What Modi recommended on futures trade in essential items

Heading a panel, the Prime Minister had called for integration of spot and futures markets

More than three year ago, Narendra Modi, chairing a working committee to suggest steps for reducing gap between the farmgate and retail prices and recommending an action plan for better implementation and amendment to Essential Commodity Act (ECA) had submitted a report.

This report is insightful, constructive and radical in its approach.

The highlights are: speedy reform of APMC Act across the country and liberalisation of agri-markets; explore unbundling of FCI operation in terms of procurement, storage and distribution functions; to set up a ministerial level coordination mechanism at the national and the regional level for coordinated policy making for evolving single national agriculture market; recommended that offences under Section 10-A under the Essential Commodities Act should be made non-bailable and special courts should be set up for speedy trial of offences under the ECA.

The report had touched on the issue of information asymmetry both on the demand as well as on the supply side.

Data flow

It had pointed that if the collation and capturing of data is supplemented with the flow of information then it would fundamentally change the face of market. If necessary, it could done by creating a dedicated agency for the purpose.

Needless to mention that India’s commodity futures market has brought in a significant change in the last ten years where “reference price” are often used by the trade for purchase as well as production decisions. The report had observed that “until effective integration of futures and spot markets is achieved, we should be cautious about the futures trade in essential commodities.”

The report further said: “Since food security being the utmost concern, for the time being there should be a ban on the trading of essential commodities in the futures market” ( Point 2.7, Page 8).

Futures market

Today, as Modi is the Prime Minister of the country and embarking on a paradigm shift what does one expect? Does this mean that the futures market should keep the essential commodities such as wheat on the watch list for possible trade suspension? The report has, however, said that futures of the other commodities can be permitted. (Page 17, Point e.4)

The report also mentions about the “market failure” and traders making excessive profits. However, no evidence or empirical data has been provided to substantiate the point.

The report talks about the creation of agri-infrastructure and, in its recommendation, has laid emphasis on post harvest linkages. It talks about the Government providing financial assistance for construction of godowns at village levels along with godowns at PACS (Primary Agricultural Co-operatives Societies). While it is appreciated that the recommendation has looked at “small is workable,” it has may have erred in recommendation of PACs in the role which does not have any specialised functional expertise.

This report is a document which gives 20 recommendations with 64 detailed actionable points that will facilitate expeditious implementation.

The report has largely been ignored till now, however, the committee needs to be complimented for taking the bull by its horns and addressing the issue which will have significant impact during the tenure of the current government.

Published in The Business Line on June 18, 2014

Asset-backed trading becoming the norm in commodity market

Helps companies link market and financial intelligence to remain competitive

From the middle of the last decade, large banks world-wide got involved in business far removed from their traditional lending activity – trading in physical commodities.

Currently, these banks are retreating from this activity. The shift is empowering commodity trading houses to consolidate their control over supply chains for food, oil and metals.

Commodity traders are rapidly expanding from the traditional intermediary business model of buying and selling, where margins are very thin, to “asset-backed trading models”, where they are investing in production, processing, and logistics.

This new trend has been triggered because across the traditional commodity market, the competitive advantage from superior price information has largely disappeared, and to protect margins, the traders are seeking to own and operate physical assets and arrange an end to supply chain solutions. These supply chains provide unique profit pools.

Some traders are also venturing into territorial specialisation such as distribution system supply and operatorship which gives them unique access to exclusive and unpublished market information.

Integrated framework

By developing deep insights into all the fundamental value-drivers in a trading portfolio, an integrated framework is providing the radar to identify the market and credit developments to which the firm’s financial performance and liquidity are particularly sensitive.

As trading houses are investing greater amounts in industrial and agricultural assets, they are being forced to raise more capital from outside investors, which in turn is threatening the private ownership model, historically favoured by the industry. In some cases sovereign funds and para-statal agencies are investing in the large trading houses. A few traders are already publicly-listed companies while others are considering floats. A few of the companies are using hybrid strategies of tapping capital markets and simultaneously seeking strategic investors while maintaining the flexibility.

The asset-backed trading is a style of commodity trading which is used to seek and exploit market volatility in order to monetise the operational assets owned by the trading entity.

It views physical assets as portfolios of traded instruments. Today, companies are linking manufacturing excellence to market and financial intelligence to remain competitive. No doubt, it poses a challenge on the business process as well as on the IT landscape.

An asset-backed trading strategy consists of control over the production (e.g. mining, plantation), processing (e.g. extraction, refining) and logistics (warehousing, tankage, railway, shipping) along with control over physical commodity.

Along with an appropriate set of financial hedges not necessarily subject to physical risk, this contributes to margin through operating efficiency and flexibility, utilisation and turnaround. Taking all these together, it is intended to extract value from market price movements and add to the valuation of trading entities.

Published in the Business Line on June 5, 2014