REPORT
OF
THE SUB-GROUP ON
INTERNAL TRADEAND FUTURES MARKET
(XIIth PLAN)
DEPARTMENT OF CONSUMER AFFAIRS
2011
i
TABLE OF CONTENTS
1. / 1 / Introduction to Commodity Futures / 1
2. / 2 / An Overview of the XIthFive Year Plan / 7
3 / 3 / Internal Trade / 12
4 / 4 / Requirements of Funds for the XIIthPlan / 22
5 / 5 / Recommendations for the XIIthPlan / 31
ANNEXURES
1. / I / Value of Trade at Major Commodity Exchangesduring the years 2008-09, 2009–10 and 2010-11 / 37
2 / II / Status of Recommendations madein the XIthFive Year plan / 38
3. / III / Concept paper on the proposed training institute. / 42
4. / IV / Regulations to be framed after the Amendment to F.C(R)Act, 1952 are passed / 47
CHAPTER 1
COMMODITY FUTURES
Historical Background
1.1Continuous supply of the goods is essential for any business activity. The Forward Contracts in commodities ensures that the manufactures, processors, or producers get continuous supply of the raw materials. Forward Contracts are merchandising contracts and provide for taking and giving of actual delivery of goods at a specified price and at a specified future date. The futures/ hedge contracts, which evolved at a later stage, provide various functionaries associated in the commodity market with a instrument to manage the price risk of the physical market. The tradition of futures markets in India is as old as in the USA and other developed markets, starting with cotton. Commodity futures trading started in due course in various other commodities like Gold, Silver, Wheat, Oilseed Complexes and Jute. The markets by and large were not subjected to any Government control / regulation till 1943. In 1943, the Defence of India Act was used on a large scale for banning forwards in certain commodities and regulating trading in others. The prohibition on commodities futures trading continued even after Independence.
1.2In 1952, Forward Contracts (Regulation) Act, 1952 (FCR ACT) wasenactedtoregulate the commodity futures marketandthe Forward Markets Commission (FMC) was set up as the commodity futures market regulator in 1953. However, due to supplyside challenges and the apprehension in the minds of the policy makers aboutdeleteriouseffects of speculation in the commodity futures, futures markets were prohibited in most of the commodities, except for a fewminor commodities likeblack pepper, jaggery and turmericetc. The prohibition continued for about 3 decades.
1.3The process of liberalization initiated in 1991 also had its impact on the futures trading. A Committee was appointed under the Chairmanship of Prof. K.N. Kabra to examine and make recommendations on changes in the policies relating to commodity derivative in the context of liberalization and globalization. The Committee submitted its report in September 1994 and recommended introduction of futures trading in various commodities. Besides, the World Bank and the UNCTAD Report of November 1996 also recommended revival of commodities futures markets in India. Various initiatives were taken post - 1998 for the revival of the markets.
1.4The major thrustin the revival of these markets came in 2003 when, prohibition on futures trading was lifted in all the commodities w.e.f. 1st April 2003and three nationallevelmodern electronic Futures Exchanges were set up.
Setting up of National Exchanges
1.5Three nationallevel Exchanges, i.e., National MultiCommodity Exchange, (NMCE) Ahmedabad (10.1.2003), Multi Commodity Exchange, (MCX) Mumbai (26.9.2003) and National Commodity and Derivatives Exchange, (NCDEX) Mumbai (20.11.2003) were grantedrecognitionfor commodity futures trading. These Exchanges are demutalised and corporatized entities and provide state-of-the-art online electronic trading platform.
Further, two national exchanges, viz, Indian Commodity Exchange Limited (9.10.2009) and Ahmedabad Commodity Exchange (10.8.2010) were also set up.
Benefits of Futures Trading
1.6Futures contracts perform two important functions of pricediscoveryandprice riskmanagement with referencetoa given commodity. It is useful to the producer because he can get an idea of the price likely to prevail at future points of time and therefore can decide between various competing crops as well as the most suitable time of marketing his produce and the price to expect, the best that suits him. It enables the consumer in that, he gets an idea of the prices at which the commodity would be available at future points of time. He can do proper costing and also cover his purchases by making forward contracts or cover his price risk through futures contracts. The futures trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contracts in a competitive market. Having entered into an export contract, it also enables him to hedge his price risk by operating in futures market. Other benefits of futures trading are:
Price stabilization - By helping in planning future production / imports / exports on the basis of the price signals emitted by the futures market, the violent price fluctuations are tempered, resulting in medium term price stabilization. It also thereby leads to integrated price structure throughout the country.
Improves thebalance in supply and demand position throughout the year.
Encourages competition and acts as a price barometer to farmers and other trade functionaries.
Scheme of Regulation of Commodity Futures Market
1.7There are three tiers of regulation of forward trading, viz., The Central Government, the Forward Markets Commission and the Recognised Commodity Exchanges/ Associations.
The Central Government broadly determines the policy as to the commodities in which futures/forward trading is to be permitted and the recognition of Exchange/ Association through whom such trading is to be permitted.
The Forward Markets Commission performs the role of a professional regulator, which includes approving the Rules and Regulations of the Exchange subject to which the trading is to be conducted, giving permission for commencement of trading in different contracts, monitoring market conditions continuously and taking preemptive or remedial measures against potential or actual market manipulation, excessive speculation or any other type of market abuse.
The Recognised Exchanges/ Associationsfacilitate, supervise and regulate the actual day to day trading as per the provisions of the Rules and Regulations approved by the FMC. It is the place where the trading is to be conducted, reporting and recording of contracts, execution & settlement of contracts, forum for exchange of documents and payments, etc.
1.8The system of regulation of the commodity futuresmarkets contributes to the overall objectives of ensuring an efficient market, reducing information asymmetry and promoting confidence in the market. The regulations aim at protecting the customers (members and clients) from manipulative practices. Regulation aimed at the prevention of market manipulation focuses on maintaining the integrity of the market price of commodities. Regulatory oversight attempts to ensure that market prices are not distorted by manipulative activity and to prevent false or misleading information from being released into the market.
1.9 Working of the Forward Markets Commission:
Forward Markets Commission is a statutory body set up under Forward Contracts (Regulation) Act, 1952. The Commission functions under the administrative control of the Ministry of Consumer Affairs, Food & Public Distribution, Department of Consumer Affairs, and Government of India. The functions of the FMC are dealt with in section 4 of the Forward Contracts (Regulation) Act, 1952 [F.C(R) Act, 1952] which is given below:
- To advise the Central Government in respect of the recognition of, or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of the FC(R) Act, 1952.
- To keep forward markets under observation and to take such action, in relation to them as it may consider necessary, in exercise of the powers assigned to it by or under the FC(R) Act, 1952.
- To collect and whenever the Commission thinks it necessary, publish information regarding the trading conditions in respect of goods to which any of the provisions of this Act is made applicable, including information regarding supply, demand and prices and to submit to the Central Government periodical reports on the operation of the Act, and the working of forward markets relating to such goods.
- To make recommendations generally, with a view to improving the organization and the working of forward markets.
- to undertake the inspection of the accounts and other documents of (any recognized association or registered association or any member of such association) whenever, it considers it necessary and
- To perform such other duties and exercise such other powers as may be assigned to the Commission by or under the FC(R) Act, 1952 or as may be prescribed.
Present Status of Commodity Futures Trading
1.10Futures trading is presently being organised through five National and 16 Regional (commodity specific) Exchanges. The value of trade in the major Exchanges is given at Annexure-I. At present, 113 commodities are notified for futures trading and actual trading is taking place in about 50 commodities. The value of trading which was just Rs.66 thousand crore in 2002-2003 increased to Rs.119.49 lakh crore in 2010-11.
1.11 Regulatory initiatives:
The ForwardMarkets Commission maintains effective regulatory oversight over the commodity futures market to ensure that the market effectively performs the dualeconomic functions of pricediscoveryandprice risk management. The Commission employs a plethora of regulatory tools, such as margins, position limits and price bands to bringdiscipline in the market place and to ensure that the market participants are protectedfrom fraud, manipulation and otherabusivetrade practices. The proactiveregulation of the commodity derivatives market by the Forward markets Commission has maintained discipline in the market and there has been no majorinstance of market misdemeanor in the past.
Inadditionto the regulatory tools deployed by the Commissionforeffectiveregulation of the market, some of the major regulatory initiatives taken by the Commission in the last three years are indicated below:
S.No / Year / Regulatory Initiatives1. / 2010-11 / Regulatory framework for market access through an Authorized Person
Amended Guidelines on the Equity Structure of the Nationwide Multi Commodity Exchanges after five years of operation
Amended Guidelines for Recognition to New Commodity Exchange under FC(R) Act, 1952
Guidelines for Members of Commodity Exchanges in Joint Ventures and wholly owned subsidiaries abroad
2. / 2009-10 / Guidelines on the Equity Structure of the nation-wide Multi Commodity Exchanges after five years of operation
Guidelines for Anti Money Laundering and Know Your Customer (KYC) Norms
3. / 2008-09 / Guidelines for recognition of National Commodity Exchanges
4. / 2007-08 / Guidelines for altering the expiry dates of the contract.
Guidelines on foreign investment in Commodity Exchanges.
CHAPTER 2
AN OVERVIEW OF THE XI THFIVE YEAR PLAN
2.1The developmental activities of the ForwardMarketCommission are beingundertaken under the CentralPlanScheme “Strengthening of FMC” 11th Five Year Plan –
An overview
2.2The major achievements of the Forward Markets Commissionunder the aforesaid planschemeduring the 11th plan period are given below:
Developmental initiatives:
2.3The Forward Markets Commission, inadditiontoregulating the commodity futures market, has also taken proactive steps in the past years to ensure that the commodity futures markets are broad based and its benefits reachall the stakeholders of the Commodity Markets. Three of the importantinitiatives in this regard are :
i)Creation of awareness among stakeholders,
ii)Capacitybuilding in the commodity sector, and
iii)PriceDissemination Project
2.4Outlines of the programs and the achievements during the 11thPlanperiod are given below :
i)Increasing the awareness levels of different categories of stakeholders, especially farmers tomake them aware of the existence of as well as benefits from the commodity futures markets.
The ForwardMarkets Commission conducts awareness programmes for all the stakeholders of the commodity derivative market, such asmembers of commodity exchanges and their clients, prospective participants in the commodity derivative market, physical market stakeholders in the agricultural, metals , bullion and energy sectors, especially farmers, grassroot levelfunctionaries and extensionservice providers in the agriculture sector, educationalinstitutes, etc. The tablebelow gives the details of the awareness programmes organizedby the FMC during the first 4 years of the 11thPlan :
Year / No. of Programmes for / % of farmerprogrammesFarmers / Others / Total
2007-08 / 75 / 39 / 114 / 65.78
2008-09 / 107 / 90 / 197 / 54.31
2009-10 / 423 / 92 / 515 / 82.13
2010-11 / 486 / 343 / 829 / 58.62
Total / 1091 / 564 / 1655 / 65.92
ii) Sensitization of policy makers andcapacitybuilding in the commodity sector;
The ForwardMarkets Commission organizes training programmes and Training-of-Trainers (TOT) programmes for market stakeholders. These programmes are directedatofficers of the central and stategovernmentengaged in policy making, educationalinstitutions with focus on agricultural universities and managementinstitutes, financial institutions and banks, the cooperative and warehousing sectors to sensitise them about the roles to be played by them for the development of the commodity futures market. The capacitybuilding programmes organized by the FMC in the pastfour years are given below:
Year / Number of Programmes Organsied2007-08 / 8
2008-09 / 18
2009-10 / 66
2010-11 / 79
iii)Implementation of the PriceDisseminationProject through APMCs andother centres toempower the farmers with up-to-date price information on spot and futures markets.
The PriceDisseminationProject encompasses the dissemination of spotand futures prices of agricultural commodities in the locallanguage on electronic price ticker boards placed at APMCs in various parts of the country. The Price Dissemination Project has been implemented in 180 APMCs during 2009-10 and in 588 APMCs during 2010-11, taking the total coverage to 768 APMCs by the end of 2010-11, covering 23 States.
iv)Exihibitions:
The Commission, inassociation with the National Exchanges, participated in the Indian Science Congress Expo at SRMUniversity, Chennai during 3-7 January 2011.The Commission in association with the National Exchanges also participated in AGROVISION 2011, organized at Nagpur during 4-7 March, 2011 by the Vidarbha EconomicDevelopmentCouncil (VEDC).
v)Inspection of Books of Accounts:
The Commission has been inspecting the books of accounts of the Members of the Exchanges, particularly of the NationallevelCommodity Exchanges on a regularbasis since 2006-07.
Details of inspections undertaken during the lastfour years are given below:
Year / Number of members audited / Number of exchanges audited / Special audits / Total2007-08 / 100 / - / - / 100
2008-09 / 104 / 3 National Exchanges and NBOT / - / 108
2009-10 / 298 / of 3 National Exchanges and 14 Regional Exchanges / - / 315
2010-11 / 280 / 3+14 Regional exchanges / 1 / 298
Total / 782 / 38 / 1 / 821
2.5The planscheme was launched in 2005-06 and has been in implementationduring the 11thFive Year Plan. While the impact on strengthening of the internal capabilities of the FMC has met with mixed success, the delay in the passage of the Forward Contracts (Regulation) Act AmendmentBill and the inability of the FMC toattract the required skilled manpowerbymeans of deputationhave impacted the envisaged expansion in the manpower and the resultant strengthening of the internal capabilities of the FMC. The expansion of officespace and infrastructure and IT facilities within the office also did nothappen as envisaged. However, with regard to the initiatives of the FMC for the development of the market, the following benefits have accrued to the beneficiaries :
i) The FMC has conducted 171 capacityand trainers’ training programmes on the subject of commodity derivative marketduring the 11thFive Year Planperiod (until the end of 2010-11)aimed at Universities and Training institutions, Governmentofficialsinvolved in policy making, Bank Officials and personnel of cooperative institutions, ruralextension workers, logistics professionals etc. These programmes haveincreased the capabilities of the trained personnel in the area of commodity derivative market and have created interest in furthering of the education in this area. The FMC has received requests fromseveral institutions for holding capacity building programmes for their faculty and students and also devising curriculum in this area. Several trained personnel have, in turn, conducted awareness programmes on the commodity derivative market for various stakeholders on behalf of the FMC, thereby enhancing knowledgeabout the market among a wider clientele. The capacity building programmes have also created greater interest in the area of commodity derivatives with a largenumber of students seeking summerinternship with the FMC as well as with the Exchanges. It is observed that these efforts have contributed in a significant way in creating capacities and capabilities in this area which are required for meeting the employment opportunities in this industry.
ii) The FMC has conducted 1655 awareness programmes during the 11th Five Year Plan (until the end of 2010-11) (most of them in the last 2 years) for the benefit of various market stakeholders that include members of the commodity exchanges, clients, stakeholders of physical commodity markets and related industries, logistic companies and other service providers, grassroots level stakeholders of the physical markets and primary market producers. The focus of these programmes has been creating awareness among farmers about the utility and use of commodity derivative market vis-à-vis marketing of their produce. 1091 out of the total of 1655 programmes (66%) were conducted for them during this period. These programmes have generated awareness about the market among a wide section of stakeholders. The farmers’ awareness programmes have also achieved the desired impact of increasing curiosity about the market and increased usage of the derivative market price information by the farmers for marketing their produce, as evidenced form the study on the benefits of the commodity derivative market for the farmers, conducted by NABCONS.
iii) During the course of the 11th Five Year Plan (until the end of 2010-11) the FMC has conducted 28 meetings with various market stakeholders which has resulted in greater understanding between them and the FMC, and has thrown up several issues for policy consideration. Besides these industry meetings, the FMC has also held one-to-one interactions with specific sections of the physical and financial market stakeholders and this process of on-going dialogue has been highly beneficial both for the regulator as well as for the market stakeholders.
iv)The audits commissionedby the FMC through pre-qualified CharteredAccountant firms, numbering821during the 11thFive Year Period (until the end of 2010-11), haveresulted in better regulatory complianceandclientprotection among the members of the commodity exchanges.
v)The FMC has entered into MOUs with the internationalcommodity derivative market regulators of US, ChinaandBrazilforbetter regulatory cooperationbetween the jurisdictions. It is also a member of IOSCO, an international organization of financial market regulators and has attended many of its meetings and contributed to its regulatory reforms initiatives. The presence of FMC and the Indian commodity derivative market in the international fora has been enhanceddue to these interactions and the contributions madeby FMC to various discussions in various international fora. These interactions have also helped FMC to keep abreast of the latest developments in the regulatory domain and adoption of the best practices from the international markets.