dynamic role in commodities futures trade, following the expected change in
regulatory framework.
Why do we require National level Multi Commodity Futures Exchanges in India?
To develop active trading interest across commodities, it is necessary to have
a common platform of commodity futures exchange where demand and supply
forces can act together in bringing out the best price for any commodity. The
main economic purpose of a futures commodity exchange as a marketplace is to
enable commodity producers / processors to sell their produce in advance to
protect them against possible price fall for their commodities and allow
consumers, traders, processors to buy in advance to protect against possible
price increase. In this way they are able to "hedge" their price risk, by locking a
price, which they will receive, and which they will pay respectively.
Commodities futures trading is a global phenomenon and offers tremendous
potential to market participants for both profit taking on small price corrections

23. as well as to hedgers looking at managing price risk on account of price
fluctuations.
In India, futures trading is now allowed in more than 100 commodities.
Most of the allowable commodities are traded through various exchanges in
India. Indian economy is directly and indirectly dependent on agricultural
produce. The agricultural commodity market already has major share and with
the availability of futures trading on national-level, commodity futures
exchanges will provide more liquidity, price discovery and better risk
management strategies. National level commodity exchanges will also
invite new streams of investors for new trading and business opportunities for
diversification. With the Government control expected to gradually come to
anend, all commodity prices will be market determined. It necessitates national
level commodity futures exchanges to provide price discover better investment
opportunities and prudent risk management practices.
Three nationwide electronic exchanges in India and 21 recognized regional
or small commodity exchanges in India had an estimated total combined
turnover of Rs 21.34 Lakh crore for the year 2005 - 06. This translates into a
373% growth over the previous financial year.
In developed markets, futures trading are conservatively estimated at 10
times the size of cash market in commodities. If we consider the fact that in the
US, where futures trading are almost 20 times that of the cash market
production, it would only be fair to suggest that our futures market Would be a
very large and deep, easily many times more than that of the securities market
itself.

24. Legal Framework
Commodity futures contracts and the commodity exchanges organising
Trading in such contracts are regulated by the Government of India
Under the Forward Contracts (Regulation) Act, 1952, and the rules
Formed there under. The nodal agency for such regulations is the
Forward Markets Commission (FMC), which functions under the aegis
Of Ministry of Consumer Affairs, Food & Public Distribution of the
Central Government.
According to rough estimates, the unorganised commodity markets have
an annual turnover in excess of Rs 12 lakh crore. Given the convenience
and transparency in online trading, commodity markets has potential to
grow to annual turnover of Rs 45-50 lakh Crore (assuming a future
Trading multiple of about 4 times the physical market), which is about
2 to 3 times the size of equity markets in India. Even globally, commodity
Markets are much bigger than equity markets. For instance, annual
Trading of gold on New York Mercantile Exchange (Nymex) alone is
Worth over $ 300 billion.
Why Commodity futures market ?
Unlike the physical market, futures markets trades in commodity are
largely used as risk management (hedging) mechanism on either
physical commodity itself or open positions in commodity stocks. For
instance, a jeweler can hedge his inventory against perceived short-term
downturn in gold prices by going short in the future markets.
In addition to this, speculators and arbitragers participate to take benefit
from changes in prices or price differential between two commodity
exchanges and are not interested in taking physical delivery. Globally
also Commodity future contracts are normally offset before the expiry and
therefore do not result in physical movement of physical commodity.

25. Commodity Exchanges in India
National Level Multi Commodity Exchanges
Sr.
No
Name and
Address
Commodities
1. Multi Commodity
Exchange of India
Ltd.,
Mumbai
Gold, Silver, Aluminum, Copper ,Nickel,
Sponge Iron, Steel Flat, Steel Long (Bhavnagar),
Tin, Castor Oil, Castor Seeds Castor Seeds
(Disa), Cottonseed, Crude Palm Oil, Groundnut
Oil, Kapasia Khalli (Cottonseed Oilcake),
Mustard Seed (Hapur), Mustard seed (Jaipur),
Mustard / Rapeseed Oil, Mustard Seed (Sirsa),
RBD Palmolein, Refined Soy Oil, Sesame seed,
Soymeal, Soy Seeds, Ghana, Masur, Tur, Urad,
Yellow peas, Rice, Basmati Rice, Wheat, Maize,
Sarbati Rice, Black pepper, Red Chilli, Jeera,
Turmeric, Cashew Kernel, Rubben Kapas,
Cotton long staple, medium staple, short staple).
Guar seed, Guargum, Gur, Mentha Oil, Sugar,
High Density Polyethylene (HOPE),
Polypropylene (PP), Brent Crude Oil, Crude Oil,
Furnace Oil., Natural Gas, etc.
2. National
Commodity &
Cashew, Castor Seed, Ghana, Chili, Coffee -
Arabica, Coffee -Robusta, Common Raw Rice,

26. Derivatives
Exchange Ltd.,
Mumbai
Common Parboiled Rice ,Crude Palm Oil,
Cotton Seed Oilcake, Expeller Mustard Oil,
Grade A Parboiled Rice, Grade A Raw Rice,
Groundnut (in shell). Groundnut Expeller Oil,
Guar gum, Guar Seeds, Gur, Jeera, Jute sacking
bags Lemon Tur, Indian Parboiled Rice, Indian
Raw Rice, Indian 28 mm Cotton, Indian 31 mm
Cotton, Maharashtra Lai Tur, Masoor Grain
Bold, Medium Staple Cotton , Mentha Oil,
Mulberry Green Cocoons, Mulberry Raw Silk,
Mustard Seed, Pepper, Raw Jute, Rapeseed-
Mustard Seed Oilcake, RBD Palmolein, Refined
Soy Oil, Rubber, Sesame Seeds, Soyabean,
Sugar, Yellow Soybean Meal, Turmeric, Urad,
V-797 Kapas, Wheat, Yellow Peas, Yellow Red
Maize Electrolytic Copper Cathode, Mild Steel
Ingots, Sponge Iron, Gold, Silver, Brent Crude
Oil, Furnace Oil, etc.
3. National Multi
Commodity
Exchange of India
Limited. Ahmedabad
Gur, RBD Pamolein, Groundnut Oil,
Sunflower Oil, Rapeseed/ Mustard seed,
Rapeseed/Mustard seed Oil, Rapeseed/ Mustard
seed oilcake. Soy bean. Soy Oil, Copra,
Cottonseed, Safflower, Groundnut, Sugar,
Sacking, Coconut oil, Castor seed. Castor-oil,
Groundnut oil cake, Cottonseed oil, Sesamum,
Sesamum oil, Sesamum Oilcake, Safflower
Oilcake, Rice Bran Oil, Safflower Oil,
Sunflower Oilcake, Sunflower Seed, Pepper,
Crude Palm Oil, Guar seed. Castor Oilcake,

27. Cottonseed ce Oilcake, Aluminum Ingots,
Nickel, Vanaspati, Soybean Oilcake, Rubber,
Copper, Zinc, Lead, Tin, Linseed, Linseed Oil,
Linseed Oilcake, Coconut Oilcake, Gram, Gold,
Silver, Rice, Wheat, Cardamom, Kilo oe Gold,
Masoor, Urad, Tur, etc.
Regional Exchanges
Sr. Name and Address Commodities
1 Bhatinda Om & Oil
Exchange Ltd., Bhatinda.
Gur
2 The Bombay Commodity
Exchange Ltd., Mumbai
Groundnut Oil, Sunflower
Oil, Cottonseed Safflower,
Groundnut, Castor seed, Castor see
Cottonseed oil, Sesamum Oil,
Sesamum Oilcake Safflower Oilcake,
Rice Bran, Rice Bran Oil, Rice Bran3 The Rajkot Seeds oil &
Bullion Merchants" Association
Groundnut Oil, Castor seed
4 The Meerut Agro
Commodities Exchange Co.
Gur
5 The Spices and Oilseeds Turmeric
6 Ahmedabad Commodity
Exchange Ltd., Ahmedabad
Cottonseed, Castor seed
7 Vijay Beopar Chamber Ltd.,
Muzaffarnagar
Gur, Mustard Seed
8 India Pepper & Spice Trade
Association.
Kochi
Pepper Domestic-MG 1, Pepper
Domestic-500g/ 1, Black Pepper
Int'l-MLS ASTA, Black Pepper
Int'l-VB ASTA, Black pepper Int'l FAQ,
9 Rajdhani Oils and Oilseeds Gur, Rapeseed/Mustard seed

28. 10 National Board of Trade
(NBOT), Indore
Rapeseed / Mustard seed, rapeseed /
Mustard seed oil Rapeseed / Mustard
seed oilcake, soy bean, soy meal soy oil,
crude palm oil.11 The Chamber of Commerce, Gur, Rapeseed / Mustard seed
12 The East India Cotton
Association, Mumbai (EICA)
Indian Cotton
13 The Central India
Commercial Exchange Ltd.,
Gur, Rapeseed / Mustard seed
14 The East India Jute &
Hessian Exchange Ltd.,
Hessian sacking
15 First Commodity Exchange Copra, Coconut oil, copra cake
16 Bikaner Commodity
Exchange Ltd, Bikaner
Rapeseed / Mustard seed,
Rapeseed/Mustard seed oil
17 The Coffee Futures
Exchange India Ltd. (COFC),
Coffee - Plantation A, Coffee -
Robusta Cherry AB, Ratf Coffee
18 E-Sugar-lndia Ltd. Sugar Grade - M, Sugar Grade - S
19 Surendranagar Cotton Oil
and Oilseeds Assoc. Ltd.,
Kapas
20 Haryana Commodities Ltd.,
Hissar
Rapeseed, Mustard seed, Rapeseed /
Mustard seed oil
21 E-Commodities Ltd. and
Bombay Bullion Association
COMMODITY FUTURES

29. Meaning and objectives of commodity futures
A commodity futures contract is an agreement between two parties to buy or
sell a specified and standardized quantity and quality 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
risks associated with frequent price volatility. The loss due to price volatility
can be attributed to the following two reasons:
Consumer Preference: In the short- term, their influence on price volatility is
small since it is a slow process permitting manufacturers, dealers & wholesalers
to adjust their inventory in advance
Changes in Supply: They are abrupt & unpredictable bringing about wild
fluctuations in prices. This can be 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.
The objectives of commodity futures are as follows:
• Hedging with the objective of transferring risk related to the possession
of physical assets through any adverse movements in price.

30. • Liquidity and Price discovery to ensure base minimum volume in trading
of a commodity through market information and demand-supply factors
that facilitates a regular and authentic price discovery mechanism.
• Maintaining buffer stock and better allocation of resources as it augments
reduction in inventory requirement and thus the exposure to risks related
with price fluctuation declines. Resources can thus be diversified for
investments
• 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 the 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 the 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.
In commodity futures, it is necessary to distinguish between investment
commodities and consumption commodities. An investment commodity is
generally held for investment purposes whereas consumption commodities are
held mainly for consumption purposes. Gold and Silver can be classified as
investment commodities whereas oil and steel can be classified as consumption
commodities.

31. Participants in Commodity derivatives
Hedgers
Futures contracts have been used as financial offsets to cash market risk for
more than a century. futures to reduce or limit the price risk of the physical
asset. Hedging is an insurance used to avoid reduce price risks associated with
any kind of futures transaction.
Commodity futures markets provide insurance opportunities to commercials,
merchant producers and processors, against the risk of price fluctuation. In the
case of a trader, an adverse price change brought about by either supply or
demand change, affects the total value of his commitment Larger the value of
his inventory, larger the risk to which he is exposed. The futures market
provides; mechanism for the trader to lower the inventory risk and his
commitments in the cash market (where actual physical delivery of the
commodity must eventually be made) through hedging. Hedging allow a market
participant to lock in prices and margins in advance and reduce the potential for
unanticipated loss or competitive disadvantage. A hedge involves establishing a
position in the futures market this is equal and opposite to a position in the
physical market. The principle behind establishing equal an opposite positions
in the cash and futures markets is that a loss in one market should be offset b a
gain in the other market. Hedging works because cash prices and futures prices
tend to move tandem, converging as the futures contract reaches expiration.

32. The degree of effectiveness of a hedge Is determined by the percentage of
the actual gain or lo: incurred in a futures transaction. Though most hedges
reduce risks related to price variations, they not eliminate them altogether.
"Margin" for futures contracts Is usually between 5% and 10% of the
contract value and is put up if good faith, indicating the buyer or seller's
willingness to pay or deliver the entire amount If the contract is held until
delivery. Because margin requirements are so low, it is possible to hedge small
or larges quantities of commodities. In fact, the low margins required for trading
in futures contract provides high "leverage" for traders. This is because; the
traders can take large exposures even by investin marginal (small) amount of
deposit with the exchange. For e.g., on 15th May 2006, if a trader wants t( take
a long position in August Gold futures contract at the prevailing futures price of
Rs. 10,000 per gm, then he would be required to deposit the margin amount (4%
or Rs. 40,000) with the exchange This enables him to obtain a leverage of up to
25 times of his margin deposit, since his total exposure in terms of the contract
value is Rs. 10,00,000.
Speculators
When supplies of a commodity are greater than the present demand or need,
prices tend to decline, If supplies appear to fall short of demand, prices trend
upward. Estimating market supply and demand conditions are the challenges
faced by market participants. It is generally accepted that speculators are
interested in making fast money by anticipating future price movements.
Commodity futures allow speculators to create high leveraged positions. A
speculator accepts the risk that hedgers seek to avoid, giving the market the
liquidity required to service hedge participants effectively by providing the

33. market with the necessary bids and offers for a continuous flow of transactions.
Speculation is the opposite of hedging. A speculator holds no offsetting cash
market position and deliberately incurs price risk In order to benefit from price
movements.
A speculator is an additional buyer of commodities whenever it seems that
market prices are lower than they should be. Consumers consider this to be
against their best interest. Conversely, when it appears that prices are too high, a
speculator becomes an active seller.
Individual speculators tend to trade a smaller number of contracts than
hedgers and hold market positions for a shorter time, so several of them may be
needed to offset one large hedge order. The maximum number of contracts that
can be held by any one speculator is limited by exchange rules.
The small amount of capital needed makes speculating in futures contracts
very attractive. If the total value of the contract had to be paid, the rate of return
on most commodities would be extremely small. The small margin provides
speculators with the necessary leverage to generate a substantial rate of return.
On the other side it also generates substantial risk
Arbitragers
Arbitragers are interested in making purchases and sales in different markets
at the same time to profit from price discrepancy between the two markets. So
arbitragers are interested in locking in a minimum profit by simultaneously
entering into transactions intwoor more markets. Anarbitrager knows the
minimum profit potential at the time of entering into transactions. Arbitragers

34. lock in profits when they spot cash and carry arbitrage opportunity or reverse
cash and carry arbitrage opportunity.
Traders who continually watch the markets can see inconsistencies in pricing
and can make relatively low-risk profits by arbitraging those inconsistencies. In
today's financial markets, most arbitrage opportunities occur either between
regions, delivery periods, types of instruments (such as options to futures) or
across a combination of these conditions. In addition to providing a low-risk
benefit to trading companies, arbitrage helps the market in two ways: It
provides pressure on prices to move to rational or normal levels and maintains
liquidity in the markets.

35. Commodity as an Asset Class
•Secular Bull market in Commodities – globally
•World GDP Growth Drivers – B R I C and other Asian and SA economies
•African Continent yet to integrate with World markets
•Commodities : Hedge against
•Currency Risk
•Political Risk
•Financial Markets Risk
•Promoter/Management Risk
•Opportunities: Time spreads, location spreads, “Badla” possible, ratio
spread
Commodity markets
• Equity markets fluctuate on local factors.
• In the short run particular shares can be manipulated by local players.
• Much higher Visibility of price direction in commodities as an asset class
compared to equity Stocks.
• Common man Familiar with Commodities
• Indian markets are a part of Global markets in commodities
• Indian markets are not part of global equity markets
Market Moving Factors
Factors affecting commodity Prices:
• Most Important factor : Demand & Supply
• Weather and Climatic Conditions.
• Producer / miner hedging interest
• Total production & expected consumption around the world
• The Economic and Political Policies like – US Dollar, Interest rates,
inflation etc

36. MULTI COMMODITY EXCHANGE OF INDIA LTD.
About MCX
Multi Commodity Exchange of India Limited (MCX) is a "new order"
exchange with permanent recognition from the Government of India for
setting up a nationwide, online (electronic multi-commodity marketplace,
offering "unparalleled efficiencies", "unlimited growth' and opportunities" to
market participants. MCX, a nationwide multi-commodity exchange, is an
indeper and demutualized exchange since inception. Promoted by Financial
Technologies (India) Limited, has introduced a state-of-the-art, online digital
exchange for commodities trading in the country. Ii with its strong belief of
setting up a truly independent and a neutral platform, MCX is committed
pursuit of broad basing its ownership and has accordingly Initiated several steps
to make the exch; ownership pattern broader, representative and inclusive. At
the time of writing this reference mati efforts are being made to go for an Initial
Public Offering (IPO) to further make the organization r dynamic. Subsequent
to this, the exchange would be accountable not only to FMC but also SEBI.
In its endeavor towards establishing India as a major hub for global trading
in commodities, has taken up the initiative by entering into tie-ups with major
international exchanges and commodity trading centers.
In a significant development that would have widespread ramifications
across the entire commodity trading circles, MCX, in the first week of
November, 2004, signed a Memorandum Understanding(MOU)with the Tokyo
Commodity Exchange(TOCOM),which is one of the largest commodity futures

37. exchange in the world, very active in metals and energy futures contracts. The
tie-up would h^ the two exchanges in information sharing, market development
and monitoring, surveillance method market operations, trading practices and
regulations in the commodities futures markets. This is the] authentic step in
bringing global recognition to the Indian commodity markets and raises
standard of commodity trading to globally acceptable levels. It would also open
up opportunities for Indian producers and consumers to get the best prices for
their products and consumables.
MCX has also forged another partnership with a major international
conglomerate, the Dubai Metals and Commodity Center (DMCC) in November
2004, to set up the Dubai Gold and Commodity Exchange (DGCX), which has
become operational from 21st November 2005. The exchange, situated in the
free trade zone of Dubai, offers a transparent trading environment for dollar
denominated Gold futures contracts. DGCX is also on the anvil of launching
currency futures contracts. Dubai has firmly established itself as the gateway of
international gold market to India. The setting up of this exchange would fill a
very critical gap for the International trading community since business from
the Gulf is currently routed to New York, London and Tokyo.
In yet another initiative taken by MCX to reduce the adverse impact of
volatility in freight rates, it has entered into a strategic alliance with the Baltic
Exchange, London, to introduce freight futures contracts in India for the first
time. The move will have a significant impact on the Indian shipping industry as
well as commodity traders, exporters and importers since the increasing cost of
freight is increasingly impacting the transportation of cargo. This will facilitate
the establishment of a very vibrant freight derivatives market in South-East Asia
for freight risk management of trade done outside the region.

38. In October 2005, MCX and London Metal Exchange (LME) announced the
signing of a licensing agreement that will allow the MCX to launch futures
contracts in non-ferrous metals using LME prices as the basis of settlement.
MCX has also signed a Memorandum of Understanding (MoU) to explore areas
of cooperation and business opportunities with the goal of assisting and
benefiting the underlying producers, end-users and investors in their commonly
traded products by maximizing the application of International best practices for
price risk management and exchange operations that could mutually benefit the
exchanges.
Key Shareholders of MCX
• Financial Technologies (India) Ltd.
• State Bank of India
• National Stock Exchange of India Ltd. (NSE)
• National Bank for Agriculture and Rural Development (NABARD)
• HDFC Bank
• Fidelity International
• Bank of India
• Union Bank of India
• Bank of Baroda
• State Bank of Indore
• State Bank of Hyderabad
• State Bank of Saurashtra
• SBI Life Insurance Co. Ltd.
• Canara Bank

39. MCX is well poised to emerge as the "Exchange of Choice" for the
commodity futures trading community in the country. MCX has formulated
strategic alliances with leading commodity trade associations in India, namely:
• Bombay Bullion Association (BBA)
• Bombay Metal Exchange (BME)
• Solvent Extractors' Association of India (SEA)
• Pulses Importers Association (PIA)
MCX has a strongly established growth path with its aim to offer:
• Liquidity - Introduce new Commodities/Members/Measures
• Expansion - Enroll Institutional & other classes of Members
• Leadership -To be a Commodity Exchange of Choice
• Information - Disseminate trade & commodity information
• Technology - Continue technological leadership for cost effective
expansion
• Trade friendliness - Work with trade & industry for growth
• Globalization - Market India's commodity sector globally
• Knowledge - Create & Share-pool of commodity knowledge
• Training - Industry & Professionals on Commodity Markets,
Operations, Risk Man
Trading strategies such as hedging underlying exposures using
commodity futures contra'
• Converge - Markets, Participants & Commodities

40. As of January 2006, MCX has already appointed more than 1500 members
with over 900C Work Stations (TWS).
Business Operations
MCX is conducting trading in derivatives contracts in various commodities
permitted Government of India under the Forward Contracts Regulations Act,
1952, subject to approval Forward Markets Commission.
Business Rules
Business Rules of Multi Commodity Exchange of India Limited is subject to
the provision Forward Contracts (Regulations) Act, 1952, and Rules framed
there under, Articles of Association Rules and Bye-Laws of Multi Commodity
Exchange of India Limited (MCX), as applicable Members of the Exchange,
their Representatives and their Clients.
Applicability
These Rules are enforceable on the Members of the Exchange,
Clearing Banks, Constituents and all other Participants operating on or through
the Exchange in respect of their rig obligations relating to trading on MCX.
They are subject to jurisdiction of the Courts of I* /irrespective of the place of
business of the Members of the Exchange or their customers and d India or
elsewhere.

41. Eligibility for Trading
At MCX, only the members of the Exchange, who have been admitted as
such by the Board, are ( to participate in trading. Persons, who are not members
of the Exchange, can participate in trading as approved users or clients through
a registered member of the Exchange.
Membership at MCX
Currently, there are three categories of membership available at MCX,
depending upon the Trading the Clearing Rights. These Membership types are
explained in detail as under.

42. CONTEMPORARY ISSUES IN COMMODITY MARKETS
Role of Banks in Commodity Markets
Financing of agriculture poses certain special risks for banks and so, banks
need to mitigate these risks in order to ensure effective credit delivery to the
agricultural sector. One of the key risks for banks is the commodity price risk.
The volatility in the prices of agricultural commodities may cause severe loss to
the farmer who may be unable to repay his dues to the bank. If the prices
collapse, the distress in the farming community can be widespread and security
obtained by the bank may have very limited usefulness, Commodity derivatives
can mitigate these risks to a certain extent. The issue has been examined in
greater detail later in the report.
A well-established system of issuance of Warehouse Receipts is a pre-
requisite of an efficient market in commodity derivatives. Warehouse Receipts
are also useful to the farmer in securing timely finance from banks at
economical rates.
In terms of Section 8 of the Banking Regulation Act, 1949, no banking
company shall directly or indirectly deal in buying or selling or bartering of
goods except in connection with realisation of securities given to or held by it,
or engage in any trade or buy, sell or barter goods of others. For this purpose,
"goods" means every kind of movable property, other than actionable claims,
stocks, shares, money, bullion and spices and all instruments referred to in
clause (a) of sub-section (1) of Section 6 of the B.R. Act, 1949. Thus, while
bullion is specifically permitted for trading under the Act, banks are prohibited

43. from entering into commodity business and therefore, they are not permitted to
participate in the commodity derivatives market.
Banks do have an extensive rural reach and expertise in agricultural lending
which enable them to play a big role in the development of the commodity
market. As they have exposure to agriculture, which is a priority sector, they
would be better off in case they were able to hedge their positions. Banks can
also help to fund margin or trading capital requirements. Further, banks can
provide loans against commodities by accepting warehouse receipts (WR) as
collateral.
The Working Group on Warehouse Receipts and Commodity Futures was
set up by the Reserve Bank of India (RBI) with the task of evolving broad
guidelines, criteria, limits, risk management system as also a legal framework
for facilitating participation of banks in commodity (derivative) market and use
of WR in financing of agriculture. The group has put forward guidelines for
banks to extend loans against warehouse receipts and also offered a framework
for participation in the commodity futures market. TheGroup had members
from the RBI, Indian Banks'Association (IBA), Forward Markets Commission
(FMC), NABARD and selected banks active in agricultural lending such as
SBI, Punjab National Bank, ofBaroda and IGICI Bank.
One of the major recommendations of the working group is to amend the
Banking Regulation Act, 1949 permitting banks to deal in the business of
agricultural commodities including derivatives. me final report was published in
April 2005. Further it also recommended that banks can maintain :/oprietary
positions with adequate limits in agri commodity derivatives to mitigate their
risk while lending to armers. Besides, banks also may be granted general
permission to become professional clearing nembers of commodity exchanges

44. subject to the condition that they should not assume any exposure sk on account
of offering clearing services to their trading clients.
Clearing bank entertains the opening of the clearing and settlement accounts
for the exchange and its members, The settlement accounts provide the facility
to transfer the funds between the members and clearing-house, In other words,
clearing bank take electronic instruction from the exchange and respond for
pay-ins and payouts.
Agriculture is integral to economic development in India. For a long time,
Indian agriculture has remained isolated from the mainstream development.
Since independence, India has come a long way in removing technological
isolation of agriculture. Efforts were made in introducing scientific methods in
agriculture, including high yielding hybrid varieties. The resulting Green
Revolution has solved the problem of food security for the country. There is a
growing feeling that time has come to remove economic and financial isolation
in which agricultural economy has been functioning so far. Of the efforts being
made in several directions, managing of risks through commodity derivatives
and facilitating financing of agriculture by using Warehouse Receipts has
received particular attention in the recent years.
In the Mid-term Review of the Annual Policy Statement for the year 2004-
05, Governor, Reserve Bank of India announced constitution of a Working
Group on Warehouse Receipts & Commodity Futures with a view to examining
the role of banks in providing loans against Warehouse Receipts and evolving a
framework for participation of banks in the commodity futures market. The
Group had members from the Reserve Bank of India, Indian Banks' Association
(IBA), Forward Markets Commission (FMC), NABARD and select banks
active in agricultural lending such as State Bank of India, Punjab National
Bank, Bank of Baroda and ICICI Bank Ltd. The Working Group was entrusted

45. with the task of evolving broad guidelines, criteria, limits, risk management
system as also a legal framework for facilitating participation of banks in
commodity (derivative) market and use of Warehouse Receipts in financing of
agriculture.
The Terms of Reference of the Working Group were;
a) To examine the role of banks in developing commodity markets - both
cash and derivative – and lay down a road map for banks' participation in
commodity markets as well as to suggest the criteria, limits and risk
management systems for banks in relation to their commodities business;
b) To examine whether banks may offer commodity derivative based
products to farmers to enable them to hedge their risks as they do not
have easy accessibility to the commodity exchanges and may lack
necessary expertise;
c) To suggest enabling measures to encourage flow of institutional finance
to farmers includinglending against Warehouse Receipts;
d) To examine the statutory provisions and suggest necessary amendments
including the provisions of the Banking Regulation Act, 1949 in regard
to dealing in commodities by banks and the Negotiable Instruments Act,
1881 for imparting negotiable status to Warehouse Receipts so as to
enable the banks to play a meaningful role in developing commodity
markets and extend necessary credit facilities;
e) To recommend appropriate level of participation by banks in various
capacities in the commodity exchanges and to suggest necessary
regulatory arrangements;
f) To examine whether the banks may be permitted to take and give
physical delivery of contracts in the commodity derivative markets; and

46. g) To consider any other matter relevant to the subject by the Working
Group.

47. Recommendations Of The Working Group On Warehouse
Receipts And Commodity Futures By The Reserve Bank Of India
(RBI)
1) The Group recommends that Central Government may issue a
notification under clause (o) of sub-section (1) of Section 6 of the
Banking Regulation Act, 1949 permitting banks to deal in the business of
agricultural commodities including derivatives.
2) The Group recommends that a system needs to be evolved by which
Warehouse Receipts become freely transferable between holders as it
would reduce transaction costs and increase usage.
3) The Group recommends creating an umbrella structure, which may act as
a Closed User Group (CUG) for everyone engaged in the agricultural
commodities business. The membership of the CUG may extend to
commodity exchanges, APMCs, commission agents registered with
APMCs, warehouses, exporters, importers and domestic users of
commodities, banks, insurance companies and producers. The umbrella
structure or the CUG is envisaged as an electronic platform that would
offer straight through processing for everyone connected with the
commodities. There can be more than one CUG and that they will be
subject to regulation and supervision by a regulatory authority such as
FMC.
4) The Group recommends that proprietary positions in agricultural
commodity derivatives could be used by banks to mitigate their risk in
lending to farmers. To achieve this, they will have to buy options and
options on futures. Therefore, the Group recommends that the Forward

48. Contracts (Regulation) Act, 1952 may be suitably amended and Fonward
Markets Commission may evolve a suitable framework for option trading
in agricultural commodities in India.
5) The Group recommends that banks may be permitted to have independent
proprietary position in commodity futures linked in a macro way to their
credit portfolio. Banks' exposure to a particular commodity is a general
exposure and cannot be linked to a particular loan. Permitting banks to
have independent proprietary positions is the best way in which banks
can cover their risks. However, suitable risk control measures may have
to be adopted by the banks.
6) The Group considered whether banks may be permitted to deal in
commodities other than agricultural commodities such as oil and gas.
However, keeping in view the current state of development of spot as
well as futures markets, the Group recommends that for the present, it
will be prudent to permit banks to deal in agricultural commodities only.
7) At present, purely cash settled contracts are not available in India. The
banks trading or dealing in commodity contracts should therefore be
prepared to make or accept delivery of physical goods. The Group
recommends that while no restriction may be placed in this regard, banks
may be persuaded to preferably close their positions and cash settle the
contracts.
8) As the farmers are likely to find it difficult to assume positions in future
market of their own, the Group deliberated whether banks can offer non-
standard contracts to the farmers and cover themselves in the exchange
traded futures. The position was examined from the angle of FonA/ard
Contracts (Regulation) Act, 1952. Accordingly, the Group recommends
that banks may offer non-standard contracts to farmers to suit their needs.
The Group also recommends that banks may be permitted to offer

49. commodity derivative based products to farmers to enable them to hedge
their commodity price risk.
9) In regard to OTC contracts, the Group recommends that in order to make
OTC contracts a feasible proposition for banks, the Government may
exempt transferable specific delivery (TSD) contracts, where one of the
parties to the contract is a bank authorized by RBI, from the operation of
all or any of the provisions of FCRA, 1952. This would enable banks to
provide bilateral contracts tailored to suit the needs of their customers
without running the risk of taking or making delivery.
10) The Group recommends that banks may be granted general
permission to become professional clearing members of commodity
exchanges subject to the condition that they should not assume any
exposure risk on account of offering clearing services to their trading
clients.
11) The Group recommends that at least for the present, banks may not
be permitted to act as Trading Members in the Commodity Exchanges.
12) The Group recommends that while banks may continue to hold
their equity stake in the commodity exchanges in order to provide them
financial strength and stability, the banks may reduce / divest their equity
holding to a maximum permitted level of 5% over a period of time so as
to avoid any conflict of interests and address the regulatory concern that
owners of commodity exchanges do not also become traders in these
exchanges.
13) In order to get a global perspective of how banks manage risks
associated with trading in commodities, the Group examined the
guidelines issued by Financial Services Authority (FSA), UK and
Australian Prudential Regulation Authority (APRA). Accordingly, the
Group recommends that the guidelines issued by FSA and APRA may be

50. suitably modified as would be consistent with the instructions issued by
Reserve Bank on capital adequacy and market risk so far.
14) The Group recommends that initially a limit may be placed on a
bank's total exposure or gross positions, long plus short regardless of
maturity, in all the commodities in relation to net loans and advances
and/or capital or net worth of the bank. Initially, the limit could be put at
5% of the net worth of the bank, which could be increased later in the
light of experience gained.
Participation of Fll 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 futures 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

51. futures exchanges remain largely in the shadows of the booming equity markets
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 into 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
managers 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 a high 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
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. Over
here, all options need to be explored from IT-enabled facilities such as display
boards and ticker boards to manual information spread where such facilities are
not available. Initiatives such as ITC Ltd.'s e-choupal need to be encouraged to
facilitate wider participation from the grassroots level of the society.

52. Conclusion
The history of commodity marketing has its origin in the rise of human
civilization. As the nomadic man settle on land to grow crops, he began to
provide service such as those of carpenter, ironsmith, goldsmith, washer man,
and barber. Thus began the exchange of different goods and services between
the producers of different agricultural crop and the service provider. The barter
trade evolved as a result, an in due course emerged the bazaars or markets.
The 21st
century saw the beginning of a transformation in the commodity
market of the country. At the dawn of century the government lifted the Ban on
futures trading and allowed the commodity exchanges to develop futures market
in different commodity and their product so that such trading could effectively
and efficiently serve its twin economic functions of the price discovery and
price risk management. While the old regional and single-commodity exchanges
were permitted to revive future trading in their traditional commodities, three
new demutualised national exchanges were also set up.

53. Visit to MCX (multi Commodity Exchange)
To Understand and study the commodity market point of view on the
investment exchange. I visited the MCX Spared some of his valuable times to
explain in brief about the commodity market he also answered to some of my
question
Which are the national level multi-commodity exchanges?
The national level multi-commodity exchanges are :
•National Commodity Derivatives Exchange Ltd. (NCDEX) – Mumbai.
www.ncdex.com•
Multi Commodity Exchange of India Ltd. (MCX) –
Mumbai. www.mcxindia. Com•
National Board of Trade, Indore(N-BOT) –
www.nbotind.org .
•National Multi Commodity Exchange of India Ltd. ,
Ahmedabad (NMCE) – www.nmce.com
Are the trading terminals / systems for commodity
Futures separate from those of equity futures ?
Since the exchanges are separate, the VSATs, trading CTCL terminals
risk Management Systems, contract notes, etc. are independent of those
for equity futures. We can connect through VSATs, High Speed Internet
Broad bands(Reliance WLL, Tata Indicom Broad bands, etc. )
It is mandatory to take Delivery ?
It is not mandatory to take the delivery of a commodity in a futures trading
contract. However there is always a provision for delivery in commodity
futures trading to ensure that the futures prices are in conformity with the
underlying.The option for delivery is normally with the seller; the buyer/
Seller ; the buyer/seller has to express his intention for delivery about
five to seven days before the expiry. However, provision vary from
exchange to exchange, For instance in MCX u have to give intention to
back office person in head office they will give intention to exchanges by
fax and for Ncdex u have to give intention both in back office as well as
dealers in head office so that dealers have to punch intention in Trader
Workstation Corporate ID on expiry date before 5 pm . Exchange will take
this file for allocation of commodities with quantity to other counter parties
confirmation of delivery can be know next day of expiry at morning as
exchange release Delivery allocation file.
How is a contract settled ?

54. The contract which are not assigned for delivery will be settled in cash.
How much margin is applicable in commodities market
And how is it arrived at ?
Margin is different for each commodity and also changes depending on
the changes in prices and volatility . Under normal circumstances, margin
is between 10 – 15 % of the contract value. As in Stocks, the margin in
commodities is calculated in VaR system. Commodities, like equities,
also have a system of initial margin and mark-to-mark (MTM) margin.
Commodities have many qualities how do I Know which
Quality is being traded in futures ?
The specification of each commodity will be given and mentioned in the
Contract master as attached with this presentation. Each participant will
Be trading in that particular quality only.
How much margin is applicable in commodities market
And how is it arrived at ?
Margin is different for each commodity and also changes depending on
the changes in prices and volatility . Under normal circumstances, margin
is between 10 – 15 % of the contract value. As in Stocks, the margin in
commodities is calculated in VaR system. Commodities, like equities,
also have a system of initial margin and mark-to-mark (MTM) margin.
Is sales tax applicable on trades ? If so , is registration
Mandatory ?
If a trade is squared off no sales tax is applicable. Sales Tax is applicable
only if a trade results in delivery. Normally it is the seller’s responsibility
to collect and pay sales tax. This sales tax is applicable at the place of
delivery should have sales tax registration number for seller not for buyer.
How does the clearing and settlement take place ?
The clearing and settlement takes place through banks arranges by the
exchanges which have tied up with different banks/ Institutions. Ncdex
has tied up with NSCCL for clearing purpose. Mcx has tied up with HDFC
Bank and IndusInd Bank for providing clearing and settlement facilities.
Without owning the commodity,how is it possible to sell
It ?
One doesn’t need to have commodity physically or to own a contract for
The commodity to enter into a sale contract in the futures market. The
Contract is simply an agreement to sell the physical commodity at later
Date or sell it short. It is possible to repurchase the contract before the
Maturity, there by dispensing with delivery of goods.
What happens if there is any delivery or fund default ?
The exchange have a penalty clause whenever the fund or delivery
default happens . There is also a separate arbitration panel of exchanges.

55. Both the exchanges (Mcx and Ncdex) will also maintain settlement
Guarantee funds.
Are options also allowed in commodity derivatives ?
Options in goods are presently prohibited under section 19 of the
Forward Contracts (Regulation) Act, 1952. No exchange or person can
organize or enter into or make or perform options in goods. However the
market expects the government to permit options trading in commodities
soon.
Unit of Trading
1 Pound = 0.454Kg
1 Quintal =100 Kg
1 MT = 1000 Kg
1 Barrel = 159.60 Liter
1 Maund = 0.373242 Quintal
1 Mann (Gujarati) = 20Kg
1 Kg = 1000 Grams
1 Bales = 500 Bags
1 Cartoon = 22.68 Kg
10 MT = 10000 Kg
1 Kg = 31.99 ounce (Gold – 0.995 Purity)
1 Kg = 32.119 ounce (Gold –0.999 Purity)
1 Kg = 32.1507 ounce (Silver – 0.999 Purity)
Contract Value = Total Qty X Price Base price = 20 Kgs

56. Bibliography
Books:
 Commodity Vision [ Magazine, July-issue 1
 Commodity Future [ Quidance Booklet fromMCX]
Websites:
 www.thefreedictionery.com
 www.google.com
 www.mcx.com
 www.nseindia.com