Crisis brewing in commodity markets?

Mon, 28 Jul Pre-Open

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Rs 5,600 cr scam that engulfed National Spot Exchange Ltd (NSEL) is still running fresh in our minds. This was followed by an audit agency scrutiny that figured out several non-genuine transactions in the books of Multi Commodity Exchange of India Ltd (MCX). The list doesn't end here. Another Universal Commodity Exchange (UCX) announced its closure on 16th July 2014 just after 18 months of its incorporation. Earlier, the Indian Commodity Exchange had shut shop.

Phew! Commodity markets have gone disarray. Perhaps a crisis is underway. Fraudulent trading practices have become rampant in the commodity markets. What's more agonizing is the fragile regulator governing these markets. Forward Markets Commission or FMC regulates the commodity trades in India. Seemingly the regulatory body failed in its duty with regards to NSEL and was accused of unscrupulous lending to the group entities with unknown promoters. Found guilty of Rs 5,600-crore payment default and persistent violations of various regulations, NSEL fraud even wiped off the wealth of many families. MCX in turn turned out to be a casualty of the payment crisis at NSEL and the imposition of commodity transaction tax (CTT) applied in July 2013. The carnage in the commodity market did not stop here. And quite shockingly FMC did not wake up to the mess. And then came the UCX fiasco. Convicted for fictitious volumes to push up profits and valuations, UCX came under the scanner of FMC. The quantum of the fraud turned out to be so huge that the exchange was left with no money to continue its business operations. Violation of regulatory guidelines, lack of due diligence backed by irregularities in risk management blew up crisis in these exchanges.

India has six national commodity exchanges and 14 regional ones. But today they are victims of mismanagement and poor governance. The value destruction as a result at the India's commodities exchanges has been enormous. The trading turnover of the entire commodity market has crashed 65% in the first quarter of this year. Primarily because the regulator had asked many to suspend their operations! The market participants had feared the worst. Clearly, this is a high-profile bust. Nothing seems to be right with the commodity markets. And quite annoyingly investors remain prone to the dodgy activities of the exchanges. The role of the regulator therefore is of paramount importance. Essentially the regulator needs to work upon enhancement of quality of due diligence. Scrutiny and surveillance standards must go up.

Poor governance has been the endemic problem in the Indian economy. While the Modi government has promised us better governance, it is time to rise to the occasion. And as far as commodity markets are concerned, the government better maintain this motif - Clean up or pack your bags! A leading financial magazine puts up a better solution. Bringing uniformity in the rules governing equity holding, suitability of promoters and governance structures across equity, commodity and currency derivatives markets will go a long way in reviving the exchanges. We hope the Finance Minister is listening.

Well that's for the government to do. But we also believe that investors too should exercise caution in their own capacity. And especially should not fall for bait. Due diligence at their end is equally important.