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NCDEX: Major steps in the commodity futures market
Forwards Markets Commission - the Regulator of futures trading in commodities in India and NCDEX the largest Agri Exchange have taken some bold and revolutionary steps in the past week to strengthen the futures markets. These would go a long way in streamlining trading in these markets in India. Major steps taken by the Regulator and the Exchange are:
1. Staggered Delivery: Most of the agricultural commodities traded on the domestic exchanges are under the “Compulsory Delivery” system wherein it is mandatory for sellers to deliver goods upon the expiry of the contract. In a move which gives the seller an option to tender delivery much before the expiry of the contract, the Regulator has introduced a system of staggered delivery in Compulsory Delivery contracts which could go a long way towards easing pressures towards the expiry of the contract and facilitate convergence in the futures and underlying physical markets. Under this system, the Seller can tender delivery any time from the 5th of the expiring month and the expiry date (for contracts expiring in June 2012 onwards). This would have twin benefits of facilitating smooth closure of the contracts as deliveries would be spread over a period of two weeks and permitting the Seller to tender delivery and exit his position, thereby reducing his holding and margining costs. It would also ensure that only buyers who intend to take delivery would remain in the expiry month contract during this period, thereby reducing speculative interest towards the expiry of the contract.
2. Reduction in Delivery Default Penalty: Hitherto, the penalty on Seller in case of delivery default in a Compulsory Delivery contract was at 3 % of the Final Settlement Price plus the difference in the Settlement Price and the average of three of the highest spot prices during five days after expiry of the contract. In scenarios of shortage of goods in the Exchange accredited warehouses, when sellers were not in a position to effect delivery this led default penalty being priced into the futures prices. The penalty has been reduced to 1.5 % plus the difference in the Settlement Price and the average of three of the highest spot prices during five days after expiry of the contract in select commodities Chana, Mustard Seed & Pepper. Relaxing the penalty percentage would reduce the probability of non-convergence between spot and future prices and ensure more orderly expiries of the contracts.
3. Change in Validity Structure: Agricultural commodities have a fixed validity period during which they are eligible to be delivered on the exchange platform. This validity period is in general governed by the shelf life of the commodity. Taking into consideration the low availability and high demand for select commodities in the current season, the Exchange proactively has reduced the validity period of Mustard Seed, Pepper, Soya Bean and Chana. This would result in stocks being moved out of the warehouse at regular intervals during the year which is beneficial in years of shortages.
The Indian farm sector makes a strong case for better cyclicality management. Mercurial agro-climatic conditions, which can seriously impact farm productivity, can aggravate the situation through large variances in agricultural production and inventories. It is felt that by-products, productivity improvements and product innovations combined with price risk management tools would help improve farm sector profitability and reduce the effects of cyclicality. Given the scarcity of additional fertile land, increase in farm productivity will be critical for sustaining the future growth in agricultural production. Other transformational opportunities include better price risk management.
Given the above, a greater adoption of hedging instruments available on commodity exchanges can help commodity value chain participants and also end users mitigate price risk which will be in the larger interest of the farmers.
The above steps are designed to further strengthen the commodities futures market in India.
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