Commodity Insights Yearbook (Part 1)

Introduction
About Commodity Insights

The Multi Commodity Exchange of India (MCX) and PricewaterhouseCoopers (PwC) joint effort — Commodity
Insights — is a first-of-its-kind yearbook on commodities aimed at giving its readers rare insights into the entire
commodity ecosystem.
Commodity Insights will have a plethora of useful databases on commodity markets arranged in a novel way so
that it is extremely useful to virtually all the ecosystem stakeholders as a one-point source for quick and easy
reference.
Additionally, this unique publication attempts to deliberate on issues and concerns (with suggested solutions)
that ought to be resolved for a healthy development of the domestic commodity market. This will be in the form
of articles authored by change agents and thought leaders to provide a rich repertoire of analytical articles.
Thus, Commodity Insights promises to be truly useful to not only all the commodities market stakeholders, such
as traders, processors, consumers, banks, policymakers, analysts, and industry observers, but also others who
matter in this industry, giving them a year-long reference book that is both fascinating and engaging. The
yearbook aspires to be a benchmark resource for spreading knowledge about the commodity market.
About PricewaterhouseCoopers
PricewaterhouseCoopers (PwC), which measures its success by its clients, provides industry-focused advisory
and tax services to build public trust and enhance value for its clients and their stakeholders. PwC professionals
work collaboratively using connected thinking to develop fresh perspectives and practical advice.
Complementing its depth of industry expertise and breadth of skills is PwC’s sound knowledge of the local
business environment in India, with offices in Mumbai, New Delhi, Kolkata, Chennai, Bangalore, Gurgaon,
Hyderabad, Ahmedabad, Bhubaneshwar and Pune. PwC is committed to working with its clients to deliver the
solutions that help them take on the challenges of the ever-changing business environment.
About Multi Commodity Exchange of India

Multi Commodity Exchange of India (MCX) is a demutualised commodity exchange with permanent recognition
from the Government of India to facilitate online trading, clearing and settlement operations for commodity
futures markets across the country. Since its inception in November 2003, millions of small and medium
enterprises, corporate houses, exporters, importers and traders have benefitted from this nationwide electronic
trading platform through its efficient and transparent price discovery and price risk management. MCX ranks
No. 1 in silver, No. 2 in gold, and No. 3 in crude oil, natural gas, copper and zinc futures trading (by the number of
contracts traded in 2008-09), according to FIA and data put up on exchanges’ websites.
2 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

Content
FOREWORD 5
FROM THE EDITORIAL DESK 7
MARKET COMMENTARY 9
EXPERTS’VIEWS
1. An Integrated Approach to Agriculture Marketing and Financing

By Prof. Gopal Naik 14
2. Commodity Futures in India – A Product of Globalisation and Liberalisation

By Mr. Lamon Rutten 22
3. Role of Mutual Funds in Commodity Markets

By Mr. Venkateswaran R. 30
4. Banks on Commodities Futures Platform – A Win-Win Situation

By Mr. P. V. Ananthakrishnan 34
5. Warehouse Receipt Finance for Farmers – A Glimpse

By Mr. Nachiket Mor and Dr. Kshama Fernandes 42
6 Carbon and Clean Energy Markets – the Potential in India

By Ms. B.G. Ramola and Mr. Prashant Vikram Singh 49
7. Commodities Derivative Hedging: Portfolio and Effectiveness

By Mr. Kumar Dasgupta and Dr. Chiragra Chakrabarty 53
8. Role of Brokerage Industry in linking Ecosystem with the Futures Markets

By Ms. Priti Gupta 62
9. Role of Banks in Indian Commodity Derivative Markets

By Mr. Shailesh Sukhthankar 65
10. Agriculture Financing under OTC Products

By Mr. Venkatesh Tagat and Mr. Narendra Rathore 69
11. Commodity Exchange Technology Concepts – Looking Forward

By Mr. Dipankar Chakrabarti and Ms. Rachna Nath 75
12. India Needs to Usher in the Next Agricultural Revolution

By Mr. Amitabh Jaipuria 81
DATA FOR READY REFERENCE
Non-Agricultural Commodities 87
Agricultural Commodities 171

Dated 6th October, 2009
FOREWORD
Commodity markets in India have had a chequered but long history with the futures markets
remaining in virtual hibernation — a large part of them in the unorganized form — for over
four decades before they were resurrected in 1999-2000 as part of various reform measures
initiated by the government. The market was opened up for futures trading in any
commodity without any restrictions. However, the commodity futures market came really
into its own with the advent of national electronic futures exchanges in 2003. In just about
six years since then the sector has embarked upon a remarkable journey of rapid growth and
national outreach, integrating the asymmetrically informed or ill-informed, fragmented
domestic physical markets through effective application of information, communication
and technology (ICT) as well as connecting them with it through the creation of forward and
backward linkages. The Indian commodity futures market, comprising 19 commodity-
specific regional exchanges and three national-level multi-commodity electronic
exchanges, has staged a spectacular comeback with the total turnover increasing by a
compounded annual rate of over 100 percent during this period.
What lay behind this whole turnaround — from the hitherto status of the Indian commodity
markets as a ‘price taker’ to be on the path of being a ‘price setter’ — has been the increased
streamlining and convergence of diversified information on the market fundamentals of
commodities through transparent interaction of various stakeholders of the ecosystem on
the organized platform. And this was largely achieved through the sustained awareness-
creation and outreach efforts taken by both the exchanges and the Forward Markets
Commission besides coming up with innovative products, dynamically aligned from time to
time in keeping with the changing market/stakeholders’ needs. The hallmark of these
exchanges lies in the level of efficiency of market mechanism, the maturity and the globally-
competitive edge that they have managed to build into them in this short span of time,
because of which the Indian commodity futures market has scaled the heights of global
reckoning.
Information on commodities that constantly flows into and out of the commodity markets
remains the key driver of the price discovery and risk management process for which they
were brought into being in the Indian economy. It also makes the exchange platforms useful
and effective for participation by various stakeholders from within the ecosystem, such as
producers, processors, hedgers and arbitrageurs. The domain knowledge and expertise of
the previous generations which was largely lost in the decades of trading ban has been built
back to a large extent in this short span of time. This market which was known for its
innovations including creation of a revolutionary trading and risk mitigation concept called
“options” is rising from the ashes like a Phoenix once again and will certainly occupy a place
of pride in the global comity of commodity markets within the next decade or so. It is the
promotion of market research and knowledge management through generation and
maintenance of market information, and building up of rational expectations in the market,
which are of paramount importance to put it on the right path towards becoming the ‘price
setters’ for the global markets in many commodities.
FOREWORD |5
In this context, the initiative of the Multi Commodity Exchange of India (MCX) and
PricewaterhouseCoopers (PwC) to bring out a yearbook on data and information related to
the commodity markets and their fundaments is both timely and a very welcome one. I
congratulate them for this initiative. I am confident that this inspiring effort of theirs will go
a long way in encouraging extensive and intensive research into the Indian commodity
markets as well as pave the way for transforming the country’s commodity database
management towards excellence, becoming a constant, ready source for all kinds of
references by various stakeholders including industry players, traders, market analysts,
academicians, businesses, researchers and students. This, I am sure, will not only nurture
and strengthen the commodity markets to bring greater economic benefits to the
stakeholders but also benefit the national development strategy for the economy as a whole.
I wish the publication all success. Happy reading.

From the Editorial Desk
It is our pleasure to come together on a joint platform objective of better decision making. Global commodity
to bring ‘Commodities Insights’ yearbook to enrich the exchanges such as CME and CBOT, among others,
whole ecosystem consisting of varied stakeholders periodically publish information on markets which is
ranging from policymakers to avidly followed by those to whom it matters most.
academicians/researchers to media. Since the Indian Domestically, various sectors including infrastructure
commodity markets came into being, not only media and financial services have their own examples that led
and policymakers but also traders themselves have us on our way to providing a shape to this product.
been scrambling for data that they could use to put
prices and the market into an appropriate perspective.
In the process, those whoever succeeded in garnering
the necessary data were enabled to achieve their
objective while others who did not had to leave their
objective behind due to this lack of information. As a
result, despite their impressive growth performance,
the commodity markets lacked appropriate scrutiny by
the stakeholders to prove the worth for their existence
even though they had started making inroads into the
lives of both consumers and producers besides
effectively linking them with the financial markets.
Having reached several milestones in its journey to Standing (L-R): Mr. Nazir Ahmed Moulvi, Mr. Sujan Bhattacharyya, Mr. Niteen Jain
become India’s largest exchange, driven by its strategic Seated (L-R): Ms. Carol Daver, Dr. V. Shunmugam, Ms. Vidya Shintre
partnerships with various other ecosystem players, it
was time for MCX to join hands with While the raw market data was a key part of the
PricewaterhouseCoopers to bring in yet another global endeavour, we gave our best to think innovatively to
benchmark practice into the Indian commodity compile and publish various useful and related
markets, fulfilling the role of empowering the market variables in such way that the collection shall remain a
participants and perfecting the process of price one-stop shop for information that would be needed
discovery on its platform. Participants and followers of by all the stakeholders. Besides the datasets related to
global commodity exchanges keenly await publication commodities and their ecosystem, in our endeavour to
of such material covering all the global fundamentals flag the market growth and related issues we
year-wise in order to empower them to achieve their approached experts, in respective domains connected
with commodity futures, to analyse them and put them
in an appropriate perspective for researchers and
policymakers to fall back on them whenever the need
arises which would otherwise be missing. We did our
best to include all the related variables and flag the
growth process and issues impeding the market
growth, along with the potential that it holds for the
future, through a number of technical and non-
technical articles authored by the invited experts.
However, we are fully aware that improvement of this
once-in-a-year effort will be a continuous affair and we
assure users that we will take a giant leap to make the
yearbook a far more enriched product when it is
Standing (L-R): Mr. Sarvesh Ramachandran, Mr. Dhruv Madeka, Mr. Ankan Mondal released from our desk next year.
Seated (L-R): Mr. Kumar Dasgupta, Dr. Chiragra Chakrabarty
FROM THE EDITORIAL DESK |7

We would like to thank Mr. Jignesh Shah, Vice Chairman MCX for the enormous efforts they put in, day in and
– MCX; Mr. Lamon Rutten, MD and CEO – MCX; Mr. day out, without which this book would have remained
Joseph Massey, MD and CEO – MCX-SX; and Mr. Kumar just a concept. And finally, this message from the desk
Dasgupta, Partner – Price Waterhouse; for their will not be complete without thanking Ms. Carol Daver
continuous encouragement and support towards this and Ms. Vidya Shintre, who efficiently marketed this
initiative of ours without which it would have been only initiative of ours and got the much needed financial as
half done. We would also like to thank Ankan Mondal, well as knowledge support towards its
Sarvesh Ramachandran and Dhruv Madeka from PwC accomplishment.
and Sujan Bhattacharya, Niteen Jain, Nazir Ahmed
Moulvi, Dr. Ritambhara Singh and Dhiraj Pandya from
Dr. V. Shunmugam Dr. Chiragra Chakrabarty

Chief Economist Associate Director
Multi Commodity Exchange of India PricewaterhouseCoopers

Market Commentary
Indian Commodity Futures Markets – Still Evolving…

Futures trading plays a key role in the marketing of a number of important agricultural and non-
agricultural commodities as it provides the industrial and farming communities with a
transparent price discovery platform, which also enables them to hedge their price risk and price
volatility. The growth of Indian commodities futures trading towards an efficient, transparent and
well-organised market has thrown open a window of benefits and opportunities to Indian
producers and traders. Besides the primary benefits of its twin economic functions of price
discovery and price risk management, commodity futures trading has also played an instrumental
role in integrating various fragmented components of the commodity ecosystem, thus
developing the overall infrastructure of agricultural commodities marketing in the country.
The yesteryears… the government in 1918 set up Cotton Contracts

Committee, which was soon (1919) replaced by Cotton
Forward/futures markets have come a long way since Contract Board. Futures trading in oilseeds was
the days of the “rice tickets” in Japan and the first organised with the setting up of Gujarati Vyapari
organised futures market in the form of the Chicago Mandali in 1900 in Bombay. And, over the years, the
Board of Trade (CBOT) in the US. Forward contracts derivatives market developed in several other
were the earliest form of commodity derivatives, and commodities in the country: raw jute and jute goods in
futures contracts have existed for centuries in one form Calcutta (1912), wheat in Hapur (1913) and then bullion
or the other. in Bombay (1920). However, soon there were wide-
spread fears that derivatives trading fuelled
In India, the earliest reference to “futures’ can be found in unnecessary speculation in essential commodities and
Kautilya’s Arthashastra, and the trade shot into was therefore detrimental to healthy functioning of the
prominence in the mid-nineteenth century when markets for the underlying commodities and,
trading in agricultural commodity futures in the US therefore, to farmers. To curb speculative activity in the
became organised. After the first recorded instance of cotton market, the Government of Bombay barred
futures trading in “rice” in 17th century Japan, it took off options trading in cotton in 1939. This was followed, in
in the US with “grain” contracts on CBOT (the first 1943, by a ban on forward trading in oilseeds and some
exchange to start there in 1848). Metals followed suit other commodities such as food-grains, spices,
with contracts traded on the London Metal Exchange vegetable oils, sugar and cloth.
(LME) in 1878. Thereafter a number of commodity
exchanges facilitating futures trading in numerous agri- As, post-World War II, the Great Depression had its
and non-agri commodities sprang up the world over. devastating effects on economies around the world
during 1939-45 and the British rulers imposed controls
In India, organised commodity derivatives trading over the financial markets, the Indian commodity futures
began with the Cotton Trade Association’s debut in market slipped into virtual extinction. It disintegrated
futures in 1875. Cotton merchants of Bombay took cues and went into a hibernation, only to continue negligibly
from the US and the UK, and to regulate futures trading in the form of over-the-counter (OTC) contracts. Almost a
MARKET COMMENTARY |9
decade later, Parliament passed the Forward Contracts ban on some commodities in January 2007 and then in
(Regulation) Act, 1952 (FCRA) to regulate commodity May 2008 as well as imposition of higher margins and
futures trading in the country. stringent norms for trading, the growth in trade
volumes slowed down to Rs.40,65,983 crore in 2007-08.
With the process of liberalisation and globalisation of Nevertheless, the Indian commodity futures market
the Indian economy and consequent reforms in its staged a comeback in 2008-09 with a sharp increase in
financial markets in the early 1990s, the Prof. K.N. the turnover to Rs.52,48,956 crore, notwithstanding
Kabra-headed committee, set up by the Government in the ban. As the percentage of Gross Domestic Product
1993 to examine the role of futures trading, made (GDP) at market prices, the total trade accounted for
several recommendations including cer tain 97.3% in 2006-07, which only marginally slipped to
amendments to Forward Contracts (Regulation) Act 94.1% in 2007-08 but shot up to 106.4% in 2008-09. In
1952 and strengthening of the Forward Markets the current fiscal, for the April 1-August 31, 2009
Commission (FMC). As it agreed to and acted upon period, the cumulative value of trade stands at
most of these recommendations, the Government Rs.27,29,248.80 crore, a y-o-y jump of 31%. And a major
allowed futures trading in all the commodities part of it was due to a surge in the trade volumes of
recommended. The trade came into being after agricultural commodities futures, which shot up by
remaining in hibernation for nearly four decades, as 53.5% to Rs. 405,671.40 crore, followed by the trade in
realization that derivatives do perform a role in risk the energy and industrial metals complex, which
management dawned. The timing of this revival effort, jumped by 27.5% to Rs.22,89,316.20 crore. After
from the four decades of restrictive government significant declines in the trade volumes of agricultural
policies, turned out to be spot on, as the 1990s commodities in the previous two consecutive fiscals i.e.
heralded an upswing in the commodity cycle, globally. 2007-08 and 2008-09, the rise in agricultural
FMC and the Government, on a fast-track mode, commodities’ trade in the current year is noteworthy.
encouraged the idea of setting up commodity
exchanges with state-of-the-art infrastructure and
global best practices, and three national-level online
exchanges — the Multi Commodity Exchange of India Given the growth in trading
Ltd. (MCX), the National Commodity and Derivatives volumes and increasing integration
Exchange Ltd (NCDEX) and the National Multi-
Commodity Exchange Ltd (NMCE) were born. of Indian economy with the rest of
the world, the Indian commodity
The current scenario futures market has begun to be
recognized among the top
At present, 24 commodity futures exchanges are
operational in India, which include 21 regional bourses derivatives exchanges of the world.
and the three national-level players, with another three
proposed exchanges on the cards. With the state-of-
the-art technology-powered modern, secure and
efficient operational infrastructure these national The Indian commodity futures market has emerged as
exchanges are creating a near-perfect market situation one of the fastest growing markets with a combined
with a much wider participation from the ecosystem trade turnover of around Rs.52.48 trillion ($1.14 trillion),
stakeholders in a large number of domestic and global and the phenomenal growth (110% compounded
commodities during local and international timings. annual average growth since the market’s resurrection
in 2003) is largely attributed to continuous outreach
Since the reintroduction of commodity futures trading efforts and all-round innovation by its national-level
in India in 2003, the bulk of trading has been taking place electronic commodity futures exchanges, which
on the three national exchanges. Despite being a late includes launches of a slew of new products suitable to
starter, MCX overtook other domestic exchanges and the fast-changing market dynamics and needs such as
continues to be the No. 1 commodity futures exchange certified emission reduction (CER), aviation turbine fuel
in the country (by numbers/lots of contracts traded) with (ATF), gold guinea contracts, and so on. As per FMC
a market share of 85% as on August 31, 2009. estimates, total turnover of commodity futures trading
is expected to cross Rs.60 lakh crore in the current fiscal
Speaking of the combined turnover of domestic (2009-10) and Rs.100 lakh crore by 2010-11, provided
commodities exchanges, what began with a notional the FCRA amendment Bill is passed.
value of Rs.1,29,364 crore in 2003-04 increased to
Rs.36,77,226 crore in 2006-07. However, following a

Given the growth in trading volumes and increasing Prevailing prices of banned agricultural commodities
integration of Indian economy with the rest of the and the volatility that existed in their cash markets
world, the Indian commodity futures market has begun clearly indicate that their trading in organised and well-
to be recognized among the top derivatives exchanges regulated markets would have kept the volatility in
of the world. According to Futures Industry Association their prices under control than otherwise.
(FIA) and data put up by benchmark international
exchanges, for the year ended March 31, 2009, MCX Regulatory and market developments
fares as the world No. 1 in Silver, No. 2 in Gold (followed
by NYMEX and TOCOM) and No. 3 in Natural Gas, Crude Abolition of CTT – The Union Budget 2009-10 did
Oil, Copper, and Zinc futures (by the number of away with the Commodity Transaction Tax (CTT) of
contracts traded). Until August 31 of the current fiscal, 0.017% proposed in the Budget 2008-09. This will help
MCX retained its leadership position with 85% of the Indian commodity futures markets not only become
total turnover of all the 24 exchanges. globally competitive but also develop into benchmark
markets, at the international level, by becoming ‘price
Drop in agricultural commodities trading volume setters’ in many commodities (India is currently a ‘price
taker’ despite being one of the world’s largest
There had been a significant decline in the volumes of producers/impor ters/expor ters of about 17
futures trade in agriculture commodities. During 2007- commodities) through much wider participation. The
08, it fell by 28.5% and the trend continued in 2008-09 move will also help mobilise the resources that would
as well. And a major part of this fall in the trade volumes have otherwise been diverted to CTT towards
of agricultural commodities was accounted for by enhancing expertise and skills of domestic commodity
Chana, Maize, Mentha Oil, and Guar seed, Potato, Guar futures markets to international standards. The
Gum, Chilly and Cardamom. The trade in these eight proposed tax, had it been implemented, would have
commodities, which accounted for 57.9% of total futures stunted the growth and maturity of a still-nascent
trade in agri-commodities in 2006-07, plummeted by market whose turnover is less than even half (only 40%
over 66.4% during 2007-08 compared with the previous in 2008) the country’s equity market turnover, while
year level. Further, this fall (in the eight commodities) globally the corresponding figure is 5 to 10 times.
exceeded the overall drop in futures trading volumes in
all agricultural commodities together.
While the trade in non-agricultural commodities,

especially bullion and crude, has increased in the past The passage of the FCRA
two financial years, the same in agricultural
commodities has declined. The share of agricultural amendment Bill, currently being
commodities almost halved during 2008-09, due to the awaited, will clear the deck for
continued ban on several commodities. Futures
trading in Wheat, Rice, Tur and Urad was banned in introduction of long-awaited
March 2007 by the government following pressure
from many quarters blaming the futures market for an
instruments in commodity
unprecedented surge in retail prices of food derivatives such as options and
commodities, though later the Abhijit Sen committee
appointed to find out the truth, found no direct link
index-based trading, which will
between the price rise and futures trading. The deepen the market through wider
agricultural commodities vertical suffered another
shock on 7 May, 2008 as four other agri-commodities participation of entities like banks,
— Chana, Soy Oil, Potato and Rubber — were banned mutual funds, FIIs.
for four months until December 3, 2008 citing the same
reason. Rice, Tur and Urad are still under ban, while the
ban on what futures was lifted on May 15, 2009. Lately,
Sugar was also banned on May 27, 2009 following a
shortage and the associated increase in its price.
MARKET COMMENTARY | 11
Amendment to FCRA: The proposed amendment to Conclusion
FCRA will make FMC an autonomous regulator with
functional and financial autonomy to play its Indian commodity exchanges have come a long way,
regulatory role more effectively alongside its with an impressive growth during the last six years
developments responsibilities. The passage of the since 2002-03 when the government embarked upon
FCRA amendment Bill, currently being awaited, will policy liberalisation. The three national online
clear the deck for introduction of long-awaited exchanges came into being, taking the erstwhile
instruments in commodity derivatives such as options turnover of Rs.66,530 crore to Rs.52,48,956 crore in
and index-based trading, which will deepen the market 2008-09. As these exchanges grew over the past six
through wider participation of entities like banks, years, they also took along with them the stakeholders,
mutual funds, FIIs. A large number of risk-averse besides nurturing the ecosystem delivering both the
economic stakeholders will likely be attracted towards felt and the unfelt benefits of their existence to one and
the market with increased information about all in the commodities supply chain right from the
commodities enabling hedging of price risk at much producer to the consumer. During this small yet
lower costs (driven by increased liquidity). This will help remarkable journey, these state-of-the-art exchanges
India emerge as a price taker with a transparent flow of have also crossed several policy hurdles to grow in
market information converging from a highly increased stature equivalent to their international counterparts,
number of domestic and international participants. This seamlessly integrating with the entire financial
will also guarantee fair returns to farmers. markets architecture. They also did help spread risks in
major commodities ecosystems across several
Regulatory measures: FMC has recommended a stakeholders thereby making the economy more
reduction in central value added tax (cenvat) from 8% competitive in the current rapidly globalising world.
to 5%. It has also directed commodity exchanges to Being online with extended hours of operation, these
levy non-compliance charges on high-value cash modern commodity exchanges have also enabled the
dealings. However, it stated, cash transactions up to Indian industry manage risks as they flow from their
Rs.10 lakh will attract no charges, while traders will origins crossing economic borders. It is a further policy
have to pay 0.1% of commodities’ transaction value if boost and socio-economic-institutional change as
they wish to settle in cash. The move obviously aims to discussed above that will take the Indian commodity
discourage cash dealing in commodities. markets to a much higher level of growth to help the
economy allocate its resources effectively as with the
developed economies, spread the risks thinly among
all the stakeholders, and wade through the fear of
globalisation affecting our economic and political
stability.

EXPERTS’
VIEWS
An Integrated Approach
to Agriculture
Marketing and Financing
By Prof. Gopal Naik
An integrated approach, in which efficient systems of e-spot trading, grading and

quality certification, scientific warehousing and collateral management, crop/weather
insurance, and futures-benchmarked OTC offered forward contracting can exploit
complementarities between agricultural marketing and financing, will help solve
current problems in these functions.
Agriculture sector development in India is very critical agricultural commodities. This Act helped in
today than ever before as the sector still supports establishing nearly 7,500 regulated markets
nearly two-thirds of the country’s population even throughout the country and stipulating how
though its share in national gross domestic product is agricultural trade should take place. The APMCs, set up
less than one-fifth, which creates a situation where a in major production and arrival centres across the
large number of households have too small an income country, perform the crucial function of organising
to sustain their life. In addition, there are also serious agriculture trade and providing a meeting point for
questions raised about food security in the country. buyers and sellers. However, during the past 50 years,
Any effort to improve rural conditions on a sustainable no significant improvement has taken place in the
basis hinges to a large extent on how agriculture functioning of agricultural markets. Though the APMCs
income can be increased. These efforts will have to be were set up to protect farmers from exploitation of
in the form of policy instruments in the area of intermediaries and traders, as well as ensure better
technology, markets, infrastructure and institutions. prices and timely payment for their produce, these
India has had a very successful technology markets have become inefficient over a period of time.
development in the past in agricultural production in
general and particularly in crops such as cotton, maize Agriculture sector financing has so far mainly
and vegetables recently. Even now, a number of concentrated on production financing, leaving behind
technology options seem to be available at the equally important marketing finance. During the Green
laboratory level waiting for appropriate market, Revolution, cooperative institutions played a major
infrastructure and institutional conditions for effective role in providing production financing in many parts of
adoption. Institutional conditions perform an India. However, over the years, various policies of the
important function of providing easier financing to the government weakened the performance of these
agricultural sector through creating appropriate institutions creating a major vacuum in financing
processes. All these factors are interrelated and unless agriculture. This has enormously affected agriculture
changes in them are made in an integrated manner, sector growth in the country. While considerable
they will not help in creating an enabling environment efforts have been made in recent years to improve
for faster growth. India has certainly lagged behind in agriculture financing through measures such as loan
terms of bringing appropriate changes in markets, wavers, reduction in interest rates, mandating banks to
infrastructure and institutions in order to leapfrog increase the share of loans to the sector, and Kisan
development of the agriculture sector. Credit Cards, among others, a large gap still remains
between provisioning and the requirement, forcing
Agricultural Marketing and Financing in India farmers to fall back on the informal sector. The world
over agricultural marketing and financing developed
During the Green Revolution, a major reform was together as complementary to each other. However, in
initiated when almost all the states brought in India, they are dealt separately ignoring this attribute
legislation the Agriculture Produce Market Committee of complementariness.
(APMC) Act to ensure an efficient system of trading

In recent years, liberalisation of agriculture trade in the crop-acreage and forward contracting decisions
India as part of the globalization process has created simultaneously based on the prices offered in the
enormous pressure to reform the agricultural forward contracting arrangement. The forward
marketing system to be in tune with the rest of the contracting system will be tagged on to the futures
world both in terms of quality and efficient handling of market, with the contract price derived from futures
agricultural produce. And this challenge has been prices. Farmers should be able to sell the crop to the
accentuated because there has hardly been any extent of insured quantity. These forward contracts are
worthwhile reform undertaken in the country’s the over-the-counter (OTC) transactions available at
agricultural marketing for a long time now, while APMCs, organised by private players and are based on
elsewhere technology development, especially that of the prevailing futures prices. This will be essentially
information and communication, has been effectively retailing futures contracts to farmers. A farmer can use
used for improving the agricultural marketing system. the forward contracting facility at any time during the
In addition to technology development, several crop production period. Based on the forward contract
process improvements need to be brought in to reduce and yield insurance, the farmer should be able to take
the cost of transaction, which will help increase the additional loans if he intends to do so. The forward
price realised by the grower and decrease the price contract buyer may have reinsurance arrangement to
paid by the consumer. Lower prices at the consumer meet the financial obligations in the event of a crop loss
level increases demand and higher prices at the farm which should not be recovered from the claim of the
level increases supply, and these two changes together farmers from the agency that had provided them with
result in large volumes of production and crop insurance. This insurance may be given by the
consumption, benefiting both consumers and same agency as the crop yield insurance which may
producers and, thus, contributing significantly to the facilitate faster processing. The Food Corporation of
economy. India should buy the contract in case farmers are
prepared to sell at the announced minimum support
New System for Agricultural Marketing and Finance prices. This futures contract, along with the crop yield
insurance, enables farmers to get bank credit in
Complementarities between agricultural marketing addition to the crop loan. Once the harvest is done, the
and financing help evolve an integrated approach to farmers can check the quantity and quality of the
address the current problems in these functions. A produce. And they will have the following options (see
good marketing system facilitates easier financing and flowchart):
a good financing system improves efficiency in
marketing. The ultimate objective is to develop 1. Deliver the contracted amount to the forward
marketing and financing systems where price contract seller and sell the remaining amount in
discovery takes place in an efficient manner, cost of one of the following ways:
marketing reduces, quality of produce improves,
farmers are able to receive payments as well as a. Wait for the better prices in the future: if the
production and marketing credit in time, transaction current prices are not attractive and the farmer
cost is reduced, and also risks are reduced. For the expects the prices to go up in the coming
development of such marketing and financing weeks/months, he keeps the produce in a
systems, the following requirements have to be met: warehouse, gets a warehouse receipt, may or
may not go for a pledge loan from the bank
• An efficient spot trading system counter, sells at a later date and realises the
• An efficient grading system remaining value.
• An efficient forward market b. Sell it in the forward market: The farmer feels
• An efficient insurance market that one or more forward prices are attractive.
• An efficient warehouse receipt system He keeps the produce in the warehouse, gets a
• An efficient Government support system warehouse receipt and forward sells it using the
forward market and delivers on the contract
With these systems in place, a farmer will be able to get maturity.
both production and marketing credit as well as sell his c. If the current prices are attractive, sells in the
produce efficiently. At the time of planting, once the spot market.
farmer takes his decision on the crop and acreage, he
should be able to avail of crop loan and crop yield 2. The farmer buys back the contracts he has sold
insurance. With the crop-acreage decision, he has an during the planting time and uses any one of the
estimate of crop yield that he should be able to sell above three options — keeps in the storage for a
forward through a forward contracting arrangement to sale at a later date, sells using the forward market,
be established at an APMC. In fact, the farmer can make sells in the current spot market.

A NOVEL AGRICULTURAL PLEDGE FINANCING MODEL
This integrated system will provide the following Price stability: With the forward contracting
advantages to the farmer: arrangements, there will be a better estimate of the
supply of commodities that would be used in the
Easy financing of crop production and marketing: futures market as forward contract sellers hedge in the
Farmers can get crop production credit and marketing futures market to cover their risks. The additional
credit through insurance, forward selling and information flow into the system will lead to stability in
warehousing. At present, crop production loan is the prices.
available, but credit limits are low. Farmers will still have
the option of going for crop loan in the existing This integrated system will work well if each one of its
arrangements, without going for forward contracting. components is made to work efficiently. And this will
However, farmers should be able to get more credit require participation of both the public and private
through forward contracting. players as well as government support.
Risks are covered: Farmers can cover the yield risk Efficient Spot Trading System
through crop yield insurance and the market risk
through forward contracting. Thus, this provides In the current marketing system, APMCs play a pivotal
comprehensive revenue insurance to farmers. role in spot trading. However, these primary markets
have not kept pace with the developments taking place
Low transaction costs: As systems develop and reach in the international markets. Some of the deficiencies in
a steady state, the transaction costs in this mechanism the existing agricultural marketing system are:
are likely to be low. A large volume of handling in
grading, warehousing, forward transaction and
insurance will facilitate transactions at a lower rate.
EXPERTS’ VIEWS | 17
Absence of a good quality assessment system: This • Setting up ‘special markets’ for perishable
often result in lower price realization for the seller commodities such as onions, fruits, vegetables, and
(farmer), while the buyer takes advantage of the state flowers.
of affairs to offer lower prices to the farmers. • Encouraging alternative marketing systems such as
contract farming, direct marketing, and farmers
Absence of a good grading system: This makes markets
farmers unaware of the quality requirement of • Promoting grading, standardization, and quality
agricultural produce at the user end, making farmers certification of agricultural produce, which would
neglect the quality aspect of their produce.
While many of these initiatives are yet to be
No post-harvest guidance system: Absence of any implemented, a significant initiative that can be taken
extended system to guide farmers on post-harvest care up immediately is the setting up of and enabling of
results in substantial losses of value of the agricultural “electronic spot trading” (e-spot trading) for
produce. agricultural produce.
Poor handling of agriculture produce: This practice E-Spot Trading

in the market yard results in large losses of the farm
produce. Poor handling also results in substantial loss The developments in ICT that have already taken place
in quality during marketing of the produce, putting it can facilitate agricultural marketing functions and
far below international standards. processes, including buying and selling, payment, and
transportation and logistics. This will connect local
Poor knowledge of packing and scientific storage: markets nationally and will effectively do away with
This leads to losses in the supply chain, which gets built information arbitrage that exists in today’s APMC
up at the consumer end. markets. ICT can also play a pivotal role in
disseminating and using trade information. Adoption
Lack of price information: Price information about of ICTs for agricultural trade, in the form of electronic
other markets is not available on right time, which spot trading, will benefit farmers enormously. Thus, the
makes farmers rely mainly on the prices quoted by local e-spot exchange is a marketplace where local farmers
traders. and traders can sell farm produce, while upcountry
buyers, processors, exporters, and end-users can buy
No access to warehouse receipt financing: This electronically through competitive bidding.
pushes farmers to distress sales and lower price
realizations. • Limitation of selling options: The system E-spot trading is an effective method which enables
of marketing through APMCs with only a few registered farmers to sell their produce to anybody, anywhere,
traders who often buy in collusion among themselves, anytime in a transparent way. This can not only reduce
farmers have restricted selling options. transaction costs and make intermediation in
commodity markets cost-effective but can also
Lack of effective information transmission: This effectively mitigate problems of lengthy supply chain
leaves very high information arbitrage possibilities through the elimination of middlemen connecting
among the markets. farmers through the shortest possible value chain,
which in turn helps farmers realize a better share of
Therefore, APMCs need to redefine their role in the consumers’ rupee. Price realization by sellers will also
context of present era of Information and be faster. Further, the anonymous nature of the system
Communication Technology (ICT) and globalization. In will ensure pricing transparency and reduce
recent years, certain policy changes have been possibilities of speculation.
announced to improve the agricultural marketing
system and they are: This screen-based trading will help small and marginal
farmers participate as it will be possible to do trading in
• Encouraging procurement of agricultural small quantities, without any dependence on
commodities directly from farmers’ field middlemen to sell their small marketable surpluses. The
• Removing all restrictions on production, supply, e-trading will also remove the problem of information
storage, and movement of produce asymmetry, as price information will be available
• Permitting the establishment of ‘private market instantaneously in any terminal and quality assessment
yards’, ‘direct purchase centres’, ‘farmers markets’ for will be done before the transaction. The trading will help
direct sales the producer get the best possible price for his
• Promoting PPP (public-private partnership) in the commodity/produce. Potential participants/traders on
management and development of agricultural the exchange platform can be farmers, farmers’
markets in the country associations/co-operatives, corporate, wholesalers,
exporters, importers, processors, the government, etc.

Requirements for successful implementation of e- buyers to local delivery points. Hence, the synergy
spot trading: between APMCs and NESEs will complete the chain
and make it most efficient.
• Amendment of the APMC Act that gives recognition
to these electronic spot exchanges. NESE is a new distribution channel with trade
• Good warehousing facilities, coupled with grading guarantee that offers advantages to the overall
facilities at market yards where farmers’ produce marketing system. It allows desktop monitoring of
can be graded and stored, as well as be able to trade, offers efficient warehousing and logistics
pledge produce for warehouse receipts. This will support, guarantees quality, functions as a
enable farmers to get easy financing. complementary market to derivative traders, facilitates
• Setting up grading laboratories at market yards for timely disbursement of commodities and funds while
establishment of uniform grading/quality ensuring transparency in transaction and settlement.
standards. APMCs stand guarantee to the quality More importantly, being online and accessible to
specified in the auctioned lots. traders located across the nation, it prevents
• Arrangement with transporters who can ensure information arbitrage from getting added to
delivery of the goods sold. consumers’ rupee. This model of marketing of produce
• Removal of restrictions on interstate movement of has advantages for farmers, APMCs, traders and
agricultural produce. exporters. Farmers will have better price realization,
• Setting up of trader work stations, leased lines, lower transaction cost, easy access to credit, clarity on
internet facilities, power backups, etc quality requirements and quicker transaction. APMCs
• Establishment of contract specifications that will have better realization of market fees, greater
include particulars such as opening of contracts, outreach and timely transaction. Traders will have a big
unit of trade, base value, price quote, maximum and liquid market, where they can sell a large quantity,
order quantity, delivery specifications (delivery unit with the elimination of counterparty risk, credit risk,
and centre) and quality specifications (grades, rejection at the buyer’s godown at the time of delivery
standards, tolerance limits, etc). and easier access to bank finance against warehouse
receipts. With the grading system in place, they can
APMCs and spot trading – the PPP model of effectively use the futures market for managing their
transformation risk. With operational ease, availability of finance and
absence of counterparty risk under the NESE system,
Though the e-spot trading is a good alternative to they can expand their activities to multiple
traditional marketing, the investment needed to set up commodities. Exporters can buy certified quality
national-level electronic spot exchanges (NESE) by material through a secured platform. Hassles relating
every APMC is likely to be a deterrent. The to procurement of material in physical markets can
infrastructure and quality of manpower needed are completely be avoided. Exporters can save brokerage
also deterrents to setting up of an e-trading platform in or commission payable to procurement agents. Using
agriculture. Therefore, a viable model is to have a PPP the price available at NESE, they can make export
with NESEs. This can be done at the state level by commitment and cover themselves immediately by
organizations like State Marketing Boards, which will buying at NESE.
link each APMC with the existing NESE.
Efficient Grading System
Synergy between APMCs and NESEs
Formal grading of agricultural commodities is very
Synergy in this PPP is feasible due to the rarely done for internal transaction in India. This has
complementary nature of the two entities — APMC caused the ‘lemon problem’ in agricultural markets
and NESE. APMCs have physical infrastructure, where bad quality produce drive away good quality
knowledge and catchment of commodities, while produce in the market as there is no price incentive for
electronic spot exchanges have pan-India reach with a farmers to supply better quality produce. This also has
robust delivery and payment mechanism, which can led to a larger gap between the quality of domestically
create an effective combination to transform traded produce and internationally traded produce,
agriculture marketing. NESE is neither a buyer nor a making exports of agricultural produce difficult. In
seller nor a commission agent. It is a facilitator that addition, imports of good quality produce are taking
undertakes delivery and payment responsibility and, place to meet the needs of the emerging quality-
thus, functions like a national-level APMC facilitating conscious section of Indian population. Reversing this
trade between the buyer and the seller. While APMCs trend necessitates development of a value chain that is
provide a backward integration, linking farmers to conscious of quality. This can be effectively facilitated
market yards, NESEs provide a forward integration by introducing grading at the primary wholesale
linking processors, exporters, end-users and upcountry market level.
Although Agmark standards and labelling has been in Efficient Forward Market
existence for nearly half a century, its reputation has
not helped produce quality crop in India. Also, for With the futures market, grading and warehousing
commodities, grading is hardly practised in the system in place, private companies can offer retailing of
country. But then the pressing need for a good system commodity futures contracts at the APMC level. A
of grading to bring in quality consciousness among formula can be established to retail futures contracts to
various participants in the agricultural value chain can farmers in the form of forward contracts. Since there is a
hardly be overstated. problem of uncertainty about the amount of yield,
forward price contract may require a yield insurance to
A good grading system ought to have unquestionable be obtained as a prerequisite. Once the decision on
integrity and standards in line with the requirement of planting certain acres of a particular crop is made, he
trade, continuous upgrading of standards and can obtain insurance and then forward sell at an APMC.
harmonising with international standards. This could In case there is a shortfall of yield, the insurance can be
be achieved effectively with participation of both the used to make up the losses. As more and more agencies
public and private sectors. While the government come up to retail forward contracts, a much needed
should set standards and continuously undertake healthy competition to provide this service will be
research to upgrade and harmonise, the private sector created at the APMC yard. With yield insurance and
can develop a system to implement it effectively. While forward contracting, farmers can effectively address
steps should be taken to update Agmark standards to both yield and price risk, which will enable the farmer
reflect consumer preferences and technical needs of to obtain credit easily.
processors, a few national-level companies can be
accredited for grading and certification of agricultural Efficient Insurance Market
produce. These companies can have franchises so as to
create enough facilities for grading and certification at Yield insurance has been existence in India for more
all APMCs. This will help in facilitating e-spot trading, than three decades for crops such as rice and wheat.
warehousing, financing and forward contracting. The However, they are offered on an area basis, as there are
commodities futures exchanges already have already a no effective ways of dealing with moral hazard and
grading system in place, but a robust grading system adverse selection problems. Nevertheless, with
can be set up only when the government too pays increasing sophistication in the data collection
adequate attention to the development of standards methodology, individual assessment-based insurance
and grading systems. will become a reality. Such an insurance system will
address the risk management needs of farmers
Efficient Warehouse Receipt System effectively. With a good insurance market, financing at
the farm level and, thus, credit access to farmers
An efficient warehousing receipt system can go a long becomes easier.
way in helping reduce transaction costs in the supply
chain and facilitate financing of agricultural Conclusions
commodities. A scientific method of storage, which
prevents deterioration in quality and quantity during An integrated approach, in which efficient systems of
storage, will give financial institutions the confidence e-spot trading, grading and quality certification,
to extend easy financing. The extent of finance that the scientific warehousing and collateral management,
market participants can obtain through pledging will crop/weather insurance, and futures-benchmarked
also increase. This will also make transactions over long OTC offered forward contracting could exploit
distances easier. There are private sector companies complementarities between agricultural marketing
which are already providing scientific warehousing and financing, will help address current problems in
facilities including collateral management. With these functions. The ultimate objective is to develop
appropriate backup of legislation, the warehouse marketing and financing systems wherein price
receipt system will become easier to implement. discovery takes place in an efficient manner, cost of
marketing reduces, quality of produce improves,
With the warehouse system available at the APMC farmers are able to get their payment in time, farmers
level, a farmer can either sell his qualit y get both production and marketing credit in time,
certified/graded produce immediately through an e- transaction costs are reduced and risks are minimised.
spot exchange or defer the sale. In case of deferment he
may go for pledge financing to meet immediate
financial requirements. This protects farmers from
distress sales.
Prof. Gopal Naik is Professor, Indian Institute of Management – Bangalore. Views expressed by the author are personal and not of the institution.

Commodity Futures
in India – A Product of
Globalisation and
Liberalisation
By Mr. Lamon Rutten
A beginning has been made towards transforming the Indian commodities sector, from its
current status of being a ‘price taker’ to a ‘price setter’, with the national online commodity
futures exchanges taking the lead. These exchanges are offering the benefits of
liberalisation and globalisation directly to the industry and consumers by empowering
them to influence the global prices of commodities they deal in. It is time the markets were
made much more vibrant and efficient by allowing participation of a larger number of new
categories of economic stakeholders and introduction of innovative derivative
instruments. This is to plug risks at the roots rather than when they finally sneak into the
prices of end products. And this will make the Indian markets a force to reckon with on the
global commodity map, turning them into a‘price setter’indeed.
Economic liberalisation took off in the early 1990s in many, is commodity price volatility. Companies need to
India. Like in many countries, policymakers, be able to manage these risks if they are to be globally
practitioners and academics responded to the growth competitive, and this is where an efficient commodity
of financial markets worldwide, and a new-found futures market plays a primordial role not only in
ebullience surrounding emerging markets, by facilitating price/volatility risk mitigation but also
advocating wide-ranging reforms. International trade catalysing near-perfect price discovery.
and investment were opened up, a process of
deregulation and privatisation initiated, the tax regime After decades of decay, India's organised futures
reviewed. industry was revived in 2003. As it matures over time, its
backward and forward linkages will strengthen,
India's economy greatly benefitted. In 2007, the resulting in widening and deepening of the market
country clocked its highest ever GDP growth rate of 9% through increased participation by various ecosystem
the second-fastest in the world after China and a far cry players. This in turn is changing the ways producers
from its annual GDP growth in the three decades post- make their cropping decisions, traders trade their
Independence. However, the reform process is still products, and banks lend against commodities or
incomplete, and the financial sector has been lagging those with exposure to commodity price risk. The
behind many parts of the real economy. Stakeholders ultimate results will be 'Financial Inclusion' and 'Market
have still not reaped the fruits of greater competition in Inclusive' growth.
financial markets, unlike what has been seen in sectors
such as telecom, banking, insurance, and aviation. But The Enabler of Efficient Price Risk Management and
now, Indian financial markets are poised to scale to the Price Discovery
next growth orbit.
The price discovery process should not be left to just a
India increasingly integrates with markets around the handful of traders in asymmetrically informed or ill-
world. This opens a window of opportunity to Indian informed, segmented markets. Rather, the best price
companies but also, exposes them to a whole new discovery comes when a large number of various
world of risks. Among these risks, of key importance to categories of market players with a wide range of

objectives and interests converge on an organized To make these markets more relevant and useful to
futures platform. Such a platform and the Multi different categories of stakeholders and thus their
Commodity Exchange of India Ltd. (MCX) is one participation more effective, it is necessary that various
ensures that all relevant information is absorbed in the risks to the participants be effectively managed. Risk
price formation process, and the “right price” is management tools on a futures platform include
discovered. The more efficient the discovered prices on margining, limits on open positions, and effective
a futures platform is, the more effective are the surveillance (see table 1). Price volatility of
business and policy decisions that are taken based on commodities traded on an exchange is an indicator of
these prices. how effectively these tools are used by the exchange
managers to improve the efficiency of price discovery.
The efficiency and transparency of price discovery That is to gauge the capability of its futures contracts to
depends on the robustness of the trading platform; its predict its maturity prices more accurately (indicated
regulations; the right mix of its participants with by the percentage deviation between the first traded
relevant price information; making participation cost- price and the last traded price of a given contract). The
effective vis-à-vis alternatives available for risk efficiency of price discovery is also indicated by the
m a n a g e m e nt a n d / o r i nve s t m e nt ; e f fe c t i ve nearness of the spot and futures price movements. In
management of the participants' varied risks and, last the case of MCX, the correlation between its gold
but not the least, a robust and transparent clearing futures contract and gold spot prices is around 99.8%
policy. (from January 2007 to August 2009), which indicates a
strong inter-linkage between domestic spot and
In just about six years, the national commodity futures futures markets. For the same period, MCX gold
exchanges in India performed better than the contract's correlation with the global benchmark,
policymakers expected in terms of catching up with COMEX gold futures contract, is around 99.9% (the
their age-old global counterparts on most of the rupee adjusted). This reflects how efficient the Indian
aforesaid parameters. A lot of efforts delivered from a futures market is in capturing global cues.
base of strong domain knowledge and technical skills
went behind this spectacular growth. Selection of
commodities relevant to the stakeholders; right
contract design; keeping ears and eyes to market
needs; taking them to appropriate participants;
creating awareness; expanding infrastructure; and
bringing in world-class technology and global best
practices are some worth mentioning.
Table 1: MCX vis-à-vis global parameters
Domestic Exchanges Global Exchanges

Particulars Commodity Stock COMEX Remarks
exchange (MCX) exchange (NSE) and CBOT
Position limit is significantly lower than that
Position limit to
of global benchmark exchanges indicating
physical market Gold - 0.9% - COMEX Gold - 18.7%
that the domestic futures market cannot be
size (%) distorted by single/a few players.
Avg. daily volatility Gold - 1.3%, The lower price volatility on MCX compared
COMEX Gold - 1.5% with global exchanges reflects that price
in January 2007 Ref. Soy Oil - 1.2%
NIFTY - 1.60% CBOT Soybean Oil discovery on the domestic platform is
MCX Comdex
to August 2009 - 2.1% happening with more price stability.
- 1.4%.
The lower impact cost on MCX at par with

Impact cost Gold - 0.027% NIFTY - 0.16% COMEX Gold - 0.019% global exchanges reflects better liquidity in
terms of market depth and width.
Note: In the case of price discovery, we considered August 2009 contracts – MCX Gold contract, COMEX Gold and Nifty Futures.
Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore sourced from NSE website on September 9, 2009.
Impact cost for Nifty was calculated based on trading happened on a regular trading day. Impact cost of MCX gold calculated for a portfolio size of Rs.2 crore.
Impact cost of COMEX Gold calculated for a portfolio of USD4 lakh (app. Rs.2 crore).
Again, as the same table shows, MCX gold contract is over the Indian economy. The prices efficiently and
more efficient than COMEX gold contract in terms of transparently discovered on these exchanges are
price discovery. The lower volatility on the Indian gradually being transmitted to the physical markets,
commodity exchanges is due to the close monitoring and this will lead to increased competitiveness both in
and the robust margining system adopted by them. the manufacturing and services sectors.
MCX follows strict vigilance with an automated system
in place. The system, for example, provides automated Global commodities traded on these Indian exchanges,
alerts when a member’s margin utilization crosses such as bullion, ferrous and non-ferrous metals
various levels. If the margin utilization crosses 100%, (copper, aluminium, steel, etc) and energy (crude oil
the member in question is put automatically on a and natural gas), account for more than 80% of their
“square off” mode. This innovative risk management average daily turnover. These commodities are largely
system has been adopted to prevent any spread of linked to the global markets as their imports and
financial contagion. Besides the functional efficiency of exports are allowed subject to a marginal tariff
trading, the technological robustness (both hardware incidence. Obviously, most of these commodities are
and software) also adds value to the MCX participants largely governed by their fundamentals (the supply
by enabling cost reduction. It has a constant and demand conditions) at the global level and partly
collaboration with FTIL, the parent company, aimed at by developments on the domestic front. Therefore, it is
improving the software through telecom technology, necessary for the users of these commodities to take
and this works towards cost-effectively connecting the positions on a futures platform with global linkages in
stakeholders to the market. order to hedge their risk. Such users may participate in
exchange-traded contracts with their underlying
Commodity Derivatives - the Road So Far physicals being the same as their raw materials and
whose prices are linked to the prices discovered on the
The introduction of commodity derivatives has international benchmark exchanges. But in the
remained one of the most significant developments in absence of such an arrangement, trading on
the Indian commodity market sector. The three exchanges having the right mix of arbitragers between
national online exchanges brought in revolutionary the domestic and global benchmark exchanges will
changes in this sector by bringing in spatial integration also serve the hedging purpose. However, the second
and temporal price discovery of commodities at the option may not be workable due to lack of clear
national level. In the span of just six years, they have participation norms for international exchanges, while
performed well, being successful in bringing various the option of indirect participation will be costly for
ecosystem participants such as producers, hedgers, most of today’s corporate hedgers.
arbitragers, and speculators on to a single platform. The
annual turnover of domestic commodity exchanges For globally traded commodities, particularly metals
increased from Rs.5.7 lakh crore ($127.6 billion) during and crude oil, the prices discovered on MCX have very
2004-05 to about Rs.52.48 lakh crore ($1,143.1 billion) high correlation (96%, on an average) with the
in 2008-09 at 74.10% CAGR. international benchmarks (see table 2) despite the high
volatility in USDINR in the recent past. This also shows
The exchanges clocked this robust growth despite that the prices of MCX’s futures on globally traded
continuance of various restrictions. For example, on commodity follow efficiently — and in tandem — the
instruments such as options and indices; participation combined forces of domestic and international
of commercial banks, mutual funds and FIIs; and so on. fundamentals. And this makes the domestic online
What helped these exchanges to leap forward and exchanges a cost-effective and superior alternative to
attain higher levels of efficiency and trade volumes are their international counterparts.
their innovative products, functional transparency
based on sound regulation, innovative applications of Table 2: Price correlation – MCX vs. global benchmark
technology, effective adoption of global best practices, exchanges in globally-linked commodities from
etc. These exchanges’ efforts and performance helped Apr ‘05-Mar ’09 (in %)
Gold 94.3
make Indian companies and economy globally
Silver 94.8
competitive. The robust growth numbers reflect the Copper 94.4
stakeholders’ strong faith in these exchanges’ Crude oil 97.6
functional efficiency and transparency, as well as Average 96.0
indicate the commodity markets’ growing influence Data Source: Exchanges' websites

The Way Forward Gone are those days when policymakers successfully
used MSP as an instrument to influence the cropping
At this juncture when the Indian markets are on their pattern and production of farmers. It is the functioning
way to the heights achieved by the global benchmark of the domestic commodity exchanges which will
markets, it is essential that they are allowed to have the strengthen the market-based trading system in India
right mix of participants —and products — to have the making it useful for Government procurement. The
necessary liquidity depth and width. Corporates and exchanges will create an environment where farmers
physical market players in India are gradually realising have multiple selling options (for their produce) such
the importance and need to participate on commodity as the spot market, the futures market, and the futures
exchanges. An increased participation of such players market-referred over-the-counter forward market. The
will go a long way in streamlining commodity trading futures market in electronic format being executable at
in India by bringing in relevant information about the the national level, integration of banks and
fundamentals into the markets and, thus, making the institutional traders into the market will create several
price discovery process more efficient. Besides, this will institutional options for farmers. Further, once allowed
also help corporate best practices percolate into the options will help farmers lock in their prices on the
markets to fine-tune their functioning and efficiency. commodity exchanges in a more efficient way than
Given the current trend of globalisation of economies, they can currently do with the existing instruments.
competitiveness remains one of the most defining
factors for developing economies. And this not only Besides the price risk, which can be mitigated by
means having competitive manufacturing and services trading in relevant commodity derivatives, the weather
sectors but also necessitates promotion of markets to risk has a profound impact on a farmer’s income under
make them globally-competitive. the predominantly rainfed farming (about 70% of net
cultivated area) conditions prevalent in India. And if
To cite an example, in I ndia, neither the there could be a single most positive and defining step
automobile/ancillary industries manage their input that can be taken towards solutions to such problems
costs effectively nor do the suppliers of their raw as mentioned above it shall be the passage of the long-
materials. This is partly due to lack of policy guidelines pending amendment to For ward Contracts
allowing and promoting them to effectively participate (Regulation) Act. The Act, once effective, will work
in the market and partly because of lack of awareness towards an efficient and vibrant commodity market in
on their part. However, of late, the coming up of the India (both on the physical and futures fronts) and
national commodity exchanges, armed with their bring a world of good to the entire commodity market
global alliances, has provided industrial users of ecosystem. The multi-faceted benefits will include
primary commodities with easy access to an alternative introduction of a number of innovative instruments,
platform to trade on. The domestic exchanges offering such as farmer-friendly weather derivatives.
such an opportunity to the industry ought to be
effectively harnessed to efficiently manage their profit
margins and safeguard their investor and consumer
interests by infusing efficiency and economy into their India is a land of billions that
procurement operations. Effectiveness of participation
in global exchanges can only be replicated if the consume a large portion of most
domestic exchanges meet the efficiency of trading in primary commodities produced in
the global benchmark exchanges, especially in the
globally traded commodities (with least trade
the country. For the domestic
distortions). exchanges to rise to the challenge
Although India has a long way to cover in harnessing of turning the country into a ‘price
the potential in the major commodities, the story of its setter’ it is necessary that India has
bullion market is bright. The Indian bullion market has
demonstrated its resilience to remain the “price setter”
strong and transparent markets
for gold and silver in the Euro-Asian time zone. Indian with robust infrastructure for
(MCX) bullion prices have strong correlation with those
of the international benchmark markets.
efficient transactions.
India is a land of billions that consume a large portion of As the WR draws its power under the act, the value to it is
most primary commodities produced in the country. added by the linkages that the warehousing institution
For the domestic exchanges to rise to the challenge of creates with the funding institutions and the strength of
turning the country into a ‘price setter’ it is necessary the collateral management services for the funding
that India has strong and transparent markets with agencies and their clients at a cost which would keep
robust infrastructure for efficient transactions. This in both the financial institutions and clients happy.
turn necessitates that Indian commodity exchanges
have an upright regulatory framework under a robust The WDRA will also create efficient linkages between
regulator. Therefore, strengthening FMC through the producers and markets. Application of information,
FCRA will be a momentous step towards strengthening communication and technology (ICT); innovative
the commodity futures market as a whole. solutions to practical constraints; and effective
nurturing of the linkages will go a long way in creating
First, once amended, the FCRA will clear the deck for a healthy warehousing system in the country.
introduction of long-awaited instruments such as Development of the warehousing sector — through
options, intangibles like weather derivatives, the linkages to be created between the players and the
commodity indices and freight indices, which through institutions in the agricultural supply chain ecosystem
value additions will attract risk-averse participants. — will help achieve the ultimate objective of creating
And the deepening of the commodity market, thus win-win supply chains for producers, intermediaries,
achieved, will enhance the market’s efficiency of price and consumers.
discovery and efficacy of risk management. And this
will eventually result in fairer returns to farmers. MCX – Unrelenting in Its Endeavour
Second, the amended FCRA will pave the way for Since its inception in 2003 MCX has taken a number of
participation of banks, MFs and FIIs in the commodities initiatives to help the farming community to realize a
market. This will not only democratise the price better value for their produce. It launched two major
discovery process on the exchange platform but will infrastructure projects - ?National Spot Exchange Ltd
also stabilise the market forces and, thus, the overall (NSEL) and National Bulk Handling Corporation Ltd.
economy. Participation of financial institutions on (NBHC). The combined strengths of MCX, NSEL and NBHC,
exchanges will also enable lending at market-linked along with its strategic partners, is committed to
prices, which in turn will lead to the benefits of price transforming the Indian rural economy to international
discovery flowing down even to small farmers, as their standards by providing the last mile connectivity to rural
holding power will be enhanced. areas and developing the required infrastructure.
Warehouses and the related institutions (quality testing, Availability of liquid futures contracts on various key
standardization, and marketing yards) form a vital cluster commodities on the MCX platform has dramatically
in the logistics sector linking the producers of agricultural changed the spot market scenario. The fact that these
commodities with their end-users ensuring effective prices are arrived through collective participation of the
carryover of the commodity from the farm gate to the stakeholders from various parts of the ecosystem and the
consumers’ table. Efficient warehousing creates efficient country makes it suitable to be benchmarked for the
linkages among the participants in a value chain resulting commodities underlying the futures contracts for the spot
in improved efficiency with which the produce is being markets. This is despite the standardised nature of
marketed, enhanced income of the farmer, availability of contracts and terms and conditions of futures trading. This
credit through warehouse receipts (WR) etc. Besides the has ensured emergence of benchmark prices of various
revenue earned from scientific stock management, the commodities representing the most prevalent varieties in
coming into force of the Warehousing (Development and the most active physical markets in India. Thus, these
Regulation) Act, 2007 (WDRA) and setting up of the benchmark prices, discovered on the MCX platform,
authority will create an efficient warehousing ecosystem reflect the sentiments of the entire producing, trading and
that will include quality testing and certification, consuming community representing a one-India market.
standardization, and marketing. Following this, issuance The futures market is also increasingly acting as a guiding
of WRs and collateral management services will enable light for the physical markets to assess the upcoming
earning of higher revenues than the plain-vanilla storage underlying fundamentals and sentiments, and provide
charges levied on their clients. price signals to the physical markets.

Creating a silent revolution… Why Can India Not Be a ‘Price Setter’?
A pre-WDRA entity, NBHC, which was floated by MCX Despite the fact that it is fast developing into a major
with the felt need for delivering the underlying at the ‘economic powerhouse’ in the global arena India
maturity of contracts, is an end-to-end solutions continues to look up at other markets to decide the
provider in the entire gamut of collateral management; local prices of commodities. With the country being the
procurement; warehousing; bulk handling, grading and largest producer and consumer of a large number of
quality certification; commodity care and pest commodities, is it not just logical that the Indian
management; audit; accreditation and commodity markets upgrade to the level of ‘price setter’ from their
valuation; trade consultancy and disposal of current tag of a ‘price taker’? And this assumes more
commodities. In just a few years, NBHC, with its robust relevance and priority with the Indian markets
standardisation and quality-testing facilities, developed increasingly opening up and integrating with markets
its own sustainable business model and came out of around the world. As for commodity markets, in which
MCX’s shadow. One such business opportunity that it is either one of the largest producers or consumers or
evolved was collateral management undertaken to both, India has immense potential to have a domestic
facilitate trading against collaterals (warehouse market that is strong enough to set global market
receipts). NBHC, with about 437 warehouses spread over prices. In fact, given its share in global supply and
18 states with a total capacity of 16.5 lakh million tonnes demand as a dominant player in the world market (see
by the end of 2008-09, facilitated in its first year of table 3), the country has the potential to become the
operation (2006-07) collateral funding of Rs.1,500 crore, price setter in 17-odd commodities.
which rose to a cumulative
figure of over Rs.8,800 Table 3: India's share in global production and consumption
crore in the current fiscal. Share (%) in
Share (%) in total Global rank in
NBHC also facilitates Commodities total global
global consumption production/consumption
output
government procurement
(cumulative of 5,34,007 Rice milled 19.4 20.5 2nd largest producer behind China
tonnes of rice and wheat by 3rd largest producer behind EU-27

Wheat 12.1 12.0
2008-09). and China
Soybean Oil 3.8 6.1 6th largest producer and 5th largest
Taking the market to the consumer
masses… Gold - 22.7 Largest consumer
Coal 7.6 7
MCX has achieved
remarkable success in Aluminium 3.1 3.2 6th largest producer
reaching out to a large
Source: USDA, GFMS, BP Statistical review
number of agri-
c o m m o d i t y
producers/farmers hitherto unreached through its To transform the country into a 'price setter' the first
unique Gramin Suvidha Kendra (GSK) model. The logical step would be to democratize its markets to
innovative outreach network in tie-up with India Post enable an efficient flow of information for effective
to leverage the latter’s vast rural infrastructure in cost- determination of commodity prices. And this has partly
effective, traditional modes of communications for been taken care of by the modern national-level
price dissemination and providing other services like commodity exchanges, thanks to policy liberalization
redressal of technical queries and supplies of farm of 2002-03. The rapid ICT developments helped
inputs such as seeds, pesticides/fungicides/weedicides penetration of the online electronic exchanges
and fertilizers, has now spread over 768 villages served through reduced participation costs and increasing
by about 160 branch post offices, across five states, awareness. With the development of liquid futures
benefiting over 3,800 registered farmers more directly. contracts in many of the aforesaid commodities, India
Farmer registration with GSK shot up by 34% to 3,897 as has started emitting price signals to the linked global
on March 31, 2009 vis-à-vis 2,869 in 2007-08 — markets of those commodities. To a large extent, such
testifying the growing popularity of the model. benchmark futures prices of the standardised
contracts, as discovered on the MCX platform, have
started influencing the global counterparts. They have
started discounting the Indian fundamentals and the participants tended to discount the global price-
sentiments in Indian time zone. For example, in moving factors rather than domestic information.
commodities such as gold, of which it is the world's Indian markets have to enable cost-effective
largest importer and consumer, and chana, of which it participation of all those with information to effectively
is the largest producer and consumer, India, on the discover prices, and the national online commodity
strength of its futures market, is slowly gaining the exchanges are already helping various categories of
rightful place among the world markets, in terms of participants get all such available information to
influencing or setting the prices. converge.
Although it is still a long way to go, a beginning has It is time these markets were made much more vibrant
been made towards transforming the country's and efficient by allowing participation of a larger
commodities sector from being a price taker to a price number of new categories of economic stakeholders
setter, with the national commodity futures exchanges and introduction of more innovative derivative
taking a lead. They are offering the benefits of instruments, besides carrying out other next-level
liberalisation and globalisation directly to the Indian reforms. This is to plug risks at the roots rather than
industry and consumers by empowering them to when they finally sneak into the prices of end products.
influence the global prices of the commodities they And this will make the Indian markets a force to reckon
deal in. With increased accuracy of the prices with on the global commodity map, turning them into
discovered and more effective price risk management, a 'price setter' indeed.
the efficiency of the Indian industries and commodity
markets will increase significantly. And this will result in
a “multiplier effect” on the national economy.
While proliferation of products and participants is

evident from the phenomenal 110% annual
compounded growth rate at which the trade on the
domestic commodity futures exchanges grew
between 2003-04 and 2008-09 (source: FMC and
Economic Survey data), in many global commodities
Mr. Laman Rutten is MD & CEO of Multi Commodity Exchange of India Ltd. Views expressed in this article are personal.

Role of Mutual Funds in
Commodity Markets
By Mr. Venkateswaran R.
Things that count, often can't be counted. Things that can be counted, often don't count.
- Albert Einstein
At present, domestic mutual funds are not allowed to invest in commodity markets. In fact, mutual funds’
role in commodity markets is of very recent origin, globally, and is very limited or absent in emerging
markets. Nevertheless, the growth so far has been good, buoyed by surging prices of crude oil, precious
metals, minerals, and food items. With increased demand of a growing world population, the prospects
for commodity markets, in general, and agricultural commodities, in particular, look bright.
The Indian mutual funds industry is older than the Interval Funds: 48) to the investors. Of the open-ended
Indian public sector banks (other than the SBI Group). schemes, six were Gold ETFs and 12 were other ETFs.
The industry has made remarkable progress in terms of The assets under the management of the mutual funds
some parameters like opening up of the sector in stood at Rs. 7,56,638.17 crore as on August 31, 2009.
stages to all sorts of players, entry of new fund houses, Equity oriented schemes, viz., Growth/Equity Schemes,
growth of assets under management (AUM), expansion Balanced Schemes and ELSS, accounted for only
in the number of unitholders, introduction of new 26.12% of the AUM. While debt oriented schemes, viz.,
products, adoption of robust risk management system Income Schemes, Liquid/Money Market Schemes and
covering all operational aspects, relaxation of Gilt Schemes, made up for 73.26% of the AUM, ETFs
investment restrictions, posting of consistent better had 0.23% share in AUM and fund of funds investing
returns, reduction of fees and other expenses, abolition overseas 0.39% share in AUM. More than 56% of the
of entry load (initially for direct applications and now AUM was contributed to by corporates and institutions.
for all) and investor awareness and distribution
initiatives. The Article describes the current state of the As a percentage of GDP at market prices at current
domestic mutual fund industry, discusses the prices, the AUM stood at 14.22% as at end-August, 2009.
investment objectives and restrictions applicable to a The AUM of mutual funds in developed markets range
domestic mutual fund and concludes with a brief between 20% and 70% of GDP. As on August 31, 2009,
overview of the commodity funds. open-ended schemes accounted for 91.42% of the AUM,
close-ended schemes 8.48% of the AUM and interval
The Indian Mutual Fund Industry funds 0.10% of the AUM. The worldwide total net assets
under management of mutual funds as at end-2008
An overview were $ 18.975 trillion. Hence, Indian mutual funds, with $
85.32 billion AUM as at end-2008, accounted for 0.45%
As at end-August, 2009, there were 43 mutual funds (down from 0.53% as at end-2007). As on August 31,
registered with SEBI, who offered a total of 852 2009, the number of folios with the domestic mutual
schemes (Open-ended: 608; Close-ended: 196 and funds totaled 4,83,51,487. Individual investor accounts

made up about 96% of the total investor accounts. money market instruments or gold or gold related
During April – August, 2009, mutual funds have seen net instruments or real estate assets. A domestic mutual
inflows of Rs. 2,56,754.96 crore. fund can invest moneys collected under any of its
schemes in accordance with the investment objectives
During 2008-09, in spite of the increase in gross specified in Regulation 43 and the investment
financial saving of the household sector, the household objective of the relevant mutual fund scheme.
sector allocated only Rs. 19,349 crore to investments in Accordingly, the moneys may be invested only in
shares, debentures and units of mutual funds, i.e., 2.6% securities, money market instruments, privately placed
of the total gross financial saving and 0.36% of the GDP debentures, securities debt instruments (which are
at current market prices (Rs. 89,134 crore; 12.4% of the either asset backed or mortgage backed securities),
total gross financial saving and 1.89% of the GDP at gold or gold related instruments or real estate assets.
current market prices during 2007-08). In the United Regulation 45 further permits a mutual fund to enter
Kingdom, investments in units of mutual funds into derivatives transactions and short selling
comprised 26% of the gross financial saving of the transactions on a recognized stock exchange. The
household sector. The global financial and economic investments permissible under Regulation 43 are
crisis had affected the Indian financial markets and the subject to the restrictions on investments specified in
Indian household sector preferred safe havens in the the Seventh Schedule to SEBI (Mutual Funds)
midst of uncertainty and high volatility. Regulations, 1996.
Prospects Role of Mutual Funds in Commodity Markets
There is a need to widen the reach of the domestic On account of high unpredictability of long term
mutual fund industry to the retail individual investors, inflation rates, investments in traditional avenues like
especially to those outside of the Tier 1 and Tier 2 cities. equity shares and non-inflation indexed bonds alone
Also, there is scope for the industry to tap the cannot protect the real value of the portfolios.
technological prowess that has transformed the Indian Commodities are often seen as a hedge against
secondary market microstructure. Though, several new inflation. This is on account of commodity prices
products have been made available over the years, there responding directly to changes in the economy that
is scope for further product innovation. From a financial tend to produce inflation. And, this trend is contrary to
point of view, the growth of the domestic mutual fund the inverse relationship between inflation and equity
industry is dependent upon the networth and share prices (A high rate of inflation is usually
profitability of the asset management companies. The associated with a high rate of interest and high interest
emergence of a self-regulatory organization (SRO) (a expense means low earnings per share). Thus,
reincarnation of the Association of Mutual Funds in India investment in commodities has proved to be a
(AMFI)) can further strengthen the regulatory rewarding option for those investors diversifying their
framework. portfolios beyond equity shares and bonds.
The Regulatory Framework Internationally, there are different ways in which

mutual funds invest in commodity markets. There are
The domestic mutual funds are registered with, and some funds that own the commodities that the fund
regulated by, Securities and Exchange Board of India represents. Then, there are other funds that do not own
(SEBI). SEBI was established as a statutory autonomous the underlying commodity at all, but that own futures
regulator to protect the interests of investors in contracts and undertake trading strategies so that the
securities, to promote the development of the assets of the fund and the net asset value (NAV) mirror
securities market and to regulate the same. SEBI came the trends in the price of the underlying commodity. In
out with the first Mutual Fund Regulations in 1993, most of these cases, the funds track the movement of
under which all mutual funds, except Unit Trust of India, an underlying index so designed to track the trend in
were to be registered and governed. The 1993 SEBI the price of the underlying asset.
(Mutual Fund) Regulations were substituted by a more
comprehensive and revised SEBI (Mutual Funds) The first case is similar to the gold ETF scheme of a
Regulations, 1996. domestic mutual fund in India. A gold ETF has been
defined as a mutual fund scheme that invests primarily
A mutual fund has been defined as a fund established in gold or gold related instruments. A gold related
in the form of a trust to raise monies through the sale of instrument refers to such instrument having gold as its
units to the public or a section of the public under one underlying, as may be specified by SEBI from time to
or more schemes for investing in securities including time. The funds of a gold ETF scheme of a domestic
mutual fund are currently invested only in gold, which
are held under the custody of a SEBI-registered
custodian of securities. As on August 31, 2009, the AUM ETFs and commodity-oriented schemes of domestic
of gold ETF schemes stood at Rs. 904 crore. Given gold’s mutual funds are also quite impressive. With reference
status as a safe haven, the share of the Indian demand to Macquarie and Rogers China Agricultural Index,
in the global demand for gold, the socio-cultural noted financial investor James Beeland Rogers, Jr. ( Jim
factors affecting the demand for gold in India and the Rogers) had said that one thing everyone could count
additional benefits of a gold ETF like absence of storage on, no matter what happened in other sectors, was
cost and insurance premium and no fear of theft, the people would continue to eat, making agriculture a key
demand for gold ETF schemes will grow exponentially part of any commodity investment portfolio.
with increased investor awareness.
Some of the commodity mutual funds/index funds that
It is worth noting that commodity based ETFs in the have become the favourites of investors on the basis of
United States, accounting for about 7% of the ETF their performance are Deutsche Bank Liquid
assets, are not registered or regulated by the Securities Commodities Index, Dow Jones AIG Commodities
and Exchange Commission (SEC). The commodity- Index, Goldman Sachs Commodities Index,
based ETFs that invest in commodity futures are Oppenheimer Real Asset Fund, PIMCO Commodity
regulated by the Commodity Futures Trading Real Return Strategy and Rogers International
Commission (CFTC), while those that invest solely in Commodities Index. This has prompted the launch of
physical commodities are not regulated by the CFTC. many new ones in the stable.
The growing demand for ETFs in the United States Several estimates are available regarding the size of the
prompted sponsors to offer more funds with a great AUM of commodity funds. According to Barclays
variety of investment objectives. As at end-2008, there Capital, the commodity assets under management of
were 231 sector and commodity ETFs with $ 94 billion institutional and retail investors at the end of March
in assets. The Investment Company Institute (ICI) 2009 amounted to $ 172 billion. Gardner Finance
estimated that commodity ETFs accounted for 19% of estimated that commodity hedge funds’ assets under
the number and 38% of the total assets of sector and management ranged between $ 190 billion and $ 210
commodity ETFs. Since their introduction in 2004, billion as at end-March, 2009. It is estimated that the
commodity ETFs grew from just over $ 1 billion to $ 36 assets of SPDR Gold Trust, the biggest exchange-traded
billion by the end of 2008. Also, about three-quarters of fund backed by gold, are more than the amount of
commodity ETF assets tracked the price of two bullion held by Switzerland’s central bank.
precious metals, viz., gold and silver, through the spot
and futures markets in 2008. Conclusion
Another category of funds own the shares of Thus, it is clear that the domestic mutual funds are
companies that are into the commodities sector. This currently not permitted to invest in commodity
strategy is also in vogue in India. There are now more markets. But the role of mutual funds in commodity
than half-a-dozen domestic mutual funds in India too markets is of very recent origin globally and is very
which invest in shares of Indian and foreign companies limited or absent in emerging markets. Nevertheless,
in the commodities sector. Some of the investments are the growth so far has been vibrant, buoyed by the
through feeder funds, i.e., through overseas funds surging prices of crude oil, precious metals, minerals
which in turn invest in the shares. Back home, indexes and food articles. With the larger demands of a growing
having companies in the commodities sector as their world population, the prospects for the commodity
constituents, like metals and oil and gas, are among the markets in general and agricultural commodities in
popularly tracked ones. Lastly, there is the commodity particular appear to be bright. According to EPFR
pool, or the managed futures fund, operated by the Global and Gardner Finance AG, of late (in the first
commodity pool operator, where many high networth quarter of 2009), investors favour mutual funds over
individual investors combine their moneys and trade in hedge funds for investments in commodity markets,
futures contracts or commodity options as a single seeking the protection of regulated asset managers.
entity.
The brighter growth prospects of the emerging

economies and search for yield (often buying into the
risk premium story) in the developed economies
resulted in the launch of many commodity index funds
blending the emerging markets and the commodity
asset class. Notwithstanding the losses in 2008, the
strategy paid off well. The year-to-date returns of gold

In the aftermath of the global financial crisis, which References:
wiped out 15 years of capital gains in 15 months, the
global asset management industry has explored how ?? SEBI (Mutual Funds) Regulations, 1996
the market dynamics would change and how the
business models would reshape. Investment goals over ?? Annual Report 2008 ? 09; Reserve Bank of India
the next three years would be conspicuous by the flight (August, 2009)
to quality, simplicity and safety. Retails investors would
be drawn into products that offer capital protection ???2009 Investment Company Factbook; Investment
and tax efficiency, with periodic opportunistic forays Company Institute
into absolute returns or cash products. High networth
individuals would venture back into active long only
???Indian Mutual Fund Industry ? The Future in a
space as well as alternatives, with a strong
Dynamic Environment, Outlook for 2015 (CII ?
opportunistic slant. In this milieu, it is all the more
KPMG; June, 2009)
imperative that the asset managers underscore what
they stand for and what they can deliver.
???Business Impact of Regulations in the Indian
Asset Management Industry: Playing in the New
Market Place; McKinsey & Company (August,
2009)
???Future of Investment: The Next Move?; Prof. Amin

Rajan (CREATE-Research; 2009)
???www.sebi.gov.in
?
?? www.amfiindia.com
?
?? www.ici.org ?
?? www.celent.com
Mr. Venkateswaran R. is Assistant Director, Securities and Exchange Board of India (SEBI). Views are personal and do not necessarily reflect
those of the SEBI.
Banks on Commodities
Futures Platform –
A Win-Win Situation
By Mr. P. V. Ananthakrishnan
With gradual liberalisation, Indian banks are getting increasingly exposed to various risks
such as interest rate risk, forex risk, commodity/equity price risk, and credit risk. They can
manage these risks by sharing them with other economic stakeholders, primarily by
participating in commodity derivatives markets. It is time one looks forward to further
policy liberalisation to allow banks’ participation in commodity futures exchanges given
that these are equally well regulated as their equity counterparts.
As economies and markets around the world opened providing credit, banks absorb a part of the risks
up amid rapid globalisation, the phenomenon has associated with individual/institutional borrowers.
thrown open huge opportunities to various industries,
especially the financial sector – being critical to Associated Risks and How Banks Usually Deal with
economic growth and stability of any economy. What Them…
followed as a corollary is that businesses and
entrepreneurs in large numbers joined the bandwagon Risks that banks carry while discharging their services
and this brought in the necessary investments as well are of various types, but they do not necessarily absorb
as global best practices for all these industries to all kinds of risks. What banks require is managing these
flourish. The banking sector, a key component of the risks with tighter rules and regulations, and better
financial services industry, has remained one of the compliance, so that they can continue to expand their
major beneficiaries of the current era of ‘globalisation business and flourish. In other words, to operate
and liberalisation’. efficiently, banks do need to absorb some risks that are
inherent in their operations and smartly avoid others
In India, both public sector and private sector banks that can be effectively passed on to other participants
have, through the use of advanced technology and in the financial marketplace. In fact, banks do not even
global best practices, made a phenomenal progress in need to assume all the risks associated with their core
recent years, making rapid inroads beyond urban India business of lending and borrowing. They can mitigate
into the country’s heartland, on the one hand, and such risks through a combination of business practice,
setting up units overseas, on the other hand. By now product design, and pricing, efficiently transferring a
everybody knows what happened to several frontline part of the risks to other financial market participants.
international banks in the recent past. They not only
reported enormous losses but went on to collapse in How Should Banks Go about Managing the Risks?
the wake of a number of their credit exposures having
met up with default deadlock. It is, therefore, just First, banks can stave off risks associated with their
logical to believe that with growing penetration, Indian business through sound banking practices that include
commercial banks, like their global counterparts, are efficient por tfolio management, systematic
getting increasingly exposed to a whole lot financial procedures eliminating chances of unscrupulous
risks. As banks play a key role in both economic growth lending, and incentive-based remuneration to
and dissemination of the benefits of economic employees who are made accountable. Second, they
development cutting across social strata and can transfer risks that are not complex and can be easily
geographies, experts lay great emphasis on banks’ shared with other participants in the financial domain,
ability to provide market information and have funding by participating in derivative markets. Interest rate risk
capability and transaction efficiency. Also, by way of is one such risk that banks can mitigate through

interest rate swaps and other derivatives such as the mitigate foreign exchange risk banks participate in the
forthcoming exchange traded plain vanilla futures forward market (to a much more extent than in the
derivatives while continuing to retain market futures market). Credit risk — for example, in the case of
competiveness in their lending products. Third, there warehouse lending — is however mitigated largely
are certain risks with financial assets which are through futures market participation, wherein well-
complex, cannot be shared by banks in their business established commodity markets act as an effective
interests and are proprietary in nature (the risk inherent cushion. Also, globally, activity in commodity
with any business activity as it is carried on the back of derivatives is rapidly growing and is increasingly being
expectations of returns). Banks have to manage such looked as an investment/business opportunity by
risks at their end itself. A failure in effectively managing many of international financial services providers
such risks not only means a reduction in the including banks and their investment arms.
opportunities for banks’ expansion but also reflects
poorly in their ability to reach performance targets, In India, however, banks are yet to be allowed to
which assumes greater importance in an increasingly participate in the commodity futures market. Banks
competitive world of banking post-consolidation and financial institutions, as lenders to various players
through mergers and acquisitions. in all the three sectors of the economy, assume certain
risks associated with the business or the firm and its
Opportunities in the Wake of Financial Reforms inherent business risks. In case of collateral financing,
banks tend to carry the price risk associated with the
In most developed economies, corporate, banks and underlying asset (see table 1). A popular example of
individuals do help each other through the this type would be lending against warehouse receipts
participatory sharing of risks and benefits. In India too, (WR) or WR financing, which as a collateral-based
with the arrival of national-level commodity futures product for farmers is finding increasingly more favour
exchanges, which threw open a new efficient and with banks for various reasons such as high risk
transparent platform for players in the commodity or associated with other types of lending to the farming
primary sector ecosystem to mitigate their risks, the sector, their inability to meet the priority sector lending
banking system received a windfall in terms of target, etc. Also, the underlying assets in the case of
enabling transactions on these exchanges along with WRs are commodities which would carry known price
their clearing functions on the exchange. They not only volatility risk (accordingly a haircut can be taken) in
got new business opportunities but also a shot in the most cases unlike equity prices which at times can go
arm in terms of being able to mitigate various risks down to even zero level.
associated with their business.
In most developed countries, WRs, being a negotiable
Globally, banks participate in the equity and instrument, are widely used and form the core of their
commodity futures markets to mitigate risks or exploit funding to the agricultural commodities sector, with
business opportunities by establishing trading desks. commonly followed trading mechanism involving
They do actively participate in various derivatives banks, warehousing companies and commodity
markets such as OTC (over-the-counter), forwards, exchanges. This could serve as a model to emulate for
futures, and swaps to mitigate various systemic risks to the Indian financial and economic structure.
a certain extent. While to reduce interest rate they
usually participate in interest rate swaps, bond
markets, and other derivative instruments, in order to
Table 1: Risk exposure arising out of outstanding funds of banks (approx. in Rs./Crore)
Sectors Outstanding credit Annualised volatility Risk exposure

by banks (2) (Percent) (3) (2) X (3)
Gems & Jewellery 24,995 20.1 (MCX Gold futures) 5,024
Metal & metal products

104,719 15.1 (MCX Metal index) 15,813
(including iron & steel)
Agri & allied activities 197,399 09.1 (MCX Agri index) 17,963
Industry (small,
871,900 25.6 (NSE Nifty) 223,206
medium and large)
Total annual price risk exposure of banks in commodities 262,006
Note: Outstanding figures as on March 31, 2008.
Some participants on the sidelines of the derivatives fluctuations that their debtors would face in their
market may tend to believe that participating in this incomes. Further, with the amendments to the Forward
market is risky because of the uncertainty of the Contracts Regulation Act, the subsequent launch of
information that flows into this market. However, being rainfall and weather derivatives will enable banks to
professional and organized banks can have research- hedge against price risk or help farmers cover
based information flowing into the market compared themselves against nature as there will be participants
with a research arm of a broking house. Besides, as in these markets ready to take the risks. So, this
central bank regulations and guidelines already produces a win-win situation for both producers and
streamline and monitor their participation in the lenders/banks.
equity market, banks can be similarly allowed to
operate in the commodity derivatives market within a As for producers, use of price risk management
given set of regulations and could counter the force of instruments provides them with some sort of certainty
unilateral market direction at times of crisis. The about the minimum prices that their produce will likely
opportunity will lend more balance and support to fetch at a future point in time. This enables them to take
banks’ portfolio of investments and also help spreading efficient farming decisions — and improve their
risks across various asset classes. economic conditions. Besides, use of price risk
management instruments nullifies the main reason
Why Should Banks Rrade in Commodities Futures behind producers’ loan default: the unanticipated price
Market? movement or inability to reap a better price that may
prevail at a future point of time. This reduces the
Commodities, like other asset classes whose prices are exposure risk perception of lenders which in turn
determined by all the various information that flow enhances small farmers’ access to credit and its terms.
into the markets about their fundamentals, inherently This win-win situation can be a reality only with further
carry price volatility. As for agricultural commodities in liberalisation of the markets ensuring appropriate
India, direct government intervention in the form of opportunities to both public and private players,
floor price, guaranteed price, minimum support price, including banks, in the price discovery and price risk
etc aimed at protecting buyers was not so successful. management mechanism that an organised platform
Of late, gradual liberalisation of domestic markets left of commodity futures exchanges provides.
this direct intervention limited and allowed market
forces to decide the prices as well as private players to Price Risk and Foreign Exchange Risk
engage in providing farmers with assured prices
through routes such as contract farming. This reform Corporate India is being increasingly exposed to global
initiative resulted in market-based instruments for markets as the Indian markets began integrating with
commodity risk management including futures, their international counterparts rapidly amid the
options, etc. In India, with more than a billion mouths globalisation since the early 1990s. The robust growth
to feed and agriculture providing the livelihood of of India’s merchandise trade, of around 30% to US$396
more than two-thirds of the total national workforce, billion in FY08 (R) over the previous fiscal, is a clear
commercial banks are traditionally mandated to reflection of the opportunities that are being reaped by
maintain an adequate credit flow to the agriculture India Inc. In this scenario, banks providing credit
sector. Even then, banks’ lending to the priority sector facilities to companies indirectly assume price risk
remained low leading to low value realisation in related to commodities that are used in various
adhering to the norms set by the central bank. Reasons business processes of these companies operating in
are many: banks’ poor penetration in rural areas; lack of various sectors. For example, banks holding gold or in
development of collateral-based credit products; lack physical trade of gold are exposed to the same amount
of effective collaterals among farmers; perception of of risk as in table 1.
risk due to uncertainty over agricultural yield; market-
related factors; and so on. From farmers’ standpoint, on Risk arising out of volatility in foreign exchange rate
the one hand, low prices are limiting their incomes and, movement is borne by exporters and importers of
therefore, the necessary investment in the overall goods and services themselves who build that into the
farming process. On the other hand, price volatility is prices of their end-products or take that into their
making it difficult for them to plan their production balance sheets making their business or product
activities, allocate resources efficiently and obtain uncompetitive in the market. Given its total earnings,
credit from organised sector. the average annualised forex volatility of around 11%
works out to forex risk exposure worth around US$44
Now, risk perception of banks can partially be billion for India Inc. Fluctuations in commodity prices
mitigated if they are allowed to participate in the simply adds to this risk exposure of Indian companies
organised commodity futures market to hedge their denting their bottom-lines. Of late, with the value of
exposure to agricultural lending arising out of price INR against benchmark foreign currencies becoming

highly volatile, the forex risk situation has become even price fluctuations that also makes their debtors
worse. For example, the rupee on March 29, 2007 had vulnerable to potential default. Under such conditions,
seen an intra-day high-low difference of Rs.1.01 — over what will be viable for banks is to lend against
2.33% movement, which is not healthy for either commodity collaterals enabled by modern collateral
companies or banks that finance their operations or management agencies backed up by the credible
imports/exports. Appropriate positions in the futures warehouse receipt system that they had developed.
market can help them mitigate such risk. By hedging
their exposure on this platform banks can safely lend Table 3: Annualised volatility (%)
and enhance their credit exposure to these players.
MCX NSE
Further, comparative data in table 2 indicate that Agri Energy Metal
Year Comdex Nifty
commodities are a much more stable asset class than Index Index Index
equities. In other words, it is less risky for banks to trade 2006 17.7 12.5 21.5% 30.2% 26.5%
in commodities than in equities, which is vindicated by
2007 12.2 9.1 20.8% 15.1% 25.6%
the fact that volatility of MCX Agri Index, which covers
2008 25.4 22.3 36.8% 25.9% 44.9%
several essential commodities, is much lower (0.9%)
than the overall volatility in the equities market. This 2009* 20.3 11.2 40.9% 19.4% 42.4%
lays a strong case for banks to be allowed to operate in Source: MCX & NSE; *Jan-June 2009
commodity markets when they are already allowed to
participate in equity markets. Table 3 shows that based on the total exposure
outstanding to various sectors of the primary economy
Table 2: Comparison of price volatility of various and the annualised volatility worked out for the sectors
commodities traded on MCX and NSE Nifty index mentioned above. The quantum of price risk in the
credit exposure will go further up if the services sector
Commodities & indices Average daily volatility (%)
and other industries are included in the analysis. It is
Gold 1.3 obvious that sharing this price risk with the economic
Silver 2.0 stakeholders ready to take it for a cost will create
Copper 2.1 balance in the economic engagement. Therefore,
Crude Oil 2.3 banks with such large price risk exposure need be
MCX Comdex 1.2 allowed to participate in an efficient market to
MCX Agri Index 0.9
effectively hedge their position by transferring the risk
to those participants who are willing to assume,
MCX Energy Index 1.9
thereby reflecting appropriately discovered prices to
MCX Metal Index 1.5 the spot markets and thus help in efficient allocation of
NSE Nifty 2.2 resources among various sectors of the economy.
Note: Prices of commodities and indices are taken from January
2006 to June 2009. Demystifying a Mystical Relationship
Banks’ Risk Exposure in Agriculture Lending and In order to identify the relationship between the Indian
Primary Sector Outstanding equity market and domestic crude oil prices — one of
the major influencing factors behind inflation and
Increasingly realising how crucial the contribution of generally in an economy, we considered BSE Sensex
agriculture to the country’s economic growth is, the and MCX crude oil prices as respective benchmarks. A
Indian government has been laying added emphasis regression analysis was done by taking the Sensex as a
on the sector. This is reflected in its various measures function of MCX crude oil prices. The analysis showed
aimed at boosting the sector in successive budget that for the last two years, a 1% rise in crude oil prices
proposals, of late, including an unprecedentedly large has led to a 0.17% drop in the Sensex as it cuts bottom
loan waiver. The Reserve Bank of India, on its part, is lines of India Inc. Significantly, for the one-year period
issuing various guidelines from time to time to make
sure that formal lenders give top priority to the
agriculture sector in terms of credit advances. Over the Table 4: Correlation analysis
years, there was only one loan that was effectively Associated
utilised by the farm sector — production credit, which Company Correlation (%)
Commodity
is often marred by poor recovery that leads to building
Sterile Industries Copper 74.00
up of scepticism in the minds of organised lenders. The
basic reason is lack of effective collateral that can take Apollo Tyre Rubber 50.45
care of the risk of default and/or an effective Note: The period considered is from the date of launch of respective
mechanism to share their risks in markets arising out of commodities contracts on MCX to June 2009. Complied from spot
prices of MCX and BSE closing prices of companies.
between February 2006 and February 2007, it shows a operations. Standard Chartered Bank - China, for
value of -1.11 indicating a 1% rise in crude oil prices example, received an approval to offer commodity
leading to a 1.1% drop in the Sensex. Incidentally, in the derivative products to cater to even a group of
first instance, the adjusted R-squared (strength of the investors who are highly ambitious yet risk-averse. In
indicated relationship) is 98%, while in the second fact, wide use of derivatives by banks in the US is a
instance it was 94% (and statistically significant as well). recent phenomenon and the reason behind the bulk of
derivatives holdings by large US banks is, interestingly,
The high correlation between equity prices and the to hedge their own risks rather than those of their
prices of the underlying commodities (in which these customers.
companies primarily deal in) on MCX (see table 4)
provides equity market players, including banks and Empowered with varied and innovative products, such
funds, with an opportunity to hedge their risk by taking as OTC and structured hybrid products, capable of
appropriate positions in both the equity and catering to a wide range of different market needs and
commodity futures markets simultaneously. With their reach to various markets the world over, such global
connectivity banks can additionally act as commodity banks additionally provide arbitrage opportunities
derivatives market access providers for the common across the globe and enable customers to hedge risks
man and small producers. For example, ICICI ranging from forex risk to interest rate risk and
commodities.com, which offers online trading facility commodity/equity price risk — all at one go. Further,
to its customers as a plain vanilla offering, can these banks have research desks not only to help infuse
additionally offer customised products to create appropriate domestic fundamentals into the markets
models of aggregation for both consumers and but also carry international fundamentals across
producers of commodities and enable their borders into different markets that are open to them,
participation in the futures market. Table 4 clearly thereby adding value to customers and economies
indicates a strong relationship between the prices of they are operating in on a continuous basis. They do
commodities and those of stocks in the case of also bring in other value-added services such as aiding
commodity-intensive industries. local companies and clients participate in both the
domestic and global markets to hedge their exposures
Commodity Derivatives and Banks – International in various markets across platforms. These activities of
Experience large international banks play an instrumental role in
integrating domestic economy with the global
Today, most international (multi-national) banks deal markets.
in commodity derivatives to add value to their
customers that include public sector and private sector Indian Commodity Exchanges – Not Far Behind
companies and individuals. Their offerings cover Global Peers
products such as OTC swaps, basis swaps, options and
several other structured transactions. Specialists Despite several restrictions, such as on the products
working with such banks, which include Bank of and participatory limitation to individuals and
America, BNP Paribas, corporate, domestic
D e u t s c h e B a n k , CRDB Bank of Tanzania – A case study exchanges in India have
Standard Chartered etc made remarkable headway
among others, come Tanzania-based CRDB Bank with one of the country’s largest in the space of just six years
up with high level of share in cotton and coffee financing and agricultural — their turnover growing
s e r v i c e f o r t h e i r commodities, carried heavy risk — and more so due to price from a negligible amount to
customers even for volatility in the commodities market. The bank’s lending to about half of the total equity
cotton, coffee, tobacco, and cashew verticals was more than
small exposures to give 50%, and the bank was facing considerable problems of turnover (see table 5).
them value for money. default in the cotton and coffee sector. CRDB Bank’s adopted Position limits as prescribed
collateral management system to exercise tighter control in commodities in India are
Delivery of various over the lending to these high-risk sectors rather than pulling much tighter than those in
services offered by out altogether. This lending against warehousing receipt global commodity markets.
such global banks enhanced its capability to lend to farmers in rural areas. It The overall growth of the
a c r o s s n a t i o n s implemented price risk management in two ways – hedging Indian commodities market
d e p e n d s o n t h e the overall portfolio related to coffee and cotton by using risk has remained constrained by
necessary regulatory management instruments and hedging the exposure by way many such strict regulatory
of acting as a market intermediary in carrying hedging
approvals acquired by transactions on behalf of borrowers. controls that prevent large
them for such companies from

participating due to their huge exposure size, and the in some way or the other by sharing them with various
sellers or buyers on the opposite side. Also, keeping economic stakeholders — largely by participating in
sensitivity of the prices of the underlying commodities the derivative market i.e. trading in derivatives on a
in view, contracts in the domestic commodity markets variety of underlying assets. An analysis of outstanding
have been made deliverable compared with credit to various industries shows that banks tend to
financially-settled nature of stock market contracts. lose an average of 23% of their aggregate lending to
Thus, Indian commodity derivative markets are much these sectors, based on the annualised volatility in the
more relevant to the physical markets at this nascent commodities which are used by these sectors in their
stage of their growth. Further, the volatility in the production processes. Moreover, in select stocks of
commodity market — for example, on MCX (as companies with extensive exposure to primary
expressed by Comdex) — has been much lower than commodities that are traded on the commodity
volatility in both the domestic stock market and global exchange platform, there is an inverse relationship in
commodity markets with equally comparable their price movements indicating an opportunity for
regulatory practices (table 5). banks which had invested in those stocks to hedge
their exposure in appropriate commodity derivatives
Conclusion traded on exchanges. Furthermore, an analysis of the
global scenario indicates that major global banks
It is evident that by the very nature of their operations participate in various products in several countries not
Indian banks are exposed to several risks ranging from only to hedge their risks but also to add value to their
interest rate risk to forex risk to commodity/equity customers, which include companies as well as high
price risk to credit risk. Banks can manage all these risks net-worth individuals.
Table 5: Commodity market vs. stock market

Commodities International Commodity
Stock Markets Commodity Markets
& indices Exchanges
Potential Affluent few with income Almost the entire Those in developed
Investors/Operators level to invest in the population (family markets reaches out to
secondary/tertiary growth heads/individuals) of the almost those who are
sector i.e. not more than 4- country who in one way or affected by the volatility in
5 lakh investors with the other would be related the commodity exchanges
sufficient flow of money to the consumption of the
commodity. Numbering
around 200-250mn.
Average Daily Market Rs. 45,359.1 Crore Rs. 17,042.1 Crore -NA-
Turnover (April 1-
March 31, 2009)
Products Available Spot, Futures, Options, Futures Futures, Options, Indices,
Indices Spot
Participants Individuals, Corporate, Banks, Individuals, Corporate Individuals, Corporate, Banks,
Institutions, Funds, FIIs Institutions, Funds, FIIs
Regulators Stock Exchange Board of Forward Markets Single or Separate
India Commission Regulators for
Regulatory tools Margins – VAR adjusted Margins - VAR adjusted Similar regulation with
Index Circuits Price Circuits variable position limits
Position Limits – Company Position Limits - Member
level and Market Valuation and Client Level
Level Penalties
Penalties
Institutional Structure Exchange Exchange Exchange,
Participating Banks Participating Banks Banks, Clearing House,
FIIs, Mutual Funds Members Members, Brokers, Clients
Members Brokers/Sub-brokers
Brokers/Sub-brokers Clients
Clients
Trade Timings Only one session Both morning and evening Limited, extended and 24
(morning session) session hours
Cross margining In the planning stages Not existing Existing not only between
(between cash market and spot and futures but even
futures market) between two exchanges
Index trading Existing Not existing Existing
Delivery logic Financial settled contracts Delivery based contracts Both financial and delivery
(derivatives market) based contracts
Electronic trading Yes Yes Yes
Demutualization Demutualized exchanges Demutualized exchanges Demutualized exchanges
Denomination of Single currency Single currency Single currency and
contracts denomination contracts denomination contracts multiple currency
denomination contracts
Stage of Somewhere between Just passed nascent stages Maturity stage
Development growth and maturity stages
(derivatives market)
In the process, these international banks have not just Foreign banks that have entered India are also most
taken these as a mere risk management practice but likely to seek an entry into Indian commodity markets
put in their best efforts in response to the intense and in line with their global operational principles to help
rising competition and came up with some marvellous them remain profitable in the market. Also, a
results in terms of quality market research by their comparison of the regulatory principles and business
analysts. This not only helped these banks’ own practices of Indian stock markets and commodity
treasury and customers but also the markets to exchanges makes it amply clear that the domestic
discover efficient prices with increased flow of accurate commodity exchanges are as efficiently regulated as
i n fo r m at i o n a b o u t co m m o d i t i e s a n d t h e i r their equity counterparts, which is also confirmed by
fundamentals into the ecosystem. Therefore, in India, commodity price volatility on the exchanges as a
commercial banks with strong connectivity with rural measure. Therefore, there are no reasons why the
areas and domestic commodity exchanges can regulators should stop banks from participating in the
facilitate participation of all stakeholders in the value commodity markets. This would rather help our
chain from the producer to the end-consumer, making policymakers achieve the two primary objectives that
this not only a business opportunity for banks but a they had aimed for while paving the way for national
tool in linking these various participants with the online electronic commodity exchanges: efficient price
markets and help them discover efficient prices. discovery and taking the hedging process closer to
producers, thus preventing risk from being priced to be
shared among others besides ensuring shrinkage of
the product value chain through the transparency
exuded by these markets.
Mr. P. V. Ananthakrishnan is Country Head & CEO, Mashreq Bank – India. Formerly as Executive Vice-President of
HDFC Bank, he started the commodity business for the bank. Views expressed in this article are personal.

Warehouse Receipt
Finance for Farmers –
A Glimpse
By Mr. Nachiket Mor and Dr. Kshama Fernandes
While warehouse receipt (WR) finance has been in existence in India for a long time, and
traders and large farmers do benefit by availing of the mechanism, small and marginal
farmers have been virtually left out of it. This paper discusses the advantages and
disadvantages of WR financing in India from small farmers’ point of view, while citing
examples of how this mechanism has been used globally. It also lays stress on some key
requirements for implementing a successful WR finance programme, concluding with a
brief on IFMR Trust’s agricultural commodity pilot in Gujarat.
Agricultural production, processing and trade are often According to a report by the Reserve Bank of India
considered low-margin, high-uncertainty operations, Working Group on Warehouse Receipts & Commodity
and are perceived as risky investments by financiers. Futures (2005), the overall efficiency of markets,
Physical collateral, such as land and real estate or particularly in the agribusiness sector, immensely
machinery and agriculture implements, is often of little improves when producers and commercial outfits are
use in mitigating financiers’ risks as such collateral able to convert inventories of agricultural raw materials
tends to either be very difficult to enforce or of very or finished products into a readily tradable instrument.
little resale value. No wonder, to obtain finance for Producers receive a receipt against goods of a given
agriculture can be really difficult and often expensive, quality, quantity and grade deposited in accredited
given the risk premium charged by financiers. In light of warehouses. It also says that being negotiable
this, warehouse receipt finance has emerged as an instruments, these receipts can be traded, sold,
attractive alternative for farmers and processors in the swapped, used as collateral to enable borrowing, or
developed world. accepted for delivery against a derivative instrument
such as a futures contract.
Under a warehouse receipts financing scheme, goods
stored in a warehouse are used as collateral against a Warehouse Receipt Finance for Farmers
loan. These goods could be agricultural or non-
agricultural in nature. This has become a fairly Despite growth projections, what remains the reality of
mainstream method of financing in most industrialised the agriculture-related business is its high dependence
countries, and there is evidence that the overall upon seasonality. Broadly speaking, farmers face two
efficiency of markets, particularly in the agribusiness major problems — lumpy cash flows and non-
sector, is greatly enhanced when producers and availability of intermediate finance. Warehouse
commercial entities can convert inventories of receipts finance can play an important role in
agricultural raw materials or finished products into a smoothening income for farmers by providing liquidity
readily tradable device. Producers deposit goods of a at times when cash flows dry out.
certain quality, quantity, and grade in accredited
warehouses and receive a receipt for it. Being WR financing as a means of extending the sales
negotiable instruments, these receipts can be traded, period beyond the harvest season: As the harvest
sold, swapped, used as collateral to support borrowing, season approaches, small and marginal farmers find
or accepted for delivery against a derivative instrument themselves in dire need of liquidity. The simple
such as a futures contract. demand and supply equation results in prices falling to
their lowest during harvest and gradually rising during

the lean season1 . Although farmers are aware of this Is There a Downside for the Farmer?
seasonal trend, they cannot take advantage of this and
benefit from it as they are hard put to organise While availing of finance against warehouse receipts
immediate cash. A typical small farmer sells his crop appears to be an attractive option for the farmer, there
when its prices are at their lowest. This crop is often are concerns about its inherent speculative nature. One
bought by traders or village-level aggregators who must seriously look into a likely adverse outcome: this
hold the stock through the harvest season till prices financing avenue may encourage farmers to take
pick up and then sell it at a profit. To cite some numbers, speculative positions having the potential of resulting
the seasonal variation in castor seed prices during 2008 in losses beyond their risk-taking ability. Warehouse
was almost Rs.200 per 20kg which translates into a receipt financing is profitable only when the expected
profit of Rs.750 a bag of castor seed (which translates rise in the value of the stored product is actually more
into an annualised return of 88.9 %). If farmers are than the cost of storage plus that of the borrowed
enabled to hold on to their crop beyond harvest, a part funds (i.e., loan principal plus interest payments, bank
of the price benefit could accrue to them. So, by fees, etc).
providing farmers with a mechanism to store and hold
on to their produce, warehouse receipts finance Many would argue that farmers ought to confine their
enables the extension of the sales period beyond the activity to the area of their core competence — farming
harvest season. — and not indulge in speculation. However, in the
absence of a readily accessible hedging mechanism,
WRs as secure collateral for obtaining finance: Most the Indian farmer is a speculator in any case. From the
banks are uncomfortable in extending pre-harvest point of time he sows the seed till the point of time he
loans to farmers. Warehouse receipts form sound sells the crop in the market the farmer is long on the
collateral whose market value can be easily estimated commodity, unless he hedges his long spot exposure
and whose liquidity is much higher than conventional by selling his produce in a forwards, futures or options
collateral such as land and machinery. In the event of market, which he has no access to in India. Most
default, the holder of the warehouse receipt has the farmers who sell their standing crop to traders and
first call on the underlying goods or its value. This other local financiers before harvest do so at sub-
provides banks and financiers with the comfort to lend optimal rates under tremendous liquidity pressure and
to the farmer without lengthy documentation and long not from the point of view of hedging their exposure.
processing delays. Farmers, on their part, can avail of So, the contention that farmers should not engage in
loans either to overcome immediate liquidity speculative activity because it is not their core
requirements or to finance future crop/investments on competence is something that must be looked into in
farm equipment or alternative businesses. According the light of alternatives available. Warehouse receipt
to the RBI Working Group report, on notion of reduced financing is in essence a speculative activity. Availing of
risk premia, collateralisation of agricultural inventories the facility simply extends farmers’ already existing
using warehouse receipts will lead to increased credit price exposure beyond the harvest, providing him with
availability and reduced cost of credit. Besides, it will a readily available cash flow and a potential upside.
lead to mobilisation of mainstream financial resources And, in general, even if the farmer wishes to sell in the
into the agricultural sector. spot market, it allows him to do price averaging (thus
reducing his exposure to “impact” cost) by selling his
In their study on the use and impact of warehouse harvest gradually instead of being forced to sell the
receipts in developing and transition economics, entire quantity on a single day.
Lacroix and Varangis (1996) concluded that warehouse
receipts are an important addition to the store of
negotiable instruments in a country’s financial sector.
According to them, they not only provide important
long-term economic benefits but also have immediate
positive impact on the farmer’s life.
1 The persistence of this arbitrage is a conundrum. If indeed this pattern was risk-less and the large traders or buyers were not credit constrained then, at least for
non-perishables, the return from this arbitrage should have been lower than the cost of financing and storage costs. In perishables, wherever possible, it should
have led to more aggressive “calendaring” (more distributed production throughout the year). However, in almost all commodities this arbitrage persists. It is
possible that the existence of the “peso problem” (the risk of a sudden, completely unexpected precipitous fall in value that is rationally anticipated by the market
– first pointed out by Rogoff (1980)) makes this arbitrage both persistent and highly risky. If indeed that is the case, then one wonders if availability of warehouse
receipt finance for the small farmer is a boon or a curse (discussed later in the note). Two alternate directions however look promising: commodity forward
contracts to be offered to farmers at the time of sowing (so that they may “square off” the “long” position that they create as soon as they commit themselves to
planting a particular crop and thereby lock in their profit margins) and an options contract or least a delta hedge (since options contracts on commodities are not
legal in India) which allows the farmer to buy protection against a further drop in commodity prices but retain the right to benefit from a rise in prices.
Warehouse Receipt Financing – International In a similar effort, the RBI Working Group report says,
Experience PTA Bank in Kenya finances coffee exporting farmers by
accepting warehouse receipts as collateral. It also offers
Experiences around the world suggest that warehouse them a put option, purchased at the London
receipt financing can be a profitable avenue for both Commodity Exchange, which guarantees sellers a
the farmer and the financier. TechnoServe in Ghana has minimum price for the coffee in storage. By assuring a
achieved considerable success in its inventory credit floor price for the stored coffee, PTA Bank can provide
programme over the past two decades. According to finance for a higher percentage of the value of coffee
TechnoServe’s Inventory Credit Programme in Ghana than it could justify in the absence of the floor price.
by Frank Hicks, the firm believes that only the
confidence of being able to sell the produce at a According to Lamon Rutten (then Coordinator –
reasonable profit to buyers can be the incentive for commodity marketing, risk management and finance
small and marginal producers, constituting 60% of at United Nations Conference on Trade and
Ghana’s farming population, to augment both Development), in Venezuela, under a system
production and productivity, and supply to local developed by private firm Induservices, provided
industries and exporters. As in most agricultural capital enhancement to warehouse receipts on
markets including India, small farmers remain the seasonal maize stocks. And this enabled the firm to
classic “price takers”, cut off from information flowing attract huge investment to finance maize stocks.
into and out of the market and profitable market
opportunities. To improve their conditions, Hicks says, Again in Colombia, Rutten said, a more complex
TechnoServe ushered in the concept of inventory structure, introduced in mid-2000, made it possible for
credit in Ghana in 1989. The idea was to create an cattlemen to receive strong financing support to feed
opportunity for these farmers to take advantage of their cattle – at rates determined through the
seasonal price swings (used smartly by local traders) to competition among institutional investors on the
mitigate risks for banks that were hesitant about country’s stock and commodity markets.
lending in the rural belt and to increase food security
for farmers who can buy back (or “redeem”) their Keys to Successful Implementation of a Warehouse
produce rather than sell it. Receipts Programme
Participating farmers usually form groups of 20-50 According to the RBI Working Group report, to work
members to store their produce and carry it into the effectively, warehouse receipts require a recognised
lean season when prices are at their peak — much foundation in law ensuring that the ownership
higher than harvest time price levels. At the same time, established by the receipts is not challenged.
they have the flexibility to exercise one of the following Warehouse receipts must be functionally equivalent to
options: stored commodities with well-defined rights, liabilities,
and duties of each party to a warehouse receipt (for
• can decide to sell the produce through the group, example a farmer, a bank, or a warehouseman). They
using the proceeds to repay the bank for its credit must be freely transferable by delivery and
and the group for the use of storage facilities, endorsement and the holder of a warehouse receipt
earning a net profit of 40 to 100%; must be first in line to receive the stored goods or their
fungible equivalent on liquidation or default of the
• They can take back the produce from the group to warehouse. A robust legal framework is a prerequisite
consume as food, repaying the bank loan and the to warehouse receipts being treated as secure
group’s storage costs, and still saving a substantial collateral.
amount by avoiding high lean season food prices.
Also essential is a warehouse infrastructure, grading
TechnoServe has refined the model of inventory credit and collateral management system that provides
and expanded its application to other areas in Ghana. guarantees on quality, quantity and storage of
At preset, it is offering facilitating over 100 farmers’ commodities, thus assuring that the quantities of
groups access inventory credit. For nearly two decades goods stored match those specified by the warehouse
now the participating farmers have maintained a cent receipt and also their quality is the same as stated on
per cent on-time loan repayment record, significantly the receipt. This will give farmers the confidence to
improved their incomes and agricultural production, store their produce and banks the comfort to accept
cut down post-harvest losses and accumulated capital warehouse receipts as secure collateral for financing
to invest in other agricultural activities. agricultural inventories.

And finally what is required is a combination of fair and This is in line with IFMR Trust's mission of ensuring
transparent spot and futures markets that provide complete access of financial services to every
liquidity and price discovery, enabling both farmers individual and every enterprise. Towards this, after
and banks to value and sell warehouse receipts at short extensive survey, Dharampur, a village 20 km from Kadi
notice if need be. town, with 1,000 acres under castor production and a
population of 3,000, has been identified as an ideal
In the Indian context, the proposed Warehousing village to operate the pilot from.
(Development and Regulation) Act, 2007 incorporates
almost all the aforesaid legal and warehouse Trading operations: The trading facility is located at
infrastructure related requirements. Once approved Kadi in the exchange-managed warehouse premises.
and implemented, it should provide a sound basis for As part of the servicer agreement, the exchange
developing and promoting warehouse receipt-backed provides guarantee on quality, quantity, and storage of
trade and finance activity in the country. commodities in the warehouses managed by it. The
electronic exchange market provides nationwide
IFMR Trust’s Pilot in Kadi Taluka (Gujarat) access to buyers and sellers. The first crop to be traded
was castor seed. While the market is still at its nascent
In pursuit of its mission for financial inclusion, IFMR stage, its volumes have been encouragingly large. The
Holdings has ventured into the agricultural space. market caters to farmers from around 125 villages
Dealing exclusively with small and marginal farmers in around Kadi. Farmers come to the warehouse with their
the Kadi Taluka of Mehasana in Gujarat, three of its commodities which are then put through a standard
entities, Agricultural Terminal Markets Network weighing and quality testing process. Depending upon
Enterprise (ATMNE), IFMR Holdings, and IFMR Capital the quality, weight adjustments are made and the
are working together on a pilot with the following commodity is packed in 75 kg bags and stacked away.
objectives: The collateral manager issues a receipt of weight and
quality, following which the farmer places a sell trade
• To provide price discovery to farmers for their crops through the ATMNE agri-broker sitting at the trading
in a fair and transparent manner (ATMNE); terminal at the warehouse. Once the trade goes
through, the farmer is handed over the cash and receipt
• To explore other services required but not available for the same.
to small farmers currently such as transportation
from the village to the market/buyer, village level So far castor seed worth Rs. 2.5 crore has been traded
warehousing capability, and agricultural extension by over 500 farmers based in 25 different villages
services (ATMNE and IFMR Holdings); surrounding Kadi, the smallest trade being one bag
and the largest 70 bags. Over the last four months, price
• To provide commodity-backed finance to farmers differentials between the mandi and the electronic
who would like to avail of finance against the exchange have dropped from Rs. 75 to Rs. 18 a bag
commodity as collateral (IFMR Holdings); possibly in response to a credible price discovery
mechanism being provided to small farmers through
• To explore other financial products and services the exchange.
required but not available to small farmers currently
such as commodity forward contracts and delta- Financing operations: Warehouse receipt finance in
hedging (IFMR Holdings and ATMNE); India is typically used by traders and affluent farmers. It is
largely perceived to be non-applicable to or non-viable
• To develop tradable Asset-Backed Warehouse for the small and marginal farmer. Barriers to
Finance Receipts (ABWFRs) so that they may be sold participation from the financiers’ side include reluctance
to mutual funds and other financial institutions on their part to deal with small-size transactions due to
(IFMR Capital). operational reasons. From the farmer’s end, there are
issues concerning non-availability of reliable price
As part of this pilot, the three IFMR Trust entities are information, lack of storage space, inefficient quality
working with the National Spot Exchange Ltd. (NSEL) to testing procedures, existence of multiple layers of
help farmers realise the best possible price for their intermediaries, hidden charges, documentation
agricultural commodities. ATMNE is an institutional challenges, and high transportation costs.
trading and clearing member and provides trading
access to small and marginal farmers. IFMR Holdings
provides warehouse receipt finance, helping farmers
wait out the low price realisation period during harvest.
In our experience, the biggest challenge in terms of Lack of awareness - For farmers used to centuries of
giving farmers access to warehouse receipt finance has trading through adhathiyas on the mandi and availing
been awareness creation. IFMR Trust has been putting of loans from them, trading on an electronic exchange
in a lot of efforts at farmer education. By interacting and availing of finance against the stored commodities
with farmers in their local settings, it is explaining to has been a new experience.
them the concept of an electronic exchange that
provides a transparent price discovery process, as well Rigour of the quality testing process - The exchange
as the documentation, process, risks and returns from follows a rigorous quality-testing procedure unlike
availing commodity-backed finance through IFMR regular mandis where quality is gauged simply by
Holdings. picking up a handful of commodity. A value reduction
is applied if the commodity does not meet the set
IFMR Holdings provides loan against commodities as parameters. Farmers who initially took a while to
collateral. The purpose of the loan product is to provide understand the quality testing process now feel the
short-term finance to farmers collateralised by process is more fair and transparent than the one they
commodities for which warehouse receipts are issued were used to.
by a collateral management company. The exchanges
arrange for collateral management services and act as a Reluctance to store commodity in warehouse -
service provider. Perishability of castor seed is almost negligible. Instead
of storing it in a warehouse and incurring storage costs,
The branch through which the IFMR Holdings finances farmers prefer to store it in their backyards.
farmers against commodities is located at Dharampur
village such that it would serve a cluster of villages that Prior advances taken from traders - Almost 30-40%
cultivate in large quantities crop such as castor seed, of farmers around Kadi have already taken loans from
mustard seed, and wheat, among others. Currently, traders against commitments to sell their existing
loans are being given to farmers coming from five commodities to these traders.
villages. Farmers can avail of finance against a single
bag of castor seed placed in a warehouse. The Conclusions
maximum loan amount they can avail of against a
particular commodity is Rs. 10 lakh (Rs.1 million). It The contribution of warehouse receipt systems in
goes like this: a farmer visits the branch and registers developing agricultural markets has been well
himself, which involves fulfilling the KYC (Know Your recognised across the world. The Ghana experience
Client) process that includes biometric identification shows that these schemes can dramatically reduce
and physical verification of address proof. On inter-seasonal price fluctuations, benefiting small and
completion of the process, the farmer is given a smart marginal farmers who otherwise have no choice but to
card which henceforth is used as a single source of resort to distress sales (sell immediately after harvest).
identification and data capture for all transactions Warehouse receipt finance can offer farmers a
done by the farmer. After charging appropriate marketing and credit option that spurs productivity
margins to cover price fluctuations, loan is given and thus increases their incomes. Farmers can also sell
against the warehouse receipt for the commodity some of their stored products to finance future crop,
stored by the farmer in the NSEL-managed warehouse. thereby obviating or reducing the need for borrowing
from moneylenders and traders. Financial institutions
While farmers’ response to the warehouse receipt benefit from reduced risks and from liquidity due to
finance mechanism has so far been a cautious one, they ready collateral to guarantee or reimburse defaulted
are definitely gradually becoming aware of this facility loans. Farmers, on their part, benefit from higher
and coming forward to avail of loans through this profitability being able to delay sales; from improved
route. Reasons for their initial inhibitions could be: price transparency, and from increased bargaining
capacity through working in farmers’ groups.

However, warehouse receipt finance is essentially a References:
speculative activity and requires serious monitoring of
grain quality as well as market price trends and 1. Bamako (Technical Note No. 5). 2000. “Warehouse
fluctuations. When properly designed and managed, a receipts: financing agricultural producers”
warehouse receipt finance programme can allow small
farmers to graduate from the status of “price takers” to 2. Evans, Martin D.D., and Karen K. Lewis. 1992. NBER
that of “price negotiators” in the local market economy. Working Paper Series, No.4003
The mechanism can also provide rural entrepreneurs
with a route to capital accumulation that can be 3. Hicks, Frank. 1998. “TechnoServe inventory credit
invested in more diversified and sustainable ventures programme in Ghana”. United Nations Conference
capable of stimulating long-term rural economic on Trade and Development
growth and development, which in turn can contribute
significantly to the overall economic growth in line 4. Lacroix, Richard, and Varangis, Panos. 1996. “Using
with national aspirations. warehouse receipts in developing and transition
economies”, Finance & Development
5. “Report of the Working Group on Warehouse

Receipts & Commodity Futures”. 2005. The Reserve
Bank of India
6. Rutten, Lamon. 2001. “Local market opportunities

with respect to warehouse receipt finance -
tapping into the local capital market”, ESCAP-ADB
Joint Workshop
7. Rutten, Lamon. 2001. “Financial engineering

techniques for directly linking domestic capital
markets and the agricultural sector – a short note”,
ESCAP-ADB Joint Workshop
8. The World Bank (Agricultural Investment

sourcebook series). 2004. “Ghana: Inventory Credit
for Small-Scale Farmers”
Mr. Nachiket Mor is President, ICICI Foundation, and Dr. Kshama Fernandes is Vice-President, IFMR Trust. Views are personal.
Carbon and Clean Energy
Markets – the Potential
in India
By Ms. Bharti Gupta Ramola and Mr. Prashant Vikram Singh
Traditional energy and clean energy hold significant potential in the Indian commodity
market. Addressing jurisdictional and market participation issues will remain crucial
even as we consider market mechanisms for achieving strategic clean energy objectives
in the country so that our commodity markets can perform their role of risk mitigation in
this important sector of the economy effectively.
Even as the debate intensifies on whether or not there volume for carbon in excess of 6 billion or more than 3
will be a global climate agreement on reducing times the underlying physical market. Trade in primary
greenhouse gas (GHG) emissions post-2012, in CERs (Certified Emission Reductions), the developing
Copenhagen summit in December 2009, and on the world’s instrument of access to the global carbon
contours of such an agreement, several developed and markets, was below the 2007 level at 389 million in
developing countries have embarked on a number of 2008, while that in secondary CERs (CERs traded among
initiatives conveyed in pending and approved developed economy banks, traders, and utilities)
legislations, policies, and measures aimed to deal with, witnessed a significant jump in volumes at 1,072
at the minimum, clean energy and, at the other end, million in 2008. This is 5.3 times the underlying physical
binding GHG emission reduction targets. There is a market of 275 million issued CERs up to 2008. We
momentum building as several of these legislations, should see greater volumes of EUA and CER trades as
policies, and measures have been set on course in the the carbon commodity markets deepen and reach the
last 12-18 months. This article looks at the potential of level of other energy markets such as electricity and
clean energy and GHG emission reduction for natural gas markets where the total financial market is
commodity markets as many of these initiatives have 10 to 20 times the underlying physical market or crude
relied on domestic and, sometimes, global market oil where it is more than 30 times.
mechanisms, which would inevitably translate into a
trading scheme and the trading of underlying targets The linkage between the energy and the carbon
or commitments as commodities on exchanges. emissions markets is obvious, but it is interesting that
some analysts predict that the emissions market may
Rise of Global Carbon Commodity one day overtake the energy market (electricity and
gas). Estimates of the size of the global carbon market
Global carbon markets have been growing at 100% a in 2020 are in the range of US$1 trillion to US$3 trillion.
year, touching US$126 billion in 2008. The EU ETS Last year, Bart Chilton, US Commissioner of the
(European Union Emission Trading Scheme) saw 3.09 Commodities Futures Trading Commission, opined
billion EUAs (European Union Allowances) traded in that “the potential size and scope of a structured carbon
2008, exceeding the annual allocation for 2008 of 1.8 emissions market in the US is unequivocally vast. It is
billion. Spot trading in EUAs jumped significantly to certainly possible that the emissions markets could
250 million out of total 2.7 billion exchange-traded overtake all other commodity markets," while estimating
EUAs in 2008 and further increased to 850 million out of emissions futures to reach US$2 trillion in five years.
total 3.2 billion exchange-traded EUAs in the first half of
2009. The explosive growth in the EUA market and the Data on transactions in the UK, one of the largest
significant increase in spot trading imply a deepening electricity, gas and emissions markets in the Euro Zone,
of the EUA market, and if this growth continues, the can read as a first sign of rapid growth of emissions
year 2009 could end up with the financial market trading with high volatility in other energy markets in
the last three years.
Contracts transacted by UK brokers – Projections by EPA show that this would require an
notional value of markets in £ billion. emissions reduction (against the business as usual) of
366 mtCO2e (million tons of carbon dioxide
2005 2006 2007 2008 equivalent) per annum during the period 2012-2020.
UK power 25 30 30 63 The total US emissions in 2005 were at 7.2 billion. The
UK gas 54 108 134 176 ACES does not automatically allow all CDM/JI credits
Euro power 77 147 193 178 but calls on the US EPA (Environment Protection
Euro gas 7 11 11 27 Agency) to develop its own process for approving
Coal 45 107 46 111 offset projects. It provides for allowable limits of two
billion tons annually from domestic and international
Emissions 1.5 5.5 8.8 36
offsets, and international allowance trading. A carbon
Source: Financial Services Authority (FSA) survey of the energy market of US GHG emissions of this magnitude will
derivatives market
increase the global emissions market multiple times.
The European Union has agreed to take a 30% Energy Markets in India
reduction below 1990 by 2020, in the event of an
international agreement on emission reductions. In its In India, electricity exchanges have been a recent
absence, it will take a 20% reduction below 1990 by entrant in the commodity market, with Indian Energy
2020, which translates into a 21% reduction between Exchange Ltd (IEX) and the Power Exchange India Ltd
2005 and 2020 in the EU ETS sectors. This implies (PXIL) becoming operational last year. Recently, a third
allocation/auction of 2 billion EUAs for 2013 decreasing power exchange, National Power Exchange Ltd, has
to 1.7 billion EUAs for 2020 valuing the physical market received approval from CERC (Central Electricity
at US$ 50 billion a year. The demand for CDM/JI (Clean Regulatory Commission). Currently a day ahead
Development Mechanism/ Joint Implementation) market, there are indications that term capacity
credits is restricted, in the event no international contracts and intraday contracts would be allowed to
agreement takes place, to the allowances unused be traded on the exchange.
during the period 2008-2012. In the event of an
international agreement on emissions, the limit on use The power exchanges deepen the existing bilateral
of CDM/JI credits will automatically be increased up to electricity trading by embedding the transmission
half the additional reduction effort. Estimates put the availability within the day-ahead contract in addition
total limit of CDM/JI credits during the period 2008- to the standard benefits of a trading platform — access,
2020 at 1.4 billion (without international agreement) risk mitigation, clearing and settlement processes. On
and an additional 300 million in the event of an an annualised basis, the electricity traded by the
international agreement being secured. However, the trading licensees stood at 21.9 TWh (terawatt hour or
CDM scheme is expected to change significantly from billion kWh) in 2008-09, approximately 3% of the total
the one that exists today — both internally, in terms of electricity generation in India, valued at approximately
improving the existing mechanism, and externally, in US$3 billion (given the high traded prices in the range
scope and coverage. There are calls for the existing of US$150/MWh). Around 2 TWh was traded on the
(improved) CDM scheme to be applicable only to ‘least power exchanges in FY09 (part year operation of both
developed countries’ in future and making sectoral the exchanges). If one were to use the 10-20 multiple
CDM applicable for major economies. Calls for benchmark of financial markets to the underlying
exclusion of industrial gases have also been raised. On physical markets, this shows a huge growth potential in
the other hand, the developing countries have been terms of electricity trade volumes and the share of
raising the issue of financing and technology transfer, exchange-traded electricity. There are some issues
the key parameters set out in the Bali Action Plan. relating to the appropriate regulatory agency that has
primary jurisdiction over the electricity commodity
The US is not yet a significant player in the global market. While these issues are being deliberated, they
carbon market. However, the recent passage of the have not come in the way of developing the exchange-
American Clean Energy & Security Act (ACES) through traded electricity market.
the US House of Representatives is expected to change
that dramatically and, at the very least, has kept the Multi Commodity Exchange of India Ltd (MCX) inter alia
momentum to Copenhagen summit (the 15th trades in natural gas, which is one of the actively traded
Conference of Parties in December 2009). The ACES contracts, while National Commodity & Derivatives
proposes 17% emissions reduction between 2005 and Exchange Ltd (NCDEX) has recently introduced trading
2020 (3% below 1990 levels) and 80% by 2050. in thermal coal. Crude oil and fuel oil are traded on both

MCX and NCDEX. Emissions trading (see section below) understood that the premium was on the account of
got underway at both the exchanges last year. That is, speculation over the exchange price (Euro Vs INR),
an entire suite of energy and emission products is which was expected to rise. However, as the global
being traded on the two exchanges and is expected to recession and economic slowdown hit Europe in the
grow significantly in volumes. We anticipate that, as latter half of 2008, the demand for the EUAs — and
energy markets are further liberalised, new products in hence for CERs — began to decrease. The price fall was
the form of spark and dark spreads with and without further fuelled by companies in Europe selling surplus
embedded emissions will also emerge as hedging EUAs to raise much needed finances. When CER prices
tools. began to decline, Indian sellers preferred to wait and
watch rather than transact at lower prices. In the
Carbon Markets in India absence of buyers and sellers in the Indian market,
speculators and arbitrators vanished. And this resulted
Carbon instruments were launched in India in 2008 in in the drying up of trades on the Indian exchanges. The
anticipation of significant growth in the global carbon 2008 preliminary verified emissions data released in
markets and India’s position as the second-largest 2009 showed that EU ETS was overall short in spite of
supplier of emission reductions. MCX initially launched the economic slowdown but this did not cause any
futures linked to EUA and later launched CER futures significant market movements as this was generally
contracts (expiry December 2008-2012). NCDEX expected.
launched CER futures contract with expiry December
2008. Indian commodity exchanges do not allow direct
participation by foreign institutions. This may not
Exchange-traded carbon instruments were aimed to impact price discovery for domestic commodities but
infuse greater liquidity and depth to a market that was CERs are different as their primary use is by Annex 1
being serviced by the over-the-counter (OTC) market, countries. As there are no compliance buyers in India
which largely comprised compliance buyers, and foreign traders and institutions are not allowed to
international brokers, traders, banks etc. The participate on NCDEX and MCX, liquidity and trading
exchange-traded market’s role in price discovery and volumes are likely to continue to be low (affecting the
transparency was of particular relevance to Indian price discovery process) until some elements of this
sellers as there was a general perception of lack of equation are modified.
transparency in the OTC market. OTC transactions
generally involve longer lead times and more complex Apart from market participation regulations, the
and largely bespoke emissions reduction purchase development of carbon markets in India will also
agreements with extensive provisions to deal with depend on the contours of global carbon markets post-
credit risk issues. Exchange-traded carbon instruments 2012, agreed in Copenhagen summit. Significant
were seen capable of addressing all these issues. opportunities could emerge for compliance and
Importantly, exchange-traded carbon instruments voluntary carbon for commodity exchanges if there is
were intended to give the treasuries of large carbon continued use of market mechanisms for reducing
sellers in India the ability and the flexibility to actively GHG emissions in the global context post-2012.
manage the company’s carbon portfolio and price risks
as commodity hedging on overseas carbon markets Clean Energy Commodities on the Horizon
requires regulatory approvals not many companies are
willing to pursue. As with any trading scheme, primary Negotiations at Copenhagen notwithstanding, there
CER sellers were seen as an important segment of the will be opportunities for commodity trading products
market but the anticipation was that very significant in the Indian clean energy space. A renewable energy
interest from speculators, traders and arbitrageurs certificate (REC) trading programme is on the anvil. The
would provide the needed liquidity. Indian government and power regulators are in the
process of defining the tradable REC scheme, which is
The initial trades and growth in the volumes of intended to promote renewable energy development
exchange-traded carbon instruments on MCX and and provide flexibility to electricity distribution utilities
NCDEX were encouraging, and there was a lot of that have renewable purchase obligations (RPO) fixed
interest. At times, the prices of CER futures contracts on for more than 10 states in the country and to the states
these exchanges were at a premium over those of the that have abundant resources for renewable energy
European Climate Exchange (ECX), the world’s largest generation. In the absence of the tradable REC scheme,
carbon exchange. However, it was generally the states with renewable energy resources will have
little incentive to promote renewable energy Looking ahead
generation beyond their RPO, while those that do not
have access to renewable energy resources will be hard The conclusion we can draw is that there is significant
pressed to meet their RPO. The REC trading is expected trading potential for traditional energy and clean
to be on the same platform as the electricity trading. energy in the Indian commodity market. If a global
Given the expectation of 25 GW (gigawatt) of carbon agreement that relies on market mechanisms
renewable energy capacity targeted by 2012, this comes into being at Copenhagen summit, the energy
creates an underlying physical renewable energy commodities markets in India can grow considerably
market equivalent of 50 TWh/yr or US$4 billion/yr. with the inclusion of carbon. However, it will be
important to sort out jurisdictional and market
The Bureau of Energy Efficiency (BEE) has established the participation issues even as we consider market
Perform, Achieve and Trade (PAT) Scheme under the mechanisms for achieving strategic clean energy
National Mission on Enhanced Energy Efficiency. Nine objectives in India so that the commodity markets can
energy intensive industries have been notified as perform the role of risk mitigation in this important
‘designated consumers’ under the Energy Conservation sector of the economy.
Act, 2001. These are thermal power stations, fertilizers,
cement, iron & steel, chlor-alkali, aluminium, railways,
textile and pulp & paper firms having energy
consumption over certain thresholds. The goal setting,
involving the setting up of specific energy consumption
benchmarks, is in progress. Over the next three-four
years, the designated consumers will have to reduce
their specific energy consumptions to the target level or
purchase Energy Saving Certificates (ESC) from others
who have improved on their targets. Let us assume that
the potential gains for industry energy efficiency are 50
TWh/yr and assuming that two-thirds of this expected
energy efficiency gains are covered under the PAT
scheme, the underlying physical ESC market is expected
to be 33 TWh/yr or US$ 3 billion/yr.
The ESCs may be made fungible with the RECs, thus

expanding the depth of the market. The potential for
trade in RECs and ESCs, including trading of derivatives
of these commodities, is significant. This will be an
interesting and relevant extension to the electricity
trading schemes already operational at the commodity
exchanges including the possibility of trading
electricity with embedded emission reductions.
Ms. Bharti Gupta Ramola and Mr. Prashant Vikram Singh are both Executive Directors – PricewaterhouseCoopers Pvt. Ltd. Views expressed
by the authors are personal and not of PricewaterhouseCoopers Pvt. Ltd.

Commodities Derivative
hedging: Portfolio and
Effectiveness
By Mr. Kumar Dasgupta and Dr. Chiragra Chakrabarty
“Commodities have been the bedrock of civilization. Ever since we arrived, our existence
has been defined by a quest for control over geological resources – call it oil, gold,
copper or even exotics like uranium. Man has undertaken treacherous expeditions and
fought battles to discover and conquer commodities. Civilisations rise and fall, and
economies prosper based on their ability to harness energy, mine metals, and cultivate
agricultural produce. Interesting to note: the progress of mankind has been marked
through the ages with different commodities – Stone Age, Bronze Age, Iron Age, and
now Nuclear Age. The enigma, called commodities, has determined the fate and wealth
of nations for eons and would continue to do so in future…”
1. Introduction to Commodity Derivatives vehicles for accumulation of significant wealth for

Markets individuals. Some of the most enduring fortunes
have been built with commodities. Among the
1.1. Commodities derivatives markets are deep and stars in the galaxy, Mayer Rothschild single-
broad, presenting both challenges and handedly built the banking empire by providing
opportunities in their wakes. It has been the vault facilities for storing bullion during World
experience of participants that they have been War II. John D. Rockefeller created the first true
besieged by the vastness of the market and the corporate, Standard Oil Co., by exploring crude
types of underlying assets available. Despite oil. Andrew Carnegie conglomerated the steel
millennia of commerce in commodities, we are industry in the United States to form US Steel.
still perplexed by questions such as: “what should Abdel-Aziz-Al-Saud, the founding father of Saudi
we trade in?”, “how much do we buy or sell?”, “how Arabia, created one of the most influential
do we give or take delivery of commodities?”, nations on energy products. Jim Rogers, the
“when is the ideal time to enter and exit the Ambanis, the Tatas and Laxmi Mittal have all
market”, and so on. These asymptomatic become legends because they had the foresight
behaviours of intermediaries and investors have to invest in commodities.
given naissance to the major commodity
markets, as we know them today. From the 1.3. With a growing population of over one billion
mandis in Asia and Africa to the sophisticated (2001 census), India would remain one of the
electronic platforms in the Western world, largest markets for traders in global commodities,
commodities trading has come a long way. The with metals and energy playing a crucial role in
mode of exchange of the value of commodities the growth and development of the industrial
has also seen a transformation over the ages — sector of the Indian economy and agricultural
from the rudimentary barter system, trade was products. At this juncture, institutional
revolutionised by the introduction of money, and development of commodity markets will: (a)
yet again with the advancement in electronic create a “near-perfect” market situation, (b)
transfer of credits called dematerialisation. enable wider participation by different segments
of the economy, (c) create a global hub for trading
1.2. While it is true that commodities have dictated in commodities due to its strategic geographical
the economic passions of sovereign and non- location, and (d) make India a potential “price
sovereign nations, they have also acted as the setter” for many commodities.
1.4. The paper has been divided into five sections. Rs.33,162.07 billion in 2008-09. The growth
While section 2 draws a comparison of Indian charted by the Indian commodity exchanges can
markets with international markets, the use of be summarised in Table 1.1.
commodity derivatives in portfolio management
is explained in section 3. Section 4 depicts the
Table 1.1: Turnover of the Indian Commodity
methodology and issues related to the
measurement of hedge effectiveness. Section 5 is Derivative Exchanges
devoted to conclusion. Year Turnover (in Rs. Billion)
2002-03 665.30
2. Indian Markets vs. International Markets –
2003-04 1,293.64
Where We Stand
2004-05 5,717.59
2.1. If we look at our history, Indian market 2005-06 21,551.22
participants have had the experience of trading 2006-07 36,769.27
in commodity derivatives for ages. Even during 2007 -08 40,659.89
the long period of ban, there were reports of 2008-09 (Nov. 2008) 33,162.07
parallel markets in commodity derivatives. It is
Source: MCX, NCDEX, NMCE & NBOT
interesting to note that, in 2002, just after the ban
was lifted and the Government approved the
launch of national-level trading platforms, the 2.3. The Group on Forward and Futures Markets, 2001,
Indian commodity market took a quantum jump. has estimated that the contribution of
Industry observers were left wondering as to how commodity derivatives exchanges would be as
India could pull off a coup d’état in such a short high as 10% of Gross Domestic Product (GDP) by
time. The question which was, and perhaps still the year 2007 compared with a nominal of 1.2% of
lingers (even after five years of operation) is: Is GDP in 1999. Compared by volumes (the number
such a progress sustainable and what are the of contracts traded), nine of the world’s top 22
obstacles that need attention if the market has to major commodity derivatives exchanges are in
realise its full potential? developing countries. And interestingly, three of
them are based in India (MCX1, NCDEX2 and
2.2. Since 2002 there has been a revival of commodity NMCE3). Further, one of these exchanges (MCX)
derivatives markets in India, both in terms of features in the world’s top 10, overtaking long-
commodities allowed for futures trading and established and mature institutions such as the
volumes of the trade. Let us consider some Tokyo Commodity Exchange and New York Board
statistics. While in 2001-02 futures trading was of Trade. A figurative assessment is given in Table
allowed only in eight commodities, the count 1.2. The figures include the volumes in terms of
jumped to 109 in 2008-09. The value of trading in contracts traded in the first half of 2009. The
Rupee-denominated terms saw a quantum jump volumes in terms of USD or INR are not
from about Rs.350 billion in 2001-02 to considered within the scope of this study.
Table 1.2: Turnover of Global Commodity Derivatives Exchanges

Turnover
Rank Exchange Country
(number of contracts traded)
1 New York Mercantile Exchange (NYMEX) USA 206,010,205
2 Dalian Commodity Exchange (DCE) China 170,869,127
3 Shanghai & Hong Kong Futures Exchange (SHFE) China 151,544,472
4 Zhengzhou Commodity Exchange (ZCE) China 93,213,149
5 Chicago Board of Trade (CBoT) USA 83,233,736
6 ICE Futures, Europe Belgium. 78,372,945
7 Multi Commodity Exchange of India (MCX) India 77,742,706
8 London Metal Exchange (LME) UK 55,185,086
9 ICE Futures U. S. (erstwhile New York Board of Trade) USA 25,271,245
10 Tokyo Commodity Exchange (TOCOM) Japan 14,643,397
Source: Industry Analysis
1
Multi Commodity Exchange of India Limited, Mumbai (www.mcxindia.com)
2
National Commodity and Derivatives Exchange Limited, Mumbai (www.ncdex.com)
3
National Multi Commodity Ex change of India Limited, Ahmedabad (www.nmce.com)

2.4. In retrospect, MCX Comdex fell by 24% during Table 1.4: Global Sector-wise Futures &
2008 — somewhat lower compared with the Options Volume
decline in international commodity futures
indices of Dow Jones AIG Commodity Index Cash Sector Contracts Traded in Millions
Index (DJAIG) at 36.6% and Reuters/Jefferies Sector Equity Index 6,488.62
Commodity Research Bureau (RJCRB) at 36%. For Individual Equity 5,511.19
a comparative analysis of MCX Comdex with the
Interest Rates 3,204.84
other global indices, we have recalibrated the
Agriculture 888.83
base period of all the indices to 100 from June
2005. Levels are calculated as in January 2009, Energy 580.40
tabulated in Table 1.3. Foreign Currency 577.16
Precious Metals 180.37
Table 1.3: Comparison of MCX Comdex with Non – Precious Metals 175.79
major global commodities indices Other 45.50
Levels in Levels in TOTAL 17,652.70
Indices
June 2005 January 2009
RJCRB 100 128.7134 Note: Prices of commodities and indices are taken from January
2006 to June 2009.
DJAIG 100 102.7972
Comdex 100 128.5218
Source: Industry Analysis 2.7. Clocking an impressive growth within five years,
this transformation has expanded the breadth
2.5. Even if we undertake a comparison of the share of and intensity of potential impacts that a
equity market investors’ wealth in GDP with that commodity derivatives exchange can make on
of the commodity futures markets, we find that underlying commodity sectors as well as the
India ranks quite high among all countries. The economy. In a comparison of the Indian
ratio of India’s market capitalisation to GDP commodity derivatives market with the
touched a historical high of 165% in early 2008. international markets, we find that there is a need
While this is a substantially sharp rise, India is still for elevating the products base of the exchanges
in the fifth position, behind Hong Kong, in India. Limited commodities are limiting
Singapore, Switzerland and Taiwan, some of industry participation. In the new economy
which have ratios in excess of 200%. The value of paradigm, banks are engaging in warehouse
investors’ wealth in Rupee-denominated spot receipt financing and collateral management.
market turnover terms is approximately Now, with the participation of banks, this industry
Rs.30,860.75 billion in 2008-09 (excluding assets is bound to flourish.
under management of fund management
houses). The derivatives segment of the 2.8. There is a need for strengthening the regulatory
historically more mature Indian equity markets framework of the market. The government's
ranks seventh (S&P CNX Nifty Futures) and tenth approval to the amendment of Forward
(S&P CNX Nifty Options), respectively, in terms of Contracts (Regulation) Act, through an
turnover ratio when compared to the top 20 ordinance, paves the way for introduction of
derivatives exchanges globally. The Indian long-awaited ‘options’ trading in commodity
commodity derivatives exchanges, on the other derivatives. The move will certainly deepen
hand, are among the top 10 in terms of volumes commodity markets, make them more mature
generated. and spur wider participation in derivatives
trading on the domestic commodity exchanges.
2.6. A snapshot of the global volumes of futures and If the move is symptomatic of the government's
options contracts traded across the asset classes softening stance towards commodity exchanges
will ingrain an impression of what we are looking and commodity futures, it must be hailed as one
at. Table 1.4 shows the sectoral break-up of of the most pragmatic pieces of economic
volumes in terms of million contracts traded legislation. Moreover, the existing national-level
and/or cleared on 69 exchanges worldwide for exchanges support a strong and advanced
the year ended March 2008. technology-driven platform.
3. W h y Yo u r Po r t f o l i o S h o u l d I n c l u d e 3.4. Furthermore, on examining the correlations of
Commodities Derivatives oil-based futures contracts with energy-related
and non-energy-related stock, bond, real estate
3.1. In our country, direct commodity investment has and commodity markets, and CPI, results confirm
not been a major part of the investors’ pool. In that, except in periods of extreme energy price
recent times, however, commodity-linked assets movement, many traditional forms of indirect
have increased the number of available energy investments such as natural resource
commodity-based products. Empirical studies mutual funds and energy-based common stocks
have shown that investment in commodities are not correlated with energy price movements.
results in significant diversification benefits. This is as expected. Given the risk management
These benefits are traced to the unique exposure and firm diversification abilities of most
of commodity investment to macroeconomic corporations, unless the price change in the
variables, as well as the potential to capture a underlying commodity is structural and long
positive ‘roll return’. But the principal thought lasting, short-term changes in commodity prices
lingers: why should the investor think about may have little impact on a firm's equity
diversifying the portfolio through investments in performance.
commodity-linked instruments? The answer lies
in the fact that direct or indirect investments in 3.5. It was also confirmed that in addition to energy-
the commodities market actually increase the based “passive” long-only commodity indices
Sharpe ratio of the portfolio and significantly offering returns not available in traditional equity
reduce the annualized volatility. A few studies investments, “active” long/short energy traders
have been cited. offer returns (positive returns in markets with
declining energy prices) not available in long-
3.2. The diversification benefits of commodities have only commodity indices or traditional
been studied in length and breadth, and across commodity-based equity investments.
the continents. Studies have found that the
inclusion of portfolios of long commodity futures 3.6. The principal argument for investing in
contracts (CRB and GSCI) improves the risk and commodities is that investing in assets that rise in
return performance of stock and bond portfolios price with inflation provides a natural hedge
for the period 1970 through 1990. It was against losses in equity and debt holdings that
observed that the improvement is more typically lose value during periods of unexpected
pronounced for the 1970s than the 1980s due to inflation. The studies have spanned across years
the high inflation of the 1970s with commodities of high inflation such as 1978, 1983, 1998 and
acting as a natural inflation hedge. Futures prices 2000. In continuation with the evidences
were also found to have little value in predicting presented, we present our case by demonstrating
inflation. Tests were performed on the theory of that during a same period analysis, equities show
storage and present empirical evidence that in a n e g at i ve co r re l at i o n w i t h i n f l at i o n .
periods of increasing volatility and risk, Commodities indices have shown a greater
convenience yields increase for a wide variety of independence from inflation. This contradicts the
metals prices. popular belief that commodity derivatives put
inflationary pressures on the economy. We have
3.3. Academicians have identified business cycle compared MCX Comdex with the BSE Sensitive
component in the variation of spot and futures Index and inflation respectively for a period
prices of industrial metals. The theory of storage spanning June 2005 to January 2009, the findings
splits the difference between the futures price of which are tabulated in Table 1.5
and the spot price into the forgone interest from
purchasing and storing the commodity, storage Table 1.5: Comparative Analysis of BSE Sensex,
costs and the convenience yield on the inventory. MCX Comdex and Inflation
The question of whether commodities represent BSE MCX
a separate asset class has been extensively Inflation
Sensex Comdex
debated. BSE Sensex 1.000 - -
MCX Comdex 0.210 1.000 -
Inflation (-)0.01 (-)0.08 1.000
Source: Industry Analysis

3.7. Adding commodities to an equity portfolio can 4. How Effective is “Highly Effective” –
minimise the damage during economic crises or An Accounting Perspective
downturns. As commodities have the ability to
react favourably to economic downturns or 4.1. Normally there are three common methodologies
macroeconomic conditions unfavourable to for testing and analysing hedge effectiveness —
equities, they are a perfect contender for the dollar-offset method, the variability-reduction
reducing downside risks. The ability to protect the method, and the regression method.
value of investment in chaotic markets is the key
to any diversification. 4.2. The above methods to an extent have also been
enshrined in the new accounting norms dealing
3.8. Perhaps the major advantage of diversifying an with such types of instruments. The new
equity portfolio using commodities is the accounting norms for derivative instruments and
mitigation of management risk. In any portfolio hedging activities were issued because the
management, risk seeps in from the style effects of the increasing quantity and variety of
incorporated by the fund manager. Even though, derivatives used by companies were not always
in a given period, a fund manager investing in transparent in their financial statements. These
equities may give higher returns, the impression standardise the accounting treatment for
of the company management may have its derivative instruments by requiring all entities to
effects on the financial statements during the report derivatives as assets and liabilities on the
same period. The return from the equity is subject balance sheet at their fair value.
to company policies, valuations, industry-wide
conditions and management styles. These are 4.3. However, the new accounting norms also
systemic risks associated with the equity market. recognise hedges that are put in place by entities
In the commodity market, however, the prices are and try to reflect the economics of such hedges in
dependent purely on demand and supply the financial statements. It basically allows for
conditions. The macroeconomic variables three accounting models for hedges — a fair
determine the prices and the behaviour of value hedge model, a cash flow hedge model and
commodities. In a nutshell, investing in a net investment hedge model — with the first
commodities automatically mitigates the two being most commonly used. A fair value
abovementioned risks. hedge offsets the price risk of a recognised asset
or liability or an unrecognised firm commitment.
3.9. However, it is also emphasised that price risk A cash flow hedge offsets the variability of the
management may not always be the most cash flows of a balance sheet item or a forecasted
important benefit. Commodity derivative transaction. If a derivative qualifies for hedge
exchanges can yield other critical impacts: accounting and the hedge is deemed to be
b ro a d e n a cce s s to m a r k e t s ; e m p owe r “highly effective”, the standard permits entities to
participants to take better decisions; reduce match the timing of the gains and losses on the
information asymmetries that have previously hedged item and with the gains and losses on the
advantaged more powerful market actors; derivative positions in their profit or loss account.
upgrade procurement, storage, grading and Or, in other words, the accounting captures the
technology infrastructure; and expand access to economics of the hedge whereby an entity has
cheaper sources of finance. Last but not the least, mitigated its exposure to commodity price risks
these exchanges enable entities to create a through commodity derivative instruments.
hedge against their exposures to the vagaries of
commodity price movements. 4.4. In principle, a hedge is highly effective if the
changes in the fair value or the cash flow of the
3.10. But the moot question is: how effective is the hedged item and the hedging derivative offset
hedge created by commodity derivatives? The each other. To qualify a derivative position for
next section tries to answer this question. hedge accounting, the hedging entity must
specify the hedged item, identify the hedging
strategy and the derivative, and document by
statistical or other means the basis for expecting
the hedge to be highly effective in offsetting the
designated risk exposure. This documentation
step is called prospective testing, and it must be
done to justify continuing hedge accounting. The
hedger must also regularly perform retrospective
testing to determine how effective the hedging
relationship has actually been.
4.5. Defining and testing a measure of hedge 4.9. The other two methods of assessing hedge
effectiveness represents an important and effectiveness i.e. the variability-reduction
potentially challenging aspect of hedge method and regression analysis are closely
accounting. Failure to meet the challenges hedge related. The difference is that the variability-
accounting presents may introduce substantial reduction method assumes that the risk-
volatility into reported earnings. minimising derivative position is equal and
opposite to the hedged item in a one-to-one
4.6. Highly effective hedge substantially offsets the hedge.
change in the fair value (or the cash flow) of the
hedged item. That is, if the hedged item in a fair 4.10. If a one-to-one hedge performs perfectly, the
value hedge appreciates by $100,000, then there change in the value of the derivative exactly
is some range of decline in values of the hedge offsets the change in the value of the hedged
that can be defined as substantially offsetting this item. The variability-reduction method compares
change. Defining this range is a matter of the variability of the fair value or the cash flows of
subjective judgment. A highly effective hedge the hedged (combined) position to the variability
has been defined in literature as one that offsets of the fair value or the cash flows of the hedged
at least 80% of this change and no more than item alone. This method places greater weight on
125%. Then the acceptable range of the change in larger deviations than on smaller ones by using
value for the derivative will be between the squared changes in value to measure
(–)USD.80,000.00 and (–)USD.125,000.00. ineffectiveness. The preferred test statistic for this
However, even when a hedge is determined to be method is the proportion of the hedged item’s
highly effective, there could be an impact on mean-squared deviation from zero that the
current earnings when there is not an exact offset hedge eliminates. To calculate the test statistic,
of the hedged risk. If, for example, the change in subtract from one the ratio of the sum of the
value of the derivative were (–)USD.110,000.00, squared periodic changes in the hedge and the
then the hedge would be highly effective, hedged item to the sum of the squared changes
because this change in value falls within the in the hedged item.
specified range and hedge accounting would
report an effect on income of 4.11. The measure of hedging effectiveness using
USD.(+100,000–110,000) = (–)USD.10,000.00. This regression analysis is based on the regression line
idea of offsetting has found its way into the hedge in which the change in the value of the hedged
effectiveness testing literature in the form of the item is the dependent variable and the change in
dollar-offset method of testing. the value of the derivative is the independent
variable or vice versa. Given the definitions of X
4.7. The dollar-offset method compares the changes and Y, the slope of this regression equation
in the fair value or the cash flow of the hedged should be negative and close to (–)1.0. However,
item and the derivative. The dollar-offset method for the hedge to be considered effective it should
can be applied either period by period or lie between -0.8 and -1.25. The interpretation of
cumulatively. For a perfect hedge, the change in the intercept term is also important. It is the
the value of the derivative exactly offsets the amount per (data measurement) period, on an
change in the value of the hedged item. average, by which the change in value of the
Therefore, the ratio of the cumulative sum of the hedged item differs from the change in value of
periodic changes in the value of the derivative the derivative.
and the cumulative sum of the periodic changes
in the value of the hedged item will equal one in a 4.12. Ederington (1979) showed that the estimated
perfect hedge (after multiplying the ratio by slope coefficient is the variance-minimising
negative one to adjust for the two sums having hedge ratio. Consequently, the accounting
opposite signs in a hedging relationship). literature explicitly allows for a hedge ratio that
differs from 1.0.
4.8. Anyone choosing this test should be aware that
researchers question its reliability because of its
excessive sensitivity to small changes in the value
of the hedged item or the derivative. Canabarro
(1999) showed that under reasonable
assumptions about the distribution of changes in
prices, the 80/125 standard rejects as ineffective
36% of all hedges when the coefficient of
determination (correlation squared) R2 is 0.98.

5. Concluding Remarks
5.1. The need for commodity derivatives is 5.2. As the recent global experience has exhibited,
multifarious in a growing economy like India. Be it growth in derivative products without
for ‘risk management’, ‘investment’, ‘portfolio corresponding development in regulation —
diversification’ or to provide access to our both from a macroeconomic perspective and a
producers to the most efficient markets in risk management perspective — is neither
commodities, it is difficult to argue for other than desirable nor advantageous from the viewpoint
an expansion of the availability of such products of long-term stability. In this arena, the new
in the arena of exchange-traded instruments. literature on the accounting for such instruments
However, as the above article demonstrates, is a welcome addition. What is also required is
there has been unprecedented growth in this more detailed guidance from a risk management
area over the last few years. perspective by the Reserve Bank of India on the
use of such products. It is only a combined
approach that will lead to the establishment of
stable and deep markets for commodities in
India, which is essential for the long-term growth
of our economy.
Mr. Kumar Dasgupta is Partner and Dr. Chiragra Chakrabarty is Associate Director, Price Waterhouse. Views expressed are personal.
ANAND RATHI GROUP PROFILE
Anand Rathi is a full service, relationship-led, financial Financial Planning, as this is known in India was hitherto restricted
intermediation company with sole focus on providing long- to large HNI and select corporate houses. We bring customized
term value to its clients. A client-centric focus, an open financial planning to you. What makes us compelling is that we are
architecture, third-party-product based platform and quality unbiased, selling only third-party products.
fundamental research across asset classes, form the
cornerstone of the Company’s philosophy, helping us to w w w. t r a d e. a n a n d r a t h i . c o m w a s c r e a t e d a s a
achieve excellence in each of our business verticals. comprehensive, interactive platform for all your financial
information, news, views and trade.
Founded by Mr. Anand Rathi and Mr. Pradeep Gupta in 1994,
Anand Rathi today has a strong domestic presence as well as Private Clients
international reach. We employ close to 4,000 professionals
and 20% of the group’s equity is currently held by Citigroup Each one of our Relation Managers is dedicated to providing
Venture Capital. We operate at over 739 locations through superior financial solutions to affluent individuals including
260 branches and 479 business associates. Our presence in NRIs.
Dubai, Bangkok and New York largely caters to Non Resident We believe private clients need to be treated like corporates.
Indians (NRIs) and Corporates and Institutions looking to Just as in the case of a corporate, we analyze the client’s
invest in India. financial profile and goals, understand his risks and offer
unbiased investment management strategies. Our holistic
The Anand Rathi team, a group of highly motivated and wealth management solutions are focused entirely on the
professional people, is our principal asset. The people are the client. Be it differentiating different kinds of wealth,
prime reason we consistently deliver strong results year after distribution of assets or creation of safety nets for clients as
year. We have grown from a base group of 15 people in 1994 well as their successors; Anand Rathi helps them capitalize on
to the current strength of over 4000 people globally and every opportunity.
continue to be the firm of choice for the best people from the
widest available pools of talent. Corporates and Institutions
We recently ranked as the “Best Domestic Private Bank” in Asia Anand Rathi works closely with Corporates and Institutions to
Money 2009 polls. understand their needs and create investment banking and
hedging solutions according to their requirement.
We provide a range of financial solutions divided across
distinct client groups instead of product groups, enabling us Our Investment Banking services include solutions in raising
to understand the client better and giving us an added debt and equity in the private markets, identifying strategic
advantage. These include: alliances and M&A opportunities, and acting as strategic
advisors. We fulfill the client’s capital raising needs through
• Brokerage in equities, derivatives and commodities equity markets (IPO/FPO/QIB), underwriting, private
placements and other activities associated with debt and
• Third-party-product distribution of mutual funds, life and equity products. We provide the insight and the expertise
general insurance clients require and deliver all the resources of our retail
brokerage network, amongst the most highly regarded in the
• Investment banking nation.
• Wealth management Hedging solutions are largely provided to Corporates that

would be exposed to commodity risk. We understand the
Individual Clients client’s physical business, identify the commodity price risk
and suggest optimal solutions in consultation with our
At Anand Rathi, we believe in your individuality and your dedicated product research team. Our membership with
individual financial, investment need and approach. We have, MCX, NCDEX, NMCE, DGCX and LME provide the client a
over the years, gathered expertise across various investment strong trading platform. Our exclusive tie-up with Natixis
platforms – equity, mutual fund, fixed income and life and Commodities Markets, one of the 11 members of the LME is
non-life insurance. That’s just one part. The other is to marry another added advantage.
this expertise to the individual risk profile understanding
your financial status and investment needs, given your Anand Rathi’s competitive advantage comes from its
lifestyle and family size. network and the strength and breadth of its relationships in
the business. These underpin the value the Company delivers
to all its clients.

Brokerage Industry: Key
Link between Ecosystem
Players and Exchanges
By Ms. Priti Gupta
A brokerage firm is the key link in the chain of commodity markets. It connects all the
players of the ecosystem — producers, consumers, traders, etc — to these markets.
The majority of India’s population — as high as 60% — to be developed and made competent by means of
depends on agriculture for its living. However, unlike in exhaustive training. The next challenge was to take it to
the developed world where a small number of people the target clients or users such as hedgers, traders,
produce large quantities of agricultural commodities, arbitrageurs, etc. Since over more than four decades
in India a much larger number of people produce little. people in the country had no idea about what
This makes Indian commodity markets radically commodity futures were all about, a massive education
different from their counterparts across the world and drive had to be taken up. The last but not the least,
extremely price-sensitive. This in turn makes the role of setting up an in-house research desk was a daunting
the government in power very critical in regulating the task indeed. And the most critical part, there was no
prices as well as the entire commodity ecosystem truly reliable historical database — even of basic data or
complex. data on fundamentals like production and
On the other hand, commodity futures markets, which consumption — to carry research on commodities. So
are currently at a nascent stage since their revival by the it was like starting from ground zero!
government in 2002-03, have, in this short span of six
years, played a commendable role in integrating the The commodity brokerage industry has come a long
country’s fragmented commodity markets and way over the last five years, but a long road yet needs to
improving the overall conditions of the agricultural be traversed.
marketing infrastructure. A brokerage house acts as a
key link connecting these markets to all categories of Creation and Spread of Awareness
physical market participants.
The commodity market itself is a complex area with a
Broking Firm – A Broader Perspective plethora of fundamentals influencing or determining
its direction and is, as such, a very difficult subject for a
General perception about a brokerage firm is that it is a common man to understand. On top of that, the
facilitator of ‘buy’ and ‘sell’ of commodities. But given concept of a derivatives market makes the commodity
the kind of role a commodity broker actually plays, this market no less than a maze even to the seasoned
would be mere understatement of the true importance trader, leave alone a novice.
of a commodity broking firm. In the Indian markets,
when commodities brokerage firms were set up with The commodity ecosystem consists of corporations,
the advent of national-level commodity exchanges, firms, and traders who do not directly deal in
they had a challenging task ahead of them mainly commodities but have information on the
because the segment was absolutely new and fundamentals specific to those commodities and want
practically diverse. to get the same converged on an efficient trading
platform to get a nominal return, from the advantage of
The first challenge was to acquire the necessary price movement. However, it is necessary that both
resources or manpower. An entirely new breed of hedgers and investors in commodities should be aware
people capable of handling this commodity space had of the advantages and disadvantages, and make the

trading process on the exchange platform a healthy Converging the Entire Spectrum on the Exchange
one. Even though awareness development has been
considered to be the prime responsibility of The commodity ecosystem consists of two different
commodity futures exchanges and the regulators, sects: the one who always intends to ‘sell’ (the
broking firms cannot escape their share of this producer) and the other who always intends to ‘buy’
responsibility of knowledge development and sharing (the consumer). For healthy market ecology, balanced
among the participants of the commodity ecosystem. participation of both the parties is essential. The
This put the onus on brokerages as well — alongside broking house plays a crucial role in reaching out and
the exchanges — to perform this crucial task of facilitating both the ends of the spectrum. Trade and
creating awareness about this market among both the industry had survived in India without commodity
hedger and the investor who look to this market with futures markets for a long time and that forced them to
completely opposite objectives. evolve several mechanisms in order to take care of their
hedging requirements, such as forward booking of the
Most commodity broking houses in the years 2004 and commodity, the supplier itself accepting a periodical
2005 spent a very large chunk of their time, efforts and average price (for metals) or farmers getting into
resources on creating awareness among the agreements with buyers at the time of sowing itself.
participants as well as undertaking training for their These well-entrenched practices and habits were the
own staff. In addition to the reach the exchanges and primary hurdles for any player to move on to the
regulators have had, brokerages have remained the futures markets, as they strongly believed that their
connecting link reaching out to both the ends of the risks were already well taken care of.
commodity chain and thus carrying the benefits from
end to end. It took a great deal of effort on the part of commodity
brokers, aided by the exchanges, to define the risks in
As most commodity deals/transactions are settled these preset mechanisms. As brokers, we were taken
through delivery of the underlying commodity on aback to see how counterparty risk was discounted by
expiration of a given contract it warrants making these risk-mitigating practices! Here brokerages play a
traders/investors understand the procedure as well as very important role of identifying the risks involved in
the risks involved in making or taking a physical the indigenous systems and off market transactions,
delivery. And this adds another dimension making and make them see the benefit of trading on the
training and spreading of awareness all the more exchange platform where there is a clean and
important. transparent process of risk mitigation.
Transparency – the Essence of Markets From the perspective of the exchange broking houses
have brought in the much-needed liquidity and depth
Transparency is the essence of electronic commodity to the markets by leveraging their customer reach.
markets and kudos to the initiatives and innovations
made by our home-born national-level commodity Taking Innovation to a New Height!
futures exchanges, which started a completely
automated trading system paving the way for the Today, broking firms are equipped with state-of-the-
Indian commodity markets to be globally competitive. art infrastructure and cutting-edge technologies for
In a short time, we have seen major global commodity risk management and trade execution and, hence,
markets realise the importance of the electronic capable of minimising human intervention and
platform — and technology — for enhancing manual error components. Less human intervention
transparency, and thus slowly move on to this format. means lower transaction cost, which in turn helps in
bring an increased number of various categories of
Apart from mere trading side of it, commodity futures commodity market players on to the exchange
are generally high-valued contracts and as such put platform and, thus, integrate them with a much larger
huge amounts of money at stake. This makes market system than where they would have otherwise
transparency in the operations of brokerage houses be trading i.e. at a mandi with higher cost of
extremely important for users. A broking firm must transaction.
ensure that all the trades it executes for its client should
be communicated in a transparent manner and its
interests be kept open to the client. Transparency in the
operations of a broking house takes it a long way in
establishing a strong bond with its clients.
Technology-enabled Smooth Compliance A few broking houses like ours took upon the task of
conducting research and take the benefits of
The broking fraternity takes on itself the responsibility information to all the parties in the system and
of compliance on its own behalf as well as on the behalf continue to do so now. Unlike in the developed
of its customer. This may sound a fairly simple task but it economies, statistics on agricultural commodities was
is not. To take the responsibility of ensuring that each of really scarce in India, and we converted a lot of
its clients is eligible and authorised to use the exchange manuscripts into software-powered systems by
platform is a daunting task, given the time-consuming manually punching them in. There was no proper
verification and documentation needed to be carried dissemination of the data that lay with the
out. This was extremely challenging in the commodity government, and government websites were not
space where most of the participants from upcountry updated month after month. We on our own initiated
or mandis were not merely sceptic but were practically crop surveys, making a fair estimate of the crop and
averse to sharing information. keeping records of daily spot prices prevalent in
various mandis. In fact, a lot of hard work goes into
On various occasions when foreign brokerage houses research, which is an integral part of a full-fledged
visited us, they were utterly amazed to see how broking house and a key to bringing the various
flawlessly we were able to manage tedious compliance ecosystem players together on a single platform, which
as well as real-time risk management for such a large helps in bringing transparency and efficiency in both
numbers of our private and individual clients. We believe price discovery and risk management.
it is the entrepreneurial instinct in Indians that help them
carry out sensitive tasks in such innovative ways. Today, the picture is slightly changed. A few data
providers have popped up, government sites are
Research and Market Intelligence getting updated regularly, and weather updates have
turned more frequent and more accurate. This change
Last but not the least, research in commodities and their is welcome, but this does not in any way lessen the
fundamentals was an alien subject in India before the responsibility of brokerage houses of keeping their
advent of commodity futures exchanges. A few clients updated on a regular and consistent basis. At
corporations had their own internal research setups that present, there are some broking firms which advise
used to advise their top brass on their exposure to even the government on decisions with regard to
commodities, and mandi traders used to get only limited imports, for example.
information in the geographical area of their activity.
To sum it up all, a broking house is a key link between
the exchanges, the participants and the regulator.
Having access to all the stakeholders, a brokerage plays
a vital role in the integration of obligations and
requirements of all the parties.
Ms. Priti Gupta is Executive Director of Anand Rathi Group. Views expressed are personal.
64 | A PUBLICATION BY MCX AND PRICE WATERHOUSECOOPERS

Commodity Derivatives –
An Opportunity for
Banks to Diversify Risks
By Mr. Shailesh Sukhthankar
As and when allowed to enter it, the commodity derivatives business holds enormous
potential for banks. It will be especially attractive for banks when they offer a
combination of multiple derivatives products to satisfy the requirements of their
customers.
Commodity derivatives in India have had a chequered • Hedging credit exposure

history. Until 2002 the market was virtually non- • Information Dissemination
existent, except trading in a few regional commodity • Advisory Services
exchanges. The advent of national-level multi-
commodity exchanges viz. Multi Commodity Exchange Clearing and Settlement Services
of India, National Commodity & Derivatives Exchange
and National Multi Commodity Exchange provided a Clearing is the process of determination of obligations,
much needed impetus to the growth of this market. after which the obligations are discharged by
settlement. Settlement is a two-way process that
With the gradual withdrawal of the government from involves legal transfer of the title to funds and
various sectors in the post-liberalisation era, the need securities/other assets on the settlement date.
has been felt for various players in the commodities
market ecosystem to be permitted to participate in The clearing bank services are a highly time critical activity
commodity derivative markets. as delays directly impact the members/exchange. Banks
can play an important role in settlement of obligations in
Bank, the strategically important institution in the the overall ecosystem including exchanges, members,
overall growth and development of the economy, can clients, custodians, etc. This is highly transactional nature
play various important roles in this market as well. This of the business. Dedicated infrastructure, trained
article dwells on some of these roles, which can help in manpower, and use of technology are the key parameters
nurturing and developing the commodity derivative to doing this business.
market in India.
The banking settlement system plays a crucial role in
Some banks are already carrying out some vital the overall risk management of the exchange
functions such as clearing and funding, as outlined mechanism, wherein daily settlement of
below, while regulatory approvals are required for trades/obligations, ability to manage fund flows in
considering other roles such as hedging and serving as volatile days, coordination with exchanges and
an aggregator: members, etc contribute towards effective functioning
of the exchange mechanism.
• Clearing Bank Services
• Depository Services Apart from clearing services, banks also provide fund
• Broking Services and non-fund based facilities to the members of the
• Professional Clearing Member exchange for managing their working capital
• Structured Finance requirements and, thus, earn revenues through float
• Aggregator funds, interest earned on overdrafts/loans, commission
• Trading & Investments income, etc.
EXCHANGE
CLEARING BANK CLEARING BANK
MEMBER MEMBER
INVESTOR INVESTOR
Depository Services similar to the existing 3-in-1 account in equity markets

interlinking the bank account, broking account and
Commodity exchanges have revolutionised Indian depository account of investors, which will be of great
markets by enabling holding of warehouse receipts in convenience to customers.
electronic form. This mechanism is accomplished
through the National Securities Depository Ltd (NSDL) Professional Clearing Member
and Central Depository Services Ltd (CDSL).
A professional clearing member (PCM) is one who can
Banks can empanel as Depository Participants of NSDL only clear trades but cannot trade on one’s own account.
and CDSL and provide this service to the members, Institutions and corporates prefer clearing the trade
clients, and general investors. through PCMs to avoid being exposed to brokers who
may lack adequate capital, professionalism, etc.
The Warehousing (Development & Regulatory) Act Banks are ideal to serve as PCM too, as they have
2007 also has provisions for issuance of electronic necessary attributes such as adequate capital, strict
warehouse receipts. The existing depository regulatory structure and strong internal controls, among
system/processes (subject to appropriate regulatory others. They can add value to market participants by
approvals/modifications) may be utilised providing an designing appropriate lending products.
impetus to holding and transacting in electronic
warehouse receipts. This will also throw open another Large corporates and institutions may trade through
opportunity for banks to lend against electronic various brokers for their execution/advisory
warehouse receipts in a seamless and efficient manner, capabilities. However, for the settlement of trades, they
with faster turnaround time. may prefer PCMs due to less counterparty risk,
customised MIS, dedicated service, etc.
Broking Services
Banks can benefit from economies of scale, additional
The sheer growth in the commodity futures volumes float funds, integration with their lending/credit
and interest among the investor community will boost assessment and generation of fee-based income.
the growth of broking services. As they already play a
key role in financial intermediation, banks can also offer Structured Finance Products
broking services by leveraging their existing customer
base, branch network, and so on. Structured finance is a very exciting development. It
involves tailoring of a product according to the
Depending upon the regulatory structure/requirement, requirements of the borrower and the lender, and helps
banks can integrate this product into their overall banks go beyond the normal balance-sheet lending by
offering of retail products and also technological structuring the cash flows/collateral. Banks can
initiatives such as online banking-broking account — leverage the exchange infrastructure in integrating the

traditional lending products with the exchange The conventional warehouse receipt lending can be
mechanism and develop products such as financing integrated with the exchange mechanism, wherein the
against warehouse receipts and settle borrower can hedge his price risk and deliver the
(receipt/payment of funds) through exchanges, enable commodity on the exchange. The borrower can store
trades in spot and futures markets, funding through his produce in an exchange-accredited warehouse and
collateral management structure, trade structure, and get a warehouse receipt issued to him from the
so on. warehouse. Thereafter he can take loan from a bank at a
competitive interest rate against this warehouse
Here are two examples of structured finance product receipt. Subsequently, the borrower can sell the
that can help the farmer and the end user industry. commodity on an exchange using the PCM services of
the bank and mark the commodity for delivery. On
(a) Payout funding: settlement, the bank shall deliver the commodity and
receive the funds. With these funds, the bank will close
Normally agricultural commodity prices tend to be the loan and release the balance funds to the borrower.
lower during the season and increase during the
offseason. Warehouse receipt lending provides the This mode of funding is very helpful to a
borrower/owner of the commodity with an producer/farmer as it provides them with a one-stop
opportunity to avail of financing to meet his liquidity solution to storage, liquidity, and hedging of the price
requirements and thereby avoid distress sale. risk. Once options are allowed, it will provide the upside
benefits as well.
Payout Funding:
BORROWER
HEDGE THE
DEPOSIT OF UNDERLYING
COMMODITY
COMMODITY
BANK LENDING
PLEDGE THE
AGAINST WAREHOUSE COMMODITY
WAREHOUSE WAREHOUSE
RECEIPT & ALSO EXCHANGE
RECEIPT
PCM SERVICES
(b) Payin funding: Aggregator
The buyer can also opt for payin funding from the bank. Since the Indian farming sector is characterised by
The buyer deposits the margin money with the bank. small and marginal holdings, individually farmers do
He then enters into buy contract with the bank acting not have the volume and expertise to hedge on the
as a PCM. On the due date, the bank takes the delivery exchange platform. Banks can play a very important
by making the payin of funds. The same is then part in this context by acting as an aggregator i.e.
converted to pledge finance by releasing the loan to pooling the individual farmer’s requirements to create
the borrower. the necessary volume and then hedge on the
exchange. A bank can perform the function of an entire
value chain for its customer by providing the crop
finance, hedge the price risk on the exchange and then
FARMER
Pool individual quantity
to get exchange
FARMER traded lot
BANK EXCHANGE
Hedge on
FARMER Exchange
FARMER
This provides a huge opportunity to various sections of Information Dissemination

the society including farmers, traders, processors, etc
to participate in commodity exchanges and hedge Information is knowledge, and knowledge is power!
their exposure at an optimal cost.
A bank’s vast network of branches across the country
Trading and Investments can act as additional information dissemination
centres for spot and futures prices of commodities and
Commodities have become an important asset class in other related information. This can greatly facilitate the
recent times, especially as a hedge against inflation. financial inclusion and general awareness process and
Currently, in India, banks are not allowed to trade in empowerment of farmers.
commodity futures. Once allowed to invest/trade in Commodity price information in this mode will also
various commodity derivatives they can contribute likely attract target customers to avail of other banking
significantly towards creating depth in the market. products, especially agriculture-related products such
as crop loan, land development loan, tractor loan and
Hedging credit Exposure so on. Banks can also mobilise the savings accounts of
these customers with their relevant products and
While lending to customers, banks, as per their credit services under their financial inclusion agenda.
policy, appraise the credit worthiness of the borrower.
In case the borrower is from the commodity sector, he Advisory Services
has an exposure/associated risk on the underlying
commodities. The concerned bank can ask the Banks are already providing advisory services to their
borrower to either hedge his position on a commodity high net-worth customers. With commodities gaining
exchange or have a process of directly hedging the the prominence as a separate asset class and a natural
underlying credit exposure himself. hedge against inflation, banks can provide/assist in
overall wealth management of individual customers.
This initiative provides additional comfort to the As and when regulations allow, there is enormous
banker, helping in: potential for banks in the commodity derivatives
business, especially when a multiple of above products
• Higher amount of facility will be combined to satisfy the requirements of their
• Longer tenor of the facility customers.
• Competitive margin
• Competitive rate of interest, etc.
Mr. Shailesh Sukhthankar is Senior Vice President & Head – Capital & Commodity Markets, HDFC Bank Ltd. Views expressed are personal and
not of HDFC Bank Ltd.

Agriculture Financing
under OTC Products
By Mr. Venkatesh Tagat and Mr. Narendra Rathore
Over-the-counter (OTC) products for agriculture financing may be seen in the light of
strong recommendations made in 2008 by the Reserve Bank of India working group on
introduction of credit derivatives. Purpose of this paper is to pursue with the
policymakers to reinitiate the debate on the use of credit derivatives as OTC products to
address problems of rural and agricultural banking through credit derivatives at least at
the interbank level and while dealing with corporates on a pilot basis.
Taking cues from various recommendations made by corporations (NBFCs), and local money lenders, which
the International Securities and Derivatives in turn is dependent on the performance of financial
Association (ISDA) and Reserve Bank of India (RBI) draft products of the agencies involved. While the informal
guidelines on credit derivatives, apex development sector has the flexibility of structuring its products to
financing institutions (DFIs) can be identified to meet financing requirements of both the borrower and
introduce various risk management systems and the lender, the formal sector has restrictions despite
infrastructure for using credit derivatives to help rural the fact that the informal sector has to deal with fewer
banks. Initially, this kind of system may be structured and smaller risks and has a better control on its
on a pilot basis for interbank transfer of risks without portfolio of loans and advances compared to the
compromising on the capital adequacy standards. formal sector.
Later, other agencies such as insurance firms, mutual
funds, hedge funds, and corporates may be included Health of formal financial institutions, especially
after due diligence. Once the systems are grounded cooperative banks, has been a major concern.
exchange-traded products may also be introduced to Cooperative banks accounted for 19% of the total
induce liquidity and wide-ranging participation. This disbursement of Rs. 2,25,384 crore in 2007. The share of
paper discusses the benefits of development of credit cooperative banks and RRBs in overall financing has
derivatives markets for rural banks and corporates such also been decreasing over the years. Some of the major
as diversification of the risk-reward profile, optimal areas of concern in the cooperative sector are low
utilization of resources, and so on. It also discusses the resource base, portfolio imbalances, high dependence
conditions necessary for the development of such on financial agencies, poor business diversification and
markets. recoveries, concentration of credit risks on a few
agricultural activities, illiquidity and inability of rural
Rural Banking and Credit Derivatives banks to transfer credit risk, absence of structure that
can attract new investment risk capital into assumption
The investment in agriculture to total national Gross of credit risks1 , etc. As on March 31, 2008 the total
Domestic Product (GDP) was in the 1.9-2.2 percent erosion in the value of assets of 127 district central
range between 2003 and 2007. Gross capital formation cooperative banks (DCCBs) aggregated to Rs.14,998.1
in agriculture is a function of investment and financing crore.
in agriculture through institutions such as commercial
banks, cooperative banks, regional rural banks (RRBs),
microfinance institutions, non-banking financial
Accumulated losses and recovery (Rs./crore)
Year SCBs DCCBs SCARDBs PCARDBs
Accumulated losses
(31March) and % Loss %Rec Loss %Rec Loss %Rec Loss %Rec
recovery (30.06.07)
2005 305 86 4776 72 1039 44 2466 54
2006 276 87 5298 69 876 46 2725 48
2007 389 86 5712 71 946 44 2870 52
NPA (31.03.07)
Sub-standard 2957.05 6375.13 4315.42 2511.29
Doubtful 2624.51 7648.34 1310.25 1783.23
Loss assets 1122.44 2471.41 17.46 21.51
Total 6704.00 16494.88 5643.13 4316.03
Source: NABARD Annual Report (2007-08)
Credit derivatives, which are OTC financial contracts, credit derivatives allow one party to shift credit risk of a
are usually defined as ‘off-balance sheet financial reference asset, which it owns, to another party
instruments’ that are designed to transfer credit risk without actually selling the asset. Thus, it “unbundles”
from the person exposed to that risk (the protection credit risk from the credit instruments and trades it
buyer) to a person willing to take that risk (the separately. Credit derivatives, generally, are bilateral
protection seller) by means of payment of fees from the contracts designed to meet the specific requirement of
protection buyer to the protection seller. It is a the counterparties to the contract. The value of a credit
protection against risk of financial loss due to derivative is derived from the credit quality of an
counterparty failure to perform its obligation. The obligation. Most commonly used credit derivatives are
credit risk is transferred between market participants Credit Default Swap2, Credit Linked Notes, Total Default
without the underlying assets changing hands. That is, Swaps, etc.
OWNERSHIP UNDERLYING ASSET(S) OWNERSHIP

(LAND, PLANT, MACH) BANKRUPTCY, INSOLVENCY, MERGER,
CROSS ACCELERATION, CROSS DEFAULT,
LOAN FAILURE TO PAY, REPUDIATION,
REF. OBLIGATION 1. COUNTER PARTY RESTRUCTURING, DELINQUENCY,
(LOAN, ADVANCES) (LOAN BENEFICIARY) PRICE DECLINE, RATING DECLINE OF
REPAYMENT
ASSEST OR ISSUER
CREDIT DERIVATIVES
LOAN
CREDIT RISK 3. PROTECTION SELLER/CREDIT RISK/

NO BUYER/GUARANTOR
PREMINIUM/FEES/INTEREST (PERSON WILLING TO TAKE RISK)
2. PROTECTION BUYER/ OR
CREDIT RISK SELLER
CREDIT RISK
(PERSON EXPOSED TO RISK E.G. BANK)
YES
CREDIT EVENT PAYMENTS
(PHYSICAL DELIVERY, CASH
SETTLEMENT: PAR LESS
RECOVERY VALUE FIXED
AMOUNT)
1
Annual Report of NABARD (2007-08); Area of Concern - Page 82.
2
These are contracts where the protection seller receives premium in quarterly installments throughout the life of the contract or till the credit event occurs,
from the protection buyer as compensation for assuming the credit risk of a specialized reference obligation. In return of these premia, the protection buyer will
receive a payment from the protection seller upon the occurrence of a credit event in respect of the reference obligation. According to RBI draft guidelines on
credit derivatives in India, ‘credit event’ is defined as the scenario or the condition agreed between the contracting parties that will trigger the credit event
payment from the protection seller to the protection buyer. The credit event usually includes bankruptcy, insolvency, merger, obligation acceleration, cross
default, failure to pay (principal or interest), repudiation, moratorium or restructuring, price decline or rating downgrade of the underlying asset or the issuer.

Use f credit derivatives as OTC products has gained provide short-term credit and protection to farmers
support especially after the release of second against their contingent financial requirements in
consultative document on New Basel3 Capital Accord in exchange of collateral or higher premium (interest) in
January 2001. RBI guidelines on Credit Risk cash or kind. These kachha adatiyas take long-term
Management 4 , Foreign Exchange (Derivative loan pacca adatiyas (bigger adatiyas) at a lower rate of
Contracts) Regulations Act 20005, and constitution of interest for lending to farmers. In the process kachha
Committee for Regulatory Framework for Derivative adatiyas seek protection from pacca adatiyas against
Trading in India (chaired by Dr LC Gupta) and RBI Draft risk of default from farmers/peasants in exchange of
Guidelines for Introduction of Credit Derivatives in part of the premium received from the farmers. The
India6 in March 2003. A working group on credit credit default of the farmers is settled either through
derivatives7 was also constituted by the RBI in 2008 physical delivery of reference assets or in cash (see the
which recommended introduction of credit derivatives adjoining figure). Although there is no
in the country. comprehensive risk management tool deployed for
effective management of credit risks, the system
Given that more than 70% of banks’ assets are loans works fairly well in rural areas, besides providing
and advances and credit risk has a major impact on flexibility to hierarchy of borrowers and lenders.
banks’ financial performance, it is important to take a Formal systems when introduced will definitely
look at certain financial OTC products that have require comprehensive risk management systems
performed well in the informal sector, albeit under through identification, measurement, monitoring,
different forms and names and even without much and control of credit risk exposures with proper
documentation and other formalities. In rural areas, documentation and registration of such transaction.
landowners and local adatiyaas (kachha adatiyas)
PHYSICAL DELIVERY / CASH SETTLEMENT AGRI/RURAL ACTIVITIES FINANCING UNDER INFORMAL SECTOR
REFERENCE ASSET
FARMER
(LAND, ANIMALS ETC)
LOAN FOR HIGH PREMINUM/

DEFAULT EVENT
AGRI-RURAL ACTIVITY COLLATERAL
PROTECTION BUYER- PROTECTION SELLER-

KACHCHA ADDATIYA PUCCA ADDATIYA
DELIVERABLE
OBLIGATION/
REFERENCE ASSET
PRE AGREED AMOUNT

OR PAR VALUE OF ASSET
AT START DATE
INFORMAL CREDIT DERIVATIVES SYSTEM
3
Basel Committee on Banking Supervision sets global standards and benchmarks on regulatory and supervisory practices. Its new accord has provide more risk-
sensitive standardized approach on capital adequacy of banks so as to ensure soundness of banks in globally networked financial system.
4
RBI circular No. BP.BC.26/21.04.103/2001 dated 20 September 2001.
5
Notification No. FEMA 25/RB-2000 dated 3 May 2000
6
RBI circular No. DBOD.BP.1057/21.04.103/2002-03 dated 26 March 2003.
7
http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/35293.pdf
Indian banks are increasingly becoming vulnerable to without selling the asset and without the
credit risk. It is felt that risk premium in the form of knowledge/consent of the borrower. Under this system
interest charged by banks, especially on priority sector there is no need for rural banks to assume credit risk and
loans, is inadequate to cover the credit risk. Margins of sell/hold assets to be able to hedge their credit risks.
banks are also at risk with loss of value of traditional
collaterals (e.g. land, animals, etc.). Credit derivatives
provide hierarchy of rural banks with an opportunity
Using credit derivatives, banks that are falling
not just to manage their own credit risk but also to
short of their lending targets for the priority sector
expand their business as discussed below. Initially, this
can be allowed to assume sector-specific credit
kind of system may be structured for interbank transfer
risks of other banks that have exceeded their
of risks on a pilot basis and later other agencies such as
targets, thereby diversifying portfolio risk and
insurance firms, mutual funds, and hedge funds may be
optimising capital of both types of banks.
included.
Benefits to Banks Returns from customisation: Institutions can use

credit-derivative structures for developing a system for
Diversification of business opportunities: Rural transferring credit risks with customised risk-reward
banks tend to have geographic or sectoral profiles. Besides, credit derivatives have the potential
concentration of their credit portfolio because of lack to succeed where the traditional methods of adjusting
of expertise and knowledge of new credit markets; exposure (e.g. participation in the secondary loan
industrial/sectoral biasness of the management; return market) cannot provide an equivalent protection as
requirement; political pressures; sticky client they suffer from problems of high transaction costs,
relationships; high switchover costs, etc. This lack of liquidity, regulatory restriction, non-availability
concentration increases their credit risk and reduces of required currency, and inability to originate assets
return on capital with in a restricted risk-return from non-traditional markets. A bank can match its
framework. These banks can manage their willingness to acquire a credit exposure to a particular
concentration-risk by optimally diversifying within their issuer, having securities with maturity different from
credit portfolio by reducing overexposed risks while that of the bank’s credit lines, by investing in a
increasing exposure to the industrial/agricultural structured credit derivative where default risks of the
segments where it is sub-optimal. With the help of credit two are linked. Current exposure norms restrict banks
derivatives their risk profile can be changed without the from concentrating certain credit risks in their books
need to either purchase new assets or dispose of existing and, therefore, they have to forgo otherwise lucrative
assets. This can be done by selling protection on an oppor tunities. O ff-balance -sheet nature of
underexposed geographical/industrial segment and transactions can help banks avail of such opportunities
purchasing protection on the segment to which the and maintain client relationships. Thus, the ability of
bank is overexposed. Synthetic means of credit banks to customise credit risks on a spatial and
exposure can enhance portfolio returns, which, temporal framework through credit derivative
otherwise, are not directly available, prohibitive, instruments provide them access to investments that
expensive or difficult in view of regulatory/legal would otherwise be difficult to secure.
constraints or higher transaction cost. Commercial
banks can provide protection to sponsored RRBs Capital optimisation: Banks can minimise their
through these derivative instruments while isolating forward gaps in utilisation of credit lines by selling or
credit risk from other risks (interest rate/currency risks / buying credit protection. In doing so it can fully utilise
regulatory / political / business / sovereign) and from the available credit capital and even increase the return
the asset itself. In the process commercial banks will on capital over the full term of credit lines by suitably
themselves be able to diversify their credit portfolio pricing forward default swap. Banks can also seize
and ensure a regular flow of revenue in the form of trading opportunity by structuring their risk-reward
premium paid by RRBs that are currently seen as a profile, adopting different credit exposures and
burden rather than a source of revenue and liquidity. defining credit events that trigger default payouts. In
the process they will release their capital that is
Hedge credit risk: Banks are often concerned with the otherwise blocked in assets which they have to
credit quality of an individual loan or a group of loans maintain till maturity. The ability to churn assets can
and want to hedge the credit risk, especially if that possibly bring higher return on capital.
involves long-term financing such as forestry, and
horticulture. Credit derivatives enable a rural bank to
transfer the credit risk associated with a loan to another
party through a bilateral and confidential contract

Accessing credit exposure without funding or Funding arbitrage/warehousing risk: A corporate
relationship costs: RRBs have to invest a lot of time with low funding cost and available capital, but with
and resources in maintaining relationship with regard low risk appetite, can purchase an asset and then
to advance agricultural loans. Credit derivative transfer the credit risk of that asset using a credit
protection can possibly be used for determining new derivative to another institution that has high funding
credit lines or freeing up the existing lines for exploring cost but higher risk-taking capacity. In the process the
new business opportunities without having the need institution selling the protection need not make an
for maintaining rigorous client relationships. outright investment in the asset to be able to gain from
credit arbitrage opportunities and there is also no need
Benefits to Corporates to incur cost of building and maintaining relationship
with reference to that asset. On the other hand, the
Besides banks, corporates that have business exposure protection buyer will pay a lower premium for the
in the rural economy can benefit from the use of credit protection than the return that he earns on the
derivatives for managing financial and project risks, for purchased asset.
increasing their range of business counterparties and
for covering default by major suppliers and purchasers The RBI working group for introduction of credit
in the following manner. derivatives has observed that credit derivatives are not
fundamentally different from convention credit risk
Protection against political and sovereign risks: management tools such as guarantees, letter of credit,
Companies willing to make investments in politically and unfunded sub-participation as credit default
volatile states can isolate the political risk from other events are protected by the ‘protection seller’ under
risks of planned investments and consider appropriate credit derivatives instead of the ‘guarantors’ who stand
protection. Similarly, sovereign credit risks incurred in guarantee under conventional systems. However,
cross-border investments can be hedged by payment conventional systems such as insurance, guarantees,
of premium for protection against default and rating and securitisation are less liquid and involve increased
downgrade on the sovereign’s outstanding debt. intermediation and transaction costs. Under these
systems banks are not permitted to assume risks of
Cost-efficient protection for business operations: other banks and write guarantees in favour of other
Credit exposures related to day-to-day operations of banks even to manage their own risk portfolio.
any company in terms of receivables, debtors, advance
contract payments, default of major suppliers or The RBI working group has however come up with a
customers, business losses, etc. necessitate use of caveat that an unbridled approach may expose banks
credit derivatives as a cost-effective protection against to other associated risks related to liquidity, price, legal
risks. These instruments can help them diversify their (compliance), foreign exchange, and reputation.
portfolio and seek protection from banks at a lower Therefore, the group has laid down policies and
cost than the current economic cost of maintaining the procedures for credit risk valuation and control such as
exposure through provisioning. Also, purchase of development of adequate systems; approval of policy
credit-risk protection will free up capital that can be by the board of directors; capturing of credit risk
used in core business activities. Companies can even acquired through credit derivatives within banks’
choose a short-term protection for continuously normal credit monitoring regime; development of an
adjusting their exposures vis-à-vis changes in the risks appropriate mathematical model to incorporate fair
involved. The high level of certainty provided under the economic value of assets and liabilities, and ensuring
system can help companies plan their future business best practices.
expansion besides deciding pricing with pre-defined
contribution margins. Although it is important to aim at increasing
participation of various sectors of the economy such as
Opportunities for new business: Corporate investors banks, insurers, mutual funds, hedge funds, and
can not only arbitrage the pricing of credit risks in and corporate in the credit derivatives market they may be
between separate market sectors but also participate permitted in a cautious, step-by-step manner. Initially,
in the loan market which till date eluded them because commercial banks, under the supervision of apex DFIs,
of the absence of required loan administrative may be allowed to assume one-way credit risks of
infrastructure. Synthetic lending swap provides them cooperative banks and RRBs. This may be done for
with an opportunity to participate in the bank markets domestic reference assets with minimal exposure to
without having created an infrastructure of a bank. foreign exchange risks. If required banks may hedge
Corporates with surplus funds can use credit their associated interest rate and currency risk on the
derivatives to invest in Credit Default Swaps and exchange trading platforms. Later, good RRBs and state
provide credit protection and earn premium on cooperative banks may enter the scenario. Once the
diversified portfolio on credit exposures. market matures other agencies may also be permitted
in two-way transfer and management of risks.
Identified DFIs will be required to standardise information, advice, representation in case of default,
documents and registration system for use of credit distress, dispute, amendments and restructuring of
derivatives by rural financial institutions. It must ensure obligations etc. should to be adequately addressed by
that due care with the consent of the top management the regulator.
of the bank is taken and it is ensured that transactions
are direct, explicit, irrevocable and unconditional8 . Development of credit risk models: Most credit risk
Issues related to exposure norms, capital adequacy, management models, created in the developed
accounting standards, etc. have also been discussed in financial markets, presume availability of default data
detail by the RBI working group on credit derivatives9. and adequate expertise. However, the Indian financial
markets are marred by difficulty in estimation of
Other conditions necessary for the development of a default probabilities, lack of term yield curve and
robust credit derivatives market are: proper identification of mismatches on account of poor
asset liability management systems, lack of
Synergy of laws: Development of the credit standardised pricing practices etc. Complex models to
derivatives market requires synergistic assimilation of suite Indian conditions need to be developed for
governing laws and regulations such as RBI guidelines enabling an integrated risk management system and
relating to FEMA, regulation relating to forex encompassing associated uncertainties in the credit
derivatives contracts, insolvency laws, Securities derivatives market.
Contracts (Regulation) Act, Securities Exchange Board
of India regulations and provisions for derivative Development of internal systems and procedures
trading, tax laws, Transfer of Property Act, state specific with trained human resources: Derivatives business
registration and stamp duties requirements, ISDA requires strong internal systems and procedures in
Master Agreement, BIS interventions etc. Any conformation with international standards. It must
confusion on the provisions of various regulations and address the issues of training and skill upgrades,
their applications on the credit derivatives market must standardisation of back office operations and
be addressed in the beginning itself. movement of funds, development of relationships,
infrastructure, credit administration and monitoring
Efficient regulatory environment: Organisations system, online trading, rating and surveillance system,
transferring/covering the risk must gain confidence in credit-risk models and techniques, etc. Trained human
the market with respect to its ability to enable them to resources are required to give regulatory treatment of
hedge trade risks with an efficient regulatory credit derivatives vis-à-vis materiality of the expected
environment. Issues related to confidentiality, access to outcome and expectations of clients. An apex financial
institution will be better placed to train the required
human resources with requisite skills sets.
8
Recommendation of the RBI Working Group on Credit Derivatives
9
http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/35293.pdf
Mr. Venkatesh Tagat is Chief General Manger, National Bank for Agriculture & Rural Development, Bangalore, and Mr. Narendra Rathore is a
freelance consultant, Bangalore. Views expressed by the authors are personal and not of the institutions.

11 Commodity Exchange
Technology Concepts –
Looking Forward
By Mr. Dipankar Chakrabarti and Ms. Rachna Nath
Technology is and will remain pivotal for any commodity exchange in the near future.
Commodity exchanges should utilise the new wave of technology innovations to create
a differentiator for themselves. This will enable them to foster ever closer relations with
their users, provide transparency and build trust.
The day the portal “eBay” went down it realized that it speculators, collateral managers, exchanges,
was not in the business of selling but in the business of clearinghouses, brokers, regulators, the government,
information technology. This is because when the infrastructure providers and technology vendors — is
portal was down there was no business. Likewise creating the challenges, and proper usage of
information technology plays a key role in the success technology can help resolve these issues to a large
of the business of an exchange helping it run efficiently extent and create a differentiator that is getting
and effectively. In fact, technology can become a huge increasingly important as the number of players
differentiator. Emerging technologies can add to the increases in this market and globalization changes the
“customer delight” through: way of business.
• Faster enablement of trading of newer & innovative A forward looking technology strategy could include
products – adding flexibility to the system to meet the use of innovative concepts for cost-optimised
new requirements communication, mobile enablement, a central
integrated exchange platform, easy information
• Faster go-to-market from the conceptualization dissemination, more self service enablement, better
state – reducing time between conceptualization market information management, faster learning kit
and actual trading for users, and increased service levels towards
customers with algorithms-embedded customer
• Improved user experience – availability of relationship management (CRM).
information of major requirement for commodity
trading The Current Need
• Integrated system – seamless integration of all To make technology act as an enabler for all actors of a
stakeholders including clearing house, banks, commodity exchange and thus leverage the maximum
warehouse, assayers, spot markets, etc benefit from it, it is essential that we look into the
holistic picture of the information flow among all the
• Proactive decision support system – easy actors of the exchange. The adjoining figure shows a
modification of contracts, management of risks, etc conceptual information flow among the different
actors with the “central integrated commodity
• Value added services - futuristic customer service exchange platform”. In this discussion note our
on an integrated voice, mail and internet platform. emphasis would be on elaborating on the concept of
futuristic technologically utilization to have an
A stream of innovations in products, platforms and integrated platform for a commodity exchange which
functionalities, as well as a fundamental restructuring will be more customer-centric, agile, collaborative and
of the relations between market actors — hedgers, self-service-oriented.
Possible technology-enabling pieces
Contracts Market Analysis Info Dissemination
Cont. & &

DS it.
S Batch e tS
k s
Info ar si
M n al y
Producers/ Analysis A Market Makers/
KYC, Raw Data Entry
Suppliers D at
a Spot Price Finders
Central Integrated
EWR - Exchange Platform
Trad
WMS in g Stn
. Buyers – Brokers -
Intrgtd. E-Com
Warehouse Agents
Automated - On
e li ne
lin fast
On Risk
Assayers Management
Clearing House Banks
Need of the day is to have an agile system to support What Does the Future Look Like?
the customer need immediately and reduce the time
from conceptualization to production. The wish list If we look back, commodity exchanges have been in
today looks something like: existence since 17th century. Modern commodity
exchanges date back to the trading of rice futures in the
• I need innovative products to take to the market 17th century Osaka, Japan. In ancient literature we find
• I need to take these faster to the market the mention about commodity futures trading. The
• My system should be flexible, robust and fault first recorded account of derivative contracts can be
tolerant to adopt these new products and traced to the ancient Greek philosopher Thales of
opportunities Miletus, who, during the winter, negotiated what were
• I should be able to integrate seamlessly all my essentially call options on oil presses for the spring
stakeholders including clearing house, banks olive harvest. Since then we have matured a lot and
• I need a ‘value adding’ decision support system to commodity exchanges are enjoying around 12% CAGR
modify contracts fast according to the market need growth where technology is the main enabler.
• I should be able to manage risk online – automate Electronic trading has led to the emergence of many
futuristic price movement management globalised exchanges, accounting for three-quarters of
• My system should give me an integrated view of all the volume of futures traded. Not surprisingly,
actors of the marketplace including warehouses agricultural products have the highest growth rate
and assayers followed by metals and energy. The globalized
• I need better spot market simulation exchange market has intensified the competition as
• I need a framework that will help me with better well. Every exchange is looking forward to innovative
customer retention. products, better reach to supplier/producer and buyers
and faster go-to-the market strategy.
Given this scenario, technology enablement with
innovation is becoming fast the theme of the day. It is The Reach
imperative to say that only running the platform for
bid-ask-rollover will not suffice as the horizon of New communication technology breakthrough has
opportunity is waiting to open. Developed market changed the landscape of reaching out to the
knowledge is getting fed back to the emerging market exchange players in the recent past. Satellite
to create an efficient risk-resilient market. communication has improved the reach by manifold.
More communication improvements are on the cards.
If we judiciously use the communication technology, it
will help us tap into the rural market easily and thus
make till-date-unearthed huge resources available to
us. Concepts like a pan-African commodity market are
possible only with assurance of better connectivity.

The cost of broadband is going southward fast making Faster Go-to-Market
internet more accessible and changing the way
exchanges perform. Multi Protocol Label Switching It is very important for the commodity exchanges of
(MPLS) networking is increasing the quality of services today to look for innovative complex products to stay
at a lesser cost. By prioritising internet traffic and the ahead of competition within the framework of the
core network more efficiently, quality of service (QoS) existing regulations of the country. This demands that
and traffic engineering functions can address the the technical platform of the exchange is such that it
performance issues related to emerging internet can launch any combination of products fast. There is
applications. Network equipment manufacturers are no time and cost for creating another platform to
constantly developing new solutions that solve many support a new product. The system should be robust
of the problems associated with today’s internet and scalable enough to go for a new product without
applications. MPLS is one such solution that has been evoking any customer dissatisfaction. In the online
standardised by the Internet Engineering Task Force scenario, a second of “service-out” makes people move
( I E T F ) . Th i s w i l l c h a n g e t h e l a n d s c a p e o f out from the marketplace. Scaling up of hardware is
communications as this is creating a network that one way of supporting the need, but the cost of such
increases the reach manifold. Internet enablement of support will only go up as the exchange scales. Time
the trading platform has made it possible to trade has come to look for innovative solutions for a faster
anytime, anywhere. Newer concepts are emerging to and better delivery mechanism at a lower cost.
reach end-users directly, to benefit the community.
Cloud computing is one of today’s most hotly
Despite the increase in penetration of information discussed/debated topics. Despite the relative decline
technology, there has been a lack of communication of grid computing and unfulfilled promises of utility
instrument availability in semi-urban and rural areas of computing, cloud computing appears to be catching
developing nations. Hence, innovative methods of on, in both industry and academia. Compared to its
expanding reach, such as Kiosks, are becoming predecessors, cloud computing seems to be better
increasingly popular. A cooperative model, where the positioned in terms of economic viability, cost-
reach can be extended to a pool of people through effective approaches to scale and reliability, early
creation of Kiosks through a private-public adoption of inter faces, and open source
handshaking, can extend the reach of the exchange. implementations. In the 1990s, the world was
Initially, the model will work on VSAT but slowly, as the introduced to the internet, and we began to see the
demand-supply scenario changes, a much lower cost power of distributed computing realised on a large
communication protocol can be adopted to minimise scale. Today, we have the ability to utilise scalable,
the cost and make information available to the distributed computing environments within the
remotest rural areas. confines of the internet, through cloud computing. This
environment strives to be dynamic, reliable, and
In the recent past, IIT-Kanpur has propagated the customisable with guaranteed quality of service.
concept of Info-Thela which can empower village Within this system, users have a myriad of virtual
farmers to connect to national/international resources for their computing needs, and they do not
commodity exchanges. It is basically a pedal-driven need a complete understanding of the infrastructure. It
vehicle just like a common cycle rickshaw with a reminds us of Sun Microsystems founder Scott Mc-
personal computer onboard which will be connected Nealy, who declared long back “the network is the
to internet using wireless technology. It is designed computer”.
keeping in mind the village conditions in the country
where electricity is not available all the time. So a pedal Using clouds, high hardware and network demanding
generator is designed in such a way that while organisations have more options to fully understand
pedalling the battery will keep on charging for running the costs associated with owning versus renting CPUs,
the onboard computers and equipment. This simple storage, and networking. The costs usually revolve
but innovative mechanism may change the way reach around managing equipment (operational) and not
to the villages can be increased. The Info-Thela can just buying it (capital). Amazon and other providers are
provide an internet Wi-Fi network in a radius of about relying on consolidating resources with automated
20 km around the nearest internet access point, management to make it cheaper for customers to rent
without access charges. resources than buy them. There are a few concerns
about the security of the environment. Researchers are
working to eliminate the lacuna, and this should be an
adaptable platform for cost-effective online service
provision.
Many models will emerge — from provisioning the In addition, there has been a large increase in the
core system on cloud to information dissemination number of contracts being traded. Therefore, a much
over cloud, and there will be an optimised model to focused data mining tool will be required to manage
have availability, security and cost in balance. Data the huge volume of data pursing the information out of
dissemination over cloud will depend to a great extent these and creating a repository which is easily
on the security of data and how that is being tackled. As accessible and understandable and can be easily
with most technological advances, regulators are d i s s e m i n a t e d. Th i s c h a n g e a l s o b r i n g s i n
typically in a “catch-up” mode to identify policy, modernisation of regulatory legal system and efforts
governance, and law. To facilitate the emergence of should be put in to seamlessly integrate technology
such policy and governance, the US created a cloud and work processes to support investigation, trial, and
computing security group. This group envisions its role appellate work.
as promoting “the effective and secure use of the
technology within the government and industry by We can very well see that the threat posed by the
providing technical guidance and promoting changing pattern of technology due to online,
standards. Given the situation, cloud computing will be internet-based trading can only be mitigated by a
excellently poised for information dissemination to highly sophisticated online, auto-learning risk
users. It may take some more time to move the base management system.
platform to cloud computing mode.
Integrated Platform
The programming technique is also getting changed to
suit faster demand where programming is becoming The central tendency of future exchanges is taking
elastic with the highest level of scalability from a few shape on an integrated platform where all actors’
users/nodes to a large number of them, delivered on- demands and needs are taken care of by robust usage
demand without significant dependencies on of an internet-enabled technology platform. Demands
hardware and with run-time composable screens. This of key liquidity providers and institutional investors will
is highly suitable for a commodity exchange to dish out include fast execution speeds; straight-through
new products from test bed to actual contracts. All processing as standard, integrated value-added
these will make the exchange more efficient. clearing services into the trading platform; enhanced
network resilience; and deployment of cutting-edge
Risk Management security software and high available systems. Users will
be more tech-savvy and will use more and more
Technology has opened up new opportunities in algorithmic trading tools. The internet is rapidly
commodity exchanges, but it has also increased the evolving into an always-on, always-connected, device
system risk. Robust online risk management is the call independent environment for commodity exchange.
of the day. Exchanges should possess an online, up-to- This is changing the way traditional exchanges were
the-moment risk mitigation mechanism which will looking at the business strategy. Technological road
make the system robust and yet user-friendly. map to align with the exchange business strategy has
Technologies like in-process data mining and auto to be developed to utilize the wave of technological
learning inference system are making the changes and innovations and thus creating an integrated platform
are providing a different level playing field for risk for trading encompassing all the stakeholders. New
management. Focus is more on proper data technologies with mobile workforces operating in
management, inference drawing from data, and dispersed mode, more technologically complex
likelihood assessment of risk to auto-enable safety environments including service-oriented architecture
mechanisms to have a sound system. (SOA), software as a service (SaaS), rich internet
The focus of risk management is also changing for applications (RIAs) and Web 2.0 make enterprises think
regulatory bodies — not the exchanges only. Change differently. Faster adoption of innovative technology
in trading pattern affected the working of market will build the differentiation. Major opportunities for
regulatory commissions to maintain a robust-yet- integration lie in the following areas.
flexible regulatory framework as market participants
have an increasing number of choices available to Mobile workforces may be deployed at different remote
them as to where, when, and how to trade. The mandis to provide online information feed for spot
continuing shift of market volume to the electronic market data which is essential for creation of a better
trading environment poses new data processing futures and option market. Technology will enable
challenges to regulatory bodies. This medium allows creation of a virtual spot market scenario for the
exchanges to gather and transmit much more exchanges. Proper algorithm can be used to deduce the
information about trading activity and hence warrants spot value from a set of large data points which will be
increase in overall capacity for processing and storage. provided to the system online multiple times in a day.

Clearing house integration is another new concept way. An integrated voice, mail, fax and walk-in system
which can provide straight-through faster processing of will give users a very special experience. Technology can
transactions. As speed is the essence of the delivery help in converging these and in faster retrieval of users’
mechanism, this will be a real help to the exchanges. nature and queries for the past few cases.
Moreover, it will be also possible using technology to
create a common clearing house across the country from Customer relationship - Finally, technology can
which services will be used by individual exchanges. This provide the means for exchanges to foster ever closer
will make the system faster, efficient, and more robust relations with their users. CRM systems can be used by
with increased liquidity. A concept of clearing house as a exchanges as a mechanism to increase the service
distribution portal can also be thought of through the levels. Algorithms embedded in CRM systems can
usage of modern Web-based technology. maximise the impact of an exchange’s marketing
efforts. These will be the basis for ‘data mining’ of
Warehouses and assayers can also be integrated with the trading information, identifying the client’s product
exchange platform. Warehouse management system focus and analysing his trading strategies. Suggestions
can be implemented at warehouses and data can be will then be generated to help greater client
integrated with the exchanges to have real-time data participation. Information dissemination to users in a
availability. This will make the supply chain more targeted and measured manner is very important and
efficient and transparent to users. Electronic warehouse should be looked into so that the system is cost-
receipts (EWR) can be utilised for financing seamlessly effective and content self-sufficient.
through the exchanges. Even banks through their
payment gateways will be integrated with the exchange Technology Investment
platform to do seamless and fast transactions.
Investments must be highly selective, targeted to those
Integration of information flow of all the actors will be areas where it will generate maximum returns.
the future of commodity exchanges, and technology Alignment of broader strategic approach to the
will be the major enabler for the integrated system. technology deployment need will be the key. The major
need will be less upfront investment and ongoing
Customer Service management through a lean IT organisation structure.
Innovative customer service will be the major While choosing a technology platform it is to be noted
differentiator for these exchanges. A few differentiation that the solution must ensure that operations can
factors to be enabled by technology will be: seamlessly scale up and scale out to handle growing
business, connectivity, and transaction needs. The
Better training tools – An online simulation-based solution must provide a fault-tolerant trading
training kit with voice over in vernacular will be a dream environment delivering the highest levels of
come true for users — more so, if the exchanges target availability and continuity in trading operations. The
the rural market. It is also to be noted that convergence technology framework must have ‘rapid customisation
of media and better packaging of video and audio and deployment’ capability to enable the exchange to
enable delivery of good quality media over less respond to market demands and requirements in the
bandwidth, which will be essential to delivery of shortest possible time.
training to the remotest places.
It is necessary to calculate the ROI for each investment
Personalisation and self service – This will be another and treat each of such improvement as projects which
major differentiation factor for the exchanges. This will, will be managed professionally.
on one hand, save cost and will, on the other hand,
make users feel at home and special. Auto-learning Epilogue
Web pages will make users feel that the exchange
understands their particular need and will thus give a Technology is and will remain pivotal for any
large stickiness factor. Self-service modules will commodity exchange in the near future. Commodity
empower users and will eliminate a majority of human exchanges should utilise the new wave of technology
intervention and, hence, miscommunication. innovations to create a differentiator for themselves. This
will enable them to foster ever closer relations with their
Complaint and suggestion handling – A smooth, users, provide transparency and build trust. For smaller
technology-enabled customer-focused complaint and exchanges facing far tighter resource constraints, the
suggestion handling system takes an exchange to a long development of close, collaborative partnerships with
technology developers will be the key to surviving —
and thriving — in the technology era.
We want to reiterate that technology deployment is References
only a means to an end, and success in the future will
depend on meeting the foundational value 1. United Nations Conference on Trade and
propositions on which investor participation is Development (UNCTAD)
premised: well-defined contracts in line with the
requirements of market users; a smooth functioning 2. PricewaterhouseCoopers’ internal analysis
delivery system; liquid, efficient and transparent
markets built on a robust, scalable, highly available and 3. Food and Agriculture Organization (FAO)
risk resilient approach.
In this note, we have provided some concepts of usage

of new technology for efficient, fast and smooth
operation of any commodity exchange. These will take
a firm shape depending upon the nature of the
exchange and will need customisation as per the
business strategy and needs.
Mr. Dipankar Chakrabarti is Managing Consultant and Ms. Rachana Nath is Executive Director, Performance Improvement,
PricewaterhouseCoopers Pvt. Ltd. Views expressed by the authors in this article are personal and not of PricewaterhouseCoopers Pvt. Ltd.

India Needs to Usher in
the Next Agricultural
Revolution
By Mr. Amitabh Jaipuria
We need to produce more using less, earn more per unit of it and improve farmers' lives
The 1965 slogan of 'Jai Jawan, Jai Kisan' coined by Late production while conserving land, water and energy,
Shri. Lal Bahadur Shastri, rightfully hailed the soldier and inclusively improve farmer lives.
and the farmer as icons of patriotism and hard work.
The Green Revolution of the 1970s with Indian famers Two-thirds of Indian agriculture is monsoon
at the forefront led to a sharp rise in food grain dependent, and we are witness to the fact that this
production enabling the country to achieve self- kharif season had deficient or scanty rainfall. It is
sufficiency and overcome the threat of famine. The unfortunate that large areas of our country are facing a
Green Revolution, increasing food production through drought-like situation. Agriculture contributes 18 per
agricultural intensification, played a significant role in cent to the GDP and the overall growth for 2008-09 was
reducing poverty, is undoubtedly a great Indian a modest 1.6 per cent.
success story.
In India, important food crops with wide consumption
Today, however, the world and our nation face including wheat, rice, maize, soybean and others,
tremendous challenges poverty, hunger, climate continue to grow in the low single-digit range. The Plan
change, amongst others. Experts estimate that document also speaks of yield fatigue and technology
between now and 2050, agriculture will need to gaps as the two main constraints in the development of
produce as much food as was produced in the last Indian agriculture. Seeds with superior genetics and
10,000 years. Land resources are shrinking, area under state-of-the-art technology coupled with quality
agriculture has witnessed a decline and water inputs are most important for productivity-led growth
resources are depleting. We're talking about having to in agriculture improving the economic fate of the
double world food production in just forty years and farmers as well.
doing it without much more land. This means that
almost all of it has to come from increased output on Today's demand-supply challenge presents an
every acre, without using more water - that means incredible opportunity for all those engaged in
getting a lot more out of the rain that is still free. Forty agriculture business to unite to help agriculture
per cent of world production of food comes from 18 per unleash its potential and solve one of the biggest
cent of land that needs irrigation. Leading this challenges facing developed and developing nations.
agricultural revolution are the farmers - majority of who
live on less than Rs. 48 ($ 1) per day. We need to take the Green
Revolution further- It's time for
According to a recent report
ushering in the next revolution
drafted for ministers of the G-8
nations, the world faces “a
Agriculture has a history of
permanent food crisis and global
making dramatic productivity
instability unless countries act
improvements due to the
now to feed a surging population
deployment of numerous
by doubling agricultural output”.
innovations, better genetics and
The world needs to increase food
better farming practices keeping
up with growth in population
defying the famous Malthusian theory. Innovation in Rapid adoption of insect-protected bt cotton
agriculture provides the greatest hope for solutions. technology has helped farmers increase yields and
Agricultural research and extension systems need to be earn an additional income Rs. 20,400 crores a direct
strengthened to improve access to productivity- contribution to India's GDP from 2002 to 2008.
enhancing technologies. Indian agriculture has the Additionally, India's Bt cotton farmers reduced pesticide
potential to augment the process of the country's usage by 80%, which resulted in savings of Rs. 1,127
economic development and has immense potential to crores in 2007 alone (IMRB). Research among bt cotton
alleviate millions of households out of poverty. With a farmers has indicated that 87% are enjoying better
stable Government and strong visionary leadership lifestyles, 84% felt more peace of mind, 72% invested in
determined to make a difference to the lives of the children's education, and 67% repaid long-pending
farmer, Indian agriculture is at an inflection point. debts (IMRB).
Agricultural innovations can make farm families Farmer Dyneshwar Buibhand from Antargaon village,
and rural India prosperous Yavatmal in Vidarbha, Maharashtra, recently purchased a
new motorcycle. Income from his 14-acre cotton farm
Today, Indian farmers have better access to technology has increased to Rs. 21,000 per acre, in addition to per
in agriculture in the form of enhanced seeds, inputs acre savings of Rs. 7,500 from reduced pesticide usage
and infrastructure. Amidst the challenges in from using Bollgard II BT cotton seeds. Mr. Buibhand is
agriculture, India's success story with insect-protected proud to be able to educate his son in an English-
cotton seed stands out as a beacon of hope and pride. medium convent school and to build a brick home worth
Farmers cultivating Bt cotton seeds have made India Rs. 550,000 for his family. Bollgard II BT cotton seed's
the world's second largest producer and second largest higher yield of 12 quintals per acre (compared with only
exporter of cotton by doubling India's cotton 7 quintals per acre with conventional seeds) has proven
production within six years of its launch in 2002 to successful for him and for cotton farmers across India
2007; thus contributing Rs. 20,400 crores in foreign who have adopted the technology. In fact, in 2008 alone,
exchange to the Indian exchequer, taking India from yields from BT Cotton in India increased by 31%,
the position of a net cotton importer at the time of its pesticide usage decreased by 39%, and profitability
launch to a strong exporter in the world markets. In increased by 88% equivalent to US $250 per hectare.
2008, farmers adopted this technology on 82 per cent
of India's total cotton acres - probably the fastest
technology adoption across all product categories.
This is testament to the benefits and superior value
farmers derive from agriculture technology.
Figure 7.7 All India area, production and yield of cotton

35 430
Area Production
30 380 Yield
Yield
25
330
20 Area
280
15
230
10 Production
5 180
1990-01
1991-02
1992-03
1993-04
1994-05
1995-06
1996-07
1997-08
1998-09
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07 (AE)
Years
Area: Million Hectares; Production: Million Bales of 170 kgs. each; Yield: Kg./Hectare
Source: Economy Survey 2007-08
India’s robust regulatory system has made this possible.

Superior technology in a single crop has benefited over
four million farmers across the country. This success can
be, and needs to be replicated across other crops. The
potential of innovative agriculture technologies for India
and Indian agriculture representing 57 per cent of our
population is tremendous.

The farmer-led white gold revolution should be Monsanto is committed to addressing these increasing
replicated – We could witness a ‘yellow revolution’ needs. Through our diversified seed production, world
in corn class breeding and manufacturing processes, and
extensive market outreach, we are ensuring that the
Corn is India’s third largest cereal crop after rice and Indian farmer has access to best-in-class products,
wheat, and is the fastest growing cereal amongst all enabling him to produce more per acre on his farm.
food grains, directly contributing Rs. 15,500 crores to Monsanto’s Dekalb™ high-yielding corn hybrid seeds,
the agricultural GDP. India is sixth largest producer and cultivated across 18 Indian states are available in 13
fifth largest consumer of corn in the world. high-yielding hybrids to suit India’s diverse agronomic
and climatic conditions. In 2008,
Corn production in India has Monsanto also started research
grown by over 60 per cent to 19.31 and regulatory work in India to
MMT in 2008 compared with 12.04 introduce our biotech-improved
MMT in 2000, even though the area corn technology offering farmers
under corn cultivation grew only solutions to the two key yield
by approx. 7 per cent (2008: 7.09 impacting factors: insects and
Mha vs. 2000: 6.61 Mha). This rapid pests, and weeds. Biotech-
increase can be attributed to enhanced corn technology has
increased hybridization and tremendous relevance and
launch and adoption of superior potential to enhance corn
corn hybrids by the Indian farmers. productivity in our country.
Farmers across India, with better
access to high-quality seeds through public and One of our noteworthy projects includes ‘Project
private sectors are adopting improved hybrids at a fast Sunshine’ - A Public Private Partnership of Monsanto
pace, thus experiencing higher productivity and with the Government of Gujarat’s Tribal Development
adopting good agronomic practices. Department (TDD), aimed at improving economic self-
sufficiency and quality of life of tribal farmers of
Demand for corn has increased significantly too. Over Gujarat. Under the aegis of their 10-point program
30 user industries produce more than 1000 products ‘Van Bandhu Kalyaan Yojana’, TDD set up a goal of
from corn for textile, paper, medicinal and other allied ‘Increasing income of tribal farmers by 100 per cent
industries. Higher incomes, better standards of living within five years’ and amongst its various programs
and changing consumption patterns have led to partnered with Monsanto on Project Sunshine.
increased demand for poultry and cattle products. Monsanto partnered via its Dekalb™ high-yielding corn
India needs to increase growth rate of corn to 5.91 per hybrid seeds (supplied to 30,000 tribal farmers across
cent from 4.2 per cent in 1995-2005 to meet the 535 villages through TDD). Additionally, we also
increasing domestic demand of 22.73 million tons by committed resources to conduct farmer education
2011-12. Corn constitutes 50 per cent of the poultry programs on agronomy, pest management, post
feed industry. India’s poultry sector consumes 7.5 harvest care and more, to increase productivity; and
million metric tons of corn today and is estimated to also partnered with TDD to provide critical project
increase to 16.5 million metric tons by 2015. According management. Due to better quality and timely supply
to IMDA Vision 2025 Report, for sustained growth of the of inputs (seeds, fertilizers, etc.) farmers experienced a
poultry sector, corn production needs to be doubled in healthy crop.
the next five years.
Project Sunshine generated outstanding results: A
Production growth is highly dependent on yield three-fold increase in yield (15 quintals per acre vs. only
growth as land under corn cultivation is largely five quintals per acre with conventional seeds) and a
stagnant at 7.2 million hectares. With only 46 per cent cumulative incremental income of over Rs. 20 crores for
of acreage under hybrid corn, and the average corn the 30,000 beneficiary tribal farmers.
productivity at less than one metric ton per acre as
compared to global average of two metric tons per Farmer Ramabhai Khoyabhai Maaliwaad is one of the
acre, there is an opportunity to increase productivity many corn farmers who are experiencing the benefits
through the most important input which can of higher productivity. A resident of Nava Muvada
dramatically alter yields, i.e. high-yielding corn hybrid village, his family of nine members had seen tough
seeds. With its potential yet to be realized fully,
increasing corn productivity can be one of the
solutions to tackle the food security issue along with
rice and wheat.
times growing corn although it partially met their food Monsanto’s worldwide three-point commitment to
needs. Low yields of not more than six quintals from develop Indian Agriculture to put the Indian Economy
conventional corn seeds and resultant low income on a high growth path and to spread its benefits among
thereof, was creating a challenge for his large family the farming community includes:
getting caught into a vicious cycle which was in
operation. Under Project Sunshine, cultivation of MIL’s Produce more – Monsanto will develop better seeds
Dekalb™ high-yielding corn hybrid seeds produced that will double yields in its three core crops of corn,
three times more than he could earlier produce with soybeans and cotton by 2030, compared to a base year
conventional seeds – 20 quintals in his one acre farm. of 2000 in countries where farmers have access to
He saved 12 quintals for the consumption of his family current and anticipated new seed choices offered by us.
and sold the remaining produce in the market. With his Recognizing the importance of wheat and rice as key
income, he has setup a small dairy farm with eight food crops, Monsanto established the ‘Beachell’ -
buffaloes that generates an additional income of Rs. Borlaug International Scholars Program to accelerate
880 daily leading to a diversification in his farming breakthrough public sector research in wheat and rice
income as well. His family now has a mobile phone yield.
connecting them better with market opportunities
outside their farm and an electricity connection in their Conserve more – Develop seeds that will reduce by
house to improve their personal productivity in various one-third the amount of key resources like land,
ways. To provide irrigation to his fields, he is investing in energy, fertilizer and water required to grow crops by
a 40-feet deep well, and will build a pipeline to link it to the year 2030. Monsanto will also undertake a series of
his farm. His son Mahesh is pursuing a vocational partnerships to address key environmental issues.
course to be an electrician.
Improve farmers’ lives – Monsanto will help improve
In a single season, Shri Ramabhai Khoyabhai the lives of farmers, including an additional five million
Maaliwaad’s family has prospered. They have moved people in resource-poor farm families by 2020 through
from being below-poverty-line to being self-sufficient innovative public-private partnerships including
and empowered. An example of the positive impact creation of effective market linkages.
through a single input, i.e. high-yielding seeds and the
power of public-private partnership. However, in the Indian context, we perceive that four
factors can positively influence the future of agriculture
At Monsanto, that remains the focus. Helping farmers and need attention from Government and Policy
produce more with less, building effective linkages and Makers:
partnerships, thereby improving farmers’ lives.
• A supportive environment and free market system
Our opportunity to help make a difference lies at that encourages competition, research investment
the intersection of demand, innovation, and and innovation;
execution
• A strong science-based Regulatory framework;
There is a unique role for technology in agriculture in
the Indian scenario. Whether it is high-yielding seeds • Effective enforcement of intellectual property
with better inherent genetic potential combined with rights (IPR) that encourages private investment in
biotech-enabled insect protection, stress tolerance, agricultural research; and,
a n d b e t te r we e d m a n a g e m e nt to p ro te c t
productivity/yields; better agronomic practices; or • Rigorous promotion of Public-Private Partnership
reduction in post-harvest losses – there is a clear and and collaborative research.
important role for agricultural technology in improving
productivity. This will help in providing farmers with a choice of
world’s best technologies and encourage investment
In our quest to improve yields sustainably, Monsanto in research to develop new higher-yielding products.
has announced three commitments to help farmers With the objective of ensuring food security for the
increase global food production in the face of growing burgeoning population through sustainable
demand, limited natural resources and a changing agricultural practices, it is heartening to note that the
climate; and have also pledged to work in new Public Sector R&D institutions in India are conducting
partnerships with other businesses, citizen groups and extensive research on the benefits of agricultural
Governments. biotechnology, in addition to the private sector.

Monsanto has been a historically trusted partner of We envision a prosperous rural India that is both
Indian farmers for over four decades and are self-sufficient in food, feed and fibre, and also
committed to further improving their lives becomes a major player in global agricultural
commodity trade
We are committed to strengthening communities and
doing what we can to help people lead safer, healthier, Imagine the potential for Indian farmers to replicate
and more productive lifestyle. As the world’s largest the Indian cotton success story in other crops to
investor in farmer-focused agricultural research and contribute to meeting the world’s needs. For this to
India’s leading agriculture company – Monsanto, its happen, they need to have access to cutting-edge
people and partners are working to meet these needs agriculture technologies to help them remain globally
playing an important role in providing solutions to the competitive and to take their rightful place in the
challenges that we face today. To cite an example, we global commodity trade. We believe, we have the
are researching innovative products that will enable capability to compete in the global market with agri-
corn farmers to reap higher crop productivity from the commodity powerhouses like Brazil and Argentina. The
combined benefits of insect- and pest-protection and success of Indian IT can be repeated in agriculture. We
better weed management via eight unique need to revive, modernize, make agriculture accessible
technologies in a single corn seed. We are also to markets and sustainable to empower India to seek its
partnering with the Government and other rightful place on the global map.
stakeholders to make our products more accessible to
farmers; and to evaluate the need and potential of We are optimistic that the time has come for a new
future technologies. slogan for Indian agriculture. It can be Jai Ho all the way!
Our commitments represent the beginning of a

journey that we will expand on and deepen in the years
ahead. As a pure agriculture company, helping farmers
succeed is at the core of all we do. We are optimistic
about the role of agriculture in driving India’s economic
development in the next decade. We believe the
visionary political leadership in our country and our
robust regulatory system will accelerate this further.
Since two out of every three Indian’s livelihood is linked

to agriculture, the potential of each entrepreneurial
farmer, empowered with seeds that enhance yields,
infrastructure and market linkages, is tremendous.
Mr. Amitabh Jaipuria is Managing Director of Monsanto India Limited. Views expressed are personal.

Commodity Insights Yearbook (Part 1)

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Introduction

About Commodity Insights

About Multi Commodity Exchange of India

2 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

FROM THE EDITORIAL DESK 7

1. An Integrated Approach to Agriculture Marketing and Financing

2. Commodity Futures in India – A Product of Globalisation and Liberalisation

3. Role of Mutual Funds in Commodity Markets

4. Banks on Commodities Futures Platform – A Win-Win Situation

5. Warehouse Receipt Finance for Farmers – A Glimpse

6 Carbon and Clean Energy Markets – the Potential in India

7. Commodities Derivative Hedging: Portfolio and Effectiveness

8. Role of Brokerage Industry in linking Ecosystem with the Futures Markets

9. Role of Banks in Indian Commodity Derivative Markets

10. Agriculture Financing under OTC Products

11. Commodity Exchange Technology Concepts – Looking Forward

12. India Needs to Usher in the Next Agricultural Revolution

DATA FOR READY REFERENCE

Agricultural Commodities 171

I wish the publication all success. Happy reading.

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FROM THE EDITORIAL DESK |7

Dr. V. Shunmugam Dr. Chiragra Chakrabarty

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Indian Commodity Futures Markets – Still Evolving…

The yesteryears… the government in 1918 set up Cotton Contracts

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While the trade in non-agricultural commodities,

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An integrated approach, in which efficient systems of e-spot trading, grading and

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Poor handling of agriculture produce: This practice E-Spot Trading

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Table 1: MCX vis-à-vis global parameters

Domestic Exchanges Global Exchanges

The lower impact cost on MCX at par with

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tonnes of rice and wheat by 3rd largest producer behind EU-27

While proliferation of products and participants is

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Prospects Role of Mutual Funds in Commodity Markets

The Regulatory Framework Internationally, there are different ways in which

The brighter growth prospects of the emerging

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???Future of Investment: The Next Move?; Prof. Amin

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Sectors Outstanding credit Annualised volatility Risk exposure

Gems & Jewellery 24,995 20.1 (MCX Gold futures) 5,024

Metal & metal products

Note: Outstanding figures as on March 31, 2008.

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Table 5: Commodity market vs. stock market

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