MCX orders Crude Oil sellers to pay to sell to buyers
· The spread of the pandemic brings crude to its knees. NYMEX fixes minus $ 37. 63 as the settlement rate for WTI Crude Oil Futures expiring on April 20, 2020.
· MCX withholds its mechanism of deriving Due Date Rate, fixes the settlement rate at minus Rs. 2884 for the Crude Futures expiring on April 21, 2020.
· Outstanding 11,000 contracts face an additional burden of more than Rs. 400 crores.
· Sellers now required to pay to sell the commodity to buyers.
· The situation challenges the pricing models and the risk management systems, requires efforts to accommodate and factor in the negative pricing in it.
· A bold step, recognizes the interplay of market forces and the interconnection of the Indian Market to international ones.
The Crude conundrum
The downward spiral in the prices of Crude Oil owing to the stagnant demand due to COVID-19 pandemic has hit the markets hard and has led to a situation which is unprecedented and marred by uncertainty.
On Monday, April 20, 2020, NYMEX declared fall in the price of the US WTI Crude Oil Futures to a sub-zero level. The Exchange fixed the settlement price for the day at $ -37.63, which means that the sellers in the respective contracts have to pay to the buyer of crude oil to get rid of the commodity.
Such a downward price plunge is creating ripples in the commodities markets in India too. The settlement price fixed by NYMEX becomes a base for fixation of settlement price in Indian commodities exchange. The Multi Commodity Exchange, one of the largest commodities exchange in India, vide its circular dated April 20, 2020 fixed the provisional settlement rate at Re. 1 but modified the same through a subsequent circular dated April 21, 2020 and fixed the final settlement price of the Crude Oil Futures, having their expiry on April 20, 2020 at Rs. -2884 per barrel. The price has been arrived according to the method mentioned in the contract specification which mentions:
“Due date rate shall be the settlement price, in Indian rupees, of the New York Mercantile Exchange’s (NYMEX) Crude Oil (CL) front month contract on the last trading day of the MCX Crude Oil contract. The last available RBI USDINR reference rate will be used for the conversion. The price so arrived will be rounded off to the nearest tick.”
By applying the same principle on the prevailing market conditions with the Dollar rate variable into play, the NYMEX Settlement Rate of – $-37.63; at USDINR Reference Rate at Rs. 76.63, rounded off to nearest tick will result in Rs. -2884, which is the settlement rate prescribed by MCX.
From the salient feature of the Crude Oil Futures Contract; irrespective of the Settlement Rate mentioned by the NYMEX being positive or negative, it needs to be factored in while determining the Settlement Rate at MCX.
Bad News or need of the hour? Play of Market Forces
The move of revising settlement price and fixing it at Rs -2884 is a breakthrough and is a step towards recognizing the paradigm shift in the pricing models of the Exchanges which accepts negative pricing as a result of the market forces and which reinforces the superiority of the fundamentals based on which the market functions.
For those arguing as to why the speculators be allowed to profit more than the targeted price, the answer is “The Market Forces”. The flow of such questions follows a particular conditioning, that they are not raised when there is an unexpected jump to a higher price in the market. On this pretext, it is also to be noted that certain traders traded in the speculation range permitted by the exchange. Traders may have foreseen that the prices of the contracts would dive towards negative as the likelihood of this notion was widely discussed in media before this situation actually arose. The decision of sellers to continue with their positions certainly was a calculated risk and the brokers do not bear the losses due to this decision of sellers.
Following the fact that a negative settlement price has been fixed, it is a misnomer that in contracts where settlement is to be done in cash, the same cannot be settled at a negative rate since these are just derivative contracts, linked to the price in the spot market and settlement in cash is an agreed mode by both the parties to the contract, in an agreement designed by the exchange itself. Therefore, making an exception by the regulators was the need of the hour.
The participants, post the sub-zero levels are arguing that they did not have an opportunity to square off their trades when the prices reached zero since the Indian markets were not functional due to the recent change in timings of the exchange. This argument will however be clearly for the sake of sheer convenience, thought and raised post facto, since none of the representative bodies made any squall when the rule relating to the trading was actually changed.
Another argument put forth is that the exchange does not permit trading in negatives, thus there is no reason or justification to permit settlement at negatives. The negative position is however time bound only applicable for a limited period of time and may lead to a change in the trading systems and platforms as the requirement to accommodate trading in negatives is the need of the hour.
Brokers are looking to challenge the settlement by joining forces as we publish this article.
In addition to above, this move of MCX, apart from the necessary implications also hints at the importance of reciprocal promises between the parties to the contract and the requirement of exchanges to be bound by and to honor the necessities of being a frontal regulator of its members and constituents. This is a bold step by the regulator to keep up with the changing time and respecting the market forces and certainly a step towards more matured markets.
Aditya Bhansali is the founding partner of Mindspright Legal (MSL) and Suyash Bhandari is an associate with the same firm. MSL is a mid-tier boutique practice headquartered at Mumbai with offices in Delhi, Jaipur and Ranchi. MSL specializes in Securities Markets and other exchanges with other practices in Corporate Law, Litigation & Dispute Reolution, White Collar Crimes, Transaction Advisory and Intellectual property.
The views mentioned here are not to be considered as legal advice and should be consulted for a complete legal opinion.
Partner: Mindspright Legal. Currently hiring for legal and HR roles.Published
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