A tech snag & a basket of worries at MCX

“It is not a wedding where the shamiana guy did not turn up at the last minute," he said. “It is an exchange where technology is the most important aspect. Negotiations and renewals of technology contracts cannot be left to the last minute."

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The executive was echoing the views of thousands of traders who use MCX, a commodity exchange that commands a near monopoly. It has over 85% market share in commodity derivatives trading in India and 100% in metals and energy.

Not all is well with a technology transition in the works. MCX’s exchange technology, or its commodity derivatives platform, is on life support.

A technology contract with 63 Moons Technologies Ltd, MCX’s former parent, was due to expire on 1 October this year. Even as late as 26 September, traders had little clue on any tech support thereafter, or if a new vendor, Tata Consultancy Services (TCS), was ready with a new platform.

The fear: any bug in the software system would end up stopping trade—a serious consequence for traders. Glitches can potentially lead to losses in millions as they leave the traders stuck, in buy or short-sell positions. In fact, the market regular Securities and Exchange Board of India (Sebi) has put in place a financial disincentive on exchanges and its top officials in case of glitches and trading halts.

Traders and the executive cited above did breathe a sigh of relief when on 30 September, a day before the expiry of the contract, MCX’s board passed a resolution stating that it has extended the contract with 63 Moons Technologies—for another three months.

“The contract with the existing technology vendor ends on December 2022 and the smooth tech transition is the greatest challenge/focus for MCX management," stated Amit Chandra, an analyst with HDFC Securities, in a research report.

This technology fiasco is one in a series of problems that have marred the exchange over the past eight years, or ever since its former promoter, Financial Technologies Ltd (FTIL), was forced by the regulator to exit in 2014.

In August 2015, FTIL was renamed as 63 Moons Technologies, “inspired from the 63 moons of Jupiter, the most powerful planet in the universe that stands for knowledge, wisdom, foresight and, above all, growth and prosperity". In reality, the change of name was inspired by a crisis, but more on this later.

So, what are MCX’s other headwinds apart from the botched technology transition? It ranges from alleged data leaks to a slow off-take of institutional participation on its platform. With crude and commodities prices volatile, it is arguably the best time for a commodities exchange to generate more revenue due to higher trading volumes. But instead of celebrating high volumes, this listed exchange has been moving from one crisis to another.

While Nifty50, in the past one year, has generated a return of 1.1%, MCX’s performance has led to wealth erosion. On 4 November, the stock was trading at ₹1,491.85, much lower than its 52-week high of ₹2,021.95.

The new platform

MCX was founded by Jignesh Shah, an entrepreneur who prides himself for establishing the “electronic silk and spice routes across continents" and for being the “innovator of modern financial markets".

Ever since its inception, in 2003, the exchange has been reliant on 63 Moons for their technology platform. But things dramatically changed after the National Spot Exchange Ltd (NSEL) crisis.

NSEL, a spot exchange for agriculture products, was also promoted by FTIL. A ₹5,574 crore payments crisis engulfed NSEL in 2013— the exchange was unable to honour payouts, causing losses for 13,000 investors and traders. Subsequently, promoter FTIL was declared ‘not fit and proper’ by the Forward Markets Commission, the former commodities market regulator. Thereby, it could not be a shareholder in an exchange. The change of name to 63 Moons, according to industry watchers, was an attempt to reinvent the company after the crisis.

MCX’s tech contract with the parent, however, stayed in place. But there was growing pressure on the MCX board to find an alternative technology vendor. In September 2021, MCX awarded a contract to build a new platform to TCS. This platform isn’t ready yet.

TCS had been contracted to build a platform for trading as well as post-trade functions. Post-trade activities—such as clearing, risk management, delivery and settlement—are expected to undergo a transformation. Additionally, TCS is supposed to implement a new software for MCX’s trading members, which would provide them with a faster and more intuitive user interface, real-time market data feed for trading and post trade activities.

However, a mock trading session to test the new platform is yet to be conducted, people in the know said. TCS did not comment on a Mint query.

The IT services company and the exchange are working to be ready with the technology platform soon, P.S. Reddy, CEO and managing director of MCX, told Mint on the sidelines of an event organized by the Association of National Exchange Members of India (Anmi) recently.

In its second quarter investor call on 1 November, MCX’s management said the full platform is expected to go live by the end of December.

Meanwhile, a senior MCX official who didn’t want to be named, said the exchange had approached 63 Moons for extension in August itself. “Somehow, it came to the last minute. We had some discussions and could not move forward much on that. We had some backup plan, which did not work out. That’s the reason for this last-minute hurry," he said. “We plan to start mock trading this month (on the TCS platform). No point in speculating on whether TCS is ready," he added.

The data concerns

Exchanges are quasi-regulators—the first line check on markets. They need to be beyond reproach. But governance lapses at the National Stock Exchange (NSE), India’s largest stock exchange, have shaken the confidence of industry watchers and investors.

There have been governance lapses at MCX, too. Perhaps not on the same scale but enough to make Sebi uncomfortable. It has asked the exchange to fix responsibility.

So, what are the concerns?

One involves the alleged leak of exchange data and its subsequent misuse.

In September 2016, under the former managing director and CEO, Mrugank Paranjape, MCX signed a data sharing pact with the Indira Gandhi Institute of Development Research (IGIDR), a research institute in Mumbai established and fully funded by the Reserve Bank of India.

As per the agreement, MCX needed to provide extensive data support to IGIDR for carrying out independent research work. IGIDR, in turn, had to identify and evaluate issues affecting the growth of the Indian commodities market and provide plausible policy/institutional solutions to address them.

A subsequent audit by T.R. Chadda and Co. in 2018, commissioned by Sebi, threw up a number of gaps and red flags.

In July 2019, the regulator wrote to Paranjape with its concerns—a copy of the letter has been reviewed by Mint. Sebi asked three pertinent questions: one, why was the data shared (with IGIDR) on a daily basis? Two, why were additional data sets shared, which were not a part of the original pact? Finally, why was an email sent by Susan Thomas, a researcher at IGIDR, asking Paranjape to meet her sister, Sunita Thomas. Her sister runs a firm which provides algo trading software to brokerage firms.

According to documents reviewed by Mint, MCX’s head of research, V. Shunmugam, told Sebi that “it was simple and easy" to transmit data on a daily basis. He added that sharing additional data fields was to reconstruct the live market condition by IGIDR to access various liquidity parameters.

Paranjape, who had joined the exchange in May 2016, decided to quit the exchange in May 2019. “Stepping down after such an exciting journey with a great year of results to look back upon was an extremely satisfying outcome," he wrote on LinkedIn after he quit.

He was replaced by P.S. Reddy, the former head of Central Depository Services Ltd (CDSL).

Meanwhile, some market watchers have drawn parallels with the lapses at NSE.

Sebi had earlier found governance lapses and inherent conflict of interest at NSE—in how a software development firm named Infotech Financials Pvt. Ltd. was granted a contract for computing the Liquidity Index, or LIX (an index meant to gauge the liquidity in the market). One of the directors was Sunita Thomas.

“The examination conducted by Sebi revealed that the trading data that was received by Noticee No.2 (Infotech) from NSE for research in the LIX project was being misused for developing algorithm trading products," Sebi had cited in an order from April 2019.

While MCX did not award any contract to the same company, the regulator was worried because of the e-mail mentioned earlier, an executive said, declining to be named.

Meanwhile, an investor association filed a writ petition in the Madras high court seeking a directive to Sebi to act against MCX on these alleged lapses. Sebi said that it had directed “MCX to conduct a forensic audit and fix accountability of the individuals based on the findings of the forensic audit".

“On 22 October 2021, a censure order was issued as well as pecuniary punishment was imposed on Mrugank Paranjape, ex-MD and CEO of MCX, in the matter of data sharing with IGIDR by MCX. Further, his variable pay of ₹41.25 lakh for fiscal 2016-17 and 2017-18 was forfeited and no variable pay was paid for 2018-19," Sebi stated in the court filing reviewed by Mint.

When contacted, Paranjape declined to comment, citing the case was a civil dispute and a regulatory matter.

The other big legal overhang is a contract awarded to a London-based company, PSEB, in August 2018—for development of a spot trading platform. At present, MCX is a derivatives exchange dominated by non-agri commodities and it wanted to enable spot trading, which involves securities traded for immediate delivery. For instance, in a gold spot contract, the trader takes delivery of physical gold immediately.

“MCX had clarified that PSEB was chosen to develop spot trading after a competitive bidding process. A payment of ₹20 crore was made. Then, conflicts arose—on non-fulfilment of the work according to the timelines. PSEB then invoked arbitration proceedings. As of July 2022, an amicable solution was being worked upon," an executive with direct knowledge of the matter said.

MCX, in a stock exchange filing in 2021, had disclosed that it had “requested the vendor for amicable resolution of dispute; to complete the project without any cost escalation and provide knowledge transfer to MCX team for the amount paid thus far."

The Path ahead

In May 2019, Sebi permitted mutual funds to invest in the commodities markets, and in June this year, the regulator allowed foreign portfolio investors (FPI) to invest.

Nevertheless, it wouldn’t be easy for MCX to attract such investors.

Unlike equities, where listed companies largely trade only in India—with the exception of depository receipts—commodities trade everywhere. And India is a late entrant. The only hope? FPIs can use MCX for arbitrage, or the buying and selling of commodities in different markets to take advantage of prices.

As for mutual funds, their investment also remains limited because of volatility in commodity prices and sectoral caps. The exposure of a mutual fund scheme to a single commodity is capped at 10%. These limits do not apply to gold exchange traded funds (ETFs) and gold funds.

“We, from our side, are making efforts. We have recently recommended Amfi (Association of Mutual Funds in India) to come out with a separate committee for commodities. Because, we want somebody from Amfi to pick up some issues related to the commodity markets. We have been asking the regulator to accommodate certain aspects…" D.G. Praveen, chief risk officer and head of investor relations at MCX, said during an investor call in August this year.

While the exchange would have to work hard to make mutual funds and FPIs participate, it is the governance concerns that need more urgent attention. The market regulator would also want a closure on these episodes as soon as possible.

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