Both are strengthening the risk management and surveillance mechanism at their level. While Sebi has set up a task force and risk management committee, which is considering the methodology for handling default by members, among others, the NCDEX has strengthened mandi-level surveillance, which influences futures the most.
NCDEX, a leading agri-centric commodity derivative exchange, had in January suspended all contracts of castor seed, which was among the top five volume gainers, “to protect the integrity of the market”. Sebi handled this episode professionally and the commodity derivatives market witnessed how the regulator managed the crisis swiftly without impacting the market’s integrity. The measures taken following the episode will shape the way the commodities derivatives market would be regulated in future.
Sebi’s whole-time member Rajeev Kumar Agarwal, who is also in charge of commodity derivatives at Sebi, said: “Sebi followed a multi-pronged approach. It examined the issue from the angle of systemic risk, governance of the exchange, market integrity and investor grievance. A task force was set up to examine systemic issues, including risk management at exchanges. The board of the exchange was advised to fix responsibility if there have been any lapses in risk management and an interim order debarring 22 entities was passed to take care of market integrity aspect. NCDEX also has been directed to address grievance and facilitate the sale of stocks of those who were on sale side and did not get the opportunity to give delivery and to consider monetary compensation.”
What went wrong with castor futures
Castor prices were rising through December due to the impact of draught and also because new crop arrivals would start only after February. Sensing that the prices went up too much, some players, especially those who were having naked short positions in the market found out that in the past few months one foreign bank and a couple of non-banking financial companies were withdrawing lines of credit from all borrowers.
Ruchi Soya, the largest exporter of castor from India, was one of them. It had to manage funds to return that prematurely. Towards the end of 2015, Ruchi is said to have picked up huge deliveries of castor seeds on the NCDEX platform.
This financial crunch further strengthened the belief that it’s better to remain short in the February contract to ensure one big competitor is badly hurt. When bears were having the upper hand, NCDEX was forced to suspend trading on castor seed contracts.
Going by Sebi’s interim order issued by whole-time member Rajeev Agarwal, Ruchi manipulated the system and built positions using some players as their front.
Now, all of them came under the regulator’s net and barred by Sebi from dealings in the securities market. This was one of the fastest regulatory actions in commodity manipulation in recent times and Sebi has signalled the market how decisively it can act.
Ruchi Soya declined to comment on any of these issues. When contacted, an NCDEX spokesperson, too, declined to comment on the castor seed episode. The exchange did its internal audit and found that it needs to include surveillance of the physical market (mandi) because most of the developments impacting derivatives were happening outside the futures market. It immediately tightened its mandi-level surveillance team by appointing 11 more persons. It buttressed the core surveillance team, too, by hiring persons with forensic skills. Sebi is in touch with the management of the exchange. The exchange’s board has ordered a forensic audit report of the whole episode, which is expected to be submitted to the board in the next few days.
How Sebi handled the episode
1. Systemic aspect: Before the castor seed episode came to light, the regulator reduced position limits. Trading in the forward segment was suspended. After the castor seed issue, it further tightened position limits for agricultural commodities and restricted netting of positions
Its task force is also considering liquidity-linked initial margins, concentration margins, methodology for handling of member default and norms for default waterfall.
2. Governance aspect: Sebi has asked the exchange's board to examine the role of the management in suspension of castor seed Contracts thoroughly and fix responsibility for failure in assessing the situation,
3. Market integrity aspect: 22 entities were debarred from the market vide an interim order.
4. Public grievances aspect: The exchange was advised to resolve the grievances of hedgers. Following this, the exchange in consultation with brokers' association facilitated liquidation of stocks of hedgers and compensated of losses arising out of suspension of castor seed contracts.
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THE CASTOR SEED CATASTROPHE: A TIMELINE
* 27 January: Suspension of castor seed contracts
* 29 January: Settlement price for outstanding positions announced
* 17 February: Constitution of a special cell for redressal of castor participants' grievances
* 18 February: offered NeML platform to sell castor seed stocks to help genuine sellers who could not give delivery
* 2 March: Restraining order against Trading members and their defaulting clients
* 6 May: Exchange announces close out price to compensate genuine hedgers