Expansion of commodity derivatives trading

Why in news?

BSE and NSE have received permission from the Securities and Exchange Board of India (Sebi) for commodity derivatives trading recently.

What is a derivative?

• Derivatives are the contract whose value is derived from the underlying asset or the contract where delivery of security or commodity held on specific future date.
• The main purpose of commodity derivative is to reduce the risk of future price uncertainty and provide the industry knowledge as well investment opportunity to a general investor.
• Derivatives could be stocks, indices, commodities, currencies, exchange rates or the rate of interest.
• Till date, commodity derivatives contracts are available only on MCX and NCDEX, the two specialised commodity derivatives exchanges in the country.
• The Bombay Stock Exchange(BSE) became the first stock exchange in the country to launch commodity derivatives contract in gold and silver.
• Both BSE and NSE has plans to launch derivatives trading in non-agriculture commodities in the initial phase, followed by agriculture commodities.

What are the other such initiatives in this regard?

• SEBI has recently redrafted the rules for trading, membership, products and risk management.
• Market surveillance has also improved with tighter supervision and scrutiny.
• Domestic companies with direct exposure to commodity price risk in gold, gems and precious stones have been barred by RBI from hedging in international markets.  
• This is likely to result in these companies using the domestic exchanges to take cover, thus helping domestic commodity derivative volumes.
• Also, all listed companies are required to disclose their commodity risk, hedged exposure as well as their risk-management policy.
• This is to make companies take greater cover for their commodity exposures due to the fear of investor displeasure, which could also help improve volumes on exchanges.

What should be done?

• Agri-contracts - Both exchanges are beginning their foray in this segment with bullion and energy-based contracts.
• SEBI needs to ensure that both BSE and NSE soon launch agri-contracts that serve farmers and companies in hedging price risks.
• Pricing - Exchanges often tend to use predatory pricing or other underhand methods to garner market share and it should be dissuaded.
• Also, SEBI needs to examine ways to bring down the high cost of trading in domestic exchanges.
• Participation & Monitoring - Increasing market participation by allowing other investor segments such as mutual funds into commodity markets should be looked out.
• A tight vigil needs to be maintained to ensure that there is no unhealthy competition among exchanges.

Source: Business Line