Addressing the hedge gap on commexes

The product specifications of agricultural contracts on exchanges do not mention the year of production; yet all the safeguards are built to ensure that no old crops are delivered at the exchanges.

Creation of FED (Final Expiry Date) category of stock on commodity exchange forces a situation where liquidity will continue to be only for the near month contracts and far month contracts will hardly be traded.

A recipient of the exchange-delivered FED stocks does not have any hedge facility available. Since the last decade this has created a major “Hedge Gap” in the Indian commodity market, yet the issue remains unaddressed.

There is lot more backwardation these days to actually encourage destocking in the market. If backwardation intensifies, not only will it be less logical to store new inventories, old inventories already financed by the market (therefore hedged from the perspective of producers) will become ever more valuable.

Yet, from the perspective of the commercial users on the other side, the loss associated with the position only grows larger by the day.

Once the FED stocks are delivered, the recipient beneficiary has two choices: First, either to take delivery of the commodity in question, being fully aware of the fact that he can no longer hedge or the second choice is to financially settle the exposure at a big loss. Naturally, the second choice is not an option for most commercial users (e.g. processors), which implies that in this situation one may most likely be exercising the first choice.

This has been a major reason why the real hedgers are not participating on the commodity exchanges in India.

The current arrangement not only leaves the producer holding profitable cash, it also leaves the recipient with an ongoing commodity long in a market environment that no longer allows him to hedge it without significant cost.

One of the recurring issues that arise is lack of clarity over what precisely one is trying to achieve. The doctrine of “hedge interest” needs to be more deeply deliberated at the product designing stage to prevent and curtail the contracts from any misuse.