‘NCDEX’s revised penalty could lead to more defaults on delivery’

‘NCDEX’s revised penalty could lead to more defaults on delivery’

New Delhi: The reduction in penalty from 5% to 2.5% for failure to meet delivery obligations of National Commodity and Derivatives Exchange Ltd (NCDEX) may lead to more defaults in the futures trade, market analysts said.

“The defaults on the commodity exchanges, which are estimated to be about 5% of the total exchange turnover, are likely to increase with the slashing of penalty," commodity brokerage firm SMC Comtrade Pvt. Ltd chairman and managing director D.K. Aggarwal said. “The percentage of defaults has so far been low due to stringent penalty, though deliveries on the exchange platforms are negligible to the tune of 1-2% of the total trade."

Last week, NCDEX and Multi Commodity Exchange of India Ltd (MCX) reduced the penalty provision on all “running and future" contracts following a direction by the commodity market regulator Forward Markets Commission.

Earlier, the buyer or seller used to receive 4.5% of the contract value if the other party defaulted on delivery, while 0.5% went to the Investor Protection Fund (IPF). Now, a buyer or seller will receive 0.5% of the contract value if the other party defaults on delivery, while 2% will go to IPF.

“The penalty revision will affect mostly compulsory delivery contracts," Karvy Comtrade Ltd analyst Harish G. said, adding that the penalty charges will be same for different delivery logics for both compulsory and seller options.

There are, however, certain advantages of the new guidelines because earlier, penalty was decided without considering spot prices on the day of delivery. “But with the new system, spot price on the day of delivery will have major impact," he added.

A seller will be only too happy to keep the positions open until expiration without delivery and escape by paying 2.5% penalty if spot is higher than his selling positions. Similarly, a buyer will benefit if the spot is lower than his positions, a commodity expert, who did not wish to be identified, said.

Analysts agreed that real market participants such as traders, exporters and hedgers are likely to be affected with the new system.

“The new penalty system will help speculators to stay in the market till the end of the expiry of the contract and may keep positions open with low penalty," Harish said. “As far as hedgers are concerned, earlier they used to roll-over positions before expiry and thereby drained the liquidity. Now, they may hold positions till the end of the contract or even keep positions open if spot market price is not favourable to them."

However, the new system would distort the fair price discovery mechanism because the seller has an upper hand in the new scenario with very low penalty. This will stop the genuine buyers from participating in the market because they are not sure whether they will get the deliveries, Aggarwal said.

Experts said the penalty revision will curb excessive volatility during the tender delivery period. The revision brought down the prices of agro commodities last week causing big losses to speculators.