5-derivatives & exchange operations

8/8/2019 5-Derivatives & Exchange Operations

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Commodity ExchangeOperations - 5


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Commodity Derivatives

Basic concept of a derivative contract remains the

same whether the underlying happens to be a

commodity or a financial asset except when there is

physical delivery.

Physical delivery warrants:

1. Warehousing-(i) Delivery notice period

(ii) Assignment

(iii) Delivery

2. Quality(iv) Specifications

(v) Assessment & Certification


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Physical Settlement

Involves physical delivery of the underlying

commodity at an accredited warehouse.

The seller/buyer has to take/pick-up the

commodities to/from the designated warehouse

Physical settlement is a complex process.


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Physical Settlement

Issues like : limits on storage facilities in different states

restrictions on interstate movement of

commodities,

state level octroi

duties impact cost of movement of goods across

locations

If seller chooses to hand over the commodity

instead of the difference in cash, the exchange

must make an arrangement with warehouses to

handle the settlements.


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Warehousing

Physical delivery necessitates Warehousing :

1.Delivery notice

2.Assignment

3.Delivery


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Delivery Notice


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Warehousing

1. Delivery notice periodA seller of commodity futures has the option to

give notice of delivery.

This option is given during a period called deliverynotice period.

Such contracts are then assigned to a buyer

Both positions can still be closed out before expiry

of the contract.


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Warehousing

Delivery notice periodThis notice is to allow verification of delivery and

to give adequate notice to the buyer of a possible

requirement to take delivery.Notice is required because actual physical

settlement of commodities requires preparation

from both delivering & receiving members.Typically, in all commodity exchanges, delivery

notice is required to be supported by a warehouse

receipt by the seller.


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Warehousing

Delivery notice periodWarehouse receipt is proof of quantity & quality of

commodities being delivered.

Some exchanges have certified laboratories forverifying the quality of goods & the seller has to

produce a verification report from these

laboratories along with delivery notice.

Some exchanges like LIFFE, accept warehouse

receipts as quality verification documents while

others like BMF-Brazil have independent grading

and classification agency to verify the quality.


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Warehousing

Delivery notice periodIn the case ofBMF-Brazil a seller typically has to

submit the following documents:

A declaration verifying that the asset is freeof any and all charges, including fiscal debts

related to the stored goods.

A provisional delivery order of the good toBM&F (Brazil), issued by the warehouse.

A warehouse certificate showing that storage

and regular insurance have been paid.


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Assignment


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Warehousing

2. Assignment - transfer of rights from assignor to assigneeWhenever delivery notices are given by the seller,

the clearing house of the exchange identifies the

buyer to whom this notice may be assigned.Exchanges follow different practices for the

assignment process.

One approach is to display the delivery notice andallow buyers wishing to take delivery to bid for

taking delivery. Among the Intl exchanges, BMF,

CBOT and CME display delivery notices.


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WarehousingAssignment

Alternatively, the clearing houses may assign

deliveries to buyers on some basis. Exchanges such

as COMMEX and the Indian commodities

exchanges have adopted this method :

Any seller/ buyer who has given intention to

deliver/ been assigned a delivery has an option to

square off positions till the market close of the dayof delivery notice.

After the close of trading, exchanges assign the

delivery intentions to open long positions.


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Warehousing

Assignment Assignment is done typically either on random

basis or first-in-first out basis.

In some exchanges (CME), the buyer has theoption to give his preference for delivery location.

The clearing house decides on the daily delivery

order rate at which delivery will be settled.Delivery rate depends on the spot rate of the

underlying adjusted for discount/ premium for

quality and freight costs.


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Warehousing

Assignment The discount/ premium for quality and freight

costs are published by the clearing house before

introduction of the contract. The most active spot market is normally taken as

the benchmark for deciding spot prices.

Alternatively, the delivery rate is determined basedon the previous day closing rate for the contract or

the closing rate for the day.


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Delivery


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Warehousing

3. DeliveryAfter the assignment process, clearing house/

exchange issues a delivery order to the buyer.

The exchange also informs the respectivewarehouse about the identity of the buyer.

The buyer is required to deposit a certain % of the

contract amount with the clearing house as marginagainst the warehouse receipt.

The period available for the buyer to take physical

delivery is stipulated by the exchange.


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WarehousingDelivery

Buyer or his authorised representative in the

presence of seller or his representative takes the

physical stocks against the delivery order.

Proof of physical delivery having been effected is

forwarded by the seller to the clearing house and

the invoice amount is credited to the seller's

account.

In India if a seller does not give notice of delivery

then the positions are cash settled on expiry


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Warehousing

Delivery

Most international commodity exchanges use

certified warehouses (CWH) for the purpose of

handling physical settlements.

Such CWH are required to provide storage facilities

for participants and to certify the quantity and

quality of the underlying commodity.

A warehouse receipt is a good collateral, not just

for settlement of exchange trades but also for

availing finance.


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Warehousing

The efficacy of the commodities settlements

depends on the warehousing system available.

In India, the warehousing system is not as efficient

as it is in some of the other developed markets.Central and state government controlled

warehouses are the major providers of agri-

produce storage facilities.There are a few private warehousing being

maintained. However there is no clear regulatory

oversight of warehousing services.


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Quality


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Quality

Variance in quality is not an issue in case of financial

derivatives as the physical attribute is missing.

Quality of the underlying asset is of prime

importance in commodities.

There may be variation in the quality of what is

available in the marketplace.

When the asset is specified, it is important that the

exchange stipulate the grade or grades of the

commodity that are acceptable.


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Quality

Commodity derivatives demand good standards

and quality assurance/ certification procedures.

A good grading system allows commodities to be

traded by specification.

Currently there are various agencies that are

responsible for specifying grades for commodities.

The Bureau of Indian Standards (BIS) under

Ministry of Consumer Affairs specifies standards

for processed agricultural commodities


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Quality

AGMARK (Agriculture Marking and Grading Act)

under the Department of Rural Development

under Ministry of Agriculture is responsible for

standards for basic agricultural commodities.

Apart from these, there are other agencies like

Export Inspection Council (EIA), which specify

standards for export oriented commodities.


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Quality - specifications

The New York Cotton Exchange has specified the

asset in its orange juice futures contract as :

"U.S Grade A, with Brix value of not less than 57

degrees,

having a Brix value to acid ratio of not less than 13

to 1 nor more than 19 to 1,

with factors of color and flavour each scoring 37

points or higher and 19 for defects, with a

minimum score 94".


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Quality - specifications

Chicago Mercantile Exchange in its random-length

lumber futures contract has specified ;

"Each delivery unit shall consist of nominal random

lengths from 8 feet to 20 feet,

grade-stamped Construction Standard, Standard

and Better, or #1 and #2;

however, in no case may the quantity of Standard

grade or #2 exceed 50%.


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Topics

1 Cotton 10 Rice

2 Rapeseed 11 Rubber

3 Soy oil 12 Gold

4 Groundnut 13 Silver5 Sugar 14 Crude Oil

6 Tea 15 Coal

7 Coffee 16 Iron & Steel8 Soy oil 17 Aluminium

9 Wheat

Content


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Content

1. Total World Trade

2. World Exporters/Importers

3. Total trade in India4. Position in Commodity Trade

5. World Production

6. Producing countries7. Country position in world trade

8. Avg./max. price fluctuation

9. How is it produced/extracted

10.Yield per hectre/acre

11.Various forms/Variety

12.Cropping/growth pattern

Content


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Content

13. Annual rainfal,temp, sunshine, harvesting

14. Global Demand & Supply

15. Supply dynamics

16. Major world Trading centres

17. Major Trading centres in India

18. Price-makers

19. Consumption patter-worldwide/India20. Influences on Demand/Supply

21. Govt. Policy

22. Competition from substitutes

23. Price trends & factors influencing prices24. Trade Policy in India


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Membership


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Membership

Who?a) Individual / Proprietorship Firm

b) Registered partnership Firm

c) Hindu Undivided Family (HUF)

d) Private Limited Company

e) Public Limited Company

f) Co-operative Societies

Basis - financial soundness, corporate structure,

track record, education, experience.


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Membership

Exchanges specify min lock-in period for all kind ofmembership & insist on following requirement:

1. Min. networth

2. Annual subscription charges3. Deposits:

a. Non-refundable admission fee

b. Contribution towards Trade Guarantee Fund

c. Initial base capital

d. Additional base capital

e. Annual subscription charges


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Membership

Application submission

Application processing

Interview

Admission Committee

Approval

UniqueMem. Code

Activation


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Membership

Types of Membership

1. Trading Member ( TM)2. Trading cum Clearing Member (TCM)

3. Professional Clearing Member (PCM)

4. Institutional Trading cum Clearing

Member (ITCM)


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Membership

1. Trading Member/Broker (TM): TM is a member of the Exchange who has the right

to execute transactions in the trading system of

the exchange & also

The right to have contracts in its own name

TM can also act as a Broker. As a Broker, he can

deal on behalf of the clients (Registered Non-members).

All the trades have to be executed only through

the Trading facilities provided by the Exchange.


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Membership

Trading Member/Broker (TM): TM will settle the transactions through Clearing

Members (Trading & Clearing Members or

Institutional Clearing Members).

TM cum Broker is required to maintain a separate

account for client transactions and is required to

maintain the margin deposit and money belonging

to clients in segregated accounts.

TMs are responsible for all the transactions of their

clients.


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Exchange membership

Trading Member/Broker (TM): A TM is allowed to have Clearing relationship with

only one TCM or ICM at any point of time.

The obligations of the TMs are monitored by theassociated TCM or ICM. If the limits are breached

by a TM, they will not be allowed to do further

trading unless the limits are reset on receipt of

additional deposits.

TMs provide liquidity in the market by acting as

Jobbers.


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Exchange membership

Trading Member/Broker (TM): TMs compete in the market place along with

customers' orders to improve the price discovery

in the market.

TMs make use of the Order Based Trading System

of the exchange to provide continuous stream of

order flows in the market.


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Membership

2. Trading Cum Clearing Member (TCM)

TCM has the right to execute transactions in the

trading system of the exchange like a TM.

TCM also a right to clear the transactions either onits own behalf or on behalf of other TMs.

TCMs are responsible to the Exchange for all the

obligations (margins, settlement obligations etc) ofTMs on whose behalf they have agreed to clear

the trades.


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Height 1,451 feet (442 m)

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Membership

Trading Cum Clearing Member (TCM)

The exchange will debit the banking account of the

TCMs for all the obligations of the TMs who are

clearing through TCMs.

TCMs enter into Clearing Agreements with their

constituent Trading Members.

They also take the required Caution Deposit fromthe TMs.

They are be allowed to set the limits for trading by

TMs.


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Membership

Trading Cum Clearing Member (TCM) TCMs are required to maintain segregated

accounts of the all the moneys belonging to TMs

on behalf of whom they are clearing the trades. If the clearing limits of TCMs are breached, all the

trading members attached to them will be stopped

from further trading until the limits are reset onreceipt of additional deposits.

The number of TCMs is limited compared to that

of TMs.


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Membership

3. Professional Clearing Members (PCMs):

Are clearing members who are not TM. Typically

banks, custodians etc. who clear and settle trades

executed for their clients (individuals, institutions

etc).

The functions and responsibilities of the PCM are

similar to Custodians.

PCMs may also undertake clearing and settlement

for TM connected to them. The onus for settling

the trade would then be on the PCM and not TM.

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Membership

4. Institutional Clearing Members (ICMs): Stock Exchanges, Trade, Industry Associations, Co-

operative Bodies, banks, Corporations, Companies

or Institutions or their subsidiaries set up forproviding financial services and large Retail

Network Commodity Brokers can become ITCM

Are admitted as Clearing members of the Exchange& Clearing House and allowed to only clear and

settle trades on account of Trading-cum-clearing

members or Trading Members.

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Membership

Institutional Clearing Members (ICMs):

In addition to the existing rights and responsibilities

as TCM they shall be also entitled to and liable to

settle and clear the trades/transactions done by the

Trading Members & their sub brokers.

They dont have right to trade on their own

account.

Institutional Clearing Members of the Association

shall be registered with the FMC


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Membership

Institutional Clearing Members (ICMs): Besides sub-brokers and authorized persons, ITCM

can appoint Trading Members while a TCM

cannot appoint Trading members

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ICEX- Membership charges

Particulars Category

Trading MemberTrading-Cum-

Clearing Member

Institutional Trading-

Cum-Clearing

Member

Professional

Clearing Member

Admission Fees* 100,000 250,000 1,000,000 1,000,000

Networth Requirement 500,000 4,000,000 10,000,000 20,000,000

Interest Free Security

Deposit

As per

ITCM/PCMs

requirement

750,000(250,000-Cash,

500,000-cash/cash

equivalent)

4,500,000(1,500,000-Cash,

3,000,000-Cash/Cash

equivalent)

4,500,000(1,500,000-Cash,

3,000,000-

Cash/Cash

equivalent)

Processing Fee* 2,500 2,500 5,000 5,000

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Charges

Members are liable to pay transaction charges to

the exchange for trades done during the previous

month.

Billing for the all trades done during the previous

month are raised in the succeeding month.

NCDEX charges are:

1. Rate : The transaction charges are payable at therate of Rs.6 per Rs.one Lakh trade done. This rate is

subject to change from time to time.

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Charges

2. Due date: The transaction charges are payable on

the 7th day from the date of the bill every month in

respect of the trade done in the previous month.

3. Collection process: NCDEX has engaged the

services of Bill Junction Payments Limited (BJPL) to

collect the transaction charges through Electronic

Clearing System.

4. Registration with BJPL and their services:

Members have to fill up the mandate form and

submit the same to NCDEX which is then forwarded

to BJPL.

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Charges

BJPL sends the log-in ID and password to the

mailing address

The members can then log on through the website

of BJPL and view the billing amount and the due

date.

Advance email intimation is also sent to the

members.

Besides, the billing details can be viewed on the

website upto a maximum period of 12 months.

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Charges

5. Adjustment against advance transaction charges:

Members are required to remit Rs.50,000 as advance

transaction charges on registration.

Members need to pay transaction charges only after

exhausting the balance lying in advance transaction.

6. Penalty for delayed payments: If the transaction

charges are not paid on or before the due date, a

penal interest is levied as specified by the exchange.

5-derivatives & exchange operations

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