120 India’s Financial Markets
of Indian gold futures loss/profits on the London Bullion Market Association
price of 995 purity gold.
Spot as well as derivative markets for commodities have existed in India for
centuries. However, the traditional markets were local markets built for local
access, spread all across the length and breadth of the country. In the tradi-
tional Indian commodity derivatives markets, instead of one exchange trading
multiple commodities, each commodity would have multiple exchanges. Each
exchange would be set up in, or close to, the region where the commodity
was produced. As elsewhere in the world, all the exchanges were associations
of brokers. Today, these markets are very different due to some liberalization
in the underlying product markets and the reforms in the financial sector.
The regulatory framework for commodities means that spot markets are still
localized, with multiple markets all over the country.
The government still
has power to control the supply and the pricing of several commodities in
the country. However, with dropping trade barriers, prices of most com-
modities are determined by import parity pricing, rather than solely by local
In the case of commodity derivatives markets, reforms have seen a more
significant development of institutions that enable a manifold increase in the
size and accessibility of commodity derivatives in India. These developments
started at the end of 2003, and the commodities markets are still in the pro-
cess of transition toward an equilibrium between the spot and the futures
The traditional commodity derivatives exchanges were organized as local
open-outcry marketplaces with broker-owners that co-ordinated the order flow
between buyers and sellers. Often, the futures markets traded a single com-
modity, such as cotton, chana or chile peppers. These have traditionally served
as localized pools of liquidity and price discovery. Such fragmentation meant
that there was little progress toward standardization of grades of commodities
or toward the development of a benchmark price for any single commodity.
This is discussed more in Section 7.5 on the regulatory and legal framework for commodity spot
and derivatives markets.
Commodity Futures Markets 121
The structure of the market today has changed. There are now 24 commodity
derivatives exchanges in India. In addition to the older local, open-outcry
exchanges, generally focusing on a single commodity, there are three elec-
tronic exchanges today which offer a single trading and clearing platform across
the nation.
1. National Multi-Commodities Exchange (NMCE) in Ahmedabad, Gujarat
2. Multi-Commodities eXchange (MCX) in Bombay
3. National Commodities Derivatives EXchange (NCDEX) in Bombay
These exchanges are unlike the traditional exchange in almost every aspect: they
are owned by financial entities rather than by brokers. Regulations mandate that
a single entity can own more than 10% equity in an exchange. This makes for a
dispersed shareholding that includes foreign ownership as well. For example,
Fidelity International is a shareholder in MCX and the Goldman Sachs Group
has invested in NCDEX. The new exchanges all trade multiple commodities.
For the commodities they trade, the new exchanges have become the best source
of liquidity. When a commodity trades on one of the new national exchanges,
traded volumes tend to move away from the traditional local exchange that
used to be the center of liquidity for that commodity onto the new national
The exchanges run trading sessions during the same trading hours between
A. M. and 3:30 P. M . In addition, the new electronic exchanges also run trading
sessions for a limited set of commodities in the evening hours between 6
P. M .
and 8 P. M . (All of India is on the same time zone, which is GMT + 5.5 hours.)
On the new electronic exchanges, the order flow comes from all across the
nation onto a single electronic order book, where the orders are matched into
trades by a computer on the principle of price–time priority. The electronic order
book has anonymous orders to buy and sell. This set of orders is visible to all
market participants. Thus, for the first time in the country, both the orders as
well as the traded prices for commodity derivatives are visible in real-time. The
accessibility of the electronic order book on a common national platform has
led to an unprecedented level of transparency of commodity trading in India.
Superior levels of price transparency have become available not just for the
futures contracts but also for the underlying spot market prices (as described
in Section 7.3.2). The transparency and the accessibility of the prices has led to
the futures markets prices gradually becoming the benchmark that traders use
to price their trades on the spot market.
This makes for a fiercely competitive environment among the exchanges.
The exchanges can compete in terms of what products they can trade futures
on. Further, when the same underlying is traded on multiple exchanges, the
specifics of the contracts that each trade are often slightly different in an attempt

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