By Anil Mishra*:
Despite its belated entry into India, Rubber Futures is a highly regulated, transparent, on-line electronic trading system showing the best buying or selling price based on national view of all the participating stakeholders at any point in time, for the standardised specification of RSS 4
Rubber Futures is being traded since 2003 on National Multi-Commodity Exchange of India Ltd (NMCE) which has now amalgamated with ICEX. The stakeholders are getting same services in ICEX as they were getting in NMCE. Rubber Futures is highly regulated, transparent, on-line electronic trading system having national reach, is more liquid, having very narrow bid-ask spread (hence lower impact cost) and shows the best buying or selling price based on national view of all the participating stakeholders at any point in time, for the standardised specification of the RSS 4.
For all the stakeholders of the Rubber supply chain, it serves two main purposes — price discovery and price risk management. The benefit of price discovery is enjoyed by everyone whether they participate in the Rubber Futures market or not. For the price risk management, they need to participate in the futures market through NMCE, now ICEX. Since one operates by just paying margin money which is about 5%, he is able to leverage 20 times, thus he needs 20 times less cash to be able to make same profit. Buyer of the futures need not have his own warehouse; he could carry on the contract and take delivery from the exchange warehouse on need basis.
All the stakeholders are safe
SEBI, the Regulator oversees enforcement of exchange rules and conducts its own surveillance of trading in futures to prevent market abuse and to enhance the transparency and efficiency of the operations of the market. It approves the regulations and rules of the futures exchanges and requires exchanges to enforce them and also audits them. Each futures contract is reviewed by economists and trading experts to confirm that its terms are consistent with cash market practices, it may serve an economic purpose, and it is not contrary to the public interest. It fixes the margin, daily price band and open interest limits to ensure that market runs smoothly with lesser volatility. There is complete trail of the activity of all the participants and can’t be manipulated. There is concept of Novation and clearing corporation becomes the counterparty to all the contracts.
How client’s interest is protected?
Exchange members (brokers) that handle the money of customers who trade futures are required to keep customers’ accounts separate from the firm’s accounts, mark customer accounts to the present market value at the close of each day, and place any funds due to a customer in an account separate from the firm’s own fund or account. This segregation of funds protects clients’ funds in case of a firm’s separate financial difficulty. The commodity futures industry has an outstanding record for protecting customers’ funds, due in part to these rules.
Is Rubber Futures Market beneficial for both farmers and the processors?
Yes, it is beneficial to both the farmers/producers and processors / consumers, but not at the same time. When the futures market rallies due to perceived or actual shortage forecast, it gives opportunity for farmers to lock higher price. When the market drops due to actual excessive supply or perceived excess supply, it gives opportunity for processors/consumers to buy at lower price. The speculators, who are well-informed risk takers, absorb the risks of the above two sets of physical market participants who hold the physical rubber in the supply chain but are always exposed to the price risk. While they speculate on the exchange they actually become counter party to the hedgers, the actual physical participants who hedge their price risk on the exchange. The act of buying and selling on the exchange is hedging for one group of participant and it is speculation for the other. Futures market acts in advance and gives the signal in advance.
Exchange helps in hedging and ensuring liquidity to farmers
On the Exchange, while farmers hedge at higher price for future delivery when market is in contango, they would get paid by the exchange only when delivery becomes due and not before that. The farmers need money now, so how can they benefit from the hedging and at the same time get cash to meet his requirement? This is met through Warehouse receipt financing. The banks lend the farmers 80 to 90% of the value at which the farmer has hedged on the exchange. This way the farmers get the cash and also have price protection. The bank is also fully protected from the price risk, quality and quantity risk. The exchange pays the hedged price to the bank the holder of e-NWR (Electronic Negotiable Warehouse Receipt)
Can importers also hedge on the Exchange?
Yes, many importers are already hedging their price risk on the Exchange. When they sign their import contract they have price risk and currency risk till the rubber arrives in India and is actually delivered to the final client, the processors. This has normally risk of 2 to 4 months depending on how forward they have contracted. The moment they enter into the buy contract with the sellers in exporting country, they sell futures on NMCE/ICEX. When the goods arrive and finally delivered to the client, they buy back the futures and get relieved of obligation.
Can investors participate on the Exchange?
Yes, many investors participate on the Exchange when rubber market goes in contango, which means that future price is higher than spot price. This happens normally during peak tapping month when the supply becomes much more than demand. The investors buy in the spot market and sell at higher future price which covers their cost of carry and gives additional profit. As long as market stays in contango these investors carry on their position. When market reverses in the off season and market goes in backwardation, they deliver their stocks to the buyers on the exchange. They don’t have to search the buyer. Thus exchange indirectly becomes the buyer of last resort.
The Exchange also helps in reducing the working capital for the processors? Many processors use the Exchange to reduce their working capital requirements for procurement of rubber upto 90%. They buy the futures contract by paying just 5% of the value of rubber as margin money and can take delivery from the exchange by paying balance money at the time of delivery. They don’t have to pay 100% value of rubber as they have to do in case of spot market.
*Anil Mishra is the Managing Director & Chief Executive officer of National Multi-commodity Exchange of India Ltd(NMCE)