Poor Supervision, The Weakest Link In Commodities Trading

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: In the 1980s, the two brothers were considered among the sharpest jobbers in the Bombay Stock Exchange (BSE). When the capital market switched to automated trading, they adapted and became big arbitrageurs in the equity markets. And although they were investigated for price manipulation at least once, the regulator hasnt come up with anything incriminating so far.

Recently, the brothers made a trip to south India to study the rubber and pepper markets. They told people that the Securities Transaction Tax (STT) would eat into their arbitrage margins, making their business unviable, so they were planning to switch over to the commodities market.

With trading turnover in commodities bourses having raced ahead of the BSE to cross Rs 3,000 crore on good days, their decision seems to make good business sense. But what is probably most attractive to such operators and traders is that regulation and supervision is minimal in the business. Most traders are looking for lucrative arbitrage opportunities by buying in the cash market and selling futures contracts.

Futures trading in commodities has been re-started after over 40 years with four multi-commodity bourses being allowed to offer derivative products, but a proper regulatory system to supervise the trade is still not in place. The Forward Markets Commission (FMC), which operates under the ministry of consumer affairs is the regulator, but knows little about monitoring electronic trading and detecting market manipulation.

Worse, even the bourses have no minimum mandatory technology requirements for tracking margin payments and trading patterns. They are also allowed to frame their own trading rules and margin requirements. For instance, the National Commodity & Derivatives Exchange Ltd (NCDEX) has the most comprehensive risk and surveillance controls to monitor prices. It has member-wise and client-wise trading limits that are monitored on a real time basis. It collects net margins and Value at Risk (VAR) margins and has also introduced demat deliveries and encourages traders to be settled through authorised agents.

However, the Multi-Commodities Exchange (MCX) until recently collected gross margins and the National Multi-Commodity Exchange of India (NMCE) used to recognise specific trading terminals and levy terminal-level margins, no matter how many individuals traded from a particular terminal, say traders. The FMC woke up last week after speculation threatened to go out of control and instructed the commodities bourses to charge net margins.