1. Integration Of Commodity Spot And Derivatives Market

Structure of the Commodity Markets

• The trading in the commodities market can be broadly categorized into two major segments viz., spot/physical segment and derivatives segment.

• The commodity derivatives markets are well regulated under a statutory regulator while the spot markets are fragmented, geographically dispersed and primarily regulated by the state governments of the country

 

Integrating Spot and Derivative Markets

• Need for integration of spot and derivative markets

• Although Spot and Derivative Markets operate in same ecosystem but on different market principles and function differently from each other, they have a symbiotic relationship.

• The commodity derivatives markets provide a platform for discovery of future prices of a commodity and also offer the participants in the spot market an opportunity to hedge themselves against fluctuations in future prices of the underlying commodities.

• Since the derivatives market ensures that the future and spot price of a commodity converges on the day the derivative contract expires for settlement, the discovery of real-time spot prices of a commodity on a pan-India electronic spot exchange will certainly strengthen the convergence of spot and future prices of a commodity thereby enhancing efficiency of both spot and derivatives market.

 

Challenges for integration of spot and derivative markets

• Legal Challenges- There is no specific central law for setting-up of or regulation of pan-India electronic spot market platform, spot exchanges in agricultural or non-agricultural commodities.

• Multiple regulators and regulations- o SEBI is regulator for the commodity derivatives markets for agricultural as well as non-agricultural commodities.

• The spot markets for the agricultural commodities are within the purview of the respective state governments. As regards nonagricultural commodities there is no dedicated central agency.

• Storage - The capacity of the available warehousing infrastructure is inadequate and the industry is localized, unorganized, and fragmented.

• Lack of ancillary infrastructure such as adequate transport system, regulated assaying and refining and testing facilities, trained and certified human resources, uniform quality standards etc.

 

Action Plan for integration of spot and derivative markets

• Spot Markets o Agricultural Spot Markets - ▪States should change their existing APMC Acts on the lines suggested in Model Agricultural Produce and Livestock Marketing (Promotion and Facilitating) Act (APLM) Act, 2017.

• Providing multiple modes to the farmer for selling his farm produce, encourage formation of Farmer Producer Organizations (FPOs), scientific storage of commodities, institution for developing grades and standards of commodities, Improvements in eNAM etc.

• Non- Agricultural Spot markets – ▪Regulated warehouse and ancillary infrastructure, developing India delivery standards and aligning with global standards, dedicated Ministry / Department for Precious metals, Gems and Non-ferrous Metals and recycling of non-agricultural commodities.

• Other issues include – reviewing Free Trade Agreements (FTA) as reportedly some are having adverse impact on the growth of the domestic sector and developing formal and regulated structure of spot exchanges.

• Derivatives Markets – Increasing participation of different stakeholders (institutions such as banks, mutual funds and entities like FPOs), introduction of new products (e.g.- weather derivatives), linkages with the Global commodities market etc

• Integration of commodity Spot and Derivatives - collection and dissemination of data with regard to spot and derivative market, warehousing and development of storage infrastructure, certification requirements for skilled workforce, robust dispute resolution mechanism etc.

 

2. Algorithm Trading

• Recently, Securities and Exchange Board of India (SEBI) has relaxed restrictions on algorithm trading at commodity derivatives exchanges. What is algorithm trading?

• Algorithmic trading or ‘algo’ in market parlance refers to orders generated at a super-fast speed by use of advanced mathematical models that involve automated execution of trade, and it is mostly used by large institutional investors accounting for 35-40 per cent of turnover on the Indian exchanges.

• It helps institutional investors increase the efficiency of trade execution and spot fleeting trading opportunities.

• However, there are concerns also that it may trigger a large volume of trades that magnify the trend causing wild swings and crashes in the market.

• Lack of explicit guidelines from SEBI has prevented many brokers from providing algo trading platforms to retail investors giving institutional investors an unfair advantage over retail investors.

• However, SEBI has proposed various measures to reduce disadvantage faced by retail investors such as: o Minimum Resting Time for Orders

• Random Speed Bumps or delays in order processing / matching which would affect High Frequency Trading but not non-algo order flow.

• Maximum order message-to-trade ratio requirement which requires a market participant to execute at least one trade for a set number of order messages sent to a trading venue.

• Separate queues for colo orders and non-colo orders to ensure fair and equitable access to the stock exchange’s trading systems

• Review of Tick-by-Tick data feed which provide details relating to orders and trades on a real-time basis.