Surely, commodities futures business can be counted as a success story. Not only has it achieved a turnover of Rs 35,000 crore a day starting with a zero base less than six years ago, the platform provided to businesses for hedging commodity price-risk has been invaluable. It has become a market benchmark where price discovery has been so efficient that commodities are delisted on the exchange when prices go up for the wrong reasons! It is also in line with India’s vision to become an Asian, even global, hub for financial services by providing state-of-the-art trading platforms and markets of all hues. Currency futures and interest rate futures are similar milestones on the same journey with varying degrees of success, qualitatively and quantitatively.
Inevitably, the comparison is with equities. Currently, at one-third of equity volumes in a short time, it is inevitable that the business becomes much bigger, especially given that India is a large producer and/or consumer of a host of commodities on a global scale. Therefore, it is natural for us to aim to be price-setters in those commodities. For example, why is the price of gold decided in the markets of New York and London when India is consistently the world?s largest consumer of gold year after year? Secondly, of late commodities are being regarded as an asset class. but the primary function of commodity exchanges is to provide a platform for price discovery and risk management ?? both of which will directly affect businesses or the public at large, or both. The energy/bullion/ base metals futures markets have done well, so well that over 80% of the business comes from them. This has effectively sidelined the main idea of having commodity futures in India i.e. having a liquid, deep agri-commodities futures market which will help in market-determined prices based on the demand-supply paradigm.
There are several reasons for this and to reach the super-ordinate goal of a common national market, the primary need is to fortify the link between the physical markets and the financial markets. An obvious way is to have a common regulator for physical and futures trading as well as warehousing. One clear positive outcome of this move will be that transaction costs will decrease, liquidity will increase and the market will grow to its potential due to seamless policies. In other words, it will be much like the securities market where Sebi has a fairly free hand in regulating all participants, products and the different arms including the Depository. However, it is true that in the case of commodities, the move will fraught with political as well as Centre-state issues (like the APMC Act) due to the nature of the business and with larger issues like food security and price-sensitivity.
Apart from price discovery and hedging, the linkage between the physical commodity sector and the financial sector is starkly clear in the way agri-produce was financed before and after the advent of commodity exchanges. Due to demat and collateral management facilities, banks now offer farmers loans with low haircut at below-PLR rates due to reduced risk. Warehouse receipts (WRs) have been made acceptable as collateral against loans only after the arrival of futures markets and its success in price discovery and risk mitigation. But an independent Warehousing regulator (courtesy Warehousing Development & Regulation Act) can possibly complicate the issue with FCRA, APMC and WDR Acts difficult to seamlessly resolve with each other. A promising solution – with the APMC Act being state controlled, it can focus on the primary markets while WDRA can concentrate on secondary physical markets at a national level. This model may work best as the WDRA will make WRs freely transferable and negotiable countrywide. But the platform needed to trade WRs will have to be the existing commodity futures and commodity spot markets – which means that seamless regulation is only possible if these entities are under a single regulator. In a sense, what the WDRA aims to achieve has already been pilot-tested and the process itself has achieved critical mass.
Each exchange is already wedded to one or more large warehousing companies and there has been sufficient exchange of information, processes and synergy for maximum benefit to users. So farmers use spot and futures exchanges to deliver agri-commodities, processors and large consumers routinely buy from the system and the attendant benefits of trading in a well-regulated electronic system accrue to all participants e.g. novation, transparent prices and standardization. In fact, the single regulator can easily facilitate trading in WRs at a national level via the exchanges already under it. This could also promote fungibility ?? therefore material of same grade lying in a different state can be given as delivery against WRs of some other location. This will increase efficiency, reduce wastage and eliminate unnecessary logistics leading to lower cost to consumer.
Taken to its logical conclusion, such a move could conceivably have the entire supply chain including food-processing under a single regulator because it will address all the major issues which have prevented India from becoming an agri-powerhouse partly due to lack of a single entity looking at the ‘big picture’. In sum, regulatory convergence in commodity business will go a long way in creating efficient markets in the shortest possible time using identifiable synergies and long-term vision.
(The author is president, Religare Commodities)