Overview on Commodity Markets

presentation for Symniosis, Pune

August 7, 2008

Overview of commodities markets

Career opportunities
For students, upon their completion, opportunities at
          

Setting up of own business and becoming a member of commodity exchanges Investment advisors Members offices Research and Analysts offices Procurement agencies Exports/ Imports Commodity trading Collateral management Commodity financing With exchanges Other institutions and agencies associated with handling of commodities

Market - Kinds
 Currencies  Bonds  Interest rates  Securites  Labour  Commodities  Art  etc.
4

Market Types
 Physical or spot or cash  Derivatives

Types of transactions
Physical  Spot: Contracts for the purchase or sale of a commodity with immediate delivery (or within few days) Derivatives  Forward: Contracts for the purchase or sale of a commodity with deferred, i.e. future, delivery  Futures: Standardized forward contract which represents an obligation to make or take delivery of a fixed quantity and quality of a commodity at a specific location

Types of transactions (Contd..)



Option: A contract giving the right, but not the obligation, to buy or sell a futures contract at a specified price at or before some later date Swap: An exchange of future payment streams between two counterparties

The Nature of Derivatives

A derivative is an instrument whose value depends on the values of other more basic underlying variables The underlying could be
     Securities Commodities Currencies Interest rates Any other form of tradeables

Forward Contracts


A forward contract is an agreement to buy or sell an asset at a certain time in the future for a certain price  It can be contrasted with a spot contract which is an agreement to buy or sell immediately

The forward price may be different for contracts of the same maturities

Transaction costs in bilateral commodity transactions

     

Finding a buyer or seller with whom to transact Appraising the reliability of the counterparty Determining and locking in an acceptable price Ascertaining product quality Securing finance to fund the transaction Defining delivery and payment modalities, and other contractual terms and conditions

10

Futures Contracts


Similar to forward contract



Agreement to buy or sell an asset for a certain price at a certain time

Whereas a forward contract is traded on OTC or on bilateral basis, a futures contract is traded on an exchange
Securities exchange  Commodities exchange  Foreign exchange market


11

Benefits of an exchange


An anonymous electronic auction platform

Confluence of demand and supply  Transparent Price Discovery


 

Real time benchmark reference price



Pan-geographic price dissemination

Counter party risk guarantee

Robust Clearing & Settlement systems  Rigorous financial standards and surveillance procedures - fair, safe, orderly market


Liquidity to participants
A Simple, Safe and Secure method of trading

12

Exchange vs bilateral trading

Exchange Common platform for all traders Price transparency Low transaction costs Absence of counter party credit risk Market prices available to wider world Standardised contract size Bilateral trading Restricted access Traded prices unknown to other players High cost and time consuming negotiations Counter party credit risk Difficulty in price dissemination Customised contracts

Cost effective solutions on exchange platforms vis--vis OTC markets

13

Futures Terminology


Long position - buy position Short position - sell position Open interest: the total number of contracts outstanding  equal to number of long positions or number of short positions Settlement price: the price just before the final bell each day  Used for the daily settlement process Volume of trading: the number of contracts/quantity traded in 1 day

14

Why Derivatives are Used



To hedge risks - hedgers To take a price view - speculators To lock in a risk-free profit arbitrageurs

15

Market Participants: Hedgers



They can be farmers, manufacturers, importers and exporters The buyers are trying to secure as low a price as possible and the sellers will want to secure as high a price as possible. The commodity contract, provides a definite price certainty for both parties, which reduces the risks associated with price volatility They take a position to minimize price risk


16

Market Participants :Speculators



The speculator's role in a futures market is imperative, the future markets cannot work effectively without them. They
Provide constant bids and offers in the market  Willing to accept and offset the risk of the commercial user or take counterparty risk  Fuel the necessary liquidity without which the commercial participant cannot effectively use the market


17

Market Participants
Arbitrageurs  Reduces the prices between different markets  Helps to fulfill a very important criteria and the raison detre for Exchanges price discovery  Removes market inefficiencies Investors  Take a long term view and position on different contracts

18

Commodity v/s Financial Derivatives

19

Commodity v/s Financial Derivatives



Per se trading wise there are no differences between commodity and financial derivatives. FINANCIAL DERIVATIVES Financial Derivatives are only cash settled today No such differences exist Holding costs normally consists of only interest costs. Cash markets are active throughout the year. Factors Impacting : Global & Local Economic Condition Performance of the entity Taxation Structure

COMMODITY DERIVATIVES Commodity Derivatives are settled by actual deliveries Quantity and quality differences exist Holding cost includes assaying, warehousing, & insurance costs Physical markets are seasonal in nature Factors Impacting : Domestic & International Demand & Supply Import-Export Regulations Government Intervention

20

Agenda

    

Growing Commodity Markets Emerging Challenges in Commodity Markets Commodity Markets in India & their Role About NCDEX Delisting and Challenges

21

Types of Commodities Markets



Agriculture Markets


Energy


Grains, Oilseeds, Livestock Gold, silver, copper, platinum, palladium Lumber, cotton, orange juice, sugar, cocoa, coffee


Metals


Crude oil, heating oil, gasoline, natural gas Debt instruments, stock indexes, currencies

Financial


Forest, Fiber, and Food



22

Commodity Value Investing

Drivers conducive for value investing in commodities:
Beginning of the Bull phase after 20 years of Bear market

Escalating commodities demand from Asia, especially China Depreciating dollar shift to hard currencies like Gold Inflationary pressures build-up Surging energy prices leading to energy crisis Rise in commodity demand with economic recovery

23

Portfolio diversification & value investing

Equity & Bond prices have a weak negative correlation with Commodities prices

Benefits from diversification

24

Commodities Emerging as an Asset Class

Historical Price Trend of Select Commodities 7000 6000 5000 4000 3000 2000 1000 0 1918 2002 1900 1906 1924 1930 1936 1942 1954 1960 1966 1972 1912 1948 1978 1984 1990 1996

Gold
25

Crude Oil

Copper

Wheat

26

The New Bull run

The New Bull run

27

Worlds Major Commodity Exchanges

LME LIFFE IPE IGE
NCDEX

TOCOM

CBoT NYBoT CME NYMEX

SICOM SFE
As against global exchanges, which specialize in some commodity segments, NCDEX offers products across the commodity spectrum

28

Global derivatives volumes A shift

7000 6000 5000

Million contracts

4000 3000 2000 1000 0

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

US Exchanges

Non US Exchanges

29

Share of non-OECD countries in nonDerivatives trade is rising

12 10 8 % 6 4 2 0 2001 2002 2003 2004 2005
Source: SFOA and UNCTAD, 2006

11 10 8

5 4

- CAGR 01-05 for OECD 21% as against 50% for non-OECD - 17 of the top 40 exchanges located in Asia in 2006 (FIA)
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..as is share of non-OECD countries in nonCommodity Derivatives trade

35 30 25 20 % 15 10 5 0 2003
Source: SFOA and UNCTAD, 2006

30 23 25

2004

2005

- CAGR 01-05 for OECD 6% as against 28% for non-OECD

31

Asian Exchanges are now dominating the commodity space



In 2005, Asian commodity exchanges (dealing only in commodities) accounted for 51% of traded volumes


Asian exchanges accounted for 58% of agri volumes

10 of the top 22 commodity exchanges located in Asia

Indian exchanges have made a mark in a span of 3 years with volumes of Rs 37,000 bn (~$900 bn)
32

Evolution of Indian commodity exchanges

33

Traded Volumes in Derivatives in India-FY07 IndiaRs lakh crore

70 60 50 40 30 20 10 0 Commodities
Source: FMC, NSE

63.5

36.8

9.8

NSE-Futures

NSE-Options

..Commodity futures catching up with capital market futures

34

Overview of Indian Commodity Markets



Over 28,000 local markets (mandis)

Over 7,000 regulated markets  1500 of them are the relatively larger ones


Markets run by regional APMCs (Agricultural Produce Marketing Committees)  Pricing system opaque  Limited access for participants  No integration with the futures markets



Separate regulatory systems

35

Growth in Commodity Markets in India



Year-wise total value of Futures Trading

Year 2003-2004 2004-2005 2005-2006 Value (in Rupees crores) 1,29,364 5,71,760 21,55,122 Growth (%)

342 277 89

2006-2007

36,76,927

Source: FMC

Average daily traded volumes on NCDEX is USD 1 billion

36

Evolution of markets A summary

History of over 100 years of trading Ban on futures trading in sixties Removal of ban by 2003 Creation of new exchanges
First exchange established Bombay Cotton Exchange in 1893 Driven by upheavals market goes underground

Corollary of Liberalization Programme and reforms National online demutualized multi-commodity exchanges

Commodity trading in 3 national and 21 regional exchanges regulated by the Forward Markets Commission
37

Historical Perspective of commodity Perspectiveof exchanges in India

1875 1900 1920 Bombay Cotton Trade Association established Futures trade in oilseeds started Gold and silver futures trading started in Mumbai

1939

Cotton derivatives banned by Govt

1952

FCRA passed, ban on cotton futures removed

1953

Forward Markets Commission established

38

Historical Perspective
1955 Gold and silver futures trading banned by Govt

1966 1980

Futures trading in most commodities banned by Govt Govt removed ban on selected commodities like cotton, Jute, potatoes etc Kabra committee recommended removal of ban on futures trading for most commodities Govt extended the list of commodities allowed for futures trading Licenses issued for setting up national level multicommodity exchanges

1994

2001 2002

Commodity markets revived in India after 4 decades.

39

Background


Stock Markets Sequential development

Spot markets have developed first leading to futures markets  Both spot and derivatives segment under same control


Commodity Markets
Futures markets have developed first  Spot Markets in agriculture under State Government control


For orderly markets, developing Spot markets would provide the Exchange both segments
40

Commodities in Indian context



What are commodities ?



Defined by FCRA (1952) as Every kind of movable property other than actionable claims, money and securities. Indices and weather

 

What are not commodities?



What are the instruments that are traded?

Only futures permitted  Options are not allowed though this issue is being actively considered

Commodities valued at 33% of GDP

41

Regulatory Structure in India

Ministry of Finance Ministry of Corporate Affairs Ministry of Consumer Affairs
National Housing Bank 1
Insurance Regulatory Pension Funds Regulatory Development Authority Development Authority (IRDA) (PFRDA) 2 3 Company Law Board
4

FMC 10

Housing Finance Companies

Insurance

Pension Funds

Corporates

State Commodity Government

Exchanges

NABARD 5

SIDBI 6

RBI 7

SEBI 8

State-wise Registrar of Co-operatives 9

Co-operative Banks & Regional Rural Banks

State Financial Institutions

Banking / NBFCs/DFIs

Capital Markets

APMCS

Besides there are separate regulators for Power (Ministry of Power) and Energy (Ministry of Petroleum)
42

Regulatory Structure - Spot & Futures

State Governments
Ministry of Consumer Affairs, Food and Public Distribution

Forward Markets Spot Market Commission (FMC)

Futures Market/ Commodity Exchange
Unlike Forex and Stock Markets, Spot Markets in Commodities are not under the same Regulator who regulates forward contracts
43

Structure of Indian Commodity Futures Exchanges

FMC

Commodity Exchanges National Exchanges Regional Exchanges

NCDEX

Others

44

Overall Market Structure

     

Regulator Forward Markets Commission Exchanges National (3) and Regional (21) Broking Houses Members Clients Individuals

45

Indian commodity exchanges different from global counterparts

Global Exchanges
Deal with limited agricultural commodities Physical delivery not common

Indian Exchanges
Cover the entire range of commodities: NCDEX covers 75% of agriculture GDP Almost 100% of open interest results in delivery. NCDEX facilitates delivery of 30-35,000 tonnes of agri commodities every month Accredits warehouses and builds capacity (1 mn tonnes built by NCDEX) Creating objective standards and working with assayers Enables lending against warehouse receipts Establish weather stations to guide farmers and assist insurance companies

Not into the business of building warehousing capacity Standards and grading in place Not a function to enable credit to farmers Do not set up weather stations

Redefining role of an exchange to suit local ground level needs

46

Product Segments in India

Product Segments Cash Futures Options Indices

Stock Currency Commodities Notes:

X X

X X

*Currency derivatives market is restricted to forwards market

only in India

47

Customer Segments Current Market Participants in Indian Derivatives Market

Customer Segment Stocks Commodities Currency

Retail Corporate FIIs Banks Mutual Funds NRIs

X X X X

X X

48

Indian Commexes


In India, commodity exchange are not run by Trade Associations The salient features of Indian commodity exchanges are
National  Demutualization  Online/Electronic  Multi-commodity


49

Advantages of electronic trading

Larger reach  Common platform for participants  Price transparency



Quotations and traded prices available online

Online monitoring of member positions  Real time clearing and settlement  Real time price dissemination


50

Advantages of demutualization
Absence of conflict of interest  Professional management  Best practices pursued  No price view taken by exchange



Neutral to developments

51

Our Shareholders
Institution Share 15 % 15 % Domain Expertise NABARD NSE Apex bank for agricultural lending Largest stock exchange in India. Highest volume in single stock futures in world. Largest life insurance company in India

LIC

15 %

CRISIL

12%

Indias first & largest credit rating agency. Now a Standard & Poor company Largest farmer cooperative with affiliation of 36,000 cooperatives

IFFCO

12%

PNB

8%

Large public sector bank with strong rural reach specially in North India Large public sector bank with strong rural reach specially in South India Global Expertise in commodity markets

Canara Bank

8%

Goldman Sachs

7%

Intercontinental Exchange*

8%

6th largest commodity futures exchange in the world

*Acquired from ICICI Bank - 46% held by public sector and balance by other institutions, NSE & IFFCO hold 24% - No private shareholding
52

Board of Directors
Name Mr. B.M.Jindel Dr. U. S. Awasthi Dr. Michael Gorham Organisation Retd. Chief Commissioner of Income Tax MD, IFFCO Director, IIT Center for Financial Markets, Stuart Graduate School of Business Illinois Institute of Technology, USA Chairman, CRISIL Sr. Partner, Amarchand Mangaldas & Suresh A. Shroff & Co. Senior Partner of M/s M. P. Chitale & Co., Chartered Accountants, Mumbai Director, FMC Professor, IIM Ahmedabad MD, NSE Expertise in Income Tax Agriculture Expertise in commodities Nominee Status FMC nominee Shareholder nominee Independent

Mr. B. V. Bhargava Mr. S. H. Bhojani Mr. Uday M. Chitale Mr. P.K. Singhal Prof. Ravindra H. Dholakia Mr. Ravi Narain

Credit rating/finance Legal Chartered Accountant Market Regulation Economics Exchange operation Credit rating Banking & Finance Agri Finance & Law Insurance, Marketing, Finance & Legal Finance and Administration, Markets and Technology

Independent Independent FMC nominee FMC nominee FMC nominee Shareholder nominee Shareholder nominee Independent Shareholder nominee Shareholder nominee Whole-time Director

Mr. R. Ravimohan Mr. H. N. Sinor Dr. Y. S. P. Thorat Mr. T. S. Vijayan Mr. R. Ramaseshan

MD, CRISIL Chief Executive & Secretary, IBA Mumbai Chairman, NABARD Chairman, LIC MD & CEO, NCDEX

30% independent directors, 30% FMC Nominees & 38% shareholder nominees, 2% Whole-time Director
53

Professional approach to management decision making

Board of Directors  Board Committees

    

Audit Committee Board Governance & Compensation Business Strategy Committee Nomination Committee Risk Committee

Executive (expert) committees

Agriculture  Metal  Energy



54

Product specific (advisory) committees

Functions of NCDEX as an Exchange

 Product Conceptualization and Design  Price Discovery & Dissemination  Robust Trading & Settlement systems  Management of Counter party Credit Risk  Self Regulation to ensure
 Overview of Trading and Surveillance  Compliance and Audit and review of Members  Enforcement of Exchange rules
The Exchange provides a common meeting ground for all market participants
55

Critical Elements of an commodity exchange

       

Legal and Regulatory Structure Technological matching engine Real time globally comparable risk management system Real time market watch & surveillance Creation of logistical systems and infrastructure for physical deliveries Conversion of physical commodity holdings to electronic de-materialized balances Linkages to banks/other markets Linkages to International Exchanges (beyond MOUs)

56

India, a leader in key commodities

Agrocommodity Global Production (million tonnes) 594.5 415.0 155.0 696.0 55-60 233.5 25.4 Indian Production (million tonnes) 73.7 91.1 25.0 13.9 14.1 8.7 4.6 Share in global production % 12.4 22.0 16.1 2 23-25 4 18.1 Global rank in production 2 2 2 6 1 5 2

Wheat Rice Sugar Maize Pulses (lentils) Soybean Cotton

Source: Third Crop Estimates - Government of India, USDA

57

Exchange Profile
Number Products 55 Remarks 41 agro, 2 bullion, 3 polymers, 2 energy and 6 metals, 1 Carbon Credit Spread across India Accessible from 655 centres Storage capacity of 1 million tonnes

Members Terminals Delivery Centres Depository Participants Clearing Banks Weather Stations

890 19,042 660 55 12 200

By associate company NCMSL

Largest Exchange for Agro-commodities in India

58

AgriAgri-contracts on NCDEX platform

               

BARLEY CASHEW KERNEL CASTOR SEED CHANA COTTON CRUDE PALM OIL GROUNDNUT GUAR GUM GUR JEERA KAPAS MAIZE MASOOR MENTHAOIL RICE* WHEAT*

              

RAW JUTE RBD RED CHILLI RUBBER SESAME SEED SOYABEAN SOYA OIL SOYAMEAL SUGAR TURMERIC WHEAT YELLOW PEAS POTATO PEPPER RAPE MUSTARD

The 39 commodities constitute nearly 75% of the agri-GDP (calculated from weight in agri products index) * Wheat and rice are currently de-listed.
59

NonNon-Agri contracts on NCDEX platform

Gold  Silver  Crude oil  Furnace oil
       

Steel Sponge Iron Aluminium Copper Nickel Zinc Plastics  LLDPE  PP  PVC

NCDEX has the only steel contract in the world which is liquid
60

Market Share Agri. Commodities

MCX

Other

Share Exchange (%) NCDEX MCX Others 85.0 11.0 4.0 100

NCDEX

61

NCDEX market share in total volumes of key agri-commodities (April 2006 -Mar 2007)
Cereals & Pulses
Chana/Gram Wheat Maize Guar Seeds Urad Tur 88% 98% 99.5% 86% 87% 91% 99% 86% 76% 16% 100% 50%

Processed Agro-products
Guar Gum Sugar Gur Mentha oil

Fibres
Medium Staple Cotton Kapas
62

NCDEX Market Share

Spices
Pepper Chilli Turmeric Jeera

contd..
84% 98% 100% 97% 99% 99% 29% 86% 89%

Oil & Oil seed complex

Rape/Mustard Seed Soya bean Seeds Refined Soya Oil Soya Meal Castor Diversifying now into energy and metals Successful Steel contract
63

NCDEX in the Global Arena

(Volume in No. of Contracts Traded)
2006 Rank 2005 Rank % Change

Exchange

2006 Volume

2005 Volume

1 2 3 4 8

1 2 3 4 7

Chicago Mercantile Exchange Eurex Chicago Board of Trade Euronext LIFFE National Commodity & Derivatives Exchange

1,101,712,533 960,631,763 678,262,052 430,037,682

883,118,526 784,896,954 561,145,938 343,829,658 51,547,081

24.75 22.39 20.87 25.07 3.36

53,278,108

Note : * Trades reported to FIA only in 2006

In India we are the largest Exchange in the country in terms of number of contracts in 2006

64

NCDEX positioning in the Agri Commexes

Source: UNCTAD

NCDEX was the 3rd largest agricultural exchange in 2005 & continues to remain so in 2006 as well

65

NCDEXNCDEX- 3rd largest agro-commodity exchange agroin the world

99,175
100,000 90,000 80,000 70,000

91,872

in '000s

60,000 50,000 40,000 30,000 20,000 10,000 0

Dalian Commodity Exchange CBOT NCDEX NYBOT Zhenzhou Commodity Exchange Tokyo Grain Exchange Chicago Mercantile Exchange Shangai Futures Exchange Euronext LIFFE Tokya Commodity Exchange

43,287 33,149 28,473 25,575 12,501 9,503 8,499

7,156

Source: UNCTAD, SFOA The worlds commodity exchanges September 2006

66

Strategic Partners of NCDEX

Goldman Sachs

Global

Intercontinental Exchange (ICE) Dalian Commodity Exchange (DCE) Tokyo Grain Exchange (TGE) Bharat Petroleum

Business

Gas Authority of India Ltd (GAIL) Bombay Bullion Association (BBA)

Grading & Standards

Central Institute for Research on Cotton Technology (CIRCOT) Indian Agriculture Research Institute (IARI)

Warehouse & others

67

Food Corporation of India (FCI) CRIDA Punjab State Cooperative Supply & Marketing Federation

Creation of Economic Infrastructure by Commexes



Price dissemination  Price ticker boards, print media, audio and visual channels Increased holding power  Better warehousing facility  Better grading facilities Lending  Cheap finance to tide over the holding period for the commodities  Bank lending against warehouse receipts Dematerialization of warehouse receipts  Holding of commodity balances in electronic form

Each economy must define based on ground needs required role for Commexes
68

Impact at the Market Level



  

 

Increasing trend of deferral of sale by producers/ farmers  Increased ability to manage price risk by trade in commodity futures Better bargaining power of farmers Increasing importance of warehousing, grading and assaying Collapse of oligopolistic pricing  Prices of commodities such as guar seed (lentil), cumin seed, pepper and chillies being determined by groups of traders  Pricing now transparent on electronic platforms Greater lending by banks Political backlash

69

Impact


contd

 

Entry of non value-chain members adding to efficiency in price determination  Commodities viewed as an investment option  Emergence of a new asset class Move towards unification  Single agro market  Need for regulatory changes to link spot and futures markets Difficulties faced by traditional commodity market participants in migration Impact better in north and west than east due to better ground level infrastructure  Opposition greater in east  Need to create political awareness

70

Robust NCDEX systems

    

Stringent Membership Norms Strict Risk Management Practices State-of-the-art Market Surveillance State-of-the-art Technology Good delivery system

71

Membership
Primary Check Members
    

Rigorous KYC Process followed Interview with promoters Background check Minimum net worth & margin stipulations Unique Client Code

72

Membership
         
73

Submission of Application Screening & clearance of the applicant by the Membership Committee Issue of In-principle approval to the applicant Submission of other documents / supporting by the applicant Payment of Fees & Cash / Security Dep. by the Applicant Scrutiny of the documents & papers Issue of TM ID Submission of Form ( MR ) to FMC for allotment of UMC Intimation of opening of Bank & Demat a/cs by the Applicant Activation of Trading terminals

Membership
Periodic Review  Continuous compliance of membership norms by the member is ensured through annual return submission by the members which includes :

   

Audited Financial Statements Net Worth Certificate from CA List of Directors Shareholding Pattern & DPG

74

Number of Members & Client

FY 2004 Members Clients As of February 28, 2007 * Members Clients Cities Covered
* Source: FMC

FY 2005 566 11,446

FY 2006 752 71,149 MCX, Mumbai 1371 41,981 401

FY 2007 890 207,315 NCDEX, Mumbai 872 2,04,292 535

336 0 NMCE, Ahmedabad 120 8,000 124

For NCDEX

- Membership has grown by 160% in last 3 years - Clients have grown by 2.9 times in last year itself - Minimum Deposit of Rs 30 lacs not waived in any case

75

Product Selection


Products selected on the basis of Economic parameters

        

Price volatility Share in GDP Correlation with global markets Share in external trade Government intervention Warehousing facilities Traders distribution Geographical spread Number of varieties

Commodities given priority where they are more relevant to India: where price discovery takes place domestically
76

Product Selection
Products Gold Rubber Pepper Guar Sesame seed Sugar Tobacco Chana Jute Silver Ground nut Mustard seed Tea Score 89 76 76 74 73 72 71 71 71 69 69 69 67 Products Sunflower seed Soybean seed Turmeric Safflower seed Coffee Maize Zinc Castor Cotton Aluminum Copper Rice Wheat Nickel Score 67 67 65 65 64 64 62 62 61 59 59 57 55 47

77

Trading platform
 Automated trading mechanism  No physical interaction between the buyers and sellers  Nationwide reach and equal access  Order matching on price-time priority  Price priority - the order having the best price gets the priority  Time priority - if two orders have the same price, the order which entered the trading system first gets the highest priority  Time stamping for each trade  Complete audit trail
78

Trader Work Station

79

Trading Process

80

Trader workstation screen



Updated on a dynamic basis The blue colour indicates that price/ quantities have improved The red colour indicates that the price/ quantities have worsened.

81

Orders
          

Order driven market Quantity fields are in units Prices are in Rupees but quoted in Rupees/Unit Lot and tick size notified by the Exchange from time to time Regular Lot size or multiples thereof Matching on the basis of contract, its price, time and quantity. Order enters the trading system, it is an active order Numbered, time stamped and then scanned for a potential match. Find a match on the other side of the book If it finds a match, a trade is generated Else order becomes passive and retained in the outstanding order book in the system

82

MATCHING RULES SINGLE ORDER



Incoming single order will be matched with the best priced counter order in the regular lot book.

Unmatched orders will be written to the book

Stop Loss orders are written into a special book after trigger have same matching rules

83

Real Time Monitoring



As soon as the member reaches 70%/ 80%/ 90% of Initial Margin Limit or his Exposure Limit message 70% limit being reached is flashed on his terminal. Once the member reaches 100% of the limit, his terminal is disabled. The terminal remains disabled till the member brings in additional funds to increase his base capital so that he can take further positions.


Called Additional Base Capital


84

If the member is not able to bring in funds then the member positions may be squared up at the members request.

Marking to Market


All open positions in any contract are open to price risk Open positions are defined as positions which have not been squared off. The netting for open positions are at client level Downward price movement will mean losses for clients with long open positions Upward price movement will mean losses for clients with short open positions

85

Open Interest
Day Trading Activity of clients Open Interest 100 gms Client wise positions A +100 B -100 A +100 B +400 C -500 A - 0 B +900 C -500 D -400 Day 1 A Buys 100 gms of Gold B Sells 100 gms of Gold Day 2 B Buys 500 gms of Gold C Sells 500 gms of Gold Day 3 B Buys 500 gms of Gold D Sells 400 gms of Gold A Sells 100 gms of Gold

500 gms

900 gms

86

Closing out of open position



Closing out a futures position involves entering into an offsetting trade i.e. take an opposite position to what you already hold  E.g. Sell if you have a long position  E.g. Buy if you have a short position Most contracts are closed out before maturity

87

Checks for Market concentration



Position limits at Market/Member/Client level to avoid excessive speculation and market concentration  These speculative limits not applicable for genuine hedgers Commodities classified into various categories to arrive at the position limits  Narrow commodities (Annual production < 10 lakh MT)  Medium size (Annual production between 10 and 100 lakh MT)  Large size (Annual production > 100 lakh MT)

88

Surveillance system


Real-time surveillance
Price monitoring  Member Volume monitoring


End of the day alerts Non- real time surveillance

89

Other Risk Mitigations

       

Screening by Membership committee Members (or their key personnel) need to clear the exams stipulated by the exchange Net worth of Rs. 50 lacs Directors should be professionally qualified Minimum base capital requirements of Rs. 30 lacs Certificate on compliance with regulatory capital to be filed at periodic intervals NCDEX would conduct off line inspections of members' on an ongoing basis. Every member to take insurance prescribed by NCDEX

90

Risk vis--vis members vis

This risk is mitigated by collection of margins:

Initial Margins  Exposure margins


Marking to market of positions on a daily basis  Position Limits and Intra day price limits  Surveillance  Other measures


91

Risk Management
Real time position limit monitoring (PRISM) Value at Risk (VAR) Initial margins Exposure margins Daily mark to market Trade surveillance for price manipulation / collusions  Investor Protection Fund for contingencies  Lean month contracts withdrawn      

NCDEX has followed Gross-margining at client level right from inception

92

Margins


A margin is cash or marketable securities deposited by an investor with his or her broker, who in turn places it with the exchange Margins minimize the possibility of a loss through a default on a contract

93

Risk Management


Initial margin based on Value at Risk (VaR) model

To estimate worst loss that can happen for a time horizon one day  99.95% confidence level 3.29 sigma  SPAN system used for margin calculation



Minimum initial margin for each commodity traded by the member Exposure margin for additional safety Other margins


 

Pre-expiry, Additional, Delivery, Special & Adhoc

94

Market Watch & Surveillance



Pre-launch
  

Elaborate mechanism for obtaining spot prices Correlation of polled & Agmarknet prices verified Historical prices to analyze volatility & seasonal patterns

During Trading


Open interest (OI)

   

Monitored on real time basis Prescribed OI only a fraction of physical availability to enable delivery EoD client level OI aggregated Near month OI drastically reduced


Prevent buyers squeeze

95

Market Watch & Surveillance

During Trading
 

Size of each order restricted



Since exchange exposed even to the last order risk In the shape of price bands (Based on historical volatility/seasonality)


Circuit filters


Eliminate fat finger (wrong entry of price)

 

Clubbing of positions


Spot Month reduced position limits

Daily MTM  Gradual shift towards Compulsory Delivery

Presently out

of 41 agro-products, 21 are under compulsory delivery

96

Market Watch & Surveillance

Post-Trade Control


System Alerts on
60% of capital consumption  Concentration, patterns in trading, circular trading


Daily reporting to FMC of



Trading details, outstanding positions, trading patterns

Delivery Margins  Stringent system of fines & penalties



Major Surveillance techniques evolved by NSE

97

Market Watch & Surveillance

Regulatory Controls


Daily reporting to FMC of



Trading details, outstanding positions, trading patterns

Weekly meetings with Regulator  Weekly reports to Ministry of Agriculture



NCDEX View-only terminals provided at FMC office The Regulator & the Exchanges work together to protect the sanctity of the Markets

98

Technology : Connectivity
Trading Link
Wireless

Terrestrial

Leased Lines

Dial-up ISDN
Connectivity Type

Internet
No. of Users (Connections) (Mar 2007) (2) 3,991 (1,585) 2,069 (542) 1,843 7,903

V-SAT
No. of users during 2006 - 2007 (3) 666 % of users added during this year (3/2 * 100) (4)

Mobile Phones

(1)

VSAT Leased Line Internet Total

17% 35%

723

579 1,968

31%

Connectivity is the Lifeline of an Electronic Exchange

99

Technology :Trading System

       

Automated trading mechanism Buyers and sellers unknown Nationwide reach and equal access Order matching on price-time priority Time stamping for each order and trade Complete audit trail Fully fault-tolerant with high availability server system In-memory database for managing high order input rate
217 Orders/Sec

Daily Peak :: Orders - 330,000 Trades 170,000

Over 700,000 messages handled per second

100

Price Dissemination
ELECTRONIC
 TV and radio
   

PRINT
 Regional newspapers
 

News agencies Mobile phones Integrated kiosk Kisan (farmer) Call centres

Training material Agri-journals

TICKER BOARDS
 Member offices
     
101

Future plans
 Rural Post offices
  

Mandis Banks rural branches Rural warehouses Bus stations Abidjan- Cote DIvoire Singapore- View Terminal

Railway platforms Co-operative offices Panchayat offices

Technology : Price Dissemination

Channel Banks Partnered with Major PSU and new generation banks like ICICI Bank DD News & DTH, CNBC, NDTV, Sahara News, Reuters, Moneyline Telerate, Telequote AgMarknet, AP Online, State Mandi Boards Kisan Call Centers Mode of Dissemination Branches connected to Banks internal network connected through respective nodal points Remote rural branches on dial-up internet Live quotes sent through dedicated leased circuits (with 1:1 redundancy) Web portals are enabled through horizontally scrolling price tickers (both spot & futures) Electronic Price Boards in mandi markets are enabled either through State WAN or dial-up internet connectivity FTP download of data at regular intervals from the trading system View-alone Market Data terminals provided at their corporate locations providing online quotes Files generated at the end of the day is transmitted to their offices for press release (The entire process is fully automated)

Media

Agri Market & Call Centers

Kiosks Corporates Print Media

eChoupal, nLogue, Drishtee, eKurshi Vipanan HLL, Godrej, ITC, Arvind Mills, Parle,Austrialian Wheat Board Business Standard, Midday, Vyapaar and other Leading Vernacular dailies

-375 ticker boards installed so far -20,000 requests for prices on SMS - Expenditure of around Rs 1 cr 102

Price dissemination
Radio TV Channels E-chaupals N-logue Mobile News agencies Phones

PCOs Newspapers & journals Kisan call centres AGMARKNET

IFFCO, HAFED Warehouses

Bank branches

103

Price Dissemination in Rural Center

Commodity prices disseminated through multiple channels Live feeds to producers, agri markets and agencies, Govt. agencies through electronic ticker boards

Delayed price information through internet on website End-of-day price information Bhavcopy in vernacular presentation Through other media
Commodity price awareness through multiple available media

104

NCDEX Price Dissemination

       

Kisan call centres Doordarshan (exclusive), CNBC and AIR Tie-up with Reuters, Telerate, Telequotes, Bloomberg Corporate tie-ups with ITC E-chaupals, n-Logue Newspapers, Agri journals AgmarkNet, BoB website Extranet, Website Others sites  IFFCO, HAFED, NAFED, MP Warehousing Corporation  Bank branches: BOB, BOI, PNB  State government offices (Karnataka)  Warehouses  Commodity trader offices

105

Efforts in Dissemination
    

Post offices Bank branches Railway Stations and bus stands APMC boards at mandis Others  Agri extension services: Mahindra Shubhlabh, Rallis  TV channels such as AAj Tak, Zee Business  FMCG dealer points

106

Price Dissemination
Implemented Doordarshan and AIR Extranet, Website (www.ncdex.com) Tie-up with Reuters, Telerate Corporate tie-ups for rural kiosks: ITC E-choupals Newspapers, Agri journals AgmarkNet Kisan call centres In process APMC boards at mandis Agri extension services: Mahindra Shubhlabh, Rallis Govt. office outlets: Post offices TV channels Bank branches FMCG dealer points

Basic idea is to encourage farmers to choose cropping pattern based on future and not past prices
107

Foreign Access


Foreign access permitted in securities marketequities & bonds under regulation Currently can access commodity markets by setting up a domestic entity for broking & investment
 

Require prior approval from FIPB Precedents: Permission granted for Proprietary trade only No precedents for Client trade

108

RBI/SEBI notification dated 22.12.2006

Permits Foreign Investment in infrastructure companies in Indian Stock Exchange to the tune of 49%, of which


26% - FDI (Foreign Direct Investment) o With specific prior approval of FIPB 23% - FII (Foreign Institutional Investment) o FII will be allowed purchases in secondary market o FII shall not seek & will not get representation on the Board No foreign investor, including persons acting in concert, will hold more than 5% of the equity capital

Similar notification for commodity exchanges announced

109

Challenges in Indian Commodity Markets

110

Myths about commodity exchanges

Myth
Exchanges are speculative markets

Fact
Speculators infuse liquidity

Enablers
Hedgers price risk gets transferred

No physical deliveries

Physical deliveries are incidental

Platform for better price discovery

How can trading volume be greater than actual production?

Trading volume is a multiple of physical production

High open Interest (Indicator of depth of the market)

Exchange responsible for price movements

Exchange reflects the price movements of spot market

Platform for price discovery

111

Awareness Challenges


Need for relentless awareness programmes targeting

    

MPs Key policy makers Media Opinion makers CEOs of large companies/banks

Sustained effort to migrate adathiyas to electronic platforms

112

Foreign Investment in Financial Sector

FDI FII Total Maximum foreign individual share 74 26 49 49 FII/FDI 5%* FII 10% FDI/FII 5% FDI/FII 5%

Private Banks Insurance Stock exchanges Commodity exchanges

Up to 74% combined at up to 26% 26 26 23 23

Source: RBI, SEBI and IRDA *:exceptional cases up to 10%

113

Introduction of New Instruments



Trading in intangibles


Indices  Weather indices can complement efforts of insurance companies

114

Agenda

    

Growing Commodity Markets Emerging Challenges in Commodity Markets Commodity Markets in India & their Role About NCDEX Delisting and Challenges

115

Regulatory Action in Jan-Feb 2007 Janand in May 2008

116

Sudden delisting of important cereals & pulses - Jan-Feb 2007 Jan

Delisting of Urad & Tur contracts January 07 Suspension of Rice & Wheat contracts February 07 Suspension of contracts in chana, soy oil, rubber and potato May 2008

Future Prices as of Jan 23

Spot Prices as of Jan 23

Spot Price as of Mar 06

Feb Expiry Urad 71.86

March Expiry 69.88

May Expiry 65.31 78.88 71.88

Tur

50.68

55.04

56.95

51.93

49.24

(USD/Quintal)

Urad: Crop arrivals from Andhra & Burma expected in Feb-March Tur: Arrivals in March; 30-40% expected production shortage

117

118

Rs/quintal

1,000

1,050

1,100

1,150

800

850

900

950

Temporary ban; expected to be lifted soon

NCDEX wheat price movements NCDEX wheat price movements

01/02/2007 02/02/2007

Spot F-May-07 F-Feb-07 F-Jun-07 F-Mar-07 F-Jul-07 F-Apr-07 F-Aug-07

03/02/2007 05/02/2007 06/02/2007 07/02/2007 08/02/2007 09/02/2007 10/02/2007 12/02/2007 13/02/2007 14/02/2007 15/02/2007 16/02/2007 17/02/2007 19/02/2007 20/02/2007 21/02/2007 22/02/2007 23/02/2007 24/02/2007 26/02/2007 27/02/2007 28/02/2007 01/03/2007
Temporary ban on wheat imposed

Why have prices gone up in commodities Traded on Exchanges (TE)

Wghts Food grains Cereals Wheat Maize Pulses Gram Arhar Masur Urad Sugar 5.01 4.41 1.38 0.19 0.60 0.22 0.13 0.04 0.10 3.62 Point to Point inflation (As of Feb 03, 2007) 10.0 8.0 11.6 16.1 23.5 28.4 19.0 5.8 24.1 -10.0 Fall in production Increased by 6 lakh tonnes Reasons Shortfall since last 3 years Shortfall of around 6 lakh tonnes Two successive years of sub-optimal production falling stocks Set to fall by 1 million tonnes Shortfall since last two years Two successive years of fall Fell by 10 lakh tonnes

Prices of commodities have gone up due to stagnant productivity and supply shortfalls
119
Source: MOA, CMIE and Agriwatch

Prices of Non Exchange Traded Commodities (NETC) have also increased

Wghts Jowar Bajra Moong Cardamom Tea Groundnut seed Groundnut oil Rape & mustard oil Niger seed Sunflower seed 0.22 0.11 0.11 0.02 0.16 1.03 0.17 0.49 0.03 0.20 Point to Point inflation (As of Feb 03, 2007) 10.6 11.8 25.6 81.7 23.4 24.3 40.8 32.1 12.2 54.0 Reasons Stagnant production Fall in production since last two years N.A. Negligible production N.A. Sharp Fall in production Because of seeds Fall in production of seeds Fall in prodcution Sharp fall since last two years International demand & rise in prices

Basic metals & alloys

6.21

13.4

Besides, inflation in metals much higher than that in food grains due to global factors
120
Source: MOA, CMIE and Agriwatch

Price Volatility Pre-Post Futures PrePrice Volatility Pre-Post Futures Pre Futures Wheat Sugar Chana Maize Cumin Seeds Pepper Chilli 37.08 10.44 22.41 26.52 53.20 25.29 75.55 Post Futures 15.62 8.65 19.52 14.90 11.33 16.48 49.50 Time of Launch July 6, 2004 July 27, 2004 April 12 , 2004 Jan 5, 2005 Feb 3, 2005 March 12, 2004 March 11, 2005 Study period 2000-2006 2000-2006 2001-2006 2000-2006 2000-2007 1998-2007 1999-2007

Price volatility has reduced with the advent of futures trading

121

AC Nielsen Survey: Methodology

 Face-to-face interviews with
the farmers growing various crops.
Sphere of Influence

Random sampling procedures followed to target the farmers

WAS

 Wide area sample (WAS)


( Beyond 25 km radius)

NAS

 Narrow area sample (NAS)



( 20 25 Km radius)

122

Sample Size and respondents

Sample size


Wide Area Sample 1499

( Beyond 25 km radius)

Narrow Area Sample 473

( 20 25 Km radius)

Areas Covered  6 States  27 centres

Target Farmers Farmers cultivating:

Wheat, Mustard, Urad, Chana, Soyabean, Tur, Guar, Castor and Jeera

State Gujarat Haryana Mstra MP Punjab Rstan

Centres Mehsana, Kadi, Deesa, Rajkot and Unja Sirsa, Hissar and Khanna Akola, Jalgaon and Latur Ujjain, Indore, Vidhisa, Ratlam and Shivpuri Amritsar, Ludhiana, Patiala Hanumangarh, Bikaner, Alwar, Kota, Jodhpur, Pilani, Shri Ganganagar & Jaipur

123

Agreement towards the overall benefit due to the establishment of NCDEX

Yes 12%

No 22%

No 88%

Yes 78%

Wide Area Sample, Sample Size - 255

Narrow Area Sample, Sample Size - 473

 Over 78 % of respondents from NAS & 12 % of WAS agreed that they have
benefited out of the price discovery taking place through commodity exchanges market, they are able benefit through better price realization) the farmers

 As NAS respondents are well aware of market dynamics ( including futures  Increase in awareness level in interior areas about commodity futures will help

124

Farmers gain from wheat price rise - NIAM

 

Study of major wheat mandis in Shahjahanpur & Hardoi in Uttar Pradesh & Kota in Rajasthan Impact of direct procurement on farmers high price realization began in 2005 & gathered speed in 2006 NIAM  Period corresponds to the introduction of trade in futures contracts on NCDEX

Results of study show:



Impact of futures trade & price discovery in far months



The wider price dissemination with the start of commodity futures led to expectation of better price realization in the lean months NIAM

125

Farmer Benefit Case Studies

1. IABM study on Guar and chana  Price movements of Guar Seed and Chana reflect that farmers are getting good price which otherwise stagnated during last few years  Declining Standard Error over the years shows evidence of more stability in the prices due to on line price mechanism  Majority of traders and farmers are aware of NCDEX  Increase in price has led to an increase in the area under the crops


This may lead to more productive with higher better varieties and thereby more export earning.

126

Farmer Benefit Case Studies (conted..)

2. Study by NIAM (National Institute of Agricultural Marketing, Jaipur)


Conclusion: wheat farmers have received better prices on account of futures trading in 2006

127

Achievements

128

NCDEX as a Catalyst: Unstructured to Structured

AgriAgri-Markets
Awareness

Warehousing & Logistics

129

Establishment of collateral management company: NCMSL

 

Establishment of a collateral management company Shareholders



Domestic: NCDEX, YES Bank, PNB, IFFCO, Corporation Bank, HDFC Bank, Canara Bank, HAFED, BOI, KVB, Indian Bank Foreign: ACE

  

Arranged for loans up to Rs 360 cr in FY06 Also involved in hedging for the FCI on CBOT A PPP Initiative


130,000 MTs paddy from various states in FY06  Covering around 42,000 farmers

 

600,000 MTs paddy from various states in FY07



Covering around 80,000 farmers

Also hedged for FCI on CBOT

130

Weather Stations
Installed 290 weather stations across the country  Covers 15 states and 81 districts  Tracks data in locations which are generally not covered by IMD

 

Regular and timely weather data through a network of decentralized weather stations Stations being set up in relevant crop areas NCDEX Agriculture Insurance Company ICICI Lombard Other Insurance Companies
Uncertain Monsoons no longer to be the cause of Distress

Information being shared and used by

   

131

Awareness
Joint Programmes conducted with FMC  Awareness Programmes

 

At Investors Associations Banking colleges/institutes

Commodity Camps jointly with reputed members on TV channels

  

CNBC NDTV Zee Business

132

Education & Certification



NCDEX Institute of Commodity Markets & Research (NICR)

 

Lack of authentic papers & research articles/journals on commodities in India New initiative to promote/encourage research on commodity markets
 

Look at fundamental research Carrying out practical research

NCFM
 

Introduced certification course - NSEs Certification in Financial Markets (Commodity Market module) 15,000 students have appeared so far

Concept papers prepared for planning commission and government

133

Increased bank participation on the exchange platform

farmer farmer farmer farmer farmer
Bank branch Bank branch Banks takes consolidated position on behalf of its customers

Exchange

Bank to also take proprietary positions

134

Facilitating lending against commodities

Banks lending against commodities in FY06 was USD 1,334 million  NCMSL facilitated finance against commodities to the tune of about USD 80 million as on 31st March, 2006


ICICI Bank: USD 50 million  HDFC Bank: USD 22 million

 

Other banks: USD 8 million

Average Interest rate charged: 9.5% - 10.5%  Number of defaults so far: NIL


135

Facilitation required


RBI Working Group Recommendations



Banks to be allowed to have proprietary positions in agricultural commodity derivatives Evolution of a system for warehouse receipts which would be freely transferable Banks to be granted general permission to become PCMs of commodity exchanges

136

Recognition to NCDEX


Economic Survey: 2004-05

Pilots in AP, MP and Gujarat  Largest trading volumes in agriculture


Economic Survey: 2003-04

Innovative spot prices polling process introduced by NCDEX  Innovative demat settlement of commodities introduced  Holding of commodity balances in electronic form


137

One Stop Shop

NCDEX terminals

Institutions

Banks

Warehouse

Single point front for farmers to meet all needs

Other needs
138

Fertilizers

Agri-extensions

Aiming to provide a whole gamut of services from single platform

Career opportunities
For students, upon their completion, opportunities at
          

Setting up of own business and becoming a member of commodity exchanges Investment advisors Members offices Research and Analysts offices Procurement agencies Exports/ Imports Commodity trading Collateral management Commodity financing With exchanges Other institutions and agencies associated with handling of commodities

139

The day when all village and semi-urban centers would be benefited by commodity price knowledge is not too far. After all, this serves the largest purpose for which the electronic trading system was introduced

140

Thank you

141

National Commodity & Derivatives Exchange Exchange Plaza, Bandra East, Mumbai 400 051
www.ncdex.com www.ncdex.com/Circulars/circulars_english.aspx

142