Prevention and deterrence of manipulation are major objectives of the regulation of futures market worldwide. Recent instance of manipulation on futures exchanges has sadly seen history repeat itself over and over again and in the very same exchange, which has had a history of similar instances in the past. Surprisingly, not only other agri commodities like Guar seed and Chana, but in the very same commodity, Castor seed few years back in 2016.
This either means that, for reasons best known to the regulators and the exchange involved, a blind eye is being turned towards such manipulation, or the regulator being new to this market is finding it difficult to get a grip of the situation and is being consumed by other issues plaguing the equity markets presently, which takes priority over commodity markets.
There were signs of trouble brewing in castor seed futures, which NCDEX should have ideally spotted early with better monitoring. Alarm bells started ringing for NCDEX after officials realised that a large section of buyers was excessively leveraged and might not have over 5 bln rupees needed to honour the delivery. The way in which NCDEX and its clearing corp handled this castor seed crisis threatens to create a major trust deficit among participants in the commodity market. However, this column is not to add oil to fire, but to suggest a possible permanent solution, so that such instances does not recur again, and more so in Agri commodities. And in that specifically in commodities without an international reference or benchmark.
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A POSSIBLE AND CREDIBLE SOLUTION
Though this has been suggested by experts in the past, due to the current circumstances, it is hugely relevant and only re-affirms and revives that suggestion to be taken seriously by the regulators and policy makers.
Apart from few instances of manipulation in commodity futures in the US, it has never come to an extent of banning a contract, or a settlement crisis, thanks to the robust mechanism that catches any aberrations in the futures prices and sends alarm bells ringing way ahead. We are not talking about any sophisticated risk management procedures here, but a wonderful and transparent compulsory reporting called, The Commitments of Traders report ( COT), that is published every week that even helps investors predict the price movement, over and above being an early warning system for the regulator and exchanges.
The Commitments of Traders is a weekly market report issued by the Commodity Futures Trading Commission (CFTC) enumerating the holdings of participants in various futures markets in the United States. It is collated by the CFTC from submissions from traders in the market and covers positions in futures on grains, cattle, financial instruments, metals, petroleum and other commodities. The Commodity Futures Trading Commission (CFTC) releases a new report every Friday at 3:30 p.m. Eastern Time, and the report reflects the commitments of traders on the prior Tuesday. The weekly Commitments of Traders report is sometimes abbreviated as "CoT" or "COT."
The report was first published in June 1962, but versions of the report can be traced back to as early as 1924 when the U.S. Department of Agriculture’s Grain Futures Administration started regularly publishing a Commitments of Traders report.
The report provides a breakdown of aggregate positions held by three different types of traders: “commercial traders,” “non-commercial traders” and “non-reportable.” “Commercial traders” are sometimes called “hedgers”, “non-commercial traders” are sometimes known as “large speculators,” and the “non-reportable” group is sometimes called “small speculators.”
The CoT report is keenly awaited by traders to gauge the trend in the market by analysing the changes in the positions of large speculators and/or commercial traders (hedgers). Many traders use the CoT report to bet in the direction of non-commercial traders, as it found in the last many years that this category of traders is usually on the right side of market. Some track non-reportable (small speculators) positions, as they believe that this category of traders is on the wrong side of the price direction.
Source: CFTC , Reuters
An example of the weekly CFTC report on cotton , can be seen above.
I strongly believe that this mechanism of voluntary disclosure by market participants could be an ideal solution. If the biggest commodity futures markets in the US, are relying on it and there has not been any major instances of manipulation, why can't we take inspiration from it, than constantly rubbishing it as too early for the Indian market system to implement? Many in the exchanges and the policy makers believe that Indian commodity derivatives markets are still not mature enough to have a CoT-like system. It has been almost 15 years since commodity futures were nationalized, and it is sad that we have not even taken baby steps to implement such a system. This could bring in greater transparency in policy formulations and also to set limits for different trading categories and avoid such repeated instances of failures that dampen sentiment for commodity markets in India as a whole.
CONCLUSION: Assuming the system was in place, both the regulators and the exchange would have been quick to spot the balooning open interest, which was almost a quarter of total production. When the Non Commercial positions ( Large speculators) positions increased/decreased on a weekly basis, both would have been quick to act by increasing margins, or the circuit filters, or dealing with it appropriately in any other way.