NATIONAL COMMODITY EXCHNAGES: HIGH EXPECTATION OR MISPLACED OPTIMISIM

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NATIONAL COMMODITY EXCHNAGES
HIGH EXPECTATION OR MISPLACED OPTIMISIM ?

• National Multi-Commodity Exchange of India Limited

14th July 2005 ASSOCHAM New Delhi
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Introduction

• NCEs in India are now young enough to walk
• The eldest NMCE Ahmedabad is 33 months old
• Next MCX Mumbai 21 months and
• The youngest NCDEX - Mumbai 18 months

Despite the high pace of growth in terms of
volume, number of contracts floated by them, and
the high public attention they have generated
the time has come to see whether exchanges have
lived up to the high expectation of the masses.
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Expectations from NCEs in India

• NCEs was a paradigm shift in Indian commodity
  futures market considered as a powerful
  institutional strategy to wake up the moribund
  commodity futures market from the decades old
  slumber, though mainly policy induced, resulting
  from the fear of the black trade of the
  scarcity decades.

Cont
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Expectations from NCEs in India

• NCEs with transparent technologies (electronic
  trading), demutualised ownership structure, with
  professional management, and modern innovative
  practices would be able to herald a revolution in
  commodity futures markets
• Thereby could effect a revolutionary transition
  to the fragmented, opaque physical market for
  commodities
• In short it was expected that the child (futures
  market) would hand-hold the physical market
  towards modernization and thereby help the
  creation of national common market
• the cherished but elusive goal of the policy
  makers.

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Institutional Model of NCEs

• The Institutional model of the NCEs was an
  adaptation of the immensely successful model of
  the National Stock Exchange of India Ltd. (NSEIL)
  which was transplanted to the commodity futures
  markets.
• The difference is - it is without the much
  maligned "monopoly model" of the NSE, as three
  NCEs were permitted to create healthy competition
  for the development of the futures market.
• This, in turn, has its implication on the issue
  of Convergence of the commodity futures and
  securities markets - an issue of tropical
  significance.

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How far we achieved?

• On-line, electronic trading has been brought in
  with the accompanying transparency - major
  achievement.
• But the large-scale participation in the markets,
  both inter-spatial or inter-groups is a matter of
  concern!
• Most of the farmers, producers and actual users
  of commodities are still keeping a distance from
  the markets. It is still mainly a traders and
  bucket shops ring.
• Despite a mandate for achieving national level
  reach, spatial concentration confining to
  traditional centres of futures market is yet
  another objective unfulfilled.
• There is little or no participation from many of
  the Eastern and North-Eastern States, excepting
  Kolkota, a traditional centre for jute futures.

Cont
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How far we achieved? Volume of trading!

• NCEs have achieved reasonable success in volume
  of trading with a daily average value of about
  3000 crores
• However, this is restricted to a few
  commodities-gold, silver, soya, guar, rubber and
  pepper.
• More over, the extraordinarily high ratio of
  futures to spot in small volume commodities such
  as guar indicates lack of maturity of the market.
  
• On line trading, it appears, has helped only in
  bringing transparency but could not yet achieve
  the other objectives.

Cont
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How far we achieved? As SROs!

• NCEs were expected to become self-regulatory
  organisations (SROs), that would play the role of
  good Samaritans in promoting rule abiding market
  place .
• They were expected to shoulder a joint
  responsibility with the market regulator in
  promoting fair practices and integrity of the
  markets
• It was also expected that , like NSE, these
  organizations would be in the forefront of in
  promoting institutional structures bringing in
  value added services

Cont
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How far we achieved? As SROs!

• However, the achievements in these areas is
  rather limited, particularly in becoming true
  SROs
• What is being witnessed, is more of 'policy
  bargaining' instead of going by the existing
  rules and trying to bring changes in tune with
  times and market dynamics co-operatively with the
  regulator.
• The shrill of policy bargaining was at its
  deafening peak on the issue of convergence of
  commodities and securities markets

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Physical Delivery in Commodity Futures

• The acid test of a mature commodity futures
  market is its delivery model
• World wide the commodity futures market use
  physical delivery as the settlement mechanism for
  deliverables
• One common argument is that - delivery takes
  place only in about 1 trading, and hence
  insignificant, but it is not true where the
  futures to spot ratio of 20 is the average
  trading volume, and hence 1 means 20 of the
  physical out put.

Cont
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Hindrances in Physical Delivery in Commodity
Futures

• With the introduction of commodity indices
  non-commodities and near commodities cash
  settlement of course has come.
• Given the conditions of Indian physical commodity
  markets,
• their fragmented nature,
• lack of a reliable reference price,
• lack of gradation and certification systems,
• logistical problems,
• There is enormous pressure to avoid physical
  delivery.

Cont
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Physical Delivery in Commodity Futures

• The difference is that though mature integrated
  markets could go for cash settlement in an
  equally efficient manner the similar is not
  possible in a developing market like Indian
  commodity futures
• The 'threat of delivery' acts as a major
  disciplining factor here and help in price
  discovery.
• Instead of going for cash settlements as a
  short cut, additional initiatives in scaling up
  the commodity physical markets by means of
  encouraging many value added functions are
  required today.

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Conclusion

• Therefore the expectation that the NCEs would
  handhold and chart a paradigm shift in the
  physical market - like a child leading the parent
  - has not materialized yet.
• What is needed?
• In order to give a new lease of life to this
  market such environment should be created so that
  more and more participation of Domestic as well
  as Foreign Institutional Investors (FIIs),
  Mutual Funds (MF), Banks Financial Institutions
  can take place. That will lead to overall
  improvement in the economy providing benefit to
  each and every stake holders in this sector.

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