Hefty fines may spoil futures party

NEW DELHI: A new ’five-day syndrome’ has hit India’s commodity exchanges. On the last five days of a contract’s life, in several sensitive commodities including wheat, the market is becoming increasingly ripe for a price crisis.

But traders can only watch from the sidelines after the Forward Markets Commission stipulated a freeze on taking fresh positions and also asked exchanges to immediately levy heavier fines on all violaters.

From August 1, exchanges have been asked to become more strict with erring brokers and their clients who violate their trading limits. Exceeding the limit by 2% attracts a minimum fine of Rs 10,000 per day. Frequent violations will now lead to suspension of the broker as well. The move is welcome as it weeds out habitually errant brokers and traders. Unfortunately, it may also have a significant impact on price discovery in commodities with seller’s option and intention matching contracts.

In a seller’s option contract, sellers are barred from marking their option for delivery five days prior to expiry. In both sellers’ option and intention matching contracts all market participants, whether buyer or seller, are barred from taking fresh positions in the last five days of a contract’s life.

Here is how a crisis can emerge. In a seller’s option contract, a seller has to mark through the trading terminal five days before the end of the contract how much quantity he will deliver on the exchange. The seller is barred from further marking of delivery despite being in a position to deliver more quantities in these last five days.

The idea is that punters should not be able to influence price movements in the last few days by influencing the spot price as well as the position they may hold for cash settlement. Sellers are allowed to exercise an option not to deliver under a seller’s option contract.

Buyers are all aware of exactly how much quantity is being delivered at the end of each contract. In case the delivery volumes marked by sellers against the outstanding open interest are low, it is entirely possible for some big punters to now pull the market in the direction they please. On the reverse, if there is any market inefficiency being created by sellers, buyers have no option but to watch from the sidelines.

Till July 31, when the fines were still affordable, sellers or buyers could come back into the market and take an opposite position if they saw an opportunity. This ensured market efficiency, albeit at a marginal cost to sellers or buyers.

Now the cost of violating trading limits is simply too high. In other words, once a price bubble is created, it can continue for the entire five days, with no possibility of a mid-course market correction. This is usually timely, healthier, and less likely to antagonise the market than a regulatory intervention which may be too often for comfort.
Commodities like wheat, gur, castor, turmeric, soyabean have seller option contracts.

“Earlier fines were there but market efficiency used to win. Now fines have won but the market is more vulnerable to distortion. The market always reads new regulations in conjunction with existing rules in closely regulated trading. With the bar on trading and stiffer penalties, the FMC has inadvertently opened a new window for market inefficiency,” said a Mumbai-based analyst.