Commodity exchanges try to revive volumes

They are banking on forward trading to make up for the loss due to the dwindling interest in gold and non-farm commodities futures

There's bad news in the commodity futures market. This year, the current annualised volume of the market stands at Rs 60 lakh crore compared to Rs 182 lakh crore in 2011-12. More worryingly, the current volume is lower than the Rs 77 lakh crore recorded in 2009-10. The commodity futures market offers a way to hedge commodity-related trade risks, but with the turnover slipping in recent years, the business finds itself in bad shape today.

Already, of the six commodity exchanges in the country, four are in a dismal condition. The Indian Commodity Exchange, promoted by Reliance Capital, Minerals and Mining Trading Corporation and Indiabulls, and the Universal Commodity Exchange, promoted by Ketan Sheth, have suspended operations, while the National Multi-Commodity Exchange (NMCE) and Ace Derivatives & Commodity Exchange are languishing with drying volumes. Only the Multi-Commodity Exchange (MCX) and National Commodity & Derivatives Exchange (NCDEX) are doing respectable business.

One of the major factors that have led to the dismal volume is the commodity transaction tax imposed on non farm-commodities futures in July 2013. Because of the tax, the spread, or the difference between two trades, has increased from 1-2 paise to 5-7 paise for highly-traded commodities like gold. With the cost thus going up, jobbers have lost interest in the futures trade, leading to a decline in transactions. Add to this the sharp fall in the price of gold and of many other commodities, and the reason behind the dwindling business becomes evident. Import restrictions on gold have also had an impact on volumes because the sudden drop in gold imports has led to a reduction in the need to hedge current positions.

Despite all this, Ramesh Abhishek, chairman of commodities market regulator Forward Markets Commission, or FMC, says, "The volume that we see now is also a good number because it is a genuine volume. There is no froth in it." If the commodities tax is rescinded, the number of transactions will likely jump by 50 per cent as the spread will get profitably narrowed. However, the volumes will continue to remain low so long as the prices of commodities languish at their current low levels.

The reasons why there is no "froth" in the business are interesting. The foremost reason is, of course, the improvement in market regulations, which has helped curb excess speculation. This has shaved off a few lakh crore rupees worth of volumes in the exchanges. A history punctuated by irregularities implies that the exchanges need a strong regulator, which so far is not autonomous. Freeing it from the finance ministry does not appear to be a priority with the government.

The first major regulatory action saw some senior officials of NCDEX being transferred and a forensic audit being carried out around eight years ago. This was followed by action against Kailash Gupta, promoter of NMCE, who was charged with impropriety. The Enforcement Directorate attached his holdings in the exchange. The case between FMC and Gupta is yet to be decided in the Supreme Court and till then the exchange will not be able to sell the promoter's equity despite the regulator having declared him unfit to run the exchange.

The Universal Commodity Exchange is facing a similar problem with FMC ordering a forensic audit of its operations after it received complaints about the promoter's conduct. The audit report is expected this month. Even MCX faced a forensic audit, and after the report highlighted irregularities, FMC declared the promoter company and three directors unfit to hold shares in the exchange, leading to their exit.

For the past seven years, the government has been trying to amend the Forward Contract Regulation Act to give FMC autonomy and statutory status. A new legislation will pave the way to introduce options and index-based futures to provide depth to the market, while allowing banks and mutual funds to hedge their commodities risk. Five months after the National Democratic Alliance government took charge at the Centre, uncertainty prevails because there still is no word on the direction that commodity futures market will take.

While FMC has been taking steps for orderly growth of the business with the aim to put an end to bad practices even at the cost of volumes, it has allowed forward trading in commodities. This is a significant development from the point of view of future growth. NCDEX has already launched this. Samir Shah, MD & CEO, NCDEX, says, "The NCDEX Gold Hedge contracts we offer have built a strong foundation in non-farm commodities. We will continue to aggressively build on it. We are also extremely bullish on the potential of AGRiM SAUDA, the exchange-traded forwards contract from NCDEX." NCDEX has received a good response to forward trading so far, with 1,360 million tonnes of sugar and maize transactions so far across the country.

"We have asked all exchanges to start forward trading as it has a huge potential," says Abhishek. "Later, there could be synchronisation among spot, forward and futures trading." He also says that exchanges should set up subsidiaries for launching spot trading. NCDEX already has one, which has proved very active. Even MCX has a plan to launch forward trading in metals and also set up an e-mandi.

NMCE hopes to revive itself by launching forward trading in a couple of months, beginning with rubber and other plantation commodities. Its CEO, Anil Mishra, says, "We are currently preparing software for forwards. We will introduce an auction mechanism through which sellers and buyers can give their specifications."

While the commodity exchanges are in the doldrums, everyone - from Abhishek to Shah to Mishra - is optimistic about forward trading. They are hoping that this will strengthen the futures market arbitrage between two trades, imparting both depth and volume to the business.