Crisis paves way for regulatory progress by FMC

Written by Devangi Gandhi | Mumbai | Updated: Sep 4 2013, 13:57pm hrs
The Rs 5,600-crore settlement crisis at NSEL has led to a significant tightening of regulations imposed on commodity derivative exchange.

In the last three weeks since the settlement cycle proposed by NSEL started to fail, the Forward Markets Commission (FMC) has released notifications around three key aspects for commodity exchanges under its regulation.

These include guidelines on the constitution of the board of directors, measures for strengthening the warehousing facilities and specifications related to the settlement guarantee fund. The NSEL crisis has revealed lapses primarily related to these three aspects.

Market experts say that even as the regulatory system for commodity futures exchanges has been evolving since their inception nearly a decade back, the NSEL fiasco has given regulators an opportunity to overhaul the entire ecosystem.

Though commodity markets always remained on the governance radar due to concerns related to inflation, price volatility and quality of the goods traded, NSEL crisis has given FMC another opportunity to look at the exchange mechanism elaborately and implement corrective measures, said the head of commodities with a brokerage house.

In recent days, FMC has announced two changes linked to the constitution of the board of directors, including a provision that makes it mandatory to get FMC approval for appointment of shareholder directors.

FMC also reiterated that at least 50% of board of directors of designated exchanges should be independent and four of them be appointed by the commission itself. Other clauses linked to age and tenure of directors have also been tweaked.

A need has been felt to revise these guidelines to ensure better corporate governance practices at the national commodity exchanges and to have greater clarity on the role of independent directors in the board of directors of these exchanges,noted the FMC in the first revision dated August 12, 2013.

Six board members of the Multi Commodity Exchange (MCX) resigned on August 30 with four of the exits being attributed to compliance with these clauses.

Meanwhile, a week after the NSEL board sacked six head of departments, along with former MD and CEO Anjani Sinha, holding them responsible for the wrongdoings, FMC asked the MD/CEO of the futures exchanges to furnish information on whether expenses made by the exchange are approved by the board and to what extent the power is delegated to the MD of the exchange.

On August 23, FMC also released detailed guideline on the maintenance of settlement guarantee fund (SGF), the contingency fund to be used in case of member default.

The market watchdog not only gave clarity on the constitution of the SGF, including the exchanges' contribution from revenues earned and allotment from the member funds, but also asked the exchanges to implement the guideline by August 31,2013. As a result, the MCX and National Commodity and Derivatives Exchange (NCDEX) earmarked Rs 232.4 crore and R251.3 crore as SGF compared to their last announced allocation of R1.9 crore (2011-12) and R2.45 crore (2012-13), respectively.

The NSEL scam has also brought to light the need for more stringent warehouse management as the value of the stock lying in the exchange's warehouses does not match the estimates given out initially.

In light of this, on August 30, FMC asked exchanges to get their licensed warehouses registered with the warehousing regulator, Warehousing Development and Regulatory Authority (WDRA), by December 2013.

Further taking note of the confusion around who is responsible to verify the quantum of commodities and their liquidation, the latest FMC guideline clarified that the settlement of the outstanding forward contacts by way of delivery is the primary responsibility of the respective exchanges.

...It has been observed that some of the exchanges have issued circulars to their trading members and other market participants in which conscious efforts have been made to evade their prime responsibility of ensuring quality and quantity of commodities as per the prescribed contract specification, and to pass on the entire onus to the warehouse service providers, which is not correct, said the notification.

FMC ordered all the warehouse service providers which are independent business entities to function as agents of the exchanges to whom they are providing their warehousing services. This should ensure a principal-agent relationship between the exchange and the warehouse service providers it declared.

The latest notification on warehousing tries to establish that while management of warehouses should be effectively carried out by the appointed service providers, exchanges bear the fundamental responsibility of ensuring deliveries, said a senior official of a brokerage house.