History of Commodity Futures in India & its Regulations

Chapter 4 Overview, Functionality and Governance in Commodities Exchanges

EVOLUTION OF COMMODITY MARKETS

Evolution of futures trading Futures in rice in 17th century Japan. Rice tickets and standardised rules for trading. Organized trading in commodities evolved during mid-19th century in Chicago. CBOT, established in 1848, introduced the first traded derivatives contract in agri. commodities. Evolution of various exchanges across the world

Global Historical Perspective

Forward markets - in London towards the end of 17th Century

US, Canada, Japan and Egypt - 18th Century.

CBOT 1848; standardised futures contracts introduced in 1865

New York Cotton Exchange started in 1870

Chicago Mercantile Exchange was set up in 1898 Legalized options trading started in 1934 in the United States

The Indian Story

Started as early as 1875 Bombay Cotton Trade Association Fears of unhealthy speculation Commodity options trading and cash settlement of commodity futures banned in 1952 Further blow in 1960s Initiative for agricultural liberalization dawn of a new era for commodities

THE INDIAN STORY.

In the 1960s & 1970s the GOI suspended futures trading in several commodities (cotton, jute, oilseeds etc) Khusro committee appointed by the GOI recommended the reintroduction of futures trading in commodities in 1980s Recent history: Suspension/ban on futures trading in Rice, Wheat, Urad & Tur

Indian Market A trip down the memory lane

1875 1900 1919 1920 1921 1927 1957 1966 1980 1994 2000 Bombay Cotton Trade Association Gujarat Vapari Mandali (now BCE) Calcutta Hessian Exchange Futures trading in Gold in B.B.A until mid-1950s East India Cotton Association East India Jute trade Association IPSTA Spices Complete ban Khusro Committee- Cotton, Jute, Potatoes K.N Kabra Committee 1994 National Agriculture Policy

2002-03

3 National Level Multi Commodity Exchange over 100 Commodities allowed for futures trading

Regulation is a Maze of Legalities

Three Tiers of Regulations

Ministry of Consumer Affairs, Food and Public Distribution

Forward Markets Commission FC(R) Act 1952 FCRR 1954 Regulations

Multi Commodity Exchange of India Limited Bye-Laws and Business rules

Indian Derivatives Sector Overview

Leading to Government Initiatives to Develop Exchanges

Ministry of Consumer Affairs

FMC (Forward Markets Commission) Commodity Exchanges

National Exchanges (2)

Regional Exchanges

MCX

NCDEX

NMCE

NBOT

20 Other Regional Exchanges

Forward Contracts Regulation Act, 1952

Empowers Govt. through FMC for regulation of commodities trading Prohibits Options trading Exempts Non transferable Specific Delivery Contracts from regulation Covers Transferable Specific Delivery contracts as well as hedge contracts Empowers Govt. to regulate specific commodity

Forward Contracts Regulation Act, 1952..Contd Grant of recognition to exchange (associations) by Govt. Not more than 4 members on Governing bodies of recognized associations (exchanges) Machinery (regulatory body) FMC Repeal of any State Act on Commodities prevailing (transfer of commodities to Union List)

Forward Markets Commission - Functions

Advises Govt. in providing recognition to exchanges

Watchdog of the commodities derivatives markets

Supplies reports to Govt. on conditions prevailing in the commodities markets Provides recommendations to Govt.

Forward Markets Commission - Functions

Inspection of accounts of exchanges and its members

Approval / amendment of Bye laws, Rules and regulations, Articles of Association and Memorandum of Association of exchanges
Vital link between commodity exchanges and Govt.

Approval of contracts before launch

Evolution of Regulation
Shri. A. D. Shroff Committee in 1950

Prof. M. L. Dantwala Committee in 1966

Prof. A. M. Khusro Committee in 1979 Prof. K. N. Kabra Committee in 1993 World Bank Study (in joint association with UNCTAD) in 1996

Shroff Committee (1950)

Draft Bill for Forward Markets Regulation was made

Inputs received from different commercial organizations Led to passage of the Forward Contract Regulation Act of 1952
Forward Market Commission (FMC) was established in 1953, dedicated to regulation of forward markets

Dantwala Committee (1966)

Review of previous 10 years of FMC Suggest amendments to FCR(A), 1952 Recommended autonomous that FMC be made

Futures in export commodities to be allowed

Futures contracts defined

Options trading not recommended

Khusro Committee (1979)

Review role of FMC commodities markets and analyze

- Not all commodities were to be allowed for futures trading

- Laid down the possibilities for specific commodities such as Sugar and Silver Condition for trade: Homogeneity of commodity and large supply and demand

- Exporters to be allowed to hedge

Kabra Committee (1993)

Exchanges to enlist more members and be demutualised

Ensure Capital adequacy norms

Encourage Computerization

Vigilance Committee surveyors

Arbitrators mechanism) (dispute

and

Panel

of

settlement

Kabra Committee (1993)..Contd.

Options and range forwards to be allowed Recognition to exchanges to be permanent (or at least for 5 years) Time limit for ready delivery contracts to be made 30 days from 11 days Futures trading to be allowed for more commodities

Allow Indian companies to hedge abroad (accepted)

World Bank and UNCTAD (Joint Study)

Opening of Agricultural markets would lead to greater exposure to price volatility Price Risk Management Price fluctuations to be sufficiently large (to ensure price discovery) Efficient transfer of risk from Hedgers to Speculators and Arbitragers Standardization of trading practices Storage facilities to be enhanced Encourage participation of large institutional investors Improve internal management of exchanges

Amendments to FC(R)A, 1952

Updation of existing definitions & insertion of new definitions Changes in provisions relating to composition & functioning of FMC

Enhancement of the powers of FMC

Establishment of Forward Markets Appellate Tribunal along with provision for designating any of the existing Appellate Tribunals under FC(R)A Corporatisation & demutualisation of regional commodity exchanges & setting up of a separate clearing corporation Registration of Intermediaries Enhancement of penal provisions in the FC(R)A Permitting trading in options in commodities

Effectiveness of Regulation

Looking Forward
Currently, Indian commodity exchanges are not allowed to trade index futures. The amendments to FCRA would allow Options to be traded, which would provide depth to the market Finally, Banks , Mutual Funds & FIIs would be allowed to provide maturity to the market

Disclaimer

This presentation has been prepared to provide awareness & information purpose only. While every effort has been made to assure the accuracy of the information contained herein, any affirmation of fact in this reference material shall not create an express or implied warranty that any example or description is correct. This material has been made available on the condition that errors or omissions shall not be made the basis for any claims, demands or cause of action. The information provided, has been taken from sources believed to be reliable, but is not guaranteed by the MCX as to accuracy or completeness , and is intended for the purposes of education and information only. The Rules and Regulations of the Exchange should be consulted as the authoritative source on all contract specifications and regulations.