Delivery contracts will aid price discovery: Sandeep Daga

Recent initiatives by SEBI and the launch of deliverable contracts will bring more participation: Director, Regsus Consulting

Introduction of deliverable contracts on the MCX and the opening of the derivative market to institutional investors were welcomed as major developments in the commodity market. Talking to BusinessLine about the importance of hedging, Sandeep Daga, Director at Regsus Consulting (for hedging of base metals), says the recent initiatives by the market regulator improves the liquidity in the exchange and helps in price discovery based on domestic market demand-supply. Excerpts:

Do you see more corporates showing interest in hedging for commodity exposure?

I think awareness on risk management has been rising over the years. As companies grow in size, they want to gradually reduce the risk of market volatility. When a company is small in size, you can put your capital at risk, but when you grow, you want to lock in a margin for yourself. So, risk management becomes important.

Commodity exchanges have launched delivery-based metal contracts. Do you see any benefits?

There are several advantages of a deliverable contract. Every country has its own demand and supply dynamics, leading to domestic prices for commodities. These prices could be linked with international benchmarks, but are overridden by domestic conditions. Let’s take some examples. When Vedanta’s copper smelter closed down last year, the domestic premium for copper soared, and thereby, domestic prices of copper rose above landed cost. This resulted in surge in imports.

Take zinc. In the past few months, its prices in India have been suppressed because of slowing domestic demand. Domestic prices have been ruling at discount to international price as deficit persists globally. This is slowing down imports to India. Same is the story for aluminium. India has added new capacities in aluminium over the last few years, and an oversupply pulled down the premiums below the international benchmark. But till recently, there was no contract in India recognising the domestic supply-demand scenario.

A delivery-based contract will not only help in exploring and establishing the ‘India’ price of metals but also make them hedgeable for the metal industry. Moreover, exchange-approved warehouses provide a good avenue for traders to park their surplus inventories and get those financed.

Hedgers were using the commodity exchange platform earlier, too, when there was no option to take delivery. So, with domestic price discovery and deliverables contract, what changes?

I think the introduction of delivery is an important development. Delivery into the Indian exchanges improves their standing on the global arena. Global investors can look at Indian prices, compare those with respective contracts in the LME (London Metal Exchange) and gauge whether the Indian market is in deficit or over-supply. Currently, too, anyone can know the India price by connecting with someone in the physical market. But an exchange contract provides it not only visibility but also an independent method of price exploration. This benefits everyone.

Secondly, a domestic deliverable contract brings the benefit of locking in a price and thus margins. For example, if somebody is importing a metal into India based on the ongoing premium that the domestic market offers, in the absence of a domestic delivery contract, one has to hope that by the time the imported metal arrives, the premium in domestic market holds.

SEBI recently allowed mutual funds and institutional investors in the commodity derivative market. Do you think this will help volumes go up?

I am not sure if the money is flowing into the commodity market from these investors already. But I think it’s an interesting development and a building block for the future of commodity derivative trading in India. In any exchange, three participants are essential — intra-day speculators, the hedging community and institutional investors. Intra-day traders have existed in the domestic bourses. Hedgers and institutional investors will now enter the market because of the delivery mechanism and the acceptance of institutional money, respectively. Over a period, the interplay of these two will lead to good liquidity in the contract and robustness in the price-discovery mechanism.

When corporates hedge on the platform, what are the few dos and don’ts that you will recommend?

The most important of all is to have a discipline in hedging. Sometimes, businesses convert hedging trades into a speculation and vice-versa to suit their convenience — this is bad. Hedging should be mapped against a certain exposure and should be continued irrespective of opportunity gain or loss. One realises the benefit of it in the long run.

Secondly, hedging requires some cash outlay because of mark-to-market margin calls. Such calls are common in futures hedging and could eventually even out. So, one has to keep some provisions and park some money for margin calls.

Also, a hedger should not look into the markets too closely. Companies should rather focus on their business, productivity and volumes. The underlying idea of hedging is to get away from speculating on prices.

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