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What is Exchange of Futures for Physical (EFP)?

By Bajaj Broking Team

June 10, 2025

8 mins read

Derivatives

What is Exchange of Futures for Physical (EFP)?

Exchange of Futures for Physical (EFP) refers to a type of privately negotiated transaction where a futures contract is exchanged for the actual physical commodity. This mechanism enables two parties—one holding a futures position and the other holding the equivalent physical asset—to swap these positions. The main purpose of this structure is to bridge the gap between futures trading and physical market dealings.

In an EFP, a buyer and a seller agree to substitute the delivery of a futures contract with the actual underlying asset. The exchange of futures for physical provides an off-market alternative to standard futures settlement, allowing participants to transfer positions without influencing the broader commodity market. It is commonly seen in sectors such as oil, metals, and agriculture where physical delivery is feasible and regularly practised.

EFP is often used by commercial firms involved in both physical commodity transactions and futures trading. It provides a structured pathway to manage inventories, hedge positions, and transfer ownership. This mechanism is integral to understanding how futures markets interact with physical commodity trading practices.

How Does EFP Work?

The EFP process starts when two parties—a buyer of a futures contract and a seller of the corresponding physical asset—agree to a transaction that mirrors both a spot trade and a simultaneous futures trade. While the trade does not occur on an open exchange, it must be reported to the relevant exchange for transparency and regulatory compliance.

Here's how a basic EFP transaction unfolds:

A firm holding a long futures position agrees to purchase a physical commodity from another firm that is holding a short futures position.
Both parties cancel their futures contracts.
The firm with the long position takes delivery of the physical asset.
The transaction is then reported to the exchange and marked as an EFP.

This approach is usually facilitated by brokers who understand the commodity market and can coordinate these bilateral arrangements. Exchanges such as the Multi Commodity Exchange (MCX) in India or the Chicago Mercantile Exchange (CME) allow such transactions under their EFP guidelines.

Importantly, EFP helps avoid price fluctuations that might arise in the open market. Since the transaction occurs off the book, it helps maintain discretion while aligning the objectives of both parties—typically hedgers or large commercial participants involved in both futures and physical markets.

Key Features of EFP Transactions

Bilateral Agreement:

EFP is a privately negotiated deal between two consenting parties.
Physical Delivery Component:

Unlike regular futures contracts that may be cash-settled, EFP involves the transfer of actual goods.
Futures Contract Offset:

Each party must hold an open position in a futures contract which is closed as part of the EFP.
Not Exchange-Traded:

Although reported to the exchange, the transaction itself takes place off-market.
Standard Lot Size:

The transaction quantity must match the lot size of the futures contract.
Timing Flexibility:

EFP can be executed at any point during the life of a futures contract, offering operational flexibility.
Price Transparency:

Though the terms are private, regulatory bodies require that EFP transactions be reported for oversight purposes.
Common in Commodities:

EFP is widely used in sectors such as oil, metals, and agricultural products within the commodity market.
Alignment with Hedging Needs:

Helps in aligning physical inventory with futures positions for better risk management.
Regulatory Oversight:

All recognised exchanges provide a framework under which EFP transactions must be reported and validated.

Benefits of Using EFP in Trading

Inventory Management:

Facilitates efficient stock management by converting futures to physical assets.
Reduced Market Impact:

Occurs off-market, reducing slippage and preventing unwanted price reactions.
Operational Flexibility:

Offers an alternative way to close or adjust a position before expiry.
Cost Efficiency:

Potential to avoid additional brokerage fees or delivery charges.
Confidentiality:

Terms of the deal are not made public, allowing discretion in trade arrangements.
Customisation:

Can be tailored to suit the specific needs of both parties involved.
Arbitrage Opportunities:

Enables capturing price discrepancies between physical and futures markets.
Hedging Alignment:

Allows traders to synchronise their futures strategies with physical exposures.
Position Management:

Simplifies transfer or adjustment of positions without going through standard market procedures.
Time Management:

Reduces time pressure related to contract expiry and physical delivery deadlines.

Risks and Considerations in EFP Deals

While EFP offers several operational advantages, certain risks and points of consideration need to be acknowledged:

Counterparty Risk:

Since the transaction is privately negotiated, there is a possibility of default by one party.
Regulatory Scrutiny:

Exchanges may investigate irregularities in reported EFP transactions, especially if used to manipulate settlement prices.
Liquidity Concerns:

Limited number of counterparties may restrict opportunities to execute an EFP deal.
Documentation Requirements:

Regulatory frameworks require proper documentation and timely reporting, adding to the administrative workload.
Valuation Complexity:

Determining fair value for both futures and physical legs can be challenging in volatile markets.
Delivery and Logistics:

The physical aspect of the deal involves transport, warehousing, and inspection, which may incur additional costs or delays.
Market Understanding:

Participants must possess sound knowledge of both the commodity market and futures contracts.
Not Suitable for All Participants:

Primarily used by commercial entities; retail traders may find it inaccessible or complex.
Exchange Approval:

Exchanges reserve the right to reject an EFP if it does not meet compliance standards.
Possible Tax Implications:

Depending on jurisdiction, the trade may have specific tax consequences that need review.

EFP vs Standard Futures Settlement: A Comparison

Feature	Exchange of Futures for Physical (EFP)	Standard Futures Settlement
Nature of Transaction	Privately negotiated	Exchange-regulated
Involves Physical Delivery	Yes	Not always (can be cash-settled)
Market Impact	Minimal	Can influence prices due to volume
Timing	Flexible	Occurs at contract expiry
Counterparty	Chosen by participant	Anonymous exchange counterparties
Transparency	Limited to reporting	Full visibility through the exchange
Pricing Agreement	Bilaterally set	Exchange-traded
Use Case	Hedging, inventory transfer	Speculation, hedging
Documentation	Required for compliance	Handled through exchange systems
Regulatory Oversight	Yes, post-reporting	Continuous

Regulatory Aspects of EFP Transactions

EFP transactions must comply with the operational guidelines laid down by the exchanges and relevant financial regulators. In India, such transactions are monitored under the purview of the Securities and Exchange Board of India (SEBI) and the exchange on which the futures contract is listed.

Each EFP must be reported with full details, including participant information, contract specifications, quantity, and price. The exchange may request documentary proof to ensure that the trade is genuine and not executed to manipulate price discovery mechanisms.

The terms must also be consistent with the contract’s standard specifications, and the physical delivery must be supported by proper logistics and storage arrangements. Non-compliance or failure to provide accurate records may lead to penalties or reversal of the transaction.

SEBI and commodity exchanges have increased surveillance around such deals to maintain market integrity. Participants are expected to maintain audit trails and comply with all exchange communication promptly.

EFP Trading Strategy

In back-door listings, companies looking to go public must adhere to certain regulatory guidelines set by authorities in their respective countries. In India, the Securities and Exchange Board of India (SEBI) plays a crucial role in overseeing these transactions. SEBI's regulations ensure that the process is transparent, safeguarding the interests of investors and maintaining the integrity of the market.

One of the key requirements under SEBI’s regulations is the full disclosure of the deal's details. Companies opting for a back-door listing must provide comprehensive information to the public, including the terms of the transaction, financial statements, and any other material facts that could impact investor decision-making. This ensures that shareholders are not at a disadvantage and are fully informed about the structure of the deal.

Although back-door listings generally involve fewer regulatory obstacles than traditional Initial Public Offerings (IPOs), they still require approval from the relevant stock exchanges. These exchanges assess the financial standing of the companies involved and review the proposed transaction's compliance with market rules. The approval process involves scrutiny of the deal to ensure that it is fair to both existing and new shareholders.

Additionally, firms are required to adhere to financial reporting requirements, reflecting their financial position accurately. This enables investors to evaluate the firm's viability and growth prospects after listing. Although back-door listings offer a quicker path to the public market, regulatory authorities such as SEBI are watchful to ensure that these deals are made in a fair and transparent manner, reflecting the principles of investor protection and market integrity.

Conclusion

Exchange of Futures for Physical (EFP) is a bridge between futures contracts and the physical commodity market. The model of this transaction permits the exchange of a futures contract for an actual commodity, providing more operational flexibility to companies that carry out both futures business and the physical commodity market. EFP can prove useful for firms that want to balance their positions in both markets, allowing for a smoother transition from futures to physical business.

However, using EFP requires careful attention to regulatory requirements and coordination between parties involved in the exchange. Companies must comply with specific rules and regulations governing these transactions, ensuring that they are carried out in accordance with market standards. Additionally, proper documentation and a clear understanding of market mechanisms are crucial to ensure the smooth execution of EFP transactions.

In physical delivery markets where it is a necessary component of business activity, like the commodity markets, EFP represents a useful risk management tool and mechanism for ensuring that physical and financial market positions are not divergent. While flexible, effective utilization of EFP relies upon extensive preparation and familiarity with the futures market as well as the physical delivery logistics.

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