Commodity Exchanges Lecture 5 & 6 PDF

Commodity Exchanges- Intermediation, Institutions, and Products By Dr. V. Shunmugam  Recognized Stock Exchange – Legal Framework Exchange MOA & AOA Exchange Rules...

Commodity Exchanges- Intermediation, Institutions, and Products By Dr. V. Shunmugam  Recognized Stock Exchange – Legal Framework Exchange MOA & AOA Exchange Rules & Regulations, Business Rules, Bye-laws SCRA 1956 & SEBI Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 2 2 Session 15: Commodity Exchanges in India  Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 (1/4) Provides for: 1) Recognition of Exchanges and Clearing Corporations No person shall conduct, organise or assist in organising any stock exchange or clearing corporation unless he has obtained recognition from the Board. An application for recognition shall be accompanied by: - A copy of the memorandum of association - Articles of association - Bye-laws and other documents as provided in the regulations. An applicant should be- a company limited by shares – demutualized – fit and proper shareholders and directors – satisfy the ownership and governance structure as provided in the regulations - specified networth requirements – Capability including (financial capacity functional expertise and infrastructure) Session 15: Commodity Exchanges 3 in India  Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 (2/4) Ownership of Stock Exchanges and Clearing Corporations - Public shareholding – not less than 51 % - Individuals – not more than 5 percent - Stock Exchange/Depository/Banks/Insurance Firms/Public Financial Institutions – up to 15 percent - Non Residents – not more than 5 percent - Foreign Stock Exchange/Depository/Banks/Insurance Firms/Commodity Exchanges/Central Govt Approved Multilateral Financial Institutions – up to 15 percent - Combined holding of foreign investors – at any point of time – Shall not exceed 49 percent - No clearing corporation shall hold any right, stake or interest, of whatsoever nature, in any recognised stock exchange Session 15: Commodity Exchanges 4 in India  Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 (3/4) Governance of Stock Exchanges/Clearing Corporations The governing board of every recognised stock exchange and clearing corporation shall include: (a) Shareholder directors; (b) Public interest directors; and, (c) Managing Director - The number of public interest directors shall not be less than the number of shareholder directors Code of Conduct for directors and key management personnel Compensation and tenure of key management personnel Statutory Committees - Functional - SGF Committee Fund - Grievance Redressal Committee – Nomination and Remuneration Committee - Oversight – Standing Committee on Technology – Advisory Committee – Regulatory Oversight Committee – Risk Management Committee Session 15: Commodity Exchanges 5 in India  Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 (4/4) - Obligation of CC in Commodity Derivatives – Shall ensure Good Delivery - delivery of goods that is in proper form to transfer title and is of the quality and quantity as per contract specifications of the concerned exchange - Right of Clearing Corporations - to recover the dues from its clearing members, arising from the discharge of their clearing and settlement functions, from the collaterals, deposits and the assets of the clearing members, shall have priority over any other liability of or claim against the CM - Settlement and netting – Settlement shall be final, binding, and irrevocable - The Payment and Settlement - shall be determined in accordance with the netting or gross procedure as specified in the bye-laws - Listing of Securities - Inspection Enquiries and Enforcement Session 15: Commodity Exchanges 6 in India  Exchange – Bye Laws (1/3) Relevant Authority shall have powers to frame Business Rules/Regulations from time to time for efficient functioning and operations of the Exchange Relevant Authority, from time to time, amend, add to, alter, modify, delete or repeal any of the provisions of the Business Rules/Regulations, as may be deemed necessary or appropriate or if so desired or directed by the SEBI. Without prejudice to the generality of the Bye-laws of the Exchange, Rules, Business Rules/ Regulations shall provide inter alia for necessary authorization for taking care of operational requirements, which need to be enforced with immediate effect. Trading, clearing and settlements on the exchange Transactions in exchange subject to risk management & Surveillance Clearing and settlement of transactions Session 15: Commodity Exchanges Setting-up of settlement guarantee fund, client7 in India protection fund and other funds  Exchange – Bye Laws (2/3) Relevant Authority shall have powers to frame Business Rules/Regulations from time to time for efficient functioning and operations of the Exchange o Conciliation and arbitration o Power to prescribe enabling provisions o Jurisdiction o Location for arbitration between members of the exchange, other intermediaries and clients o Records for evidence o Governing language o Secrecy or confidentiality o Disclaimer, severability, force majeure CONTRACTS – Members shall execute and clear transactions in only such contracts as specified by the Board and approved by the SEBI. Trading on the exchange Trading system Surveillance, market watch system, investigation and exchange members database 8 Session 15: Commodity Exchanges in India  Exchange/CC – Bye Laws (3/3) Clearing House of the Exchange Margins Clearing and Settlement Delivery Reports Settlement Guarantee Fund Investor (Client) Protection Fund Clearing Limits Code of Conduct Investor Service Centre (ISCs) Investor Grievance Redressal Arbitration Session 15: Commodity Exchanges 9 in India Trading - Flow Chart 10  Introduction SEBI designed processes that had multiple checkpoints by creating commodity market intermediaries. In India, there are four primary intermediaries in the commodity derivatives market: Stock Broker Repository or Repository Participant Bank Clearing Corporation In the market parlance, who is a Member? A member is a brokerage firm (or broker) that has been granted membership on an Membership - Introduction Membership of Commodity Derivatives Exchange is governed by the SEBI Stock Brokers Regulation. The Regulation prescribes Procedures of grant of recognition of member Different types of members Networth criteria Deposit for these members’ fees and Charges for different categories of members Membership - Overview Commodity Exchanges prescribe different eligibility criterion for different classes of membership. While admitting members, the commodity exchanges generally take into account specific factors. An applicant for commodity exchange membership must possess the minimum stipulated networth. The networth varies across commodity exchanges as per their rules, regulations and bye-laws. The membership categories are more or less similar across the exchanges. However, vary considerably on criteria of the membership in terms of 13 deposit/networth requirements, Membership – Eligibility Criteria The following persons are eligible to become members: Individuals Sole proprietorships Partnership Firms Registered under Indian Partnership Act, 1932 Limited Liability Partnership firm(LLP) registered under limited liability partnership Act,2008 Companies, Corporations or institutions 14 Membership – Eligibility Criteria The applicant should comply the following requirement: Minimum Age of Individual / proprietor / partner / directors should be 21 years Minimum education qualification of Individual/proprietor/one of the partner/one of the director should be at least a graduate or having an equivalent qualification or adequate experience in commodities/financial markets Two designated directors/partners should be at least HSC or equivalent qualification and should have minimum 2 years’ experience in commodities market. All corporate members should have minimum paid up capital of Rs. 30 Lakhs.15 Eligibility Conditions for Membership Eligibility Conditions for Membership Indian National Age not less than 21 years Net worth requirements as prescribed by the Exchange from time to time Registration with SEBI Member is activated for trading on receipt of Unique Membership Code (UMC) from SEBI Provisions - Ineligibility to become a Member No person shall be admitted as a Member of the Exchange if such proposed member: Is an individual who has not citizenship of India Is a body corporate who has committed any act which renders the entity liable to be wound up under the provisions of the law Is a body corporate who has had a provisional liquidator or receiver or official liquidator appointed to the person Has been adjudged bankrupt or a receiving order in bankruptcy has been made against the person or the person has been proved to be insolvent even though he has obtained his final discharge Has been convicted of an offence involving a fraud or dishonesty 17 Provisions - Ineligibility to become a Member Has compounded with his creditors for less than full discharge of debts; Has been at any time expelled or declared a defaulter by any other Commodity / Stock Exchange / Clearing Corporation; Has been previously refused admission to membership unless the period of one year has elapsed since the date of rejection; Incurs such disqualification under the provisions of the SEBI Stock Brokers Regulation or Rules made there under as disentitles such person from seeking membership of a commodity exchange. Exchange determines that it is not in public interest to admit him as Member of Exchange. 18 Membership Admission Process Submission of Application Form along with Documents & Payments Processing of Applications Interview before the Membership Selection Committee Admission as a member by an Exchange Submission of Application to SEBI for Registration Receiving Registration from SEBI Activation of Trading Rights 19 Types of Membership Types of Membership Trading Member (TM) Trading-cum-Clearing Member (TCM) Institutional Trading-cum- Clearing Member (ITCM) Professional Clearing Member (PCM) Trading Member (TMs) A Trading Member / Stock Broker can trade either on their own account or on behalf of the clients. This category of membership entitles a member to execute trades on his own account as well as for clients registered with him. The clearing and settlement of the trades is done through a clearing member. TMs will have to get affiliated with any one of PCM/STCM for clearing their trades/transaction. TM – Entities Eligible Corporates Registered Partnership Firms Limited Liability Partnerships registered under the Limited Liability Partnership Act, 2008 (LLPs) Sole Proprietors/Individuals (Proprietary Firms) 22 TM – Eligibility Criteria Criteria Particulars For Non Corporate (Individuals/Partnership Firm/ Minimum Net-worth LLP/HUF) Rs. 10 Lakh For Corporates - Rs.25 Lakh Without Algo With Algo Base Minimum Capital * (BMC) trading Facility trading Facility BMC - Interest free cash deposit Rs.2.5 Lakh Rs.12.5 Lakh BMC - Cash Equivalent (In the form of Cash/Bank Rs.7.5 Lakh Rs.37.5 Lakh Guarantee/Fixed Deposit) Interest Free Cash Rs. 10 Lakh Deposit(IFSD) Admission Fee (onetime, non- refundable) Rs 5.00 Lakh (With applicable Tax) Annual Membership Fees (With Rs. 0.20 Lakh applicable Tax) SEBI Registration Fees Rs. 0.50 Lakh SEBI Annual Regulatory Fees NIL 23 Trading cum Clearing Member (TCM) Self Clearing Members (SCM) / Trading cum Clearing Member (TCM) This category of membership entitles a member to execute trades on his own account as well as for his clients. TCMs can also clear and settle these trades themselves. Clearing members are members of the clearing corporation. They carry out risk management activities and confirmation/inquiry of trades through the trading system. Most of the members of the commodity derivatives exchanges operate as Trading cum Clearing Members(TCMs) of more than one exchange. TCM – Entities Eligible Corporates Registered Partnership Firms Limited Liability Partnerships registered under the Limited Liability Partnership Act, 2008 (LLPs) Sole Proprietors/Individuals (Proprietary Firms) 25 TCM – Eligibility Criteria Criteria Particulars Minimum Net-worth Rs. 100.00 Lakh Base Capital - Interest Free Cash Rs. 25.00 Lakh Deposit Base capital – Cash Equivalent (In the form of Cash/Bank Guarantee/Fixed Rs. 25.00 Lakh Deposit/Government of India Securities) Without Algo With Algo Base Minimum Capital *(BMC) trading trading Facility Facility BMC - Interest free cash deposit Rs.2.5 Lakh Rs.12.5 Lakh BMC - Cash Equivalent (In the form of Rs.7.5 Lakh Rs.37.5 Lakh Cash/Bank Guarantee/Fixed Deposit) Interest Free Cash Deposit(IFSD) Rs. 10 Lakh Admission Fee (onetime, non- Rs. 5.00 Lakh refundable) (With applicable Tax) Annual Membership Fees (With Rs. 0.75 Lakh applicable Tax) SEBI Registration Fees Rs. 0.50 Lakh SEBI Annual Regulatory Fees Rs. 0.50 Lakh 26 Institutional Trading cum Clearing Members (ITCM) Institutional trading cum clearing members (ITCM) / Strategic trading cum clearing members (STCM) are entitled to trade on their own account as well as on account of their clients, clear and settle trades executed by themselves as well as of trading members and trading cum clearing members of the Exchange. Eligible Entities: Companies or Institutions ITCM / STCM – Eligibility Criteria Criteria Particulars Minimum Net-worth Rs. 300.00 Lakh Base capital - Interest Free Cash Deposit Rs. 20.00 Lakh Base capital - Cash Equivalent (In the form of Cash/Bank Guarantee/Fixed Rs. 50 Lakh Deposit/Government of India Securities) Without Algo With Algo Base Minimum Capital * (BMC) trading trading Facility Facility BMC - Interest free cash deposit Rs.6.25 Lakh Rs.12.5 Lakh BMC - Cash Equivalent (In the form of Rs.18.75 Rs.37.5 Lakh Cash/Bank Guarantee/Fixed Deposit) Lakh Interest Free Cash Deposit(IFSD) Rs. 10 Lakh Admission Fee (onetime, non- Rs. 5.00 Lakh refundable) (With applicable Tax) Annual Membership Fees (With Rs. 1.00 Lakh applicable Tax) SEBI Registration Fees Rs. 0.50 Lakh SEBI Annual Regulatory Fees Rs. 0.50 Lakh 28 Professional Clearing Member (PCM) A professional clearing member is entitled to clear and settle trades executed by other members of the commodity exchanges (TMs/ TCMs). PCMs are not allowed to trade on the Exchange platform. A professional clearing member is a clearing member who is not a trading member. Typically, banks and custodians become professional clearing members and clear and settle for their trading members. Eligible Entities: Companies or Institutions PCM – Eligibility Criteria Criteria Particulars Minimum Net-worth Rs. 100.00 Lakh Base capital - Interest Free Cash Security Rs. 25.00 Lakh Deposit Base capital - Collateral Security Deposit in the Rs. 25.00 Lakh form of Bank Guarantee/Fixed Deposit Receipt Base Minimum Capital – Interest Free Cash Not Applicable Security Deposit Base Minimum Capital – (Collateral Security Deposit in the form of Bank Guarantee/Fixed Not Applicable Deposit Receipt) Admission Fee (onetime, non-refundable) (With Rs. 5.00 Lakh applicable Tax) Annual Membership Fees (With applicable Tax) Rs. 1.00 Lakh SEBI Registration Fees Rs. 0.50 Lakh SEBI Annual Regulatory Fees Rs. 0.50 Lakh 30 Authorized Persons(APs) SEBI Board in its meeting held on June 21, 2018 decided that sub-brokers as an intermediary shall cease to exist with effect from April 01, 2019. All existing sub-brokers would migrate to become Authorised Persons (APs) or Trading Members, if the sub-brokers meet the eligibility criteria prescribed under Stock Exchange bye-laws and SEBI Regulations and by complying with these Regulations.  Collateral Valuation Matrix Collateral Permitted Components Remarks / limit Category Cash Cash Full Limit Cash Equivalent Bank Guarantee ​Full Limit Fixed Deposits Eligible Government Securities ​ overned by the upper cap as G Eligible Securities - Units of at Mutual Fund Schemes Liquid individual security level Funds overall security level Non Cash Eligible Securities & Units of Governed by the upper cap as Collateral Mutual Funds Schemes other at than Liquid Funds individual Warehouse Receipts security/commodity level overall Interest Free Security Deposit (in ratio of 1:1): Minimumsecurity/commodity 50% in the form of Cash and balance in the form of FD/BG; level Also restricted up to sum total Base Minimum Capital(in ratio of 1:3): No Exposure; 25%and in Cash andcash Balance of Cash Eligible 75% in FD /BG equivalent. 32 Member’s Responsibility (1/2) Ensure maintenance of minimum of net-worth requirement Member’s Obligations with respect to all acts of Authorized Person Maintenance of necessary Books of Accounts/Documents/ Records Members required to follow Uniform client registration process and ensure KYC for all their clients Margin Collections from the clients Maintain high standards of integrity, promptitude and fairness in the conduct of all his business. Exercise Of Due Skill And Care 33 Member’s Responsibility (2/2) Not indulge in manipulative, fraudulent or deceptive transactions or schemes or spread rumours Issue Of Contract Note Refrain from Breach Of Trust - Not to disclose/ discuss information of the client with others Adequate training of staff & arrangements to render fair, prompt & competent services to his clients Protection of Clients Interests Not resort to unfair means of inducing clients from other stock- brokers 34 Member Compliance Member Compliance Code of Advertisement SEBI Turnover Fees Stamp Duty Member Disclosures Compliance Handbook Compliance Calendar Compliance Training Client Registration Documents System Audit Compliances Cyber Security  Enhance the Participation in CDM Formation of CDAC (Commodity Derivative Advisory Committee) Permit new participants on ETCD Phase-1: – Alternate Investment Fund (Category-3) - 2017 – Portfolio Management Service- 2019 – Mutual Funds- 2019 – Direct participation of Foreign participants having exposure to commodities Phase-2: – Banks – Insurance/reinsurance Companies – Foreign Portfolio Investors – Pension Funds  Amendment of Regulations Following changes were made to enable participation of institutional investors in commodity derivatives markets Appropriate amendments to SEBI (Mutual Funds) Regulation, 1996 SEBI (Portfolio Manager) Regulations, 1993 SEBI (Custodian of Securities) Regulations, 1996  Cat III AIFs - Participation in Commodity Derivatives Market Category III AIFs may participate in all commodity derivatives products as ‘clients’ and shall be subjected to all the rules, regulations and instructions, position limit norms as may be applicable to clients. Shall invest not more than ten per cent of the investable funds in one underlying commodity The leverage of a Category III AIFs may not exceed two times of the NAV of the fund Must appoint a custodian regardless of the size of the corpus. May be open ended or closed ended. Make disclosures in a private placement memorandum issued to investors about investment in commodity derivatives and should take consent of the existing investors if such AIFs intend to invest in such derivatives.  Guidelines on ETCD - Mutual Fund Permissible Mutual Fund Schemes: Hybrid schemes, which includes Multi-Asset Scheme Gold ETFs Investment Limit: Single commodity is permitted up to 10% of Scheme AUM Aggregate Exposure to ETCDs (As % of Scheme AUM) Multi Assets Allocation Scheme – up to 30% Other Hybrid Schemes – up to 10% Limits for GOLD ETF Cumulative Exposure to Gold Related Instruments – up to 50% Cumulative Exposure Gold Deposit scheme or Gold Monetisation Scheme – up to 20%  Guidelines on ETCD - Mutual Fund Allowed to invest in all commodity derivatives except ‘Sensitive Commodities’ Mutual fund schemes cannot invest in physical goods except in ‘gold’ through ETFs Funds may hold the underlying goods in case of physical settlement of contracts Mutual funds to dispose of Physical goods from the books of the scheme, within 30 days from the date of holding the physical goods or next immediate derivative contract. In case of Gold & Silver Physical commodity can be held up to 160 days No Net short positions in ETCDs on any good including physical and Commodity derivative positions Dedicated Fund Manager with skills and experience in Commodities Market Appoint a custodian registered with the Board for custody of the underlying goods, arising due to physical settlement of contracts. Institutional Participants in ETCD – Dos and Don'ts Mutual Funds Dos Permitted to participate in ETCDs in India, except in commodity derivatives on ‘Sensitive Commodities’. MFs are permitted to participate through Hybrid schemes (includes multi asset scheme) and Gold ETFs. MF schemes participating may hold the underlying goods in case of physical settlement of contracts (timeline prescribed regarding dispose of such goods from books). Prior to participation in ETCDs, the AMCs shall adhere to certain conditions. (Appoint fund manager, custodian, investment and valuation policies) Before investing in GDS of Banks, GMS and ETCDs having gold as the underlying, … written policy and approval (Board of AMC, Trustees) MF schemes (position limit of client level) & MF level (TM position limit) Participation of MFs in ETCDs shall be subject to investment limits Don’ts No Mutual fund schemes shall invest in physical goods except in Institutional Participants in ETCD – Dos and Don'ts Portfolio Management Services (PMS) Dos Portfolio Managers are permitted to participate in ETCD on behalf of their clients’. Compliance with all the rules, regulations including SEBI (Portfolio Managers) Regulations, 1993 and position limit norms as may be applicable to ‘clients’. Responsibility of liquidating the physical goods shall be with the Portfolio Manager. Portfolio Managers shall report the exposure in ETCD in the monthly reports submitted to SEBI. Mandatory for Portfolio Managers to appoint SEBI registered Custodian before dealing in ETCD. Don’ts Portfolio Managers shall not onboard Foreign Portfolio Investors until they are permitted to participate in ETCD. Institutional Participants in ETCD – Dos and Don'ts Eligible Foreign Entities (EFEs) Dos Foreign entities having actual exposure to the Indian commodity markets allowed to hedge their actual exposure. Eligible commodities – All commodity derivatives except Sensitive Commodity, Compliance with the applicable norms prescribed by SEBI, RBI or any other statutory authority in India. Don’ts Tenor of the hedge shall not be greater than the tenor of underlying exposure. EFE shall not undertake any arbitrage/speculative transactions. Quota for hedging shall be used to only hedge/ unwind the hedge. Institutional Participants in ETCD – Dos and Don'ts Foreign Portfolio Investors (FPIs) Dos allowed to participate in cash-settled non- agricultural commodity derivative contracts and indices comprising such non-agricultural commodities. Eligible commodities – All commodity derivatives except Agricultural Commodities, Compliance with the applicable norms prescribed by SEBI, RBI or any other statutory authority in India. Don’ts Individuals, family offices, and corporates will be allowed a position limit of 20 percent of the client-level position limit in a particular commodity derivative contract. Exceed client-level position limits – if other than the above. Institutional Participants in ETCD – Dos and Don'ts Banks Dos Bank shall restrict itself only to clearing and settlement transactions done by the trading members/clients on the exchange. The bank may fulfil pay-in obligations arising out of trades executed by its clients. Pay-in obligations confined to its role as a PCM. Don’ts Bank shall not undertake trading in the derivative segment of the commodity exchange on its own account. No bank shall offer broking services for the CDS of SEBI recognized SEs except through a separate subsidiary set-up for the purpose or one of its existing subsidiaries. Opportunities for Commodity Value Chain Participants Introducing institutional investors in commodity derivatives markets brings lot of opportunities for entire “Commodity Value Chain” Investors- Retail and Corporate- Enhanced Portfolio Diversification Fund Managers- Effective diversification- Array of Commodities to invest in- Gold to Green Exchanges: Enhancement of liquidity, Open interests and Trading Volume- Derivative Contracts Trading and Clearing Members: New set of institutional clients to trade in Commodity Derivatives Warehouse Service Providers/Vault Service Provider: Business opportunity in storing goods Product Distributors: New Product offerings  Warehousing Comprehensive warehousing norms prescribed by SEBI for adherence by Warehouse Service Provider, warehouses, assayers & allied service providers Financial safeguards – Minimum networth prescribed – Security deposit to guarantee performance Corporate governance safeguards Not to participate in the derivatives market of the commodity Fit and Proper Criteria Infrastructural standards for the warehouses approved Only WDRA accredited warehouses to be accredited 47  Custodian Role Maintaining accounts of commodity balances as electronic balances/ title documents as prevalent in the exchange-accredited WSP ecosystem Physical goods safe-keeping –setting up vaulting agents, WSPs under contract for storage Asset Servicing o Notifications to clients regular basis specifying the upcoming expiry dates and any actions necessary on commodity balances o Record keeping, reconciliations and providing holding statements o Internal, regulatory and statutory audit support o Confidentiality and data protection Transaction processing o Trade capture, matching and delivery tracking o Transfer of collateral to the Clearing member for the purpose of clearing and settlement of contracts 48  Custodian Role Regulatory safekeeping –fiduciary responsibilities in the context of institutional investors who manage other people’s money o In their mandate to protect retail investors, regulators impose certain restrictions –Custodian is the trusted intermediary who holds the assets of financial institutions safe from any disposal not permitted under regulations. This is essentially regulatory safekeeping-a fiduciary responsibility to protect assets from illegal behavior. o Segregation of assets o Permissions to pledge/encumber assets or prohibitions thereto o Bankruptcy-remote mode of holding/safekeeping of assets o Macro-prudential limits –investment caps, derivative exposure limits, quotas, concentration limits, etc. o “Independent” custody –holding assets with a third-party (where the asset manager has no ownership or control ) Insurance coverage against all risks –WSP related as well as other Regulatory / Audit Reporting and Statutory Audit Certifications Adequate systems and infrastructure to cover commodity asset class operations, back-up and BCM arrangements etc. 49  Capital Market Intermediaries : Custodian Policy makers – Ministry of Finance Central Bank Capital Market regulator Banks Clearing Depository Stock House Exchanges Cleari Clearin Deposito Custodian Brokers ng g ry Bank Membe Participan rs Invest ts ors Custody areas Core Intermediate Value Add  Advisory Market Entry  FPI licence  Processing  KYC  Regulated Safekeeping  Physical  Off-shore assets Existing Areas  Trusted intermediaries  Lending Asset Servicing  Corporate Actions  Asset Diversification ( commodity)  Transaction Processing  Settleme Settlements  Clearing and nt Risk Management Finality 2  Operational Model / Workflow  Energy and index futures are cash settled contracts, hence no need for safekeeping services. However, due to regulatory requirements Custodian is still needed, with primary role as a banker for handling cash  Bullion, Metals and Agri-commodity contracts are physically settled - stored with Exchange-accredited Vaulting Agents and/or Warehouse Service Providers (WSPs)  Vaulting agents/WSPs are supervised by Exchanges, with rigorous accreditation standards, audit governance and SEBI supervision  Agri WSPs are regulated by WDRA (Warehousing Development & Regulatory Authority) – an independent Regulator  Electronic records are maintained by “repositories”, in partnership with Exchanges  For offering settlement services, a Custodian needs to set-up storage facility, using the exchange-accredited service providers Exchange Ecosystem Investor Broker Trading Platform Clearing & Deutsche Bank Settlement Electronic Repository Vaulting Deutsche Bank’s Agent Vaulting Agent  Custodian Role : Responsibility Scope 1. Maintaining accounts of commodity balances as electronic balances/ title documents as prevalent in the exchange- accredited WSP ecosystem 2. Physical goods safe-keeping – setting up vaulting agents, WSPs under contract for storage 3. Asset Servicing — Notifications to clients regular basis specifying the upcoming expiry dates and any actions necessary on commodity balances — Record keeping, reconciliations and providing holding statements — Internal, regulatory and statutory audit support — Confidentiality and data protection 4. Transaction processing — Trade capture, matching and delivery tracking — transfer of collateral to the Clearing member for the purpose of clearing and settlement of contracts 4  Custodian Role : Responsibility Scope 5. Regulatory safekeeping – fiduciary responsibilities in the context of institutional investors who manage other people’s money — In their mandate to protect retail investors, regulators impose certain restrictions – Custodian is the trusted intermediary who holds the assets of financial institutions safe from any disposal not permitted under regulations. This is essentially regulatory safekeeping- a fiduciary responsibility to protect assets from illegal behavior. — Segregation of assets — Permissions to pledge/encumber assets or prohibitions thereto — Bankruptcy-remote mode of holding/safekeeping of assets — Macro-prudential limits – investment caps, derivative exposure limits, quotas, concentration limits etc — “Independent” custody – holding assets with a third-party (where the asset manager has no ownership or control ) 6. Insurance coverage against all risks – WSP related as well as other 7. Regulatory / Audit Reporting and Statutory Audit Certifications 8. Adequate systems and infrastructure to cover commodity asset class operations, back- up and BCM arrangements etc. 5  Commodity Custody : Key Risks  Commodity market model  Complexity of deliveries across multiple locations and WSPs  Prevalent allocation model may result in unplanned “uncovered” deliveries  Good-delivery verification issues in physical commodity world –reliance on exchange-supervised process  Quality deviation and shelf-life – from asset servicing perspective  Transit Risk  Safekeeping Risk & Mitigation  physical storage risk with vaulting agent/WSP  Vendor risk  Physical delivery percentage is seen to be a minor percentage of total volumes long position in futures – Long put -> short position in futures – Short call -> short position in futures – Short put -> long position in futures Exercise Style – European Strikes – Minimum of Three in ITM and OTM and 64  Options on Goods Eligibility – – Exchange either is already trading the futures contracts or is proposing to launch the futures contracts on or before the day of launching option in those goods Commodity Futures Contracts of a Specified Month Settlement – On exercise: – delivery of goods Exercise Style – All exercise style are permitted (European / American style) Strikes – Minimum of Three in ITM and OTM and one ATM Exercise – ATM and 2 CTM – All ITM 65 What is an index futures contract? A contract that facilitates the purchase or sale of an underlying index at a fixed price for delivery on a future date. In actuality, index derivatives contracts are cash settled in India. How commodity indices work? Commodity indices group together individual commodities to make a commodities ‘basket’. The indices track the underlying prices of the commodities within that index. If the individual commodity prices in that index increase, then the value of the index will go up. Conversely, if the individual commodity prices decrease, then the value of that index will fall. 66  Why Index Trading? Commodity index trading can also be a good way to spread your risk, as you are exposed to a wider range of instruments as opposed to just one commodity. The indices can also be used for benchmarking, in order to gauge the performance of an investment portfolio consisting of the constituents. For Instance, Bullion Index can be used as a powerful portfolio diversifier on account of its low volatility and low correlation with other financial assets over a long period. Base Metal Index also is an indicator of the fundamentals and performance of the industrial sector, particularly the metals-using manufacturing industry. Long-term investors can use the Index to gain from exposure to the commodity sector as a whole. Index trading can be a more cost-effective and efficient way of trading the market, as it allows you to take a view on a commodity sector as a whole, without having to open a position on each individual commodity. 67  Cost per Lakh of Turnover for Prop. Trading (MCX) Round Trip Round Trip Commodity Futures Cost per Rs. Cost per Rs. Commodity Options Trading Costs Lakh Futures Lakh Options Trading Costs Turnover Notional Exchange Fee @ 2.23 per Turnover side 4.46 Exchange Fee (Currently Nil) - GST @ 18% 0.80 GST @ 18% on Exchange Stamp Duty @ 0.001%* 2.00 Fee - CTT @ 0.01% (Sell side) 10.00 Stamp Duty @ 0.002%* 0.040 Regulatory Fee @ CTT @ 0.05% (Sell side) 0.500 0.00015% 0.30 Regulatory Fee @ Total Trading Cost 17.56 0.00015% 0.003 * Maharashtra state Total Trading Cost 0.543 All levies are applicable on Premium Turnover; Assumptions: Premium is assumed to be 1% of Notional Option Turnover; Options positions are squared off before expiry without any exercise; * Maharashtra state  Cost per Lakh of Turnover for Trading as a Client (MCX) Round Trip Round Trip Commodity Futures Cost per Rs. Cost per Rs. Commodity Options Trading Costs Lakh Futures Lakh Options Trading Costs Turnover Notional Exchange Fee @ 2.23 per Turnover side 4.46 Exchange Fee (Currently Brokerage Fee @ 0.01% Nil) - per side 10.00 Brokerage Fee @ 0.01% per side 10.00 GST @ 18% 2.60 GST @ 18% 1.8 Stamp Duty @ 0.001%* 2.00 Stamp Duty @ 0.002%* 0.040 CTT @ 0.01% (Sell side) 10.00 Regulatory Fee @ CTT @ 0.05% (Sell side) 0.500 0.00015% 0.30 Regulatory Fee @ 0.00015% 0.003 Total Trading Cost 29.36 Total Trading Cost 12.343 * Maharashtra state All levies are applicable on Premium Turnover; Assumptions: Premium is assumed to be 1% of Notional Option Turnover; Options positions are squared off before expiry without any exercise; * Maharashtra state Comparison of Indian Contracts with Global Markets Commod Unit Avg. Vol Avg. OI Correlatio ity n of MCX with MCX Global MCX Global Global Benchmar ks in INR Gold MT 18 713 12 1323 >95% Silver MT 860 11,261 500 25,678 >95% Aluminiu ‘000 MT 48 5,265 27 22,968 >99% m Copper ‘000 MT 50 969 26 2,574 >99% Lead ‘000 MT 99 1,049 24 3,301 >99% Nickel ‘000 MT 11 475 6 1,871 >99% Zinc ‘000 MT 156 2,673 59 9,250 >99% Global Contracts – Chief Characteristics Commodit Exchan Lot Size Max. Trading Hours y ge Contract (IST) Duration Gold CME 100 Tr. Oz. (3.11 kg) 6 years 4.30 am to 3.30 am Silver CME 5,000 Tr. Oz. (155.5 5 years 4.30 am to 3.30 kg) am Crude Oil CME 1,000 bbl 9 years 5.30 am to 4.30 am Copper CME 25,000 pound (11.33 5.1 years 4.30 am to 3.30 MT) am LME 25 MT 5.1 years 24 hours Aluminium LME 25 MT 10.2 years 24 hours Lead LME 25 MT 5.1 years 24 hours Nickel LME 6 MT 5.1 years 24 hours Zinc LME 25 MT 5.1 years 24 hours 71 Thank You