The Committee under the Charimanship of D S Kolamkar suggested steps for fulfiling the objectives of price-discovery and risk management of commodity derivatives market.
MUMBAI (Commodity Online): India’s agri-commodity futures market is much better at price discovery than in hedging effectiveness, acording to a study done by a government appointed committee.
The Committee under the Charimanship of D S Kolamkar suggested steps for fulfiling the objectives of price-discovery and risk manageemnt of commodity derivatives market.
The study covered eight commodities: Castorseed, Pepper, Rubber, Soya Oil, sugar, wheat, crude oil and gold.
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Hedging effectiveness is low for eight of the commodities studied, the commitee observed. However, the effectiveness was found to be highest in rubber futures contracts, where the price risk can be reduced by 61%. The second highest is soya oil, where the price risk can be reduced by more than half, at 53%.
The committee observed that from discussions with stake holders and analysis of data, it is clear that futures market is faring relatively well on price discovery and relatively poor on hedging effectiveness.
The key element of the marketplace which reduces basis risk is arbitrage. A vibrant ecosystem with a large number of sophisticated arbitrageurs will give
reduced basis risk. The work of arbitrageurs is, however, impeded by the transactions costs that they face. When the ecosystem supports frictionless trading, the arbitrage will take place seamlessly and deliver the highest possible hedging effectiveness.
The committee has recommended that market regulator Forward Markets Commission (FMC) should pursue a program of market development, including promoting a diverse array of firms as members in order to improve market liquidity.
-One ways to reduce the cost of capital for the commodities trader is, to make banks and other financial institutions an integral part of trading in commodity derivatives. RBI restrictions and Banking Regulation Act regulations have to be removed.
-Foreign finanicla firms should be pertmitted to participate in commodity futures trading. The existing system of limits on open interest and risk management provides adequate safeguards against the risk of allowing foreign participation in Indian markets.
-The committee noted that modernisation and professionalisation of warehousing is a critical policy priority that will reduce the frictions faced in arbitrage.
-FMC should establish an annual process of computing measures of futures market liquidity, price discovery and hedging effectiveness. This report should be released into the public domain and its implications discussed at the meeting of the FMC .
-Exchanges should explore new ideas in contract design, to more tightly define the product with a narrower set of grades and locations, so as to reduce the frictions of arbitrage and thereby improve hedging effectiveness wherever the movement of prices of the commodities across grades and locations are not aligned.
– Commodity Online
