A typical investor or trader steers clear of agri futures such as soyabean, chana, turmeric, and so on. The reasons vary from lack of liquidity and large contract sizes to uncertainty over price discovery, given the lack of a proper spot market in the country. There is also a widespread notion that there is rampant price manipulation in this segment. Here’s a look at some of the factors impeding agri-commodity trading.
The background
The history of trading in agri-commodity futures contracts in India goes way back to 1875, when the Bombay Cotton Trade Association was set up. It was followed by the introduction of futures trading in oilseeds (groundnut, castor seed and cotton) in 1900 and in wheat and bullion futures in 1913 and 1920 respectively. In 1953, the Forward Market Commission (FMC) was formed under the Ministry of Consumer Affairs. The FMC regulated the commodity markets until it was merged with the Securities and Exchange Board of India (SEBI) in 2015.
Currently, commodity futures are traded at three national-level exchanges, namely the Multi Commodity Exchange of India (MCX), National Commodity and Derivatives Exchange (NCDEX) and National Multi Commodity Exchange of India (NMCE). While the MCX concentrates on metals and energy, the NCDEX leads the table when it comes to agri commodity trading. Though NCDEX also trades non-agri products, the exchange’s major volumes come from agri products. Pulses, cereals, spices, softs, etc., are the different categories under which agri-commodities are classified in the NCDEX. Commodities such as soyabean and chana are a few of the top traded products on the exchange.
Scam hits hard
It was a smooth ride for trading in agri-commodities until the National Spot Exchange Ltd (NSEL) scam hit the market. The NSEL was supposed to be a spot exchange, but allowed contracts that could be settled any time between 11 and 36 days. The longer settlement days had increased the participation of speculators rather than genuine users of the commodity.
Trading on the exchange was halted in July 2013, and investigations revealed multiple misdoings, including absence of stocks in warehouses to settle the outstanding contracts, a depleted exchange guarantee fund and creditors unwilling to repay investors their due. This single scam shook the entire Indian commodity market. As a result, volumes in the commodity exchanges tumbled. In 2014, volumes fell by 11 per cent over the previous year while in 2015, there was a small increase by one per cent.
Abrupt halts
Another major issue that makes investors prefer other commodities, such as gold, metal and other asset classes, such as equities, is the sudden and abrupt halting in trades of the commodities traded on commodity exchanges. A good example is the most recent suspension of trading in castor seed in January this year. Increase in speculative activity and volatility made the NCDEX stop trading in this commodity, explaining in a circular that the action was taken to “ensure market equilibrium”.
It is not the first time the NCDEX had suspended a commodity from trading. Earlier, in 2008, chana, rubber, potato and soyoil were suspended for a few months. This was followed by such commodities as sugar, guar seed and pepper. While other commodities were reintroduced for trading later by issuing fresh contracts, pepper is still not available for trading.
More recently, in June, SEBI ordered the NCDEX to stop trading and launching new contracts in chana. As per the order, no new contracts can be launched in chana and no new positions can be taken on the existing contract. The only activity you can do now in the chana contract is to square off existing positions.
In addition to these, the exchanges frequently raise the margin requirements in the contracts to curb volatility and reduce the speculative activities. Last week, the NCDEX increased the initial margin requirement for selected commodities. For instance, the trading margin in dhaniya was raised from 4.45 per cent to 6.3 per cent and for chana (2 mt) from 7.9 per cent to 11.17 per cent. Margins are increased with the intention of checking speculation by increasing the cost of trading. However, experts say such moves have not actually served the purpose.
What’s on the cards?
With SEBI at the helm, regulating commodity markets now, commodity trading processes are expected to improve and the various issues described above are likely to be sorted out.
SEBI also intends to introduce options contracts and allow foreign investors and banks to participate in the commodity markets. Such moves will be a big positive from a long-term perspective as they could aid in improving market participation. But the biggest challenge before SEBI is to restore investor confidence; that will be evident only if volumes pick up.