Indian companies have largely stayed away from hedging the price risk of raw materials on domestic exchanges. The Securities and Exchange Board of India (Sebi) has sought help from the Reserve Bank of India (RBI) to bring them on board.
The market regulator, along with members of the Commodity Derivatives Advisory Committee (CDAC), is planning to meet the RBI, which can ask banks to advise Indian corporate borrowers to hedge their commodity price risk on domestic exchanges. The proposal to meet the RBI was made at the CDAC meeting last week.
Mandatory hedging by companies of their commodity risk on domestic exchange is set to serve a dual purpose and protect interest of both buyers and sellers from price volatility. This will eventually swell trading volumes on commodity exchanges. Unfortunately, the bourses have failed to grab corporate hedging opportunity during the past 17 years of their recognition in 2002.
“In the last CDAC meeting, it was discussed that Sebi would lead a delegation of commodity value chain and other committee members and meet the RBI with a request for banks to advise their clients to make corporate hedging mandatory on domestic exchanges,” said Narinder Wadhwa, President, Commodity Participants Association of India (CPAI).
Sebi has already done its best to attract corporate participation. Through a recent circular, it has asked exchange-listed entities to disclose their hedging details in the annual report. Corporates in their respective annual reports have disclosed minimal quantities of hedging on domestic commodity exchanges.
“Except for a few commodities, corporate hedgers have stayed away and that has posed a severe threat to businesses that are exposed to highly volatile commodity prices. Lack of hedging has eroded profits in the high-risk commodity business. Companies are not hedging on their own. If, on RBI’s instructions, banks who are lending money to these borrowers insist that they hedge on commodity exchanges, that would protect the lenders also,” said the source.
Sebi, however, cannot direct corporates on their business decisions. Hedging of commodities, whether raw materials or finished products, should be done by the respective corporate entity only. Lenders can advise their corporate clients to hedge their risks wherever they have commodity exposure, especially those borrowers who have placed commodities as collateral or have taken loans to manufacture them.
“Hedging should be a decision of individual corporate to protect itself from commodity price volatility,” said Kishore Narne, Associate Director, Motilal Oswal Financial Services Ltd.
Sources, however, raise issues of thin liquidity on many contracts and several commodities are still not available for hedging, but the regulator is of the view that once the hedgers come, financiers and exchanges will be ready.
Apart from corporate participation on commodity exchanges, the CDAC meeting discussed issues like enhanced disclosures with respect to exchange-accredited warehouses and lean-month policy for derivatives contracts on agricultural commodities. The CDAC delegation is set to meet RBI by September-end.
Wadhwa, however, said that even RBI cannot impose business decisions on banks or change the banking regulation to force corporate to hedge their commodity risk on domestic exchanges. “The concerned lenders can only advise their clients. Beyond issuing an advisory, even banks cannot do anything,” he added.
Meanwhile, commodity exchanges have posted a 44 per cent increase in their cumulative daily average turnover (DAT) to Rs 41,363 crore for September 2019 from Rs 28,744 crore crore in January this year. The Multi Commodity Exchange (MCX) recorded a 50 per cent growth in its DAT this calendar year to Rs 39,577 crore in September, from Rs 26,473 crore in January. Other exchanges posted a decline in their DAT this calendar year.