Commodity Derivative Market

Commodity Derivative Market

Subject :Economy

Context:

The Securities and Exchange Board of India has allowed Foreign portfolio investors (FPIs) to participate in the exchange traded commodity derivatives (ETCDs) market subject to certain risk management measures

Details:

• It aims at increasing the depth and liquidity in the commodity derivative market.
• FPIs will be allowed only in cash-settled non-agricultural commodity derivative contracts and few non agricultural indices.
• The previously used Eligible Foreign Entity (EFE) method has been terminated due to non participation.
  • In October 2018, Sebi had permitted eligible foreign entities (EFEs) having actual exposure to Indian commodity markets, to participate in the commodity derivative segment of recognised stock exchanges for primarily hedging their exposure.
• FPIs other than individuals, family offices and corporates may participate in commodity derivatives products as ‘clients’ and would be subject to rules and position limits.
• FPIs belonging to categories such as individuals, family offices and corporates will be allowed a position limit of 20% of the client level position limit in a particular commodity derivative contract

Concept:

• Derivatives are financial contracts that derive their values from the price fluctuations of their underlying assets such as stocks, currency, bonds, commodities etc.
• Two types of derivatives:
  • One that is subject to standardised terms and conditions, hence, traded in the stock exchanges and known as Exchange Traded Derivatives (ETDs), 
  • Second type that is traded between private counter-parties, in the absence of a formal intermediary and  known as Over the Counter (OTC) derivatives.
• Commodity derivatives are financial instruments that allow investors to profit from commodities without actually owning them. A derivatives contract entails the right to exchange a commodity at a later date for a specified price
• The commodity derivatives market is a place where investors can buy stocks in commodities rather than in major corporations that trade in these commodities.
• Two separate commodity markets:

• 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.
• Commodities ETDs-These types of Exchange Traded Derivatives have commodities as the underlying asset and are traded on the price fluctuations of commodities. Some of the examples of standardized contracts on commodities include gold, crude oil, silver, natural gas, copper, zinc etc.
  • The Multi Commodity Exchange of India Limited (MCX), India’s first listed exchange, is a state-of-the-art, commodity derivatives exchange that facilitates online trading of commodity derivatives transactions, thereby providing a platform for price discovery and risk management.