Spot fixing II

The blind spots in India’s financial regulatory system aren’t confined to chit funds or ponzi schemes operating in rural hinterlands. The crisis at the National Spot Exchange Ltd (NSEL), which has exposed lacunae in the regulation of exchange-traded commodity contracts, highlights they are very much a part of the formal financial markets.

The chain of events that led NSEL to suspend trading in nearly half of its contracts is clear. A couple of weeks ago, the Department of Consumer Affairs, concerned that traders were taking forbidden ‘short’ positions on the exchange, asked it to shift its contracts to the trade-to-trade category (where transactions are to be settled through cash or goods, with no netting off as in futures trading). The exchange was further told to trim the settlement period for its contracts to 10 days or less, as demanded of spot (ready delivery) transactions. The directives forced NSEL to alter its contract terms with immediate effect. As it triggered speculation about a payments crisis, the exchange halted trading in such contracts, while offering a 15-day moratorium on settlements and giving public assurances of having sufficient commodity stocks in its warehouses to cover any default risks. But even assuming the settlement of trades proceeds smoothly, this episode has flagged fundamental issues about the regulation of commodity exchanges. How was NSEL, a spot exchange, mysteriously allowed to launch one-day forwards through a special exemption — a grant that probably precipitated this crisis? When contracts outside the Forward Contracts Regulation Act are required to be settled within 11 days, how did trades with 25-35 day settlement cycles flourish (that too, with rollover facilities) without the regulators taking note? Morevoer, when short trades were disallowed on the NSEL, why didn’t the exchange have internal checks to prevent them? The Forward Markets Commission has taken shelter in the unconvincing argument that it has no regulatory powers over ‘spot’ exchanges. But what prevented it from seeking such jurisdiction, when it was clearly forward contracts that were being traded here. After all, NSEL’s platform wasn’t a small remote grey market operation; it was an authorised exchange that recorded a turnover of nearly Rs 3 lakh crore last fiscal.

It is certainly in the country’s interest to have well-developed exchange-traded commodity markets, for both futures and spot contracts. But equally necessary are proper systems for regulating the operations of commodity exchanges. Reports of large equity broking houses offering their clients ‘assured return’ schemes based on commodity contracts, indeed, merit a parallel investigation by SEBI, as they blatantly violate its disclosure and investment protection norms. Investor protection cannot happen by heavily regulating one section of the financial markets (that is, equities/debt), while allowing market players to take advantage of lax systems in others. Plugging such regulatory arbitrage is essential to restore confidence, not just in spot commodities trading, but in the exchange mechanism itself.

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