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Mumbai: India’s commodity markets will see the debut of forward contracts later this month, a move termed as an attempt to create a national agricultural market.

The National Commodity & Derivatives Exchange Ltd (NCDEX) will launch forward contracts based on two commodities—sugar and maize— by the third week of August after receiving a go-ahead from the commodity market regulator.

Commodity market participants say that the introduction of forward contracts could be a game-changer, as it reduces counter-party risk and keeps out speculators, besides creating a central platform for forward trading in agricultural commodities.

“Currently, there is no organized secondary market where the farmer can sell his produce and so he is totally dependent on the commission agent at the local mandi (market) or APMC (agricultural produce market committee)," said Samir Shah, managing director & chief executive officer, NCDEX. Shah said that his exchange will expand the number of commodities available for forward trading over time.

“We can bring all the bilateral forward contracts happening at the mandi, or APMC, on the exchange platform and eliminate the counter-party risk and also the whole cost of intermediaries," said Shah.

According to Forward Contracts (Regulation) Act, 1952, which regulates commodity trading in India, a “forward contract" is a contract for the delivery of goods and which is not a ready delivery contract. The Act further defines “ready delivery contract" as one which provides for the delivery of goods with a maximum tenure of 11 days.

Currently, commodities can be traded on the exchange platform only in the form of futures contracts, wherein the quality and quantity of the commodity is pre-fixed as per the contract specifications.

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. This means that the buyer of a futures contract does not have to take physical delivery of the underlying commodity.

Forward contracts, however, will include physical delivery.

Ramesh Abhishek, chairman of commodity markets regulator Forward Markets Commission (FMC), feels that forward contracts on the exchange platform could filter out speculative activity in commodities that can impact the price discovery mechanism.

“The exchange guaranteed forward trading will only be for compulsory delivery. There will be no speculation, as only those interested in physical delivery will participate. Future contracts would be completely separate from these contracts," said Abhishek. in an interview last week.

The FMC has decided to keep the segment lightly regulated in the initial stages to encourage more participation and to bring over the counter (OTC) trades to the exchange platform.

“There is a huge amount of forward trading already happening between individual parties just like an over-the- counter trade, but there is no trade guarantee," said a person involved in the process of launching forward contracts.

“The delivery is fixed at a future date, but there is always the risk of the buyer or the seller backtracking on his commitment based on the price movement," he said, requesting anonymity, as he is not authorized to speak on the matter.

“The pricing of commodities traded in a mandi or an APMC suffers from a lot of inefficiencies such as the risk of counter-party default, absence of a mechanism for settling disputes, built-in cost of intermediaries and lack of transparency in the price discovery process," says Shah of NCDEX.

As a way to neutralise any risk of default, NCDEX will be collecting an initial and incremental margin from members. If an entity defaults, then 90% of the blocked margins would be passed on to the counter-party as compensation, while the balance 10% will be retained as transaction charges by the exchange.

Naveen Mathur, associate director-commodities and currencies at Angel Broking Ltd, said forward contracts will bring more flexibility in the basket of commodities available for trading and also create more depth.

“The initiative is good, as futures contracts are very standardized contracts," says Mathur.

“There are forward contracts available on the London Metal Exchange and we can also create something of that sort here. Different qualities or grade of the same commodity can be traded through forward contracts," he said.

“While the key issue would be implementation, it does offer a great opportunity and the potential to penetrate across the country," he added.

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