Once Parliament gives its assent to the Forward Contracts (Regulation) Amendment Bill cleared by the Cabinet on Thursday, farmers? ability to hedge the risk of price fluctuations in their produce will increase. This is because of option and derivative products being introduced as part of the change.
Moreover, market participants say commodity exchanges would be able to offer trading in intangible products, such as weather derivatives, instead of the current practice of trading only in items that can be physically delivered. A weather derivative would allow farmers to hedge say, against a possible failure of monsoon.
A put option gives the right but not the obligation to sell a commodity at a certain price in future. So if the price of the commodity falls below a certain level in the spot market, the farmer who buys the put option can sell the commodity at the rate agreed upon earlier and, thereby, protect himself against the downside risk of volatility.
?As exchanges can introduce more trading products, farmers and other investors including traders will have greater choices besides more avenues to hedge their risks,? said a senior official with a commodity exchange, who did not want to be identified.
Significantly, the futures trade in farm commodities, stymied by periodic bans, could thrive as a result of the proposed changes. Former Forward Markets Commission (FMC) chairman BC Khatua, who had fiercely fought for greater autonomy for the regulator, said: ?The proposal in the Bill to give more powers to the FMC would ease the trust deficit among some stakeholders ? who are otherwise interested in hedging risks ? about potential regulatory arbitrage.?
The FMC would be able to generate its revenue through transaction fees and hire quality manpower and garner other resources to better regulate the market, Khatua added.
The changes will also facilitate the launch of commodity indices and weather derivatives, among others, and within these, many types of products can be launched. For example, sub-indices for various commodity baskets like metals and foodgrains can be introduced.
?The put option is a great product for farmers as they will have no obligation to sell their produce if they are not satisfied with the price,? said FMC chairman Ramesh Abhishek. ?They can hedge their risks better by paying a simple premium. Moreover, if banks enter the commodity market at some point of time in the future, aggregation of farmers in large numbers will be possible, although amendments to the Banking Regulation Act is necessary for banks to enter. But the passage of the FCRA Bill will at least enhance their interest in participating in the commodity market.”
Currently, banks are scared of taking deliveries of physical commodities and once the choice to avoid delivery is created, it will prompt them to consider participating in the commodity market, said Tanushree Mazumdar, senior economist at the National Commodity and Derivatives Exchange.
Although market participants and analysts generally welcomed the government’s move, they stressed utmost caution in the implementation of the measures.
“Theoretically, the launch of options is good for farmers, but adequate awareness level has to be created among them to reap the benefits. Also, adequate infrastructure facilities need to be built,” Khatua said.
Khatua, however, said great caution needs to be taken while allowing products such as weather or rainfall derivatives. “To start with, I would say they should launch indexes and avoid weather derivatives as such products tend to increase the risks of speculation in the market.”
Experts also say launches of greater products would expose the market to greater manipulative elements and tighter vigil by the FMC will be required to stem their presence.
