New Delhi: The Serious Fraud Investigation Office (SFIO) has initiated a probe into the recent crude price settlement by Multi Commodity Exchange (MCX) that has opened up a virtual Pandora’s Box in the country’s commodities markets.
The probe, which has just started, will take a look at a number of issues including the settlement price that prompted some of the top brokerage firms to sue the exchange and also the Securities and Exchange Board of India (SEBI), the market regulator.
Not just SFIO, there are high chances that the Enforcement Directorate could look into the case, especially to probe if top Indian brokerage firms were violating Indian regulations through their global subsidiaries, which falls under the Prevention of Money Laundering Act, or, PMLA.
Interestingly, the Bombay and Delhi High Courts have refused to provide any interim relief to the brokers who claimed to have been hit by negative pricing settlement of crude oil by MCX. The Bombay High Court petition was filed by Motilal Oswal Financial Services. In Delhi, the petition was filed by Prasar Commodities, a small-time broker. The petition has been listed for the first week of June. Both SEBI and MCX, against whom the case was filed in Delhi, wanted the petition to be dismissed. The court said the submissions are substantial. “The court is not inclined to dismiss the present writ petition, but it needs to be answered, comprehensively, by the petitioner,” it said.
Last week, brokers and investors knocked the doors of the high courts against the decision of market regulator SEBI and MCX to settle April crude futures contract at minus Rs 2,884 per barrel for the first time in history of commodity trading in India.
MCX, which initially announced a provisional settlement price of Re 1 for the crude oil futures contract, calculated a price of minus Rs 2,884 per barrel, leading to investors losing about Rs 435 crore. Investors, who had paid the entire money for their trade in crude oil, had to incur an additional expense of 300% over and above due to the negative pricing.
Brokers claimed that the settlement price of MCX derived from crude oil contracts traded on Nymex are not comparable. While MCX contracts are cash settled, Nymex contracts are deliverable and hence negative pricing cannot be applied in India, which does not have provision in law for negative pricing, brokers claimed.
But that is on paper, it is for everyone to see. What is not visible to many is a crucial point: If someone trades simultaneously in both markets—first leg profit in NYMEX and second leg loss in MCX—there are high chances a brokerage firm can lock risk-free profit.
The SFIO will specifically probe if two India-based brokerage firms covered their positions from faraway Hong Kong and Singapore through their international subsidiaries. “There is news filtering into India that two brokerage firms during the second leg of arbitrage on NYMEX sold positions through its global subsidiaries and earned over Rs 200 crore. Such transactions are not permitted under the Indian laws and could come under the ambit of PMLA. This is what the SFIO will probe,” said the sources.
Top sources in Mumbai and Delhi have told this reporter that there were efforts by the SFIO to get to the bottom of the case, including tracing those who backed brokers and whether some of these were members of the Association of National Exchanges Members of India (ANMI).
“Efforts are on to find out if the brokerages called crude shorts because they were paying attention to the OPEC calls. OPEC Plus nations have been asking people to decrease oil production for quite some time. In a way, even Washington is responsible for the mess because the US government negotiated the number of barrels per day to be decreased for the countries. It needs to be probed if the brokerages had advanced information from some backroom players completely away from the scene since Covid became a real thing,” the sources further added.
So on paper, the loss in India is Rs 435 crore, what is not known is the profit of Rs 475 crore in the international market. So the net gain, as per standard calculations, is Rs 40 crore. But this is not the end of the story. There are now huge suspicions in the Indian commodities markets that some brokers could have played a bigger game. They had chanced upon a huge opportunity in India to fortify the loss by taking advantage of the situation through some questionable means. As a result, it is not a case of Rs 40 crore profit, but a case of Rs 400 crore plus profit.
There is growing suspicion in the markets that a handful of brokerage houses—backed by former and current bureaucrats supported by former Finance Minister P. Chidambaram—are pushing MCX to pay them. If that happens eventually, the cartel of brokers would manage what actually would be an illegal gain from the CME. Once that happens, the cartel—claim top sources—would successfully impute this in India as their lost leg.
Another issue that triggered suspicion is the fact whether the brokerage houses lost cash is actually their clients’ money and that the clients were their investors. But there are doubts whether the cash was from their portfolio management services (PMS) or benami cash of speculators. It was not immediately known if the shareholders of Motilal Oswal had egged on the brokerage firm to fight with the exchange and regulator on behalf of its clients. Many were surprised at the dustup, ostensibly because these very clients had traded with full knowledge, as per the rules of the contract, and as per guidelines framed by both SEBI and MCX. If the brokerage firms could not meet the liquidity obligation, they could easily dip into the Settlement Guarantee Funds (SGF), right? The other point that SFIO officials claim merits attention is the fact that how come the brokers—who routinely claim to maintain one of the finest research staff in India—allowed their so-called clients to keep their position open beyond 1700 hours when MCX had already announced trading is open till 1700 hours.
These are some of the issues that are now under the scanner. Equally disturbing and surprising was the way the entire matter reached the courts. First, never before brokerage firms have gone against the market regulator and an exchange so aggressively, filing simultaneous cases in Delhi and Mumbai High Courts, and also at Securities Appellate Tribunal in Mumbai. Remember, the petitions were filed despite a nationwide lockdown to combat the deadly coronavirus.
Many are also wondering why the Securities and Exchange Board of India (SEBI) is silent on this issue. The market regulator has sought inputs from all exchanges about their ability to handle negative pricing. But that is just on paper.
Top sources in Mumbai told this reporter that the MCX imbroglio, once again, highlighted the way some Indian brokerages do business. And the way these scandals get buried right under the nose of SEBI.
Let’s first check the background of this incident that triggered the crisis. Triggered by a record slump in the West Texas intermediate (WTI) contract price for May, Multi Commodity Exchange Clearing Corporation, an MCX subsidiary, settled April expiry during the late hours of April 20 at a negative Rs 2,884 per barrel. Thanks to the unprecedented move, many retail traders with long positions in the April 2020 contract would have to pay around Rs 2.88 lakh more for every lot of crude, i.e. 100 barrels, at the MCX quoted closing price of Rs 965 on April 20.
So what happened? Producers and traders who participated in the global oil market worldwide were smashed, Indian traders were collateral damage.
Now this brings to fore some of the most crucial issues of the Indian markets. First, it is now clear the Indian brokers should take a lesson from the way the global brokers operate. In short, every broker—worldwide—is responsible to the exchanges and also to their clients. It happens across the world but not in India.
For the records, exchanges, since March 27, 2020, had reduced trading hours to 1700 hours.  Now oil prices in Indian exchanges are directly linked to those traded in New York Mercantile Exchange (Nymex). As a result, once the timings were curtailed Indian traders were always exposed to overnight price risk if they were carrying their trades to the next day. No one did anything about it. There’s more to this crisis. Nymex allows the trade to be settled by taking delivery, in the Indian market contracts have to either be squared off or the exchange closes the trade based on the settlement price. In real market terms, this is a very delicate, crisis zone. So when the massacre took place, April futures contracts ended both in India as well as on Nymex. But what many did not notice is the fact that the huge open interest in the Nymex oil market ahead of expiry was the first sign that the oil market was in trouble. The US was running out of storage space for crude, it was clear that by mid-May 2020 tanks would overflow and traders who would have insisted on taking delivery for April contracts would run out of storage space. Once this information was out, it immediately led to the long unwinding of future contracts which pushed prices into the negative zone.
This unwinding happened when MCX was closed, Indian traders who had left their position open were rattled out of shape. Had the exchange not curtailed trading hours, Indian exchanges would have been operating till 2230 hours—their usual time—and traders could have exited.
Pandemonium prevailed, it was the Black Swan Day for MCX which failed to arrive at a settlement price for its contract ended on April 20 and announced a provisional settlement price of Re 1 per barrel after the Indian market closed. It later changed it and aligned the rate with that of Nymex and announced a settlement rate of minus Rs 2,884 per barrel. Now, 11,500 April contracts open in the Indian markets caused a potential loss of Rs 435 crore to the broking and trading community.
The billion dollar question that remains unanswered is: Who will foot the bill for these losses?
What has happened cannot be brushed under the carpet. The crisis is big, ostensibly because over 95% of all trades in crude oil futures in India pass through the MCX platform.
If it is found that some brokerage houses indeed benefited from the midnight scandal, it would be another Black Swan Day for the markets in India.