Mumbai: A Securities and Exchange Board of India (Sebi) audit of warehouses accredited by commodity exchanges has found discrepancies in both the quantity and quality of stock they hold, said two people familiar with the matter.

Current Sebi norms allow commodity exchanges to outsource warehousing of stocks to third-party warehouse service providers that are accredited by the bourses.

“Stocks of exchange members as well as those that did not belong to them were found clubbed together in some warehouses. The quality of the stock was also not up to the standards prescribed," said one of the two people, who spoke on condition of anonymity.

The findings come ahead of the third anniversary of a settlement crisis that led to the suspension of trading on the National Spot Exchange Ltd (NSEL) and the exposure of a fraud to the tune of 5,574 crore at the bourse.

Discrepancies in stocks can give a misleading picture of the actual quantity that forms the basis of futures contracts that trade on commodity exchanges. Indeed, the lack of stocks, or the underlying commodities, in the warehouses of 24 members was at the core of the NSEL fraud (apart from the fact that the exchange was allowing futures trading despite being a spot exchange).

Owing to the absence of underlying commodities, these members defaulted on their payout obligations, leading to the exchange suspending contracts on 31 July 2013.

“The warehouses are woefully lacking. Sebi will seek an explanation from the exchanges," said the second of the two people cited earlier, also speaking on condition of anonymity.

A Sebi spokesperson didn’t respond to an email seeking comment.

A spokesperson for the Multi Commodity Exchange of India (MCX), the country’s largest commodities bourse, declined to comment.

A spokesperson for National Commodity and Derivatives Exchange (NCDEX) said in an email that it had not heard anything from Sebi.

“The Exchange will take appropriate action on receipt of the observations. The exchange remains committed to creating a robust warehousing infrastructure for deliveries on its platform," the spokesperson said.

MCX and NCDEX account for 90% of commodity exchange trades in India.

The NSEL fraud, which caused losses to 13,000 investors, led to stronger regulations for warehouse providers. Typically, exchanges have to make good on these losses through their settlement guarantee fund, but in NSEL’s case this was just 4 crore.

On 30 August 2013, the Forward Markets Commission (FMC)—the commodities market regulator at the time—made it mandatory for all exchange-accredited warehouses to be registered with the Warehouse Development and Regulatory Authority (WDRA).

While FMC tried to address warehousing concerns after the NSEL crisis, considering that “WDRA doesn’t have adequate enforcement powers, there was little that these regulations achieved", said Girish Dev, managing director and chief executive officer of Geofin Comtrade Ltd, a commodities broking company.

After FMC was merged into Sebi a year ago, the regulator on 3 June came out with new rules for warehouses, aimed at increasing the transparency of deliveries associated with commodity-market transactions and curbing risks arising from potential frauds. Since the merger, this has been the first full-scale audit of warehouses.

According to norms proposed by Sebi, a warehouse service provider has to be a corporate entity, the promoters of which have sufficient credibility and have been in the business of public warehousing for at least three years. Every accredited warehouse service provider must have share capital of at least 10 crore.

Further, an accredited warehouse service provider serving a single exchange must have a minimum net worth of 50 crore for multi-commodity or multi-location trading and a minimum net worth of 25 crore for single-commodity or single-location trading.

“Any non-compliance (with the laid-down exchange bye-laws) will attract penal measures including cancellation of accreditation of the warehouse service providers," says the guidelines on NCDEX’s website.

“What Sebi is trying to achieve with the warehousing norms is forward-looking; it will ensure that warehouses of certain net worth are registered with the exchanges. But the actual change will happen over time when there are enough deterrents—such as penalties and other penal actions—for intermediaries to avoid manipulation," said Dev of Geofin.

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