EXCHANGES AND THEIR ROLE

How many recognized/registered associations engaged in commodity futures trading?

At present 21 Exchanges are recognized/registered for forward/ futures trading in commodities.

Under the Forward Contracts (Regulation) Act, 1952, forward trading in commodities notified under section 15 of the Act can be conducted only on the Exchanges, which are granted recognition by the Central Government (Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution).

All the Exchanges, which deal with forward contracts, are required to obtain certificate of Registration from the Forward Markets Commission.

All the associations concerned with regulation and control of business relating to forward contracts in goods, including recognized associations, are required to obtain Certificate of Registration from the Forward Markets Commission.  Such business can be conducted only in accordance with the conditions of Certificate of Registration.  All the Associations concerned with the regulation and control of business relating to forward contracts in commodities, which are notified u/sec. 15 of the Act have to obtain recognition from the Central Government. The associations organizing trading in commodities other than those notified under section 15, need not seek recognition; they merely have to obtain certificate of registration.

 The application for grant of recognition will have to be made in triplicate in a prescribed form to Secretary, Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution, Krishi Bhavan, New Delhi – 110 00.  Form A prescribed for application for the recognition is placed on the web site of the FMC http://www.fmc.gov.in/ .The application for grant of recognition should be  forwarded through Forward Markets Commission, Everest, 3rd Floor, 100, Marine Drive, Mumbai – 400 002..  The Government may grant recognition to the applicant association on the basis of recommendations made by the Forward Markets Commission.  A fee of  Rs. 2500/- will have to be paid by the applicant association for grant of recognition.  The fee could also be deposited in the nearest Government Treasurery or the nearest branch of State Bank of India; provided that at Mumbai, Kolkatta, Delhi, Kanpur and Chennai, the amount has to be deposited in the Reserve Bank of India.  The fee can also be remitted by crossed Indian Postal Order drawn in favour of Secretary, Forward Markets Commission. The application has to be accompanied by 3 copies of Memorandum and Articles of Association and Byelaws.

Application in triplicate for grant of certificate of Registration in Form B - placed on the web site of the FMC <http://www.fmc.gov.in/> - should be sent to Forward Markets Commission, Everest, 3rd Floor, 100, Marine Drive, Mumbai – 400 002. A fee of Rs. 50/- will have to be paid by the applicant association for grant of registration certificate.  The fee could also be deposited in the nearest Government Treasurery or the nearest branch of State Bank of India; provided that at Mumbai, Kolkatta, Delhi, Kanpur and Chennai, the amount has to be deposited in the Reserve Bank of India.  The fee can also be remitted by crossed Indian Postal Order drawn in favour of Secretary, Forward Markets Commission. The application has to be accompanied by 3 copies of Memorandum and Articles of Association and Byelaws.

Government identified the best international systems and practices in respect of trading, clearing, settlement and governance structure and invited applications from associations – existing and potential – to set up National Commodity Exchanges by introducing such systems and practices. The term,  "National" used for these Exchanges does not mean that other Exchanges are restricted from having nationwide operations.

How do National Commodity Exchanges differ from other Commodity Exchanges?

National Commodity Exchanges would be granted recognition in all permitted commodities; the other exchanges have to approach the Government for grant of recognition for each futures contract separately. Also, National Commodity Exchanges would be putting is place the best international practices in trading, clearing, settlement, and governance.

The Government of India identified four commodity exchanges – two existing  and two at proposal stage for setting up of Nation-Wide Commodity Exchanges. One of these existing Exchanges, Online Commodity Exchange of India Ltd. – now renamed as National Multicommodity Exchange of India Ltd. -  completed the preconditions for grant of national status, and was granted permanent recognition in all commodities, permitted from time to time. National Board of Trade, Indore is also an existing  Exchange, recognised in Soya Complex, Mustard Complex and Palm Derivatives. Three Exchanges, including National Board of Trade, Indore, were given ten months’ time to complete the preconditions. They are expected to be operational by October, 2003.

An Exchange designs a contract, which alone would be traded on the Exchange. The contract is not capable of being modified by participants, i.e., it is standardized. The Exchange also provides a trading platform, which converges the bids and offers emanating from geographically dispersed locations. This creates competitive conditions for trading. The Exchange also provides facilities for clearing, settlement, arbitration facilities. The Exchange may also provide financially secure environment by putting in place suitable risk management mechanism (margining system etc.), and guaranteeing performance of contract through the process of novation.

The aim of margin money is to minimize the risk of default by either counter party.  The amount of initial margin is so fixed as to ensure that the probability of loss on account of worst possible price fluctuation, which cannot be met by the amount of ordinary/initial margin is very low.  The Exchanges fix rates of ordinary/initial margin keeping in view need to balance high security of contract and low cost of entering into contract.

Different margins payable on futures contracts are:
Ordinary/initial margin, mark-to-market margin, special margin, volatility margin, and delivery margin.

It is the amount to be deposited by the market participants in his margin account with clearing house before they can place order to buy or sell a futures contracts.  This must be maintained throughout the time their position is open and is returnable at delivery, exercise, expiry or closing out.

Mark-to-market margins (MTM or M2M or valan) are payable based on closing prices at the end of each trading day.  These margins will be paid by the buyer if the price declines and by the seller if the price rises.  This margin is worked out on difference between the closing/clearing rate and the rate of the contract (if it is enterned into on that day) or the previous day’s clearing rate. The Exchange collects these margins from buyers if the prices decline and pays to the sellers and vice versa.

Collecting mark-to-market margin on a daily basis reduces the possibility of accumulation of loss, particularly when futures price moves only in one direction. Hence the risk of default is reduced. Also, the participants are required to pay less upfront margin – which is normally collected to cover the maximum, say, 99.9%, of the potential risk during the period of mark-to-market, for a given limit on open position. Alternatively, for the given upfront margin the limit on open position would have to be reduced, which has the effect of restraining the trade and liquidity.

It is a measurement of the variability rate (but not the direction) of the change in price over a given time period.  It is often expressed as a percentage and computed as the annualized standard deviation of percentage change in daily price.

Client Account is an account maintained for any individual or entity being serviced by an agent (broker, members), for a commission.   A customer’s business must be segregated  from the broker’s/member’s/principal’s own business and clients’ money should be kept in segregated accounts.  

It is a legal document entered into between the broker and the client setting out the conditions of their relationship and meeting the requirements of the relevant self-regulatory organization and the Regulator.

The main objectives of Trade Guarantee fund are  (a) to guarantee settlement of bonafide transactions of the members of the Exchange (b) thereby, to inculcate confidence in the minds of market participants’ (c) to protect the interest of the investors. All the members of the Exchange are required to make initial contribution towards trade guarantee fund of the Exchange.

Clearing House performs post trading functions like confirming trades, working out gains or losses made by the participants during the course of the clearing period – usually a day-collecting the losses from the members and paying out to other who have made gains.

Some Clearing Houses interpose between buyers and sellers as a legal counter party, i.e., the clearing house becomes buyer to every seller and vice versa. This obviates the need for ascertaining credit-worthiness of each counter party and the only credit risk that the participants face is the risk of clearing house committing a default. Clearing House puts in place a sound risk-management system to be able to discharge its role as a counter party to all participants.

How does an exchange ensure the guarantee of the performance of the contract ?

The performance of the contracts registered by the exchange are guaranteed either by the exchange or its clearing house.  The exchange interposes itself between each buyer and seller thereby becoming  a seller to every buyer and a buyer to every seller. The Exchange In order to safeguard its interest by imposing mark to market margin (which is clearing all the transactions at the closing price of the day.  All the profits and losses are either paid in or paid out).   This minimises the chances of default as buyer or seller is exposed to one day of price movements.  The Exchange also maintains its own TGF / SGF which can be used in case of a default.   The Exchange also puts in place a membership criteria and some of the new  Exchanges have also prescribed  certain minimum capital adequacy norms.