Paying for past sins

Some of the fears about speculator-driven turmoil in commodity futures trading seem to be coming true. The guar seed, seldom viewed as a commodity of any significance, has seen mayhem in the market over the past few weeks, creating problems for genuine stakeholders, notably exporters of this agro-commodity and user industries.

It is remarkable that guar trading should outstrip trading in all other commodities, at a time when hardly any deliveries are taking place. Through unchecked speculation and circular trading a few players have obviously been making a killing on the bourse.

What should cause worry is that the malaise can spread to other commodities, including more important and sensitive ones. Futures trading, which is supposed to lead to price discovery and price stability, is causing prices in this case to diverge sharply from spot market rates, causing needless instability.

This is far from desirable, especially in the context of the huge trading turnover that the commodity exchanges have started clocking within just a few years of their re-emergence on the Indian commodity scene.

It seems obvious that the Forward Markets Commission (FMC), the main monitoring and regulatory agency for commodity futures, has failed to act in time to address the problem.

The regulatory and surveillance system it has put in place has not been successful in spotting rogue traders. Of course speculation is part of futures transactions but unguarded speculation, devoid of market intelligence and fuelled mainly by surplus cash, can take the system for a ride.

The FMC woke up only last week and advised the commodity exchanges to follow the gross margining approach in order to tame speculators. Besides, to cover up its own failure in monitoring activity at the client level, the FMC asked the exchanges to come up with more stringent norms for this purpose.

Client-level monitoring is vital to ensure that risks do not spread through the entire system. Indeed, since deliveries in futures trading are not supposed to be too many, there is the risk of the commodities bourses becoming cash-holders' casinos.

The genesis of the problem as it has surfaced can be traced to disregarding crucial advice given by the Kabra committee in its report, which paved the way for the re-introduction of futures trading in a large number of commodities.

The committee laid down a sequence of actions that required strengthening and expansion of the FMC and chalking out an effective surveillance and regulatory mechanism to precede the launch of trading on the exchanges.

This sequence was simply not observed and the exchanges began functioning. Moreover, many commodities traded at the exchanges are still subjected to various trade or import-export curbs""something completely undesirable for futures marketing.

Furthermore, hassle-free linkages with important foreign commodity exchanges, essential to curb vested interests dominating the local bourses, are wanting.

Also lacking is market intelligence, especially unbiased information about crop prospects and demand trends for different commodities. In the absence of this, and especially in commodities that do not have internationally bench-marked prices, players on the bourses are in no position to take informed decisions.

A futures market cannot function properly under such circumstances. These issues need to be addressed without delay to ensure fair trading and the healthy growth of commodity futures.