IT Offers Price Discovery In Spot Commodity Trading

NCDEX (National Commodities and Derivatives Exchange) has launched a spot exchange for commodities trading that runs on an electronic trading platform. Biztech2.0 spoke to Sanvli Kaushik, CEO, NCDEX Spot Exchange, and Nirmalendu Jajodia, Chief – Technology and Operations, NCDEX.

How did the Idea of launching of a spot market come up?

While comparing the futures segment and the commodities space with securities, we felt that the spot market for commodities will be very facilitating for futures. There was a need felt during the interaction with the market participants for the construction of the contracts for futures, that there was clearly a need to provide similar transparency for a demutualised kind of trading in the spot market space also.

There are two components to price: one is the price risk management and the second is the price discovery. The futures provide price risk management; that’s the hedge against price volatility. However, the futures cannot help in the price discovery of a particular commodity considering the huge geographical spread. In that sense there was a space and need in the market to provide a transparent and a demutualised trading platform that will also be a transparent price discovery system. An electronic trading platform proved to be a price discovery facilitator.

Could you describe the process of mutual consultation between the management team and the IT department for coming up with the trading platform?

It was a joint effort right from the beginning. We realised in the process that the system has to be highly flexible because each commodity is traded in a slightly different manner as far as the spot market is concerned. Futures contracts are very standard specified. However in the spot market (for example a commodity like chana), the rules of trade for the chana spot market differs from one location to the other. Every market place has evolved over a period of time, so it was very important for us to be very flexible with the system and sort of plug in.

Another important role that IT plays in case of the NCDEX spot trading market in comparison with other Indian spot markets is that an electronic spot market exposes a local market to all of India. Currently in the case of the conventional spot market the sellers and the buyers are restricted to the geographical area. So the physical transportation of goods is limited to the geographic area, and moreover the trade also gets restricted to that area. So after the introduction of the spot market, while the sellers will still be localized due to the logistics advantage, buyers will be pan-Indian. For example, a trade exchange member from J&K can even buy a commodity that is not produced in the state; this was not possible earlier due to the physical restrictions of the trade.

The commodity prices can be monitored as they are traded. This is a very important function that removes information asymmetry. Consequently it redefines the value chain because the prices are uniform throughout. We have heard people say that we will shrink the value chain, but we say we will redefine the value chain. The value chain is composed of the producer, wholesaler, retailer and consumer. Since everybody is watching the same price, they have to render the services for the same price. This results in a cost-effective trading of commodities. So nobody can charge a premium just because of the information asymmetry or because they have an access to the market.

How does IT help in actualising the spot trade exchange?

The experience in this case was varied because the requirements of various kinds of spot markets are different. The way sugar is traded is very different from the way wheat or rice is traded. There are different ways or kinds of trading. So the flexibility of the system will always be challenged. One needs to make the system more and more flexible, and because the local market is very small the cost to the end-trader should be kept as low as possible; thus the emphasis on the Internet. We have certain lighter weight mechanism for handling logistics, thereby using the warehouse management system.

We have also provided for innovative ways of collecting payments by using a direct payment gateway to the bank. We have not done this for the futures market. The application should be flexible enough to be independent of IT every time there is a need to open a new market. The application needs to be parameter driven to the extent that users should be able to create new types of market as and when they want.

Actually IT can be applied to various kinds of business models but our USP lies in applying IT in an exchange-like fashion, so that we are able to offer the benefits of better price discovery. In fact, NCDEX is the world’s first electronic spot exchange in the world.

How does IT help in avoiding information asymmetry?

Without IT you can’t have a stable network facilitating uniform price dissemination. There are two things that we do: one is that we provide the network that connects the market so everybody looks at the same market and thus information asymmetry holds true; and secondly even if the members are not trading in the market they can always track the market. For example jeera is a heavily traded commodity in the Unjha market in Gujarat. Bikaner is also a large production center for jeera. So a member sitting in Bikaner can keep track of the spot price of jeera in Unjha, but he will still trade in the spot market in Bikaner. It becomes an all-India price discovery.

Do you have an IT-supported mechanism that keeps a check on the information asymmetry?

Information asymmetry is more a concept. As long as there exists a file the data delivery will be done. The tooling keeps us abreast about the network speed. The prices are also available on the Internet, and in case of spot exchange we have also made arrangements so that trading can be done on the internet and people don’t need to have a fixed line with them. The people using the Internet are still using our application.

What’s the central application that runs the spot exchange?

The software is custom built for us by TCS in collaboration with our team. It is only parts and pieces that have gone to TCS, so we have other in-house developments and operations integrating into it. The three modules of the software – basically those included in any trading software – are the application at the front end on the desktop, the matching engine, and the price dissemination. The main challenge has been to educate the market. Some minor changes have been requested on the front end along with some additional information.

NCDEX has a competent panel of promoters on the board. How did they help in coming up with the IT setup for the spot exchange?

We are a tightly regulated entity. The IT setup by regulation has to be independent. They helped us in capacity building in terms of how market operations are done, the demands, and the kind of customisation offered. And of course, also the standardisation that should be offered in terms of adopting practices.