An unprecedented case of settling a futures contract at negative price regained focus after six years, with the Bombay High Court dismissing several traders' petitions related to commodity bourse Multi Commodity Exchange of India Ltd (MCX) fixing the settlement price of crude contracts during the pandemic at Re 1.
The 24 June ruling is significant as the case relates to traders who had taken long positions in crude oil contracts requesting annulment of the trades citing the massive losses they suffered, and the court upholding the commodity bourse's settlement mechanism which did not envisage a negative pricing back then.
MCX crude futures mirror the West Texas Intermediate (WTI) contract which is traded on the US-based New York Mercantile Exchange (Nymex). By this logic, MCX crude price is settled at the prevailing price on Nymex during contract expiry.
The pandemic resulted in a global lockdown, disrupting supply chains across the world. Crude on the high seas was diverted to Nymex-related warehouses, causing a supply glut and pushing the price into negative territory, as buyers were unable or unwilling to take delivery due to the lockdown.
This caused Nymex crude to fall below zero (-$37.63/barrel) on 20 April 2020, which also happened to coincide with MCX crude expiry at 5 pm. The rupee-equivalent negative price was minus ₹2,884 a barrel, but as MCX pricing lacked a settlement mechanism at negative rates, the contract was settled at Re 1. This led to losses for some traders, who moved court.
Court's view
The ruling by the division bench of Justice R.I. Chagla and Justice Advait M. Sethna stated that courts cannot rewrite completed market settlements only because the traders suffered losses. The petitioners were challenging the MCX circular of April 2020 deciding to settle expiring crude oil futures contracts at minus ₹2,884 per barrel.
In April 2020, WTI crude oil futures contract on the Nymex settled at minus $37.63 per barrel, meaning sellers were paying the buyers to take the delivery obligation off their hand. MCX crude oil contracts which mirror the Nymex contract also settled at a negative value. MCX then issued a circular fixing a provisional settlement price of Re 1 per barrel. “MCX was conscious of the fact that the least that a seller could expect to get from a buyer was Rs.1/- and that the price could never be negative,” the judgement order mentioned.
Acknowledging that that futures were a sophisticated instrument, the court stated, “The petitioners were aware of the nature of the contracts they were trading in and the risks associated with such trading.”
One of the lead petitioners in the case was Dhanera Diamonds, which was trading crude oil futures through their broker Motilal Oswal Financial Services, and took a big hit when prices turned negative. According to the judgment order, the petitioners had 2,965 barrels notional crude oil futures at the time of expiry on April 20, 2020. The petition asked the court to invalidate the trades, which happened at Re 1 per barrel, and argued that MCX had reduced trading hours to 5 pm during the covid lockdown, whereas the sharp collapse into negative territory happened later.
The court found no merit to the argument, and found a reduction in trading hours a reasonable move owing to the pandemic restrictions. Along with it, the court also stated that a negative territory situation occurred late at night, after MCX trading had already closed.
The Securities Exchange Board of India (Sebi), which was also a respondent in the case, argued that MCX oil futures are not something that is governed by a statutory framework and are not any other ordinary sales of goods contract.
The judgement upheld Sebi's stance of being a market regulator along with protecting investors as a class. It is not expected to act as a “nursemaid” for every trading loss that the investor is doing by making a risky bet. It also stated that the petitioners had consciously agreed to the mechanism of Nymex prices and should not challenge it just because the market movement was against them.
A derivatives contract facilitates the delivery of a good at a fixed price on a later date. It is used as a hedging tool by actual users for price risk management. Speculators, who are financially savvy traders, are the counterparties to the hedgers who take an informed view on prices.
The long-running debate of Indian commodity derivatives not being settled at negative pricing was also dismissed by the court, stating petitioners failed to identify any law, regulation or exchange rule prohibiting a commodity derivative from being settled at a zero or negative value.
“The parties trading the Nymex crude contract on MCX were aware that trading is available until 5 pm IST only, they were equally aware that Nymex had already spoken about the possibility of crude oil trading in the negative; so, rather than hoping against hope that price will not close in the negative as had been anticipated, they should have liquidated their long positions before market close in India. They were always aware that the settlement price will be Nymex close multiplied by USD-INR,” said senior securities lawyer Chirag Shah, adding 'brave' longs were actually just being 'sore losers'. "If this was a bear trap and the price had gone up by $50 per barrel, they would be rejoicing too," Shah added.
Mint’s queries to Sebi and MCX went unanswered.