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Can a new owner revive MCX’s fortunes?

LiveMint logoLiveMint 26-05-2014 Mobis Philipose

Will a change in ownership at Multi Commodity Exchange of India Ltd (MCX) revive its fortunes? Investors certainly seem to think so—last Thursday, MCX shares jumped 20% on speculation that Kotak Mahindra Bank Ltd had submitted a binding bid to Financial Technologies (India) Ltd (FTIL) which is in the process of divesting its stake in the exchange.

But this might well be a case of putting the cart before the horse. Though FTIL has so far retained its 26% stake in MCX, it had been ousted long ago as far as the exchange’s management goes. Despite this, the exchange’s volumes have continued to languish. It’s unlikely that a new owner will be able to trigger a significant jump in volumes. This is because the commodity futures market is plagued by other factors.

To start with, a large part of the drop in MCX’s volumes (roughly 60%) was owing to the imposition of a commodities transaction tax (CTT) by the government in July last year. Volumes fell by over 40% in July and August compared with the average in the preceding three months. Until then, commodity futures markets had gained considerably at the expense of the equity markets, because trading in the latter involved the payment of securities transition tax (STT) before CTT was introduced. With the competitive advantage lost, jobbers and arbitrageurs preferred other trading avenues such as currency futures, where STT is not applicable, and equity options, where STT accounts for a much smaller portion of total trading costs.Yatish Asthana/Mint

It’s not surprising, therefore, that over time, volumes have fallen even more on the MCX. Of course, the exchange also had to contend with the fraud in an erstwhile group company, National Spot Exchange Ltd (NSEL). Worse still, a forensic audit on MCX revealed a number of malpractices, including so-called “wash trades”, or trades that weren’t genuine and were entered into only to boost volumes. According to a person at the Forward Markets Commission, thanks to the clean-up process in the past year, such wash trades are no longer taking place and could be another reason for the decline in volumes.

According to the head of commodities trading at a multi-national broking firm, the NSEL episode has caused a severe trust deficit as far as the commodity futures markets go. This is the reason, he says, volumes haven’t come back, despite a change in management at MCX. Besides, National Commodity and Derivatives Exchange, which had nothing to do with the scam, and has introduced new products in the past year, hasn’t seen a meaningful increase in volumes either. Of course, its volumes haven’t fallen much compared with pre-July 2013 levels; but then, most of its turnover comes from agricultural commodities, on most of which CTT hasn’t been imposed.

It’s unlikely that volumes in commodity futures markets will improve in a hurry. Prices of many commodities have fallen and volatility levels have been low, factors that are dampeners as far as traders go. Besides, lately, there is a clear preference for equities trading, thanks to the sharp rise in the markets in the run-up to and after the elections. It’s also unlikely that the government will bring back the unfair advantage commodity markets had by abolishing CTT. With the commodity markets also coming under the purview of the finance ministry, it appears that CTT and STT will both go, or will be cut by the same rate.

In this backdrop, it’s premature for investors to assume that MCX’s volumes can rise sharply only because of a new owner and management. Of course, this is not to say a change in management won’t have any benefits, but that underlying factors are tough and a quick revival will not be possible.

Meanwhile, a committee set up by the finance ministry on the commodity futures markets has just submitted its report. Its recommendations such as allowing domestic and foreign financial firms in the market are welcome, and will go a long way in improving the depth of the market. Of course, some of the recommendations are long-due reforms, which have been unduly delayed because the Forward Contracts Regulation Act bill hasn’t yet be passed. The committee has also rightly said that the government should stop the suspension of trading in commodity futures contracts abruptly. Interestingly, the committee has stayed silent on the CTT issue—it should have argued for abolishing it.

Reforms in the commodity derivatives markets are long overdue, and now that the markets are overseen by the finance ministry, they should be put in place sooner than later.

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