Suspension Of Commodities Derivative Contracts: Some Lessons And Way Forward

To begin with, could you explain the background of the study and the reasons behind the extended ban on futures trading in agricultural commodities?
Certainly. The market regulator extended the ban on futures trading in agricultural commodities until December 20, 2024. Effectively, the extended order places the agricultural commodities derivatives under a trading ban for the last three years. The continued suspension of commodities derivative trading has been driven by concerns among policymakers that speculative trading volume in the derivative market is responsible for the observed rise in the spot prices of the commodities. 

Can you describe the broad approach adopted in your study?
Our study attempts to assess the impact of the suspension on the effectiveness of the commodities spot market and also its impact on the efforts to develop market a vibrant commodities market. Specifically, we study the effectiveness of the ban by examining its impact on trading volumes, volatility, and co-movement of futures and spot prices. We benchmark these indicators against a peer group of commodities that are not banned.

Do you think the premise under which the suspension was ordered is validated by the study?
Interestingly, we find that there is very little correlation between spot prices and the futures market trading volumes of the suspended commodities in the pre-ban period. In the case of commodities Mustard, Mung, Palm oil, Soybean, and Soyoil, the futures market trading volume does not significantly affect the daily spot price changes. It suggests that the trading activity in the market does not substantially affect the spot prices, largely ruling out the possible role of speculative trading in destabilizing the physical market prices. It is more likely that the price rise observed prior to the ban is driven by supply and demand factors.

Did the study observe any decline in the volatility of banned commodities in the post-suspension period?
No, we do not observe a decline in the volatility of banned commodities in the post-suspension six-month period. Instead, we find that the volatility of the suspended commodities in the spot market has increased in the post-suspension period relative to the unsuspended agri-commodities. 

In an efficient commodities market ecosystem, we expect the prices across the mandis to be strongly associated with each other. In this regard, how did the co-movement of prices across different mandis change after the suspension?
We examined the long-term association of commodities prices (co-movement) across the mandis and find a deterioration in the market quality in the post-suspension period. In the case of several commodities, the co-movement of prices across different mandis becomes weaker in the post-suspension period.

What about the price trend of the suspended commodities in the post-suspension period?
In the post-suspension period, the banned commodity prices showed a declining trend, aligning with the intent of the ban. In the absence of a significant link between futures market volumes and commodities spot prices prior to the ban, the favorable price movement could emerge out of the measures taken by the government in the physical market, such as (a) actions to improve the supply of commodities in the market (b) heightened vigilance on price manipulations and (c) restrictions on commodities export, etc.

How did contract suspensions impact value chain participants and other market intermediaries?
Our analysis based on prior suspension episodes indicates that contract suspensions seriously impact value chain participants, traders, and other market intermediaries. Particularly, the unavailability of the derivative contracts disrupts the hedging and commercial planning of the value chain participants in the suspended commodities. The relatively small players in the commodities ecosystem, including farmers have a greater adverse impact of the ban than the large players who are able to hedge their positions in the international markets.

In your view, how does the trade ban impact the initiatives taken to develop a liquid commodities market?
An analysis based on prior suspension episodes shows that the volume trend of relaunched commodities is adversely affected after lifting the suspension. The lower volume on relaunch is on expected lines given the long cycle involved in derivative trading, and the adverse impact of the suspension on cross-commodity arbitrages. Evidently, the lost momentum observed in building liquidity in commodities derivative trading on account of the suspension needs to be assessed against the need to develop the Indian commodities markets. A vibrant commodities market is necessary for a rapidly industrializing economy with a high commodity intensity like ours.

Considering the findings, what would be your recommendations for dealing with excessive spot price volatility in commodities?
Our study suggests that outright suspension of trading might be counterproductive for the development of the markets. We suggest exploring alternative avenues rather than outright suspension. Monitoring and managing speculative behavior and adopting standard operating procedures for dealing with excessive volatility are some of them. The noticeable lack of evidence of the desired outcomes from the intervention in the futures market suggests that policy actions on observing excessive volatility may be limited to the physical commodities market. 

In exceptional circumstances where contracts are suspended, what approach do you propose for relaunching them?
In such cases, we propose a programmatic approach based on volatility levels. Maintaining the same contract specifications when relaunching contracts is ideal to minimize the impact on entities resuming their trading.

Thank you for sharing your insights on the suspension of commodities derivative contracts and the potential way forward.