In the last few posts, we talked about various facets of commodity trading.
In this post, we will talk about the Commodity Exchanges in India.
WHY DO WE NEED COMMODITY EXCHANGES?
Commodity derivative contracts introduce counterparty risks – i.e. the risk that one party fails to abide by the terms of the contract.
Consider that you hold some commodity which is trading in the spot market at a price Rs. 50 per unit now. You think that the prices will down in one month and sell a forward contract at a forward price Rs. 50.33. Now, after one month the prices are at Rs. 51. Abiding by the terms of the contract means selling the commodities at a price Rs. 50.33 instead of Rs. 51 in the spot market. In this case, your counterparty is exposed to Delivery Risk i.e. uncertainty about getting delivery of the commodities as per the terms of the contract.
Consider another situation. The price of the commodity mentioned above decreases to Rs. 49. Now, the forward contract buyer will have to buy the commodities at Rs. 50.33 instead of at Rs. 49 from the spot market to abide by the terms of the contract. Your counterparty has enough incentive to breach the contract and buy from the spot market. This is called the payment risk – i.e. uncertainty about receiving the payment as agreed in the contract.
A commodity exchange helps the buyer and seller manage the payment and delivery risk along with providing technology for easier transactions.
SERVICES PROVIDED BY A COMMODITY EXCHANGE
1. Market Making
Commodity exchanges act as counterparty to all buy and sell trades providing easier price discovery and liquidity.
2. Settlement Guarantee
Commodity exchanges manage the settlement and payment risk for the buyers and sellers by guaranteeing the settlement of all the trades on their platform. This is done with the help of ‘Settlement Guarantee Fund’.
3. Risk Management
Exchanges provide Risk Management tools. Exchanges require different margins for the futures contracts such as Initial Margin, Tender Maring, Additional Margin, Delivery Period Margin etc. which help manage the settlement risk.
Apart from that Exchanges use various risk management methods such as Annualised Actual Volatility (AAV) and Value at Risk (VAR).
4. Trading Technology
Information technology is the backbone of modern exchanges. Exchanges provide the traders with the necessary technology for timely and easy trading so that they can take advantage of market opportunities.
MAJOR COMMODITY EXCHANGES IN INDIA
1. Multi Commodity Exchange – MCX
MCX is India’s first listed exchange which provides facilities for online trading of commodity derivatives. It started operation in November 2003 and provides trading facilities for bullions of metals such as Gold and Silver, base metals such as Aluminium, Brass, Copper, Lead, Nickel etc. It also provides a trading facility for energy commodities (Crude Oil and Natural Gas) and agricultural products such as Black Pepper, Cardamom, Castor Seed, Cotton etc.
2. National Commodity and Derivatives Exchange – NCDEX
NCDEX is an online multi-commodity exchange which commenced operations in December 2003. NCDEX primarily deals with agricultural products such as cereals, pulses, oil and oil seeds etc.
3. Indian Commodity Exchange – ICEX
ICEX is an online commodity derivative exchange. This exchange provides a nationwide trading platform through appointed brokers.
This exchange primarily deals with agricultural products such as spices, oil seeds, rubber plantation, jute etc. Apart from these they also provide trading facilities for Diamond and Steel.