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Products and participant base of commodity markets would undergo a radical change in five years from now

Mrugank Paranjape, Managing Director & CEO, MCX

1. How has the commodity derivatives market landscape changed in the last three to four years since SEBI has taken charge of the sector? What has been the positive fallout of these changes on the overall Indian commodity market ecosystem?

SEBI successfully managed an undisruptive transition of stakeholders in the commodity markets from one regulatory framework to another and registration of commodity brokers in a time period of less than a year. Further, to effectively regulate and develop the commodity derivatives market, SEBI constituted an advisory committee i.e. the Commodity Derivatives Advisory Committee (CDAC) in January 2016.

Immediately prior to the merger, SEBI has mandated all listed companies, under the Listing Obligations and Disclosure Requirements (LODR) regulations in September 2015, to assess and disclose their commodity price risks and hedging activities in their annual reports under the corporate governance section for the corporate and stakeholders to take cognizance of commodity based risk in pricing their stocks and debt.

Over the period of last 3 to 4 years, SEBI has undertaken various initiatives, aiding to the development of commodity derivatives market. SEBI has initiated various reforms such as strengthening of Risk Management framework of commodity derivatives market, mandating commodity exchanges to set up separate Clearing Corporations, strengthening of market surveillance, delivery norms etc. Besides in 2017, SEBI permitted launch of trading in much-awaited options on commodity derivatives. Further, SEBI also paved way for institutional participation in commodity derivatives by permitting participation of Alternative Institutional Funds –Category III. In recent past, SEBI Board on March 1, 2019 approved allowing Mutual Funds and Portfolio Managers to trade in commodity derivatives market.

Meanwhile, distribution services in the commodity derivatives market received a boost with permission to universal broking entities – ending the artificial segregation of broking services between the different segments of the securities market. The Reserve Bank of India (RBI), in 2017, permitted bank-sponsored broking entities, which have deep penetration and large retail clientele, to offer distribution services in the commodity derivatives segment, further boosting access of investors to the commodity derivatives segment.

As a result over the period of last 3 to 4 years, Indian commodity derivatives market have not only expanded both in terms of products offerings and participant profiles but also have inherently strengthened to effectively discharge its two main functions of facilitating efficient price discovery and enabling cost-effective risk management platform. This period also witnessed a rise in Indian commodity derivatives market average daily turnover by 16% from Rs. 24,182 Cr in FY2014-15 to Rs. 28,003 Cr in 2018-19, despite levy of Commodity Transaction Tax (CTT), effective July 1, 2013.

2. MCX has been the market leader in the commodity derivatives market. What has been the innovations in product and market space that you have executed in the recent past to ensure MCX continues its leadership position? How have the market participants responded to these new developments?

Innovations in products and processes have played an important role in the success of MCX. MCX launched India’s first Options on October 17, 2017 in gold, and is also the first exchange anywhere in the world to launch futures trading in several commodities, e.g. brass, cardamom, mentha oil, etc., many of which are actively traded on MCX platform. Trading in options has also picked up significant momentum with the introduction of options trading in more number of commodities in 2018-19, including crude oil, copper, silver and zinc.Market acceptance of MCX commodity options can be seen in the form of rise in options (notional) turnover from Rs. 10,354 crore in 2017-18 to Rs. 1,80,945 crore in 2018-19.

Further, on the products front, evolving demand shall continue to lead MCX to introduce derivative products on more commodities, as also modify existing contracts to suit the emerging needs of market stakeholders. Accordingly, MCX has recently converted four base metals futures contracts – Aluminium, Lead, Nickel and Zinc - into compulsorily deliverable contracts. Notably, MCX along with MCX CCL (MCX Clearing Corporation Limited) was able to successfully complete its first physical delivery of Aluminium MCX 2019 futures contract, seamlessly concluding a pay-in and pay-out of 10 MT.

Trading in commodity index based products are still not allowed in India so far. However, the SEBI had recently made public a “consultation paper on design of commodity indices and product design for futures on commodity indices” on January 16, 2019 seeking comments. Globally, investments in commodities are dominated by index-based instruments or products especially in the portfolios of institutional investors and fund managers. In this context, in preparation for the above, in September 2019,MCX in partnership with Refinitiv (formerly known as Thomson Reuters) the launch commodity index series, Thomson Reuters-MCX India Commodity Indices (iCOMDEX), tracking the performance of commodities listed on MCX.

3. Coming to precious metals, MCX has the most number of products in gold and silver futures contracts. Lets talk about the standard gold one kg 995 contract. In a way, it has redefined the gold market in India where "MCX+" has became a common parlance. How is the performance of standard gold and standard silver contracts? Has the multiple delivery centre option been a success?

Bullion segment commodities i.e. both gold and silver continues to amongst highly traded commodities in futures segment of MCX. Together they account for about a quarter of total futures trading turnover at MCX in FY2018-19.

Since its launch in 2003, MCX has played a significant role in strengthening of the physical bullion and jewellery industry with the Gold contract prices which have emerged as price benchmark for the physical markets ecosystem for bullion. Gold prices as discovered on MCX also reflects the movements in international gold price, exchange rate, import duty and prevailing premium/discount, thus the contracts provide comprehensive hedge against these movements. Significantly, amidst rising awareness on need for gold hedging and RBI now not permitting gold hedging on overseas exchanges, stakeholders have entrusted their faith in MCX gold futures contract. Consequently, total gold futures contract’s open interest on MCX moved to more than 5-year high levels.

Further, with the objective of connecting the physical markets for Gold in India in line with facilitation provided by the GST regime, MCX added five more locations to the list of additional delivery centres for Gold and Gold Mini contracts with contracts expiring from December 2018 and onwards. In addition to Ahmedabad (basis centre), Mumbai and New Delhi, the Exchange has now set up additional delivery centres at Chennai, Hyderabad, Kochi, Bengaluru and Kolkata. The network of eight delivery centres spread across India’s main consumption centres will be a harbinger of seamless and efficient integration between the spot and derivatives market. This would facilitate the jewellers, big and small, to conveniently take physical deliveries of gold through exchange mechanism from their nearest location. This would further strengthen country’s bullion ecosystem and benefit stakeholders at large. Notably, since inception MCX has witnessed deliveries of more than 100 tons of Gold and importantly participants have engaged in physical delivery of gold via additional delivery centre as well.


4. How are the retail investor centric products such as MCX gold guinea / gold petal /silver micro contracts doing? Is there a multiple city physical delivery option for these contracts also?

Retail centric products of MCX bullion segment such as gold guinea, gold petal, silver micro continues to be favoured contracts amongst participants. Despite relatively low contract value, combined turnover of these contracts stood at a healthy Rs.46,396 crores in 2018-19.Besides appealing to the retail investors, these contracts also help market participants fine-tune their hedging strategies to a granular level. Moreover, Going forward, impending participation from institutional players such as Mutual Funds and Portfolio Managers in commodity derivatives would also better guide retail participation in commodity derivatives.

Further as far as multiple city physical delivery option for these contracts are concerned, MCX continues to explore and act at appropriate time in its continual efforts towards bettering servicing the market stakeholders.

5. Next let me come to options contract. MCX has been doing a fantastic job of training the market participants on using Options. We have been seeing a steady increase in volume and activity levels. What is your comment on the acceptance of 'options' contracts by the market participants? Is there a scope to bring in new kinds of participants through options, now that SEBI has permitted mutual funds and AIFs also?

In past FY 2018-19, as mentioned above, options trading on MCX have grown both in terms of commodities (from 1 commodity i.e. gold in 2017-18 to 5 commodities i.e. gold, silver, copper, zinc and crude oil in 2018-19) and in notional turnover (from Rs. 10,354 crore in 2017-18 to Rs. 1,80,945 crore in 2018-19).

Thus while the options volume have shown a growth indicating increasing acceptance of options contract, there is scope for raising awareness around the options strategies and use of advanced options strategies to cost-effectively hedge commodity price exposures. In this regards, Exchange has been taking up extensive outreach initiatives amongst various stakeholders.

Besides, entry of institutional participants such asmutual funds as well as banks, when permitted will add to the growth of the options segment.  

6. Gold spot exchange is the hot subject. MCX has an institutional infrastructure. MCX has all India reach and client network also.  Where do you see these aspects as an advantage and opportunity for MCX going forward? How in your opinion the gold spot exchange would co-exist with the derivatives markets in providing a competitive and cost-effective solution to the market participants?

MCX has been successfully running, for the last decade and half, a derivatives platform in gold backed with delivery of precious metals on maturity which has acquired a benchmark status over time. As has been mentioned above, physical gold market often takes price reference from MCX prices. Further development of pricing benchmarks from the spot platform will help stakeholders take advantage of an overlying financial futures contract that can be traded on MCX for their price risk management and price discovery. It may be noted here that the existing derivatives platforms operates like de-facto spot exchanges during tender/delivery period of the gold futures contracts when daily settlement cycles operate successfully, resulting into physical delivery of more than 100 tons of gold since 2004 via MCX platform.

Thus, there are identifiable overlaps both in operational aspects, as well as in the value that can be derived from the co-existence of spot and derivatives platforms.  As such, spot platforms are adjunct to the derivatives platform on MCX, which as mentioned above already have necessary institutional infrastructure in terms of reach and receptive participants. Hence,a spot platform as an adjunct to MCX can usher in a number of benefits for the target group of stakeholders.  MCX had entered into an MoU with India Bullion and Jewellers Association Ltd (IBJA), the apex industry body for all bullion and jewellery associations in India for cooperation in various activities for the growth and development of bullion industry, including a joint viability of setting up a ‘Bullion Spot Exchange’ in India.  Besides other, a thriving spot exchange will help make the ecosystem vibrant with effective Good Delivery Standards and various other institutions associated with storage and governance including ethical sourcing.  Shanghai Gold Exchange is a perfect example of how a spot exchange can make the entire ecosystem vibrant and connect with the global markets in an effective manner. 

A spot platform and derivative platforms have their respective roles to accomplish and in fact leverage from each other’s existence to better serve varied needs of the market stakeholders.  Standardized spot contracts and their delivery-based spot price discovery will also yield a perfect platform for the design of a successful derivative contract on the same.  Together with the derivatives platform, a robust online gold spot platform can help India emerge as a regional ‘Price Setter’ in the yellow metal given the significant size of the Indian market.

7. How would the next five years shape up for commodity derivatives market?

Fundamentally, products and participant base would undergo a radical change in five years from now.   While the securities and bank based brokerages will provide access to larger base of direct market participant and thus enhancing information efficiency of the markets, institutional participants such as Mutual Funds when allowed will enhance access of the markets to a wider retail participant base.  Besides, institutional participants such as Mutual Funds when allowed to participate in the commodity markets, will help them introduce new value-added products such as commodity ETFs based on varied commodity derivatives providing them a commodity plus returns and commodity-based funds that provides for better risk adjusted returns to the investors on a given portfolio.  Portfolio Management Service providers will strengthen the advisory ecosystem when allowed for participation in commodity markets - A missing element that has a bearing on market efficiency in India.  Further, such institutional participants can potentially enhance the liquidity in the long-ended contracts making the commodity derivative markets the most suitable market for hedging often long-dated exposures by the corporates as the compliance to SEBI-LODR norms for commodity and commodity risk management will likely be firmly monitored for its compliance by listed commodity oriented companies by the regulators and market analysts. With banks/subsidiaries already been allowed to intermediate the markets as the clearing members and brokerages, banks when allowed to participate in the commodity derivative markets can finally render the markets more inclusive. 

To put a measure, while currently our annual traded value is equivalent to 0.5 times that of GDP, in five years from now with more participation and products, the annual aggregate value of commodity derivative markets should measure up to 2.1 times equivalent to the current performance measure of Chinese commodity derivative markets.  Noteworthy that China’s best performing manufacturing economy is highly dependent on such markets for sharing risks in commodity prices that form its base, making it the competitive exporter of finished products to the global consumers.       

Disclaimer: Views are personal and not the views of the publisher.