FMC to ban over-leveraging in futures market

In a major blow to the commodity futures markets, the Forward Markets Commission (FMC) is planning to ban extra-leveraging of exposure by members to their clients.

The commodity derivatives’ market regulator is set to issue a directive in this regard shortly.

In usual practice, commodity exchanges offer exposure of up to 20 times of clients’ deposits. Members, in order to grab business, also allow leveraging of double the exchanges’ limit. This means, clients get exposure of up to 200 per cent of their deposits with a member. This, FMC said, has proven risky for all stakeholders.

Overall exchange turnover
Year	Turnover (Rs  crore)*	Change (%)
2008	4,958,379	—
2009	7,146,458	44.13
2010	10,152,500	42.06
2011	17,118,951	98.62
2012	16,731,088	-2.27
* Overall turnover of Multi Commodity Exchange, National Commodity & Derivatives Exchange, National Multi Commodity Exchange, Indian Commodity Exchange, Ace Derivatives & Commodity Exchange Source: Forward Markets Commission             Compiled by BS Research Bureau

The regulator has also noticed risks evolving, with members who took positions on the clients’ behalf and sent debit note to clients to pay the difference. FMC has received over 100 such complaints seeking reasons for a debit note emerging out of extra-leveraging. “Complaints are pouring in, some of them under the Right to Information Act, where the complainants have sought details of the clause under which a member can take position on a client’s behalf, of course without his notice, and send debit note to him,” said Ramesh Abhishek, chairman, FMC.

Terming this as an “unscrupulous” trade practice that happens possibly in thinly traded commodities, Abhishek said, “This is not in the interest of commodity trade.”

For example, trader X deposits Rs 1 lakh in his account with a member and gets exposure from the exchange worth Rs 20 lakh. But the member concerned allows the trader to buy contracts worth up to Rs 40 lakh. As the trader anticipates the price of that commodity to go up, he books full to his capacity. The member, however, in this process gets transaction charges and hence, allows the client to book as much as possible amid expectations to square off the same by the end of the day.

In case the commodity’s price declines, it creates mark-to-market losses for clients. If the client’s loss surpasses his deposit amount, he prefers to forgo his deposit money and not to cough up the balance loss he incurs during the whole process. “This is not acceptable,” said Abhishek. “Consequently, we are not going to allow exposure over clients’ deposits in any circumstances. We will soon issue instructions to commodity exchanges to immediately square off a client’s position if the exposure surpasses his limit.”

FMC is set to prescribe a heavy penalty on violators. This will further reduce the turnover of commodity exchanges, from where complains of excessive regulation have come.

Priti Gupta, executive director of Anand Rathi Commodities, said commodity derivatives markets were over-leveraged. “Against 20-25 of margins in equity market, commodity futures give 5-10 per cent. Hence, over-leveraging in commodity futures beyond exchanges’ limit should be warded off.”