Non-commercial traders operate in the commodity futures market for gains from a rise in futures prices, whereas commercial traders, including producers and processors, utilise futures contracts to insure the future inventories against the risk of fluctuating prices.

The surge in the commodity futures trade volume in India in the last one decade has been mainly driven by non-commercial users, along with retail participation.

Classification In the US, based on each trader’s registration with the CFTC and its positions in the Large Trader Reporting System (LTRS) database, the trader is classified as a commercial hedger or another category.

By regulation, when a trader’s position in a commodity futures contract becomes larger than a certain threshold, clearing members are obliged to report the trader’s end-of-day positions in the commodity to the CFTC.

Transactions in the physical delivery are subject to contract conditions and transport costs, cash flow and the need for storage for the physical commodity, which renders spot prices slow in their response to new information.

In contrast, futures market transactions can be implemented immediately by participants who react to new information with minor cash requirements.

Mere holding of the commodity does not always qualify a participant as a hedger, as the nature of the transaction may be financial, and a temporary ownership of goods is unlikely to change the objective of the transaction.

Objective Commercial hedgers, who are typically net short in the commodity futures market, offer premium to attract other participants to take the long side.

The traditional hedging pressure theory takes the capacity of financial traders as given. However, during financial crises, funding and risk constraints may force financial traders to unwind positions across the holdings.

The liquidation can exacerbate a crisis and cause synchronised price fluctuations, in both spot and futures markets. Similarly, financial distress can force financial traders to cut their positions in commodity futures, which, in turn, may force hedgers to reduce their hedging positions.

FMC has taken several measures to encourage participation of hedgers in commodity futures market for some time and new measures are likely to reduce the cost of hedging.

From the policy perspective, there is a need for increased attention on reporting the data of the participants in commodity futures market in India. While several exchanges in the world regularly announce the data of participation of commercial and non-commercial users in the contracts along with the distribution of open interest position, commodity futures in India are yet to begin this practice. This will definitely go a long way in broad basing the participation in the futures market.

(Shyamal Gupta is the Chief Business Officer of NCM. The views are personal.)

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