Default Shadow Ebbs in Commodity Trade Rebound: Corporate India

Aug 19, 2014 7:12 am ET

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Aug. 19 (Bloomberg) -- A year after a $920 million payment default at a spot commodities bourse cut trading from gold to soybeans futures, jolting India’s biggest brokerages, investors are returning as newer regulations buoy confidence.

The volume of commodities traded on the Multi Commodity Exchange Ltd., India’s biggest commodity bourse, has rebounded from a five-year low after the regulator tightened warehousing and shareholding norms in response to the payment crisis that unraveled at the National Spot Exchange Ltd. Volumes on the National Commodity & Derivatives Exchange of India Ltd., the second-largest bourse, have recovered from a 10-year low.

“It is a relief for us,” R. Venkataraman, managing director of Mumbai-based Indian brokerage IIFL Holdings Ltd., said in a phone interview. “Slowly and steadily, volumes are building, but it’s still early days.”

The rebound is brightening the prospects of brokerages Religare Commodities Ltd., Motilal Oswal Commodities Ltd. and IIFL, with the shares of the latter two more than doubling this year. India’s Forward Markets Commission, the commodity regulator, said it has told exchanges to set aside funds to pay for defaults while it is also hiring more lawyers and computer experts to make the market more transparent and cut risks.

Lessons Learned

NSEL broke rules by allowing sales of goods traders didn’t keep in its warehouses, according to regulators. The bourse was owned by Jignesh Shah, the founder of Financial Technologies India Ltd. and Multi Commodity Exchange, or MCX, which trades everything from bullion to base metals and natural gas.

“When something like NSEL takes place, which is outside the regulatory space, there are some lessons to be learned from this,” Ramesh Abhishek, chairman of the Forward Markets Commission, said in an interview in Mumbai.

Shah’s NSEL escaped regulatory scrutiny as spot exchanges were not supervised by any authority, he said. NSEL investors have so far been paid back less than 10 percent of the 56 billion rupees ($920 million) in frozen trades, he said.

Shah and other NSEL officials were arrested, while regulators ordered Financial Technologies to sell its stake in MCX. The NSEL crisis and police investigation drove away investors from commodities.

“Whatever fear was there in the market has been more or less discounted. Traders have digested this and are all moving ahead,” said Faiyaz Hudani, associate vice president at Kotak Commodity Services Ltd., in Mumbai. “Whatever steps the regulator has taken and will take will always improve the market.”

Gold

Gold volumes significantly picked up on MCX, with delivery against August contract climbing to 1.1 tons, the highest since April 2013, the exchange said Aug. 6. Deliveries tumbled to only 4 kilograms against the February contract and started reviving from June, it said.

“We are getting a lot more queries than we used to get one year back, maybe an increase of 50 percent to 60 percent,” said Ajitesh Mullick, a vice president at brokerage Religare Commodities. “People are trading, people are interested, and it shows that some kind of confidence has come back.”

In July, about 10.5 million contracts were traded on the MCX, compared with a five-year low of 9.74 million in November, according to exchange data. The volume on the NCDEX climbed to 21.5 million contracts last month after slumping to a 10-year low of 17.3 million contracts in April, data showed.

Annual Turnover

Shares of Motilal Oswal have jumped 124 percent this year to 207.65 rupees, and IIFL surged 118 percent to 136.10 rupees. Shares of Religare Enterprises Ltd., the parent of Religare Commodities, have risen 2.2 percent to 316.45 rupees this year. MCX jumped 3.2 percent to 845.85 rupees, the highest price at close since July 24.

The value of commodities traded on India’s 11 exchanges slumped 40 percent to 101.5 trillion rupees in the year ended March 31, the second straight annual decline since futures were introduced in 2003, according to the FMC.

Turnover, including cash and derivatives segments, at the two biggest stock exchanges, the National Stock Exchange Ltd. and the Bombay Stock Exchange Ltd., was 510 trillion rupees in 2013-14, according to the exchanges data.

“The commodities market has a lot more potential than the equity market,” Mullick said. “But for the market to realize its potential the government has to bring in the foreign institutional investors and banks to improve liquidity.”

While foreign investors are allowed to invest in India’s stock market, they are barred from buying or selling commodities on Indian exchanges. Changes to the Forward Contracts (Regulation) Act are pending approval from Indian lawmakers that would allow the introduction of new products such as options and indexes for commodities. The law now permits only futures trading.

‘Rough Phase’

“The industry is really going through a rough phase right now after what happened last year. Confidence has been lost and a lot of industry veterans have left the market,” said Kunal Shah, a vice president at Nirmal Bang Commodities Pvt. Ltd., in Mumbai. “All this is a sign that a lot more needs to be done. Now is the time for our policy makers to understand the importance of the market and they should allow options in commodities and bring back hedgers.”

Police probing the default at NSEL seized properties and shares worth $487 million from exchange officials and defaulters in December, which may be used to clear dues to investors. The commission in December declared Shah and former MCX Managing Directors Joseph Massey and Shreekant Javalgekar as ineligible to hold any post in the bourse. While MCX held no stake in NSEL, it was controlled by Financial Technologies, which also owns exchanges in Bahrain, Botswana and Dubai.

Governance Issues

“There were some governance issues at MCX, we got an audit done and we have taken various measures,” Abhishek said. “We have taken a number of measures in the last year to strengthen the markets, regulation and confidence. Turnover has been improving.”

The commission revised the shareholding norms for exchanges to ensure that no single entity played a major role and ordered margin reporting for consumer protection, he said.

Kotak Mahindra Bank Ltd. agreed to buy 15 percent stake in MCX from Financial Technologies last month, and shareholders in the bourse now include billionaire investor Rakesh Jhunjhunwala and HDFC Bank Ltd. National Commodity & Derivatives Exchange counts National Stock Exchange of India Ltd. and Intercontinental Exchange, Inc. among its shareholders.

“Regulations are evolving, and there is a lot of transparency in the market now,” Motilal Oswal, chairman of Motilal Oswal Financial Services Ltd, said by phone from Mumbai. “The ownership structure is changing in exchanges and the governance is improving. It’s just a matter of time for the confidence to come back.”

--With assistance from Santanu Chakraborty in Mumbai.