Home >Market >Stock-market-news >Forward contracts in commodities find few takers

Forward contracts in commodities launched in September 2014 to reduce speculative activity in the commodity market and draw genuine investors to the exchange platform have found few takers.

Market participants blame it on structural issues in the product as it does not offer full trade guarantee and zero counter-party default risk, two essentials for any product traded on the exchange platform.

The fraud at the National Spot Exchange Ltd (NSEL) too has made entities wary of trading in any product where the bourse does not guarantee the trade, market participants say.

According to the Forward Contracts (Regulation) Act, 1952, which regulates commodity trading in India, a “forward contract" is a contract for the actual delivery of goods unlike futures contract, wherein the buyer can opt for the contract to be settled in cash. Entities that are not producers or buyers of the physical commodity are major participants in the commodities futures market, where contracts are settled in cash. But since forward contracts are compulsorily settled by delivery of commodities, only genuine users participate in this segment.

“The trades will be done on the exchange platform but it does not explicitly state the mechanism of reducing counter-party risk and settling disputes between the buyer and seller. So, our clients do not see a real benefit of trading through an exchange. We have had a series of meetings with the exchange officials on this issue," says the head of a domestic brokerage who has executed trades in the forward segment. He did not want to be identified as discussions are still on and a decision is yet to be taken.

Currently, the National Commodity and Derivatives Exchange Ltd (NCDEX) and the National Multi-Commodity Exchange of India Ltd (NMCE) offer forward trading facilities in various commodities. While NMCE recently launched forward contracts in rubber, NCDEX has a basket of 27 commodities for forward trades.

As per the current practice, commodity exchanges collect a certain percentage of the trade value as a margin when the contract is entered into and if there is any kind of default by the seller, then 90% of the margin is given to the buyer.

An investor brochure of NCDEX states that the margin is collected by the exchange clearing house and “market participants can reduce the counter-party default risks."

“Forward contracts launched by the exchange are compensation guarantee contracts where in case of default by either of the parties, the counterparty is guaranteed compensation to the extent of 90% of the margin collected," said Kalpesh Sheth, NCDEX spokesperson.

The spokesperson said commodities such as castor seed, coriander, gold, cumin seeds, maize, sugar and turmeric have seen trades in the forward segment totalling 5,866.88 crore between December 2014 and June. This is still lower than the commodity futures’ trading segment which sees a turnover of nearly 3 trillion every fortnight. An email query sent to NMCE regarding feedback by market participants on forward contracts remained unanswered.

The broker community too is not satisfied. They say the margin is typically only 5-10% of the trade value and does not compensate the loss of the buyer.

Girish Dev, managing director and chief executive officer, Geofin Comtrade Ltd, a commodities brokerage entity, says that market intermediaries will be able to push for a product only when there is complete clarity on the role and liabilities of the member.

“Brokerages have to reach out to the genuine participants and so their role should be explicitly stated. This is a product for assured delivery and not for hedging and so the element of counter-party risk and trade settlement should be addressed by the exchange," he says.

According to a person familiar with the matter, this issue has also been discussed between exchange authorities and officials of the Securities and Exchange Board of India, which will soon become the regulator for the commodities segment as well.

Note: NCDEX has clarified that the volumes in the commodity forwards market and the commodity futures market are not strictly comparable.

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