Commodity Exchanges, Platform, Structure, Exchange membership, Capital requirements

Commodities are the standardised resources or raw materials with intrinsic value that are used to manufacture refined goods. It can be categorised as every kind of movable good that can be bought and sold, except for actionable claims and money. The quality of commodities may be variable, but they must be substantially uniform on some criteria across different producers.

There are two types of commodities in the market, i.e. hard commodities and soft commodities. Hard commodities are often used as inputs to make other goods and provide services while soft commodities are mainly used for initial consumption. Inputs such as metals and minerals are classified as hard commodities while agricultural products like rice and wheat are softer commodities.

Commodities are traded on the spot market or exchanges. The commodities must meet minimum standards set by the exchanges to be able to trade. Traders can either buy these commodities on the spot market or through derivatives such as options or futures. Commodity trading offers portfolio diversification beyond traditional securities. And since commodity price moves in the opposite direction of stocks, investors indulge in commodity trading during the periods of market volatility.

Similar to any other market, the commodities market is either a physical or a virtual space, where interested parties can trade commodities (raw or primary products) at present or future date. The price is dictated by the economic principles of supply and demand.

Types of commodities

There are about fifty major commodity markets worldwide trading in more than 100 commodities. Traders can trade in four major categories of commodities:

Metal: A wide variety of metals like iron, copper, aluminium, and nickel, which are used in construction and manufacturing, are available for trading in the market, along with precious metals like gold, silver, and platinum.

Energy goods: Energy goods used in households and industries are traded in bulk. These are natural gas and oils. Other energy commodities that trade are uranium, ethanol, coal, and electricity.

Agricultural goods: A wide variety of agricultural and livestock products trade in the commodity market. For example, sugar, cocoa, cotton, spices, grains, oilseeds, pulses, eggs, feeder cattle and more.

Environmental goods: This group includes renewable energy, carbon emission, and white certificates.

Globally, the most-traded commodities include gold, silver, crude oil, Brent oil, natural gas, soybean, cotton, wheat, corn, and coffee. 

Types of commodities traded in India (Multi Commodity Exchange of India – MCX)

• Agricultural commodities: Black pepper, castor seed, crude palm oil, cardamom, cotton, mentha oil, rubber, Palmolein
• Energy:Natural gas, Crude oil
• Base Metals: Brass, Aluminium, Lead, Copper, Zinc, Nickel
• Bullion: Gold, Silver

Types of commodities traded in India (National Commodity and Derivatives Exchange – NCDEX):

• Cereals and pulses: Maize Kharif/south, Maize rabi, Barley, Wheat, Chana, Moong, Paddy (basmati)
• Soft: Sugar
• Fibres: Kappa’s, Cotton, Guar seed, Guar gum
• Spices: Pepper, Jeera, Turmeric, Coriander
• Oil and Oil seeds: Castor seed, Soybean, Mustard seed, Cottonseed oil cake, Refined soy oil, Crude palm oil

Commodity Trading in India

The legal entity that decides, regulates and enforces the rules and procedures for trading commodities, such as the standardised commodity contracts, and other related investment products is the commodities exchange. It is an organised market where various commodities and derivatives are traded.

In India, one can trade commodities by going on any of the 20+ exchanges which facilitate this trade under the regulatory eye of the Securities and Exchange Board of India. Till 2015, the market was regulated by the Forward Markets Commission which was finally merged with SEBI to create a unified regulatory environment for commercial investing.

To start trading in commodities, you will need a Demat account, Trading account and a Bank account. The Demat account will function as a keeper of all your trades and holdings but you will still need to go through a good broker to place orders on the exchanges.

India has six major commodity trading exchanges, namely,

• National Multi Commodity Exchange India (NMCE)
• National Commodity and Derivative Exchange (NCDEX)
• Multi Commodity Exchange of India (MCX)
• Indian Commodity Exchange (ICEX)
• National Stock Exchange (NSE)
• Bombay Stock Exchange (BSE)

Working

Suppose you bought a gold futures contract on MCX at Rs. 72,000 for every 100 gm. Gold’s margin is 3.5% on MCX. So you will be paying Rs. 2,520 for your gold. Suppose that the following day, the cost of gold increases to Rs. 73,000 per 100 gm. Rs 1,000 will be credited to the bank account you have linked to the commodity market. Assume that the day-after, it drops to Rs. 72,500. Accordingly, Rs. 500 will be debited from your bank account.

While you get higher leverage with commodity trading, the risk associated with trading in commodities is also higher as market fluctuations are common.

Types of Commodity Market:

• Spot markets are also known as “cash markets” or “physical markets” where traders exchange physical commodities, and that too for immediate delivery.
• Derivatives markets in India involve two types of commodity derivatives: futures and forwards; these derivatives contracts use the spot market as the underlying asset and give the owner control of the same at a point in the future for a price that is agreed upon in the present. When the contracts expire, the commodity or asset is delivered physically.

Structure

The commodities market exists in two distinct forms:

• over-the-counter (OTC) market
• exchange based market

Similar to equities, there exists the spot and the derivatives segments. Spot markets are essentially OTC markets and participation is restricted to people who are involved with that commodity, such as the farmer, processor, wholesaler, etc.

A majority of the derivatives trading takes place through the exchange-based markets with standardized contracts, settlements, etc. The exchange-based markets are essentially derivative markets and are similar to equity derivatives in their working, that is, everything is standardized and a person can purchase a contract by paying only a percentage of the contract value.

A person can also go short on these exchanges. Moreover, even though there is a provision for delivery, most contracts are squared-off before expiry and are settled in cash. As a result, one can see an active participation by people who are not associated with the commodity. The typical structure of commodity futures markets in India is as follows.

Ministry of Consumer Affairs, Food, and Public Distribution

The Department pertaining to consumer affairs is responsible for the formulation of policies for:

• Monitoring Prices
• Consumer Movement in the country
• Controlling of statutory bodies (Bureau of Indian Standards (BIS) and Weights and Measures)
• Internal Trade
• Inter-State Trade- The Spirituous Preparations (Inter-State Trade and Commerce) Control Act, 1955 (39 of 1955).
• Control of Futures Trading- the Forward Contracts (Regulations) Act, 1952 (74 of 1952)

The Department for food and public distribution is responsible for the formulation of policies for:

• Ensuring food security for the country through timely and efficient procurement and distribution of food grains.
• Building up and maintenance of food stocks, their storage, movement and delivery to the distributing agencies and monitoring of production, stock and price levels of food grains.
• Incentivizing farmers through fair value of their produce by way of Minimum Support Price mechanism, distribution of food grains to Below Poverty Line (BPL) families.
• Covering poor households at the risk of hunger under Antyodaya Anna Yojna (AAY).
• Establishing grain banks in food scarce areas and involvement of Panchayati Raj Institutions in Public Distribution System (PDS).
• Concerns for the sugar sector such as fixing of Fair and Remunerative Price (FRP) of sugarcane payable by Sugar factories, development and  regulation of sugar industry (including training in sugar technology), fixation of levy price of sugar and its supply for PDS and regulation of supply of free sale sugar.
• Export and import of food grains, sugar and edible oils.

Forward Market Commission

The Commission functions under the control of the Ministry of Consumer Affairs, Food & Public Distribution, Department of Consumer Affairs, Government of India. The functions of the Forward Markets Commission are:

• To advise the Central Government in respect of the recognition or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of the Forward Contracts (Regulation) Act 1952.
• To keep forward markets under observation and to take such action in relation to them, as it may consider necessary, in exercise of the powers assigned to it by or under the Act.
• To collect and whenever the Commission thinks it necessary, to publish information regarding the trading conditions in respect of goods to which any of the provisions of the Act is made applicable, including information regarding supply, demand and prices, and to submit to the Central Government, periodical reports on the working of forward markets relating to such goods.
• To make recommendations generally with a view to improving the organization and working of forward markets.
• To undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considers it necessary.

Exchange membership

Trading-cum-clearing members (“TCM”) are entitled to trade on their own account as well as on account of their clients. TCMs can also clear and settle these trades themselves.

Eligibility criteria

Entities: Following entities are eligible to apply for membership subject to the regulatory norms and provisions of SEBI and as provided in the Rules, Regulations, Byelaws and Circulars of the Exchange:

• Corporates
• Registered Partnership Firms
• LLPs
• Sole Proprietors/Individuals (Proprietary Firms)

Self Clearing Member (SCM)

A Clearing Member who is also a TM. Such CMs may clear and settle only their own proprietary trades and their clients’ trades but cannot clear and settle trades of other TM’s.

Professional Clearing Member (PCM)

A CM who is not a TM. Typically banks or custodians could become a PCM and clear and settle for TM’s as well as of the Custodial Participants.

Networth

The minimum networth for the purpose of eligibility is Rs.100 Lakh