Common clearing could bring about a sea change for commexes

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A common clearing corporation for commodity exchanges could change the way the commodity derivatives market functions.

To reduce transaction costs of market participants and strengthen the risk management system, the finance ministry has set up a panel of experts headed by V K Sharma to prepare a road map for a common clearing system for all commodity exchanges in India. It is possible the national Spot Exchange Ltd (NSEL) crisis and possibility of manipulation could have been triggers for the ministry to consider a common clearing mechanism for commodities.

Currently, in equities, cash and derivatives and currency derivatives clearing and settlement activity is carried out by the clearing corporations set up by various exchanges. Clearing corporations collect money, deliver the goods and settle deals. Collecting margins and risk management are exchanges’ responsibilities. In case of a default, an exchange takes counter-party guarantee and, therefore, the shortfall is compensated by the exchange, even if it has to use its settlement guarantee fund.

In the commodities segment, only one exchange—-National Commodity and Derivatives Exchange (NCDEX)—-has its own clearing corporation, perhaps because it is the dominant player in agricultural commodities, in which deliveries play a major role. In the case of Multi Commodity Exchange (MCX), a large part of the volumes are from commodities such as precious and base metals and energy products, for which deliveries aren’t much. Excluding NCDEX, all other exchanges have clearing members and banks, through which clearing and settlement is carried out. MCX has set up a clearing corporation, but is yet to operationalise it.

Nilanjan Ghosh, chief economist, MCX, said, “As an economist, I personally view it from two perspectives: From a monitoring and regulatory perspective, a common independent clearing corporation leads to ease of operation. But multiple clearing corporations could promote competition and enhance efficiency. Therefore, a policy trade-off will always exist, and one needs to make a judicious choice.”

For commodities, there are several limits on open interest, etc, for members and clients. If a common clearing platform for all exchanges is in place, it will be easier to track whether a player is concentrating positions through deals on multiple exchanges.

The terms of reference for the expert panel mentions setting up a repository, which will store records of transactions, especially of warehouse receipts. Repositories are different from depositories, which dematerialise underlying assets. In the commodities space, keeping records of warehouse receipts will be the first step towards making such receipts negotiable, freely transferable and, consequently, tradable.

A common clearing platform will need common infrastructure facilities such as warehouses, assayers, elevators or aggregators to facilitate delivery of the right quality and quantity of commodities for settlement of trade. This will lead to a less prominent role for exchanges, in terms of settlement and ensuring qualities, as these responsibilities will be moved to the clearing corporation.

An exchange official said the exchange’s job would be confined to trading and developing the market, as well as new products. In the US, clearing and settlement is carried out by external agencies; the Depository Trust and Clearing Corporation and the option clearing corporation are responsible for these tasks. In the UK, the London Clearing House has been the clearing corporation for many exchanges.

“A common clearing corporation will create room for many commodity exchanges to exist, as clearing will no longer be their headache and, therefore, niche exchange will come up, rather than omnibus exchanges,” said a derivatives market expert.

For clearing, commodity exchanges have members who aren’t involved in trading. The ministry has asked the expert panel to review membership categories and the separation of clearing membership from trading membership, with the introduction of professional, self-clearing members.

Currently, self-clearing members aren’t allowed in markets. This concept, an exchange official said, should be reviewed.