Market players have argued that abrupt changes in the regulations relating to contracts on the National Spot Exchange (NSEL) have caused panic. Before the consumer affairs ministry cited violations in physical trades with contracts that had a settlement cycle of more than 11 days, NSEL offered contracts for which the settlement cycle ranged anywhere between 25 to 36 days for various commodities.
Market observers said such long-period contracts effectively acted as forward contracts that are similar to long-dated derivative products offered by an over the counter market.
Unlike spot contracts of T+1 or T+2 structure, where the delivery has to be made within one or two days of a trade being executed, such long-dated contracts created an arbitrage opportunities.
Market observers said as a result, NSEL ended up facilitating arbitrage trading between an investor and a supplier of a commodity as the counter-parties. For example, in a commodity where prices were trending up, the investor would buy a contract while simultaneously selling a contract of T+25 settlement cycle.
The supplier or processor of the commodity acted as the counter-party to both these trades. As a result, the investor could execute an arbitrage trade which offered 1% to 2% of returns over the duration, while the supplier could utilize the money earned in the first tranche of the trade for financing working capital requirements.
In effect, the ownership of the commodity just changes hands on paper without involving a change in possession. ?Castor seed, sugar, paddy and raw cotton are the products where these kind of trades were quite popular,? said a trader.
After the government and the forwards market commission (FMC) got a wind of such trading activity, they asked the exchange to cancel all the contracts with a settlement cycle of more than 11 days. As a result, these trades got affected as an increasing number of physical suppliers faced problems to adjust to the changed settlement cycle given its implications on their financing.
?Some of these members are believed to have refused to honour the second leg of the arbitrage trade in the recent past creating a snow-ball effect on the liquidity of the exchange,? said a market expert.
NSEL on Thursday confirmed that the exchange had access to physical stocks of commodities worth Rs 6,200 crore to compensate for the outstanding contracts worth Rs 5,500 crore.
However, a section of market remained anxious on the exchange’s ability to liquidate these stocks as well as the value assigned to it.
At the current market price, the stocks of sugar and castor ? which are a significant part of the inventory available with NSEL ? could amount to Rs 1,800 crore. The value of the remaining commodity inventory could not be ascertained by FE.
NSEL spokesperson meanwhile confirmed that designated certifying agencies, including SGS, Dr Amin controllers, NSCEL (Comgrade) and NBHC – a group entity – carry out the quality check for all commodities maintained at the NSEL warehouses.
The settlement guarantee fund, the contingency fund which NSEL pegged to be close to Rs 800-850 crore, consists of an initial contribution of R 5 lakh per member and additional contribution that is demanded in line with the trading activity carried out by the members.
According to a spokesperson of the exchange, the amount linked to trading activity is not reversible.