From relative obscurity, guar seed and guar gum have been propelled to near-celebrity status in the agri-commodity market, thanks to strident price appreciation despite regulatory brakes applied from time to time.
Willy-nilly, the functioning of the commodity futures exchange – National Commodity and Derivatives Exchange (NCDEX) – has come in for scrutiny. Did the exchange acquit itself well? Business Line caught up with the exchange's MD and CEO, Mr R. Ramaseshan, a former bureaucrat from the Indian Administrative Service. He asserts that futures prices of guar seed and guar gum simply reflected the acute tightness in the physical market, and that nowhere in the world was any commodity ever subjected to such stringent regulatory steps.
What triggered the price rise in guar seed and gum?
Guar is a naturally rain-fed crop. The crop size varies year to year depending on the rainfall. Guar seed output in 2011-12 season is estimated at 12.10 lakh tonnes compared with 15.46 lt in 2010-11.
According to APEDA, from April 2011 to January 2012 guar gum export aggregated 5.59 lt, a rise of nearly 60 per cent compared with 3.50 ltduring the same period in the previous year.
Guar gum is largely exported and has seen very strong demand from the oil drilling industry overseas since 2010 due to its chemical attributes and absence of cheaper and comparable substitutes. Market fundamentals in guar complex have been very tight during the past two years on account of a spurt in demand from the oil drilling industry for the “Hydraulic Fracking” process.
It is reported that the oil industry is outbidding food and various other industries where guar gum has been in use for many years. It is seen that there has been a consequent surge in international prices. The unprecedented, high level of exports due to increased demand from the oil exploration industry overseas appears to have caused very strong demand for guar seed and guar gum locally. With less-than-required arrivals in the physical market, mandi prices have been increasing continuously with awareness among the value chain participants that the demand is much higher than the anticipated supply of guar seed. Currently, production is down 20 per cent while demand from oil industry is up 84 per cent.
What actions did the exchange initiate when sharp price rise was noticed?
The Exchange initiated various regulatory actions in consultation with FMC (the commodity futures market regulator).
· Progressively hiked margins on the long side. Margins were as high as 60 per cent (cash) towards the end of the January expiry.
· Member and client level limits were reduced on January 21, 2012.
· Fresh positions disallowed in the January expiry contract with effect from January 17 onwards to facilitate smooth closure of the contract.
· On the basis of market reports and certain other criteria, open positions of certain entities were clubbed and these entities were considered as a single entity for monitoring purposes. The Exchange directed these entities to reduce their open positions to within that of a single client limit, thereby curbing their ability to participate in futures trading.
· Change in delivery system from “Early Delivery” to “Staggered Delivery” for March expiry contract.
· Cancelled launch of August and September contracts in view of the probable depleting stock position in physical markets.
· Disallowed fresh positions in all guar seed and guar gum contracts with effect from March 21, 2012.
· Eventually, in view of the reduced liquidity, the exchange closed out all the running contracts in Guar seed and Guar gum on March 27, 2012 at the Daily Settlement Price (DSP).
We are not aware of any other instance the world over, of such a series of stringent regulatory steps for controlling the market.
What are the guidelines to ascertain cartelisation? Was there any cartelisation or entities working in concert? If yes, when was it noticed and what action was taken?
Some entities were found to be acting in concert in Guar Seed and Guar Gum futures contracts trading on the Exchange. The inter-relationship amongst these entities was noticed by the Exchange in the course of detailed investigation of trading in these contracts, KYC forms and other client details as collected from the members and inspection of some members conducted by the Exchange.
Accordingly, the Exchange in terms of revised guidelines on clubbing issued on January 10, 2012, advised related / linked entities within a group to bring the combined positions of such entities within the single client level limits. The same was enforced by January 18, 2012 when Guar Seed prices were around Rs 10,000 a quintal and Guar Gum prices were around Rs 34,000 a quintal.
Reports suggest FMC clubbed several entities together on basis of common address, etc. Could the exchange have not done it?
The clubbing of entities according to the report of FMC was initiated by the Exchange based on inter-relationships / linkages / source of funds, etc, and implemented in consultation with FMC in January 2012.
Are there any lessons from this episode? How guar gum-like sticky situations can be avoided in future? And any thoughts on the way forward?
The Regulator/Exchange in the post-Guar scenario have introduced some major reforms with a view to strengthen the commodity futures markets:
· Staggered delivery in compulsory delivery contracts has been introduced. This would have twin benefits of facilitating smooth closure of the contracts as deliveries would be spread over a period of two weeks and permitting the seller to tender delivery and exit his position, thereby reducing his holding and margining costs. It would also ensure that only buyers who intend to take delivery would remain in the expiry month contract during this period, thereby reducing speculative interest towards the expiry of the contract. By introducing this measure, domestic markets would take a big step in moving towards international best practices.
· Lowering the penalty on delivery default in Compulsory Delivery contracts would reduce the pressure on the near-month contracts towards expiry in cases where there is a shortage of deliverables on the Exchange platform.
This would reduce the incentive of a participant on the long side from squeezing the contract. Relaxing the penalty percentage would reduce the probability of non-convergence between spot and future prices.
· The clubbing provisions have been made more stringent.
· Taking into account the current physical market conditions, the Exchange has reduced the validity period of Mustard Seed, Pepper, Soya Bean and Chana. This would result in stocks being moved out of the warehouse at regular intervals during the year.
These steps are major reforms in the futures markets and should help commodity exchanges to provide a robust trading platform to value chain participants. These steps should aid in commodity exchanges being a platform for better price discovery and enable value chain participants to better hedge their price risks.
Discrepancies noticed on the Exchange platform were limited to trading related offences such as margin funding and taking of positions through related entities to circumvent position limits. Market fundamentals were buoyant throughout the past two years and continue to remain strong despite the ban on futures trading. This is reflected in the current prices of guar gum at around Rs 1,00,000 a quintal and guar seed at around Rs 30,000 a quintal which are much higher than they were at the time of closure of futures trading.