NSEL’s doom has raised doubts about the framework and risk management in the commodities market. But today, after nearly two years of the NSEL fiasco, the commodities market is a better place with regulations on promoter holdings and mandates on the settlement guarantee fund (SGF). BusinessLine spoke to Raj Benahalkar, Chief Risk Officer of NCDEX, the largest agri commodity bourse in the country on commodity bourse risks and how they manage it. Edited excerpts:
What is the kind of risk management system you follow? Is it the same as that for equity exchanges?
NCDEX follows a comprehensive risk management framework that includes minimum net worth and capitalisation requirement, position limits, robust life-cycle-based margining system, daily mark-to-market, alerts and triggers, penalty, settlement guarantee fund and many other risk reduction mechanisms besides a broad framework on the warehousing side to cover the operational risks.
The risk profile of a commodity exchange is fundamentally very different from that of a securities exchange.
The differences primarily arise on account of the physical nature of commodities; issues such as assaying, grading, warehousing, transportation and non-uniformity of State regulations. Also, settlement of physical commodity is at the State level unlike equities. NCDEX has, in the last two-three years, worked on building the physical side of the business. We normally deliver close to 1 lakh tonnes of commodities through our futures contact on a monthly basis. This January, we delivered over 2 lakh tonnes just in castor. That is the capability we have built.
On the financial side, we are far more conservative than equities given the nature of commodities market and the regulatory risk in the past. Now with the SEBI-FMC merger, participants are looking towards a stable and progressive regulatory regime.
What are the assurances you give a trader on your platform?
First, it is the trust that NCDEX brings – we are owned by institutional shareholders, such as NSE, LIC, Nabard, IFFCO and other marquee investors.
Second, the participant is assured of fairness. We have displayed commitment to resolve issues in the market place through our partners and our ecosystem players. For example, in the forward contracts that we recently launched, we provide compensation guarantee. If a default were to happen in an OTC market, resolution is very difficult. But in our forward contracts, in the event of default by either of the parties we give compensation.
What is the risk you assume?
We accept a comprehensive array of collaterals which is extremely cost-efficient to traders and at the same time does not increase risks to the exchange. In futures contracts, where we are responsible for the good delivery on the contracts, we have a settlement guarantee fund.
In forward contracts, because it is a bilaterally negotiated trade through the exchange platform, we offer compensation if there is default by either of the parties. We pay 90 per cent of the margin collected to the aggrieved party and that will be more than sufficient in the normal market as prices don’t move very sharply.
How much is your SGF? What constitutes your SGF?
Our SGF is close to ₹130 crore. It is constituted by the base minimum capital (BMC), our own initial contribution, which is mandated at 5 per cent of revenues, investment income on BMC and then there are settlement-related penalties.
What are the checks and balances you have?
First of all, our proactive risk management system can sense if things are wrong well in advance before it gets to the stage of default.
Even before the margin utilisation is 100 per cent, we send out alerts to members at 50/60/70/80 per cent and before it reaches 90 per cent we ask the member what he wants to do – whether he is getting more funds or he is reducing his position. If he doesn’t do either, we cut his position. This ensures that the risk transmission does not happen back to the market in the event of default.