supply chain cost management role of commodity derivativesmcx).pdf · 2019-11-23 · a few...
TRANSCRIPT
Supply Chain Cost Management – Role of Commodity Derivatives
- Dr. V Shunmugam,
Head, Dept. of Research
A FEW CHALLENGES IN SUPPLY CHAIN MANAGEMENT
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Planning & risk mgmt.
Cost control
Stakeholder relationship
mgmt.
Customer service
Fast changing markets
Quality Compliances
Technological advancement
Talent retention
A few directly linked to commodity price volatility…..
RISK: COMMODITY PRICES IMPACTED BY MULTIPLE FORCES
COMMODITY PRICES IN RECENT PAST
COMMODITY PRICES MOVEMENT: FINANCIAL IMPACT
5
Sr. No.
Price movement
Impact
Inventory Sales Purchasing Earnings
1 Fall in commodity price
Higher cost of inventory - lead
to a constraint in cash flow
Reduced sales values due to lower price –
impacts profitability
Increase in purchasing power
– higher volumes
purchased
Net realizable value is below cost and sales realizes at lower value –
reducing earnings
2 Rise in commodity price
Lower cost of inventory - lead to increase in
cash flow
Increased sales values due to higher price
Decrease in purchasing power
Net realizable value is above cost and sales realizes at
same or higher value –
increasing earnings
Source: Commodity Risk Management – A manual of hedging commodity price risk for corporates; Deloitte – MCX Investor (Client) Protection Fund
COMMODITY RISK VS FOREX RISK….
Commodity price risks - volatility in commodities - greater than forex volatility 6
Annualized Volatility for USD-INR
Period 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19
Volatility 12.3% 5.5% 5.1% 4.2% 4.3% 6.9%
Data source: Bloomberg
Annualized Volatility for some of the Commodities Listed on MCX
FY ALUMINIUM COPPER ZINC CRUDEOIL COTTON SILVER GOLD
2013-14 17.7% 18.2% 17.5% 21.9% 16.8% 30.0% 22.2%
2014-15 16.5% 18.1% 17.3% 29.6% 15.8% 23.7% 14.8%
2015-16 17.9% 20.4% 26.9% 44.3% 13.2% 21.6% 14.9%
2016-17 14.9% 19.8% 25.7% 34.5% 18.3% 20.3% 12.1%
2017-18 15.9% 17.3% 22.4% 24.1% 19.3% 14.6% 8.7%
2018-19 26.7% 18.6% 24.0% 32.8% 16.2% 14.8% 9.5%
ROLE OF COMMODITY DERIVATIVES IN SCM CHALLENGES
Reduction in both risk and cost
Cost control
Protects business margins;
Better cash management
Helps in better future planning
Enhances efficiency and competitiveness
Alternative marketing channel
Assurance on quality
Supplier/partner relationship management
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eNWR – TRANSFORMATION OF CREDIT MOBILISATION
• On Sept 26, 2017, “Electronic Negotiable Warehouse Receipt (e-NWR) System” was launched.
• Negotiable warehouse receipt, allows transfer of ownership of that commodity stored in a warehouse without having to deliver the physical commodity.
• Warehouse receipts are made negotiable under the Warehouse (Development and Regulation) Act, 2007, and regulated by the Warehousing Development and Regulatory Authority (WDRA).
• With no threat of any tempering, mutilation, fudging, loss & with no possibility of any multiple financing, eNWRs facilitates an easy pledge financing by banks and other financial institutions
• Huge savings in logistics cost as the stocks traded without physical movement.
• Currently WDRA has notified 123 agricultural commodities and 26 horticultural commodities.
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27/04/2019 9
FUTURES CONTRACT & ITS FUNCTIONS
A futures contract is a binding agreement between a seller and a buyer to give (by the seller) and to take (by the buyer) delivery of the underlying commodity (or a financial instrument) at a specified future date with agreed upon payment terms.
Main functions of exchange-traded futures contracts are:
● Trade guarantee
● Risk management (hedging)
● Price discovery
● Transactional efficiency
● Liquidity
WHAT ARE OPTIONS?
An option contract offers the buyer of the contract protection if the price of the
underlying moves against him but allows him to walk away from the deal if the
underlying price moves in his favour.
Options:
• Give buyer the “right”, but not the “obligation”
• To buy or to sell an agreed amount of underlying asset
(Notional Value)
• On or before an agreed future date (expiry date)
• At an agreed exchange rate (Strike Price)
• In exchange for
fee (Option Premium)
FUTURES OPTIONS
Buy / sell at pre-determined price & time (Obligation)
Buy / sell right to but / sell at pre-determined price & time (Right)
Exchange Traded Exchange Traded & OTC
Margins Upfront Premium
Future Price reflects holding cost & market perceptions
The Premium reflects holding cost & market perceptions
Square-up positions Buyer- no obligation
CALL OPTION Buyer has the right but not the obligation to buy
specified quantity of the underlying asset at the set strike price on or before a specified date.
The seller (writer) has the obligation to sell the underlying asset if the buyer decides to exercise his option to buy.
PUT OPTION Buyer has the right but not the obligation to sell specified
quantity of the underlying asset at the set strike price on or before a specified date.
The seller (writer) has the obligation to buy the underlying
asset if the buyer decides to exercise his option to sell.
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Taking a position in the futures market that is opposite to a exposure in the physical market
The objective behind this mechanism is to offset a loss in one market with a gain in another
Reduces or limits risks associated with unpredictable price changes
HEDGING USING FUTURES
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ILLUSTRATION OF HEDGING
Time CASH FUTURES
30th Sep'
201X Spot market at Rs. 187/kg
Buys 50 lots of MCX Nov'201X at Rs.
185/kg
16th
Nov'201X Buys at Rs.194/kg
Sells 50 lots of MCX Nov' 201X at Rs.
192/kg
Result A potential loss of Rs.7/kg Gained Rs.7/kg
On 30th Sept’ 201X ABC Galvanizer got an order to be delivered in December 201X, which requires 250 MT of Zinc.
Company cannot purchase the required quantity of zinc before November due to warehousing concerns.
To protect against unforeseen rise in Zinc price, company decides to hedge by buying 50 lots of MCX Zinc Futures.
The profit of Rs. 7/Kg made in the futures market was used by the company to reduce the cost of buying zinc in physical market and was able to offset its potential loss.
ELEMENTS OF RISK MANAGEMENT STRATEGY
Identification
of exposure
Measurement of
exposure and risk
Design of hedging strategies to achieve set
objectives
Identification of hedging vehicles
Monitoring of risks against predetermined limits via appropriate mechanisms
and governance structure
Execution of risk management activities
HEDGING ON DOMESTIC EXCHANGE IS HEDGING AGAINST BOTH VOLATILITY IN GLOBAL COMMODITY PRICES AND USDINR
MCX Commodity Benchmark Exchange
Correlation* in FY 2018-19 (%)
Gold CME (COMEX) 99.3%
Silver CME (COMEX) 97.6%
Crude Oil CME (NYMEX) 99.8%
Copper CME (COMEX) 99.1%
Zinc LME 99.2%
Lead LME 99.3%
Nickel LME 99.8%
Aluminium LME 87.6%
* - Correlation of MCX Closing prices with INR - denominated benchmark prices
REGULATORY INITIATIVES ON HEDGING
• Govt. of India Income tax benefits for hedging
The Finance Act, 2013 provided for coverage of commodity derivatives transactions undertaken in recognized commodity exchanges under the ambit of Section 43(5) of the Income Tax Act, 1961.
Hedgers are no longer forced to undertake physical delivery of commodities in order to prove that their transactions are in the nature of hedging and not ‘speculation’.
• Reserve Bank of India Liberalized access to overseas hedging markets
Advisory to banks to encourage their large borrowers to hedge their risks related to agricultural commodity prices
• Ministry of Corporate Affairs Notified Ind AS Accounting Disclosures
• Ind AS 107 – Financial Instruments : Disclosures; specifies comprehensive
• Quantitative & qualitative risks disclosure requirements for financial instruments
• Hedge Accounting Norms
• Ind AS 109 Financial Instruments
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Phase I from 1 Apr. ‘16 : Listed or unlisted companies (net worth >= INR 500 Crs) Phase 2 from 1 Apr. ‘17: Listed companies (net worth < INR 500 Crs); Unlisted companies (networth >= INR 250 Crs but < INR 500 Crs)
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INITIATIVES FROM SEBI
• Enhanced LODR w.r.t commodity price risk and its management
• Listed companies to disclose commodity price risks and commodity hedging activities in AR (Cir. dt. Sep 2, 2015)
• Format prescribed by SEBI (Cir. dt. Nov. 15, 2018)
• All listed entities shall make the
disclosures in a prescribed format as part of the Corporate Governance Report in the Annual Report under clause 9(n) of Part C of Schedule V.
• Strengthened RMS in domestic exchanges and Oversight over intermediaries
• Permitted foreign entities having exposure to Indian commodity markets in domestic commodity derivatives markets • Entities classified as ‘Eligible Foreign Entities’
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INDIAN COMMODITY DERIVATIVES MARKETS – REGULATORY OVERVIEW
• National online multi commodity exchanges started operations during 2003-04
• Under SEBI regulations since September 28, 2015
• Futures contracts on commodities are predominantly traded
• Options commenced from Oct. 17, 2017.
• AIF Cat III is the first institutional investor permitted to participate
• Custodians permitted to offer services for commodity derivatives and ‘goods’
• SEBI Board approved participation of Mutual Funds and Portfolio Managers in commodity derivatives
• Universal Exchanges : Single exchange operating various segments w.e.f October 1, 2018
SEBI
Stock Exchanges
Members
Clients
COMMODITIES TRADED ON NATIONAL EXCHANGES
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BULLION Gold, Silver, Diamond
ENERGY Crude Oil Natural Gas
METALS & ALLOYS Aluminium, Copper, Lead Nickel, Zinc, Brass , Steel
AGRICULTURAL Grains: Barley, Maize, Wheat Spices: Black Pepper, Cardamom, Coriander, Jeera, Turmeric
Fibre: Cotton (Bales), Kapas, Raw Jute
Oil Complex: Castorseed, CPO, Soybean, Soyoil, RBD Palmolein
Others: Guarseed, Guargum, Mentha Oil, Isabgul, Rubber, Sugar
91 notified commodities; 36 commodities traded on futures segment
HEALTHY TRADING IN COMMODITY FUTURES & EMERGING COMMODITY OPTIONS
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Avg. Daily Futures Turnover (Rs. Crs)*
Commodity 2018-19 2017-18
GOLD 3,393 2,876
SILVER 2,497 2,493
CRUDE OIL 8,169 5,693
NATURAL GAS 1,367 1,365
COPPER 2,388 1,840
LEAD 1,550 1,564
NICKEL 1,235 1,041
ZINC 3,546 3,109
ALUMINIUM 1,107 763
COTTON 177 162
CPO 135 167
MENTHA OIL 81 117 * on MCX
Avg. Daily Options Turnover (Rs. Crs)*
Commodities 2018-19 2017-18
All 1,80,945 10,354
* On MCX; Options trading launched in gold on MCX on October 17, 2017, followed by options trading in crude oil, copper, zinc, silver in phased manner.
Parameters Trading
Unit Price
Quote Tick Size
Basis Centre
No. of Contracts in
a Year
Max Contract Duration
(in months)
Delivery Logic
Gold 1 Kg Rs/10g Re 1 Ahmedabad 6 12 Physical
Gold Mini 100 g Rs/10g Re 1 Ahmedabad 12 4 Physical
Gold Guinea
8 g Rs/8g Re 1 Ahmedabad 12 4 Physical
Gold Petal 1 g Rs/1g Re 1 Mumbai 12 4 Physical
Silver 30 kg Rs/Kg Re 1 Ahmedabad 5
12
Physical
Silver Mini 5 Kg Rs/kg Re 1 Ahmedabad 5 Intention Matching
Silver Micro 1 kg Rs/Kg Re 1 Ahmedabad 5
BULLION FUTURES
Parameters Trading
Unit Price
Quote
Tick Size (Rs)
No. of Contracts in a Year
Max Contract Duration
(in months) Delivery Logic
Light sweet Crude Oil
100 Barrels
Rs./bbl 1 12 5
Cash Settlement Crude oil Mini 10
barrels Rs./bbl 1 12
Natural Gas 1250
mmBtu Rs./mm
Btu 0.1 12 3
Aluminium 5 MT Rs/Kg 0.05 12 5
Physical Alu. Mini 1 MT Rs/Kg 0.05 12 Physical (from June expiry) Copper 1 MT Rs/Kg 0.05 5
6 Intention Matching Copper Mini 250 Kg Rs/Kg 0.05 5
Lead 5 MT Rs/Kg 0.05 12
5
Physical (from June expiry) Lead Mini 1 MT Rs/Kg 0.05 12 Intention Matching
Nickel 250 Kg Rs/Kg 0.10 12 Physical (from June expiry) Nickel Mini 100 Kg Rs/Kg 0.10 12 Intention Matching
Zinc 5 MT Rs/Kg 0.05 12 Physical Zinc Mini 1 MT Rs/Kg 0.05 12 Physical (from June expiry)
FUTURES IN ENERGY AND BASE METALS
Parameters Basis Centre Trading
Unit Price
Quote Tick Size
No. of Contracts in a Year
Max Contract Duration
(in months)
Delivery Logic
Cotton Rajkot 25 bales Rs/bale Re 1 10 6 Physical
CPO Kandala 10 MT Rs/10 Kg 10 p 12 5 Intention Matching
Mentha Oil Chandausi 360 kgs Rs./kg 10 p 12 6 Physical
Cardamom Vandanmedu 100 Kg Rs/Kg 10 p 12 5 Physical
A FEW AGRI. FUTURES CONTRACTS
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USE COMMODITY DERIVATIVES TO TACKLE A FEW CHALLENGES OF SCM
• Price volatility risk can potentially threaten the mere survival of firm in current era of ever-increasing competition, if not managed appropriately.
• Research studies suggest the use of commodity derivatives to tackle a few challenges of SCM esp. linked to price volatility • Shi, Daniels & Grey (2003) shows how options enhance information flows, encourage risk sharing, and improve
supply chain efficiency1.
• Maamoun (2015) finds that use of financial derivatives in supply chain risk management is better when facing high levels of price volatility2.
• Addition of commodity options trading to existing robust commodity futures trading on domestic
exchanges – Firms can now better customize their price risk management strategies with in-built forex hedge.
1 IBM Research Report 2 School of Graduate Studies, CONCORDIA UNIVERSITY
THANK YOU!