Indian exchanges: The electronic silk road

Among other things, Jignesh Shah knows his numbers and his history. “In the 16th Century, India accounted for 15% of world trade and 50% of world GDP,” he says. “At present, India’s share of world trade is just 0.5% and GDP is about 2%.” (See“GDP growth,” showing India’s strong growth trend.)

Shah embedded the mini history lesson in a speech at the Swiss Futures and Options Association’s 29th Burgenstock Meeting, held this year in Interlaken and sponsored by two Indian powerhouses he founded: Financial Technologies (FT) and the Multi-Commodity Exchange (MCX).

He went on to cite a litany of other numbers designed to illustrate the power of India’s economy and the potential of its securities and derivatives exchanges: foreign reserves that have surged from just $2 billion when Manmohan Singh took office in 1991 to $300 billion today, a population dominated by people less than 30 years old, and with household savings of $330 billion per year (see “Growing prosperity,” right). Then come the country’s 11 million registered small and medium-sized enterprises, most of which Shah says are making money despite dishing out interest payments at rates that would make the most usurious of credit card companies envious and whose capital requirements have helped catapult the National Stock Exchange (NSE) into the world’s top spot for single-stock futures, while its “Nifty Fifty” stock index (officially the Standard & Poor’s CRISIL NSE Index 50) has become the world’s second most liquid futures contract. The exchange ranked ninth in the world in 2007, and is growing at a clip of 95% per year.

And as for the commodity sector “70% of India’s population, which is 700 million people, derive their livelihoods from the commodity sector,” he says, before pointing out that the nation’s three national commodity futures exchanges: MCX, the National Commodities and Derivatives Exchange (NCDEX), and the National Multi Commodity Exchange of India (NMCE) together list contracts on 105 commodities just five years after a 60-year ban on commodity futures was dropped. Not only that, but NCDEX is the number two commodities exchange in the world in terms of volume from agricultural products, while MCX is the world’s third-largest futures exchange when all products are considered.


The exchanges have managed to build up the volume despite serving fragmented and disjointed cash markets, with trading taking place at thousands of small “mandis” across the country.

“Both of us, MCX and NCDEX, realize that the cash market is absent in India,” says NCDEX boss Ramalinga Ramaseshan. “So both of us have created a vehicle to bring all of these thousands of regional markets into a formal national platform.”

Those vehicles, pan-Indian cash markets, are designed to build liquidity for the futures contracts by cultivating a trading-literate community of farmers. Ramaseshan says the task is proving just as challenging as was building the trading infrastructure.

“With agricultural products, the people who can best benefit are illiterate farmers,” he says. “If that category of user doesn’t come in, then the infrastructure we have so carefully created doesn’t serve anyone.”

Efforts to develop nationwide education programs also have run into challenges. “The country is very widely spread out, and the same commodity in one part of the country is completely different from the same product in another part,” he says. “A coffee grower in the south of the country is more educated, wealthier and better able to take on risk than is a pulses grower in a semi-arid basin.”

So NCDEX has begun reaching out to specific users by speaking their language, most recently in a series of 20-minute films. “In these, we’ll have, say, a farmer who has used the markets speaking about his experience in a language that is understood by people like him,” he says, adding that farmers often benefit from the moment they begin looking at NCDEX prices.

“Information dissemination is the first step,” he says. “If they see national prices, they at least begin to go and demand a better price for themselves.”


Shah points out that all three commodity exchanges have achieved stunning growth in the face of crippling regulatory impediments.

“We are in the midst of a tremendous reform to our futures markets,” he says. “But only 20% of the reforms have been carried out.”

Among the obstacles embedded in the 80% still pending: the country allows no direct access to financial futures from outside the country and no access at all to commodity futures from anywhere but inside India, forbids even domestic mutual funds from trading commodity futures and has a complete ban on commodity options and commodity indexes, not to mention last year’s banning of futures on four of the country’s most liquid products (tur, urad, wheat, rice) and the current suspension of futures trading on four other products (potatoes, chick peas, rubber and refined soya oil) set to expire in November (although originally slated to end in September).

Each of these obstacles is either slated to fall soon or looks to be on shaky ground, beginning with the ban on commodity options, which is a legacy of the old “Defense of India Rules” that colonial England imposed in the closing days of World War II to protect India’s food supply, in part by banning speculation. When bureaucrats wrote the 1952 act governing commodities and creating the Forward Markets Commission (FMC), they simply lifted swathes of wording from the rules.

“Because of that, the FMC technically existed for years to police a ban, and not to regulate a market,” says MCX Chairman Venkat Chary, who headed the FMC in the 1980s and led the drive to legalize futures beginning with an education campaign targeted at civil servants and policy makers.

That drive culminated with the legalization of commodity futures in 2003, but stopped short on several fronts, among them the failure to clearly define the FMC’s authority and give it the political autonomy that an effective regulator needs.

Bishnu Charan Khatua took over the FMC last year, and compensates for his commission’s foggy mandate by leveraging his right to approve exchange bylaws.

“It works for now, but the situation is far from ideal,” he says, adding that it’s all set to change under a sweeping new law that more clearly defines the FMC’s authority and gives it more political autonomy, freeing it from the type of grandstanding that led to the current de-listing of eight commodities.

The pending law, which also legalizes commodity options, was slated to take effect earlier this year, but hit the skids when leftists began throwing their weight around and the government decided not to present it for a vote. But Parliament reconvenes on Oct. 17, and both Khatua and Chary expect the reauthorization of the autonomy and the lifting of the ban to follow within four or five weeks.

“There are about 60 odd members of Parliament who belong to the leftist parties,” says Chary. “The government, which is quite centrist, didn’t want to push pro-market reforms in the climate of leftist opposition earlier this year, but that climate seems to have abated, leaving the government able to take bold decisions.”

One of those bold decisions already being transposed into action is the allowance of direct access to financial futures from outside the country in a phased set of reforms set to reach fruition in April 2009.

That’s when the Indian government aims to complete its recognition of Foreign Institutional Investors, which are non-Indian companies allowed to trade Indian financial futures products from abroad through omnibus accounts.

Until then, non-Indians looking to access the country’s financial futures markets can only do so through so-called “Participatory Notes” (P-Notes), which are over-the-counter swap instruments that the Securities and Exchange Board of India (SEBI) has not so much promoted as allowed to develop as an intermediary phase towards full opening.

P-Notes have proven a boon to international investment banks with the scope to establish a presence within India and a distribution network abroad, and also deliver a certain degree of liquidity by proxy to the Indian markets but in an expensive and opaque way, according to John Mathias, who is global head of financial futures and options for Merrill Lynch.

“P-Notes have been great for companies like us, but in terms of benefit to end users, my bias is towards the vanilla (standardized, exchange-traded) product,” he says. “It encourages transparency, greater openness and greater possibilities for risk management with reduction of credit risk, because of the central counterparty function.”

“This transition from P-Notes to a vanilla product will lead to a transition in technology and access in India,” says Matthias, adding that exchanges like NSE are revamping their platforms to be compatible with international protocols, while connectivity providers like GL Trade and Trading Technologies are lining up to connect Indian markets to the rest of the world.

“We’re going to see a virtuous circle, where direct access to listed transactions from abroad opens the market and leads to speedy rendition of information,” he says. “This leads to greater transparency — far greater than a resident who relies on these P-Note structures can hope to enjoy. That increased transparency ultimately leads to more investor confidence.”


Meanwhile, two new families of contract have just launched: greenhouse gas emission reduction contracts on both MCX and NCDEX, and currency futures on those two exchanges plus the NSE and the Bombay Stock Exchange.

“Currency futures are a giant step towards going international,” says Chary. “By authorizing the development of forex futures, the government has given a vote of confidence to India joining the global marketplace.”

Chary and MCX, meanwhile, have launched the Indian Energy Exchange, which provides day-ahead spot trading in electricity, and he sees futures on government bonds coming as the country’s treasury becomes more comfortable with non-Indian ownership of Indian debt. He also believes international access to commodity futures will come sooner than most observers expect, although it is not yet on the government agenda. “Sometimes people say that India has been too slow to open up and is hurting its potential,” says Khatua. “But when you consider that this is a country with 18 languages, 300 dialects, and seven religions, things have moved tremendously fast.”

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