They will get the benefit of protection in case prices fall below cost of production
The stage is being set for farmers to get the benefits of the commodity futures market. This will be possible with the enactment of the Forward Contract (Regulations) Amendment Bill, which is expected to be tabled in Parliament in its winter session.
While the commodity futures market has grown by 40 per cent annually in the past few years, most of the growth has taken place in non-agricultural commodities, and farmers have for various reasons virtually kept away from the futures market for hedging their produce. The direct hedging facility on the futures market helps them improve their realisation, which they generally lose to middlemen.
The proposed changes seek to empower the commodity derivatives market regulator, the Forward Markets Commission (FMC), with statutory autonomous status, introduction of options, power to penalise wrongdoers, power to grant exchanges permission to introduce futures trading in intangible contracts (including weather derivatives, indices and freight rates), and help farmers to lock in their cost of production.
Introduction of “options” would allow farmers to fix selling prices by selling their products in the futures market.
“The options would be introduced after this Amendment, which would be very beneficial to farmers. They would then get the benefit of price protection in case the price falls below their cost of production, as well as the benefit of any rise in price. This would be a better instrument for farmers than futures or MSP,” said Anil Mishra, managing director of National Multi Commodity Exchange. This will help all those hedging on the futures exchange.
In futures today farmers have to pay mark to market margins even if they go in for hedging, which is difficult for them to keep track of. In options buying, once they have paid the premium, they have nothing more to pay. The MSP benefit is currently being enjoyed in a few commodities. Options would create pan-India opportunities. Whenever the government wants to help farmers it could pay the premium for the option to the exchanges directly on behalf of the farmers. There would be a complete trail of accounts available.
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Today, the Damocles sword of banning or delisting futures in agri commodities hangs over the exchanges and all stakeholders, and sufficient investment is not being deployed in creating marketing infrastructure. Once FMC becomes autonomous this fear will go, because attempts to control the market or ban or delist futures in any commodity would be a last resort.
“A well regulated marketplace builds confidence in the participants. Increased liquidity brings efficiency in the markets. Participation by FIIs, banks and institutions in the market will increase liquidity and depth,” said Rajnikant Patel, managing director, Indian Commodity Exchange.
Participation by institutions and banks would be encouraged, as the regulator will then have more powers. Banks may play the role of aggregators, even if they don’t take risks.
Warehouse receipt funding against forward sales on the exchange would become the norm in agri funding, because it would become risk-free lending for banks, directly paid by the exchanges on production of a warehouse receipt on expiry of the contract.
“Over the last seven years, India’s commodity ecosystem — from grading to warehousing and finance — has improved greatly, in part thanks to the catalytic role that the national exchanges have played. But much remains to be done, in particular in creating the right regulatory framework for sustainable growth. This will be much helped by an early passage of the FC(R) Amendment Bill 2010. So, we truly hope that this will happen sooner rather than later,” said Lamon Rutten, managing director and CEO of the Multi Commodity Exchange of India.
With the expansion in the market, the list of intermediaries is likely to include collateral managers, the clearing house and all other entities associated with the commodity derivatives market. This widens the span of supervision of the FMC to include all stakeholders.
Dilip Bhatia, CEO of Ace Derivatives and Commodity Exchange Ltd, expects the commodity derivatives market to expand at a compound annual growth rate of over 30 per cent in the years ahead. This will be commendable, since the current base of the market is wide and large.
As the commodity futures market enters its next phase after its infancy, uniformity across all exchanges will be preferred. Uniformity in practices across exchanges will encourage retail participation in commodities, which is currently low. Also, provisions for penalties differ in each exchange, making matters confusing for market participants, he added.
A uniform penalty structure would help regularise trade and help the various stakeholders. For farmers and actual hedgers, the fungibility of agri stocks across exchanges is a must, so that they are able to manage their stocks, inventories and dealings on the commodity futures markets well.
This will also give rise to uniformity in quality standards across exchanges and strengthen warehousing and grading infrastructure, which is the major need of the market today. Simplification of KYC norms and introduction of mini-contracts in agri will also prove trader-friendly, leading to increased participation.
Other changes expected in the commodity futures market once the bill becomes law would be the introduction of commodity exchange traded funds, commodity mutual funds and portfolio management schemes for commodities.