The last few years has seen the Indian commodity market grow at a fast pace. Trading volumes have increased on commodity exchanges like the Multi Commodity Exchange (MCX) and the National Commodity & Derivatives Exchange (NCDEX). The expansion of this market has also led to the development of effective ways to settle futures contracts. For instance, paper documents such as warehouse receipts have been largely digitized. This process is known as ‘dematerialization’.
A commodity futures contract may be settled either by cash or by the delivery of a commodity. In the case of the latter, the seller will not deliver actual physical commodities. He will instead deliver warehouse receipts to the clearing house of the commodity exchange. The clearing house will then pass these warehouse receipts to the buyer.
What is a warehouse receipt?
Warehouse receipts are title documents issued by warehouses to depositors against the deposited commodities. These documents are transferred by endorsement and delivery. Only the holder of these receipts can claim the commodities from the warehouse.
The paper warehouse receipt system is cumbersome, costly, and inefficient. It gives rise to the following problems:
Dematerialization means the conversion of paper documents like share certificates and warehouse receipts into digital records. The physical paper is destroyed and the electronic balance is credited to the demat account of its owner.
The concept of dematerialization was introduced in the securities markets in India in 1996. In that year, the National Securities Depository (NSDL) was established. The organization promoted dematerialization to improve settlement efficiency on stock exchanges. Since then, the concept of dematerialization has been applied to commodity markets in India.
In the next chapter, we will learn about the roles and responsibilities of entities in dematerialization.