Mapping Indian exchanges on the global exchange services mosaic
http://www.financialexpress.com/news/mapping-indian-exchanges-on-the-global-exchange-services-mosaic/305164/0
V Shunmugam
Posted: 2008-05-04 01:19:57+05:30 IST
Updated: May 04, 2008 at 0119 hrs IST

As India opens the door to trade and transactions, it is logical that domestic goods and services would move from a high cost economy to a low cost economy. Comparative advantage in costs would remain the mirror of the efficiency of the economy’s manufacturing and services sectors. Commodity futures trading service offered by the national online exchanges would be no exception to it when it comes to competing within themselves and competing with the global exchanges, as borders disintegrate with a country’s progress in its path towards globalisation. While competing within themselves, national exchanges follow established domestic benchmarks or establish their own benchmarks by way of their own innovative business practices, in all to add value to users of the platform. Upon opening up of the borders to foreign currency transactions, the participants would benchmark even the efficiency of the domestic benchmark exchanges with that of their global counterparts in terms of their ability to deliver value for money.
Value for money on commodity derivative transactions is a composite function of a number of factors that could begin from the design of the contract, healthiness of participation, availability of information, effective management of trading risk, impact cost (a function of volatility and trading cost), efficient price discovery, liquidity, etc. Of these, while some are within the control of the exchanges governing their own rules and regulations besides the exchange practices and trading procedures, the others are beyond the ambit of the exchanges. Hence, it is clear that the exchanges by improving their operations, contract design, stricter surveillance, etc, shall be able to contribute towards an increase in their service delivery efficiency. This would finally contribute not only towards improving their operational procedures and efficiency but would also push themselves towards benchmarks. These benchmarks could be domestic or global, depending on whether the markets for exchange-traded derivatives are close or open both the ways.
Apart from having a larger production capacity by sheer cultivable size of the area in the case of agricultural commodities and larger reserves in the case of certain mineral ores such as iron and aluminium, being a billion plus populous country puts India in the position of an influential player in global primary commodities markets along with China. It necessitates that the primary markets are efficient not only to squeeze the supply chain costs but also to send the right future prices signals to the secondary or the tertiary sector. Hence, it is not only necessary that these markets should be competitive for the participants to trade in them, it is also necessary that these markets discover efficient future prices of commodities.
Commodity exchanges trade primary commodities that are at the bottom of the economic pyramid of our country and hence any inefficiency in the price discovery process is more likely to have a magnified impact on the economy as these pass through several hands in the supply channel and on most occasion gets value added as well. An efficient futures market is one that enables effective participation of traders with varied objectives (facing other risk management alternatives), converging all possible information about the fundamentals on the platform to discover the best possible price. The more efficient the discovered prices of commodities on a futures exchange platform is, the most effective would be the business and policy decisions that were taken based on these prices. The efficiency of price discovery depends on the robustness of the trading platform, its regulations, having the right mix of participants with relevant price information, making their participation cost effective vis-à-vis the alternatives available for risk management or investment, effective management of risk of the participants, and last but not the least - a robust clearing policy.
To make participation effective, it is necessary that the risks to the participants are effectively managed. Tools of risk management include margining, limits on open positions, and effective surveillance (Refer Table). Price volatility of various commodities on an exchange platform is an indicator of how effectively these tools are used by the exchange managers to improve the efficiency of the prices discovered on their platform. Price discovery efficiency in layman’s term refers to the ability of the futures contract to better predict its maturity prices ie the percentage deviation between the first traded price of the contract and the last traded price of the contract. The efficiency of price discovery can also be indicated by the closeness of spot and futures price movement. In the case of the MCX gold contract, the correlation between domestic futures and spot prices is around 99.2% in the last two years (2006& 2007) indicating strong inter-linkage between domestic spot and futures market, while the correlation with COMEX gold futures contract at around 99.4 (2007 and rupee adjusted) reflects how good is the Indian futures market in capturing global cues.
The efficiency of the MCX gold contract seems to better its global benchmark the Comex gold in terms of price discovery (table). More importantly, it is notable that the efficiency comes at the lowest impact cost of trading on MCX gold ie a typical combination of low cost of participation and lower volatility. Lower volatility is the result of close monitoring and the robust margining system adopted by the Indian commodity exchanges vis-à-vis the same adopted in domestic and global benchmark exchanges. Notably, MCX follows strict vigilance with an automated system in place for the same. For example, the system is designed such that it provides automated alerts when member’s margin utilisation crosses various levels and if margin utilisation crosses 100%, the concerned member is put automatically on a “Square Off” mode. Apart from the functional efficiency of trading, the robustness in technology (both the hardware and software) also adds value to the participants through reduced costs. Any additional cost burden on them in terms of taxation would only impair the efficiency of their service delivery in this globally competitive market, leading to flight of trades or their disappearance into the ground.
Having come to India just about four years ago, the national online commodity exchanges seemed to have exceeded the expectations of the policy makers catching up with their age-old global peers in terms of performance. As one would recognise Indian commodity exchanges after reading this for their global feat, it may not last longer in their minds unless they understand the efforts that had gone behind it. It includes choosing commodities relevant to the stakeholders, right contract design, taking it to appropriate participants, creating awareness, besides expanding infrastructure, etc. No doubt that the professionals with strong domain knowledge and technology, exchanges’ efforts to reach out, besides vigorous procedures have taken Indian commexes to their current position. Considering the large production and consumption base of the country, Indian commexes have the ability to outwit the existing domestic/global benchmarks and set their own mark at the global level given an appropriate policy dosage.
The author is chief economist, MCX. These are his personal views