The Hindu Business Line : The future of forward contracts

The Forward Contract (Regulation) Act, 1952 recognises three kinds of contracts — ready delivery, forward, and options in goods. Ready delivery contracts and options in goods (prohibited for the time being) have been discussed. A look at forward contractsand their variations.

Forward contracts are for the purchase/sale and delivery of goods that are `not ready-delivery' contracts. When either delivery or payment or both take place beyond 11 days from the date of the contract, it is considered a forward contract under the FCRA, and governed by the Act.

Forward contracts are of two types — specific delivery and other than specific delivery. The first, which is a merchandising contract, enables producers and consumers to market a commodity. Generally, sellers and buyers directly negotiate the contract terms.

The variations

The specific delivery contract has two variations — Transferable Specific Delivery (TSD) and Non-Transferable Specific Delivery (NTSD). As the name suggests, in a TSD contract, the performance can be transferred to a third party. For instance, if `A' is the seller and `B' the buyer, the former can transfer the contract (thereby his performance obligation) to `C' who will be the seller and supply the contracted goods to `B'. Similarly, `B' can transfer the contract to `D' who will take delivery of goods and effect payment. NTSD contract, on the other hand, is not transferable. The original parties to the contract have to perform and fulfil their contractual obligation. In `other than specific delivery contract', delivery is not compulsory. The contract can be by settlement of the price difference between the parties.

Futures contract

A futures contract has some special features and needs to be distinguished from a forward contract. Unlike a forward contract (a party-to-party contract), a futures contract is necessarily entered into under the auspices of a recognised exchange or association. Indeed, technically, sellers and buyers enter into a contract with the exchange (rather than between themselves). It is the exchange that guarantees performance of the contract. All the contract terms are standardised in a futures contract. What parties can and do negotiate is the `price'. In other words, "standardisation of terms" is the key feature of a futures contract.

Price discovery

Trading takes place in standard units. The price quote is for a `basis' variety. Delivery month is standardised. Again, unlike a forward contract, in a futures contract, all open positions are marked-to-market daily at the settlement price. In case of delivery, the tenderable goods must meet the contract specifications. In addition, these goods must be certified for quantity and quality by an approved surveyor. The trading volumes and prices at which trades are effected are in public domain. This is what is known as `price discovery'.

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