Sucheta Dalal :Past Is The Key To The Future (19 August 2002)
Sucheta Dalal

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Past Is The Key To The Future (19 August 2002)  

There was flutter among members of the National Stock Exchange last week at the circulation of an information memorandum by the Online Commodity Exchange of India. The document offered brokers an opportunity to be part of a NSE-like commodities market with an initial payment of just over Rs two lakh (Rs 25,000 on application and Rs 1.75 lakh on selection). Given the large volumes that modern commodity exchanges generate around the world, the NSE-like exchange certainly created a stir.

The OCEI is a consortium led by Ahmedabad-based Kailash Gupta of Neptune Overseas Ltd; he is its managing director and was a past president of the Ahmedabad Seed Merchants Association. The OCEI has an in-principle approval from the Forward Markets Commission to set up an oilseeds exchange. Other members of the consortium are Central Warehousing Corporation, National Cooperative Marketing Federation of India Ltd, Gujarat Agro Industries Ltd, National Institute of Agricultural Marketing and Gujarat State Agricultural Marketing Board. The Ministry of Consumer Affairs and the FMC had initially granted permission to the OCEI to trade in 24 oilseed products, but it hopes to trade sugar as well. Time is running out on the OCEI. Its original approval lapsed this August and its six-month extension also ends in November 2002.

But the OCEI proposal is interesting. It envisages a modern, demutualised commodity exchange with on-line trading based on the NSE model. Although Kailash Gupta is a commodities businessmen, the memorandum emphatically states that none of the office bearers including the chairman, managing director and other directors will be allowed to participate in the trading and clearing activities of OCEI. Also, the exchange will be run by an independent team of professionals, through an autonomous chief executive. It also plans to set up a modern warehousing mechanism and believes that its warehouse receipts will be like share certificates and turn into a new financing mechanism for the benefit of traders.

That is the good news. But look at the wider scenario. The OCEI will be the 19th association recognised under the Forward Contracts (Regulation) Act, 1952, to trade in commodities. Many of these exchanges constantly squabble with each other and OCEI faces hostility from the existing oilseeds bourses as well. The commodities market structure is weak. Some commodities are traded on a single exchange -- for instance, pepper in Kochi, turmeric at Sangli or jute in Kolkata.

If the OCEI truly manages to replicate NSE’s efficiency and success in the capital market, it will need both size and volumes to become viable. OCEI estimates that the value of oil trade in India, at around Rs 31,500 crore, is large enough. It claims a conservative trading volume estimate of Rs 22,000 crore annually and believes that futures business could top Rs four lakh crore. Whether this would materialise depends entirely on the effectiveness of OCEI’s warehousing and trade guarantee mechanism.

But the larger question is, aren’t there any lessons that the Ministry of Consumer Affairs and the FMC should learn from the capital market’s experience? There are several. The OCEI’s structure emulates the NSE, but it is essentially a regional exchange trading in various types of oilseeds. Moreover, it has yet to work out the full cost of its ambitious plans. The memorandum mentions no project cost. Potential members have been given initial payment estimates and are told that all other costs, deposits to cover operations, the VSAT network expenses and other charges are to be intimated separately. These could be very steep.

We already have 18 recognised commodities exchanges, which beg comparison with India’s 23 stock exchanges. All but four or five stock exchanges are expected to die; the others are deeply in the red and have no trading volumes.

Among the lessons that need to be learnt from capital market developments are: First, that if the government plans on setting up a National Multi Commodities Exchange, the FMC itself needs to be revamped and brought on par with the Securities and Exchange Board of India in terms of structure, powers, surveillance systems and risk-assessment abilities. The NMCE, if successful, will cause trading volumes to surge and the regulatory mechanism should be capable of dealing with it. Regulating commodity markets is far more complex than regulating the capital market. Rampant speculation or the cornering of a commodity invariably plays havoc with retail prices and has disastrous political consequences. India has experienced this in the past and it led to a long-term ban on trading in commodity futures.

Secondly, the FMC must stop granting permissions to new regional exchanges that would trade in single or small groups of commodities. Instead, it should clear two or three national multi-commodity exchanges to foster competition and avoid the sort of acrimony witnessed between the NSE and BSE. If consortia such as the OCEI can drum up the requisite funding, they too should be encouraged to be more ambitious. Otherwise, the FMC would learn the hard way that regional exchanges do not die out -- there are always powerful vested interests that keep them alive.

Finally, the key to a successful multi-commodity national exchange that would work on the lines of the mighty Chicago Board of Trade depends on how well its clearing and warehousing mechanism works. Unlike the securities market, where the delivery product was a homogenous piece of paper (the share certificate), the commodities business has a million complexities relating to delivery, price, storage and, above all, quality. These have to be carefully addressed if concepts such as warehousing receipts are to work.

The ground work for strengthening the FMC’s regulatory framework ought to have begun three years ago when it had cleared an NMCE to be set up by a consortia led by Mahindra & Mahindra, Punjab Warehousing Corporation, the NSE and ICICI. That proposal had lapsed because of a foolish promise by one of the members that the exchange would be headquartered in Punjab. Now that the Prime Minister has mentioned the creation of a national commodities exchange on Independence Day, it is time the Consumer Affairs ministry works overtime to address basics such as strengthening FMC’s regulatory structure to prepare for the future.

-- Sucheta Dalal