High margins on narrow agri commodities may hit corporate hedging

Strengthening risk management system further, markets regulator the Securities and Exchange Board of India (Sebi) is planning to increase special margins in narrow commodities to reduce leverage of clients and members and avoid fear of default in case of high volatility. While this could be a safety measure to address high volatility and stop market abuse in case of smaller commodities, brokers fear this could also impact corporate hedging in smaller or narrow commodities. 

There is no definition as of now to call some commodities as narrow commodity, brokers point out.

Although corporate hedging has yet not penetrated in a big way, in some commodities the processors hedge on commodity derivatives exchange because there are no other risk management tools available. This is more important ion case of narrow commodities.

Sources said that Sebi is working to reframe margins clause which participants fear would result into an increase of special or additional margins of 10-15 per cent in narrow commodities especially of high risk potential commodities like castor seed which has already seen several default cases in its high price volatility in past.

Late last year, castor seed prices saw sharp volatility in futures trade with bears dominated the market after bulls took huge position on highs. Castor seed prices in futures trade hit lower circuits continuously for around a week rendering thereby small and medium size traders out of business due to their huge mark-to-market losses.

"This is a risk management tool which would not affect genuine hedgers but certainly arbitrageurs and speculators. Hence, increase in margins would strengthen the entire agri commodity ecosystem and avoid trading default on futures exchange,” said Pritam Patnaiyak, Head- Business, Reliance Commodities.

Interestingly, the regulator is yet to define the parameters of broad and narrow commodities in which regulations are expected to be strengthened.

“While there is no definition set as of now to classify broad and narrow commodities, traders term narrow commodities to the one which is produced in one pocket or state with limited trade accessibility. Similarly, broad commodities are produced, traded and consumes across states or country,” a market trader said.

Meanwhile, the National Commodity & Derivatives Exchange (NCDEX) has already strengthened its trading guidelines after a number of trading members and clients defaulted in castorseed last year. The exchange ensured that genuine losers in castorseed are adequately compensated.

“The increase of 10-15 per cent would help lower leverage in commodity futures trade but certainly help strengthen risk management on commodity exchanges,” said Naveen Mathur, Director (Commodity & Currency), Anand Rathi.

Normally, large traders take funding either from banks of financial institutions on the stocks of narrow commodities. But, in case of high price volatility, they surrender the stock without compensating the mark-to-market margins which renders lenders huge losses.

“The increase in margins would not discourage corporate trading in commodity exchanges but dissuade cartels,” said another trader.

Normally, exchanges levy margins to protect the interest of traders from high price volatility. But, margins sometimes prove insufficient to protect traders in case of extreme high price volatility.