From the April 01, 2007 issue of Futures Magazine • Subscribe!

Do chickpeas have a future?

India’s dynamic commodity futures exchanges have become lightning rods in a volatile election year amid rising food prices, raising the specter of a complete ban on futures, even as Parliament debates sweeping reforms to liberalize the industry.

The Indian government’s decision to delist futures on wheat, rice, lentils and peas (see “Traders' view of the world,” April 2007) has sparked fears of a wider delisting of chickpeas, sugar and edible oils. It’s also given the largest of India’s three national commodity futures exchanges a distinct advantage over its two competitors, even as all three exchanges cooperate on efforts to promote the industry as a whole.

The most critical project for the long term viability of futures as legitimate hedging instruments in India is certainly the campaign to build a functioning national spot market, but the story most likely to grab headlines in the coming month, beyond the obvious issue of which futures contracts will be allowed to trade and which will not, is the touchy issue of foreign investment in commodity exchanges.

Goldman Sachs has already taken a nearly 10% stake in the National Commodities and Derivatives Exchange (Ncdex), while Fidelity has a similar stake in the Multi-Commodity Exchange (MCX), the nation’s largest exchange and the only one listing so-called “mirror” contracts based on products traded in New York, London and Chicago. MCX’s core products are precious metals, while Ncdex and the National Multi-Commodity Exchange (NMCE) focus primarily on agriculture products. The delisting therefore hits Ncdex and NMCE the hardest, but other proposed reforms could swing against MCX.

Spokesmen for both Goldman and Fidelity say neither stake is a step towards partnership, but exchange bosses at all three exchanges have made no secret of their desire to bring in strategic partners from the United States, Europe and Asia.

For that to happen a bundle of bills before Parliament will have to pass in a form that provides clarity as to how large those stakes can grow and how much influence non Indian stakeholders can exercise on strategic issues.

A similar issue on the securities front was resolved in December, when the Reserve Bank of India gave the green light for Indian securities exchanges, depositories and clearing corporations to sell up to 49% of their shares to foreign entities, provided no single one of those foreign entities owns more than 5%. They also put limits on the type of investment: Foreign Direct Investment, or investment from groups interested in helping to run the exchange, is capped at 26% and each strategic investor has to be approved by the Foreign Investment Promotion Board. Foreign Institutional Investment (companies investing for returns alone) is capped at 23%.

Within a month of the rules being laid down, a consortium led by the New York Stock Exchange (NYSE) and Goldman Sachs snatched up a 20% strategic stake in the National Stock Exchange (NSE), which is Ncdex ’s primary “promoter” (Indian argot for “equity-holding strategic partner”).

Deutsche Boerse then followed with a 5% stake in the rival Bombay Stock Exchange, which is also talking to the Singapore Exchange, the London Stock Exchange, Nasdaq and the NYSE.

On the commodities front, most participants also expect a 49% limit on foreign investment, with no individual investor being allowed to hold more than 5%. Unlike in the securities sector, most participants we spoke to do not expect mandated caps on strategic investors as opposed to institutional investors. However, the debate is far from settled and the recent delistings have only served to highlight that fact.


Some worry an ownership cap, be it of 5%, 10% or 15%, could apply to all shareholders, foreign and domestic. That would force major shifts in the ownership structure of MCX, with the other two exchanges being less dramatically affected.

That’s because nearly 70% of MCX belongs to one promoter: Financial Technologies (India) Ltd.; and one man, Jignesh Shah, drives the company’s vision.

The other two exchanges have more diverse ownership, but each has promoters who are above the 5% threshold. The NSE, for example, has 15% of Ncdex, whose ownership is dominated by financial services companies.

NMCE’s promoters are more diffuse and skewed towards commodities-oriented entities, including the Central Warehousing Corporation, the National Institute of Agricultural Marketing and other commodity cooperatives based in Gujarat.

To a large extent, it’s the wide variance of promoters among the three that has led to differentiated business models. While all three offer contracts targeted to domestic hedgers, MCX became the subcontinent’s largest commodities exchange by launching new products designed to attract speculative volume. Many of its most successful products, as we mentioned above, are clones or mini versions of established products trading in Chicago, London or New York.

Those mirror products, however, are only viable because of capital restrictions, making it difficult for Indian traders to access foreign markets. If the government reconsiders its delisting of futures on food products soon and then opens its markets down the road, MCX could see its fortunes turn.

“We believe that by the year 2010 or 2011, Indians will be able to trade abroad and foreigners will be able to trade here with very little in the way of restrictions,” explains Ncdex boss P. H. Ravikumar. “If such a scenario happens, then Indian traders will clearly gravitate to the most liquid products. So if you trade gold, you will trade on Comex or CBOT; but if you want to participate in contracts specific to India, you will have to come to Indian exchanges.”


India, like China and Russia, does not have a functioning national spot market for commodities. Instead, Indian spot trading takes place at so-called “mandis.”

“These are literally places where farmers show up with their whole inventory and offer them to buyers,” says Ravikumar. “Each state has between 150 and 200 such ‘mandis,’ and the farmers don’t know the prices until they show up, so they are then forced to sell at whatever price is being quoted in front of them or via a call-in market.”

It also leaves no clear way of determining the basis between spot and futures, so the one clear place the recent global price rises showed themselves in India was on the futures exchanges.

Building the spot market has proven difficult because spot commodity trading is regulated not at the federal level, but at the state level, which means the new National Spot Exchange has to become registered as a mandi in each of India’s 28 states.

But because a mandi is not an electronic platform, the exchanges had to draft so-called “model legislation,” which each state must evaluate and implement if it wants the spot exchange to operate there. So far, two states have given the green light, with others expected to follow.

The new system will make it possible for farmers in all states to see in real-time the prices of all spot products in all participating states and to sell their products to any participating buyers anywhere in the country using accredited warehouses for quality control. Not only does that generate transparency, but it makes it possible for farmers to receive payment for their goods via their electronic bank account.

Also, because the banks handle the money, they control the cash-flow, which reduces the risk of default.

“If the banker has lent the farmer money against the commodity, he can collect both the loan and the interest from the buyer and then and pay out the balance to the farmers,” says Ravikumar. “The clearing house assumes the payout risk and the bank’s Basel II capital requirement goes down. Everybody wins — except the middle men.”

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