The article starts with an overview of the recent ruling by The Securities and Exchange Board of India (SEBI), banning derivative trade of multiple agricultural commodities. This decision is expected to have far-reaching consequences for the Indian agricultural market and its stakeholders.
The SEBI: A Brief Introduction
Established on the 12th of April, 1992, SEBI operates under the Securities and Exchange Board of India Act, 1992. Its primary role is to protect investors in securities and regulate the securities market. Most recently, it has banned the derivative contracts trade in various agricultural commodities for a year on the future’s platform of National Commodities and Derivatives Exchange (NCDEX).
Understanding the Reasons Behind the Ban
SEBI’s ban was implemented to combat rising Food Inflation that rose to 4.91 % in November 2021 due to a significant increase in food inflation. Another reason behind the ban was the double-digit Wholesale Price Index-based inflation for eight consecutive months, primarily fuelled by rising prices of food items. Furthermore, this stringent move aims to protect the market from any future price shocks resulting from possibly compromised Rabi Output due to recurrent fertiliser shortages.
Predicting the Impact of the Ban
This abrupt suspension will inevitably affect the market dynamics before the arrival of the rabi crop. Traders will likely lack future sentiment references, thereby putting importers, who depend on derivative markets to protect themselves from price fluctuations, at increased risk.
All About Derivatives
In finance, a derivative is a contract drawing its value from an underlying entity’s performance such as an asset, index, or interest rate. Common types of derivatives include Forwards and futures, Options, and Swaps. While they offer several advantages like hedging risk exposure or determining an underlying asset’s price, they also have high-risk, inherently speculative features and are susceptible to counterparty default risk.
The Significance of Derivatives
Derivatives are crucial for efficient financial markets as they offer risk hedging, assist in determining the price of the underlying asset, contribute to market efficiency, and provide access to otherwise unavailable assets or markets. Despite their advantages, they pose significant risks, namely high volatility, complicated valuation processes, speculative features, and potential counterparty default.
Dissecting the Issues with Derivatives
Derivatives present several challenges, including inherent high risk due to their high volatility and complex design. They are also viewed as a speculative tool, potentially leading to significant losses. Another key concern is the counterparty risk associated with certain over-the-counter contracts, lacking a due diligence benchmark, leading to possible counterparty defaults.
About National Commodities and Derivatives Exchange
NCDEX is an online commodities exchange primarily dealing with agricultural commodities in India. Established on 23rd April 2003, it was founded by leading financial institutions like ICICI Bank Limited, the National Stock Exchange of India, and the National Bank for Agricultural and Rural Development, among others. With an independent board of directors overseeing its operations, NCDEX lists 25 contracts for agricultural products.