WTI Crude’s Negative Plunge Bares Vulnerability At India’s Largest Commodity Exchange MCX

Five days before WTI Crude price fell into negative territory, the CME Group, operator of commodity exchange Nymex, had alerted that such an unprecedented event could unfold. It asked members to prep systems for prices below zero.

India’s Multi Commodity Exchange, which offers futures mirroring New York crude oil prices, its second-most traded contract on the platform, didn’t pay heed. Neither did brokers and the regulator in India.

On April 20, the benchmark Nymex crude for May settlement, a delivery-based futures contract, tumbled from $13 a barrel at the start of trade to minus $37.63 at close. Meaning, traders were willing to pay buyers to take the commodity off their hands as the U.S. was running out of storage for oil because of the glut caused by fall in demand during Covid-19 lockdowns.

For brokers in India tracking WTI crude oil prices for trading on MCX, it was a double whammy. Not only was the exchange not prepared for negative prices, but they were also locked out of trading at 5:00 p.m. as the Securities and Exchange Board of India had curtailed trading hours during the lockdown.

Three brokers—Motilal Oswal Financial Services Ltd., Religare Broking Ltd. and PMC Securities Ltd.—have dragged MCX, its clearing corporation and SEBI to the Bombay High Court for the losses citing trading restrictions and inadequate risk management. BloombergQuint has reviewed a copy of the petition filed with the Bombay Stock Exchange.

The brokers alleged:

• Neither MCX nor any other commodities exchange has the provision to trade in a commodity by assigning a negative value.
• Crude derivatives traded in India are not delivery-based contracts, unlike in the CME, and these contracts can at best trade at Re 1 base value, not negative.
• The margin system is based on the hypothesis to check value erosion, not negative pricing.
• The risk management software provided by MCX does not allow negative value for calculating risk and margin for the futures contracts.

Volatile Markets

MCX, in consultation with SEBI, announced on March 26 that it’s restricting trading across commodities to 5:00 p.m. The decision was taken as members faced travel restrictions due to the lockdown. That temporarily ended the second trading session that coincided with the international markets till 11:30 p.m. The restriction started on March 30 and was extended on April 14. A day later, CME issued its advisory.

“Recent market events have raised the possibility that certain Nymex energy futures contracts could trade at negative or zero trade prices or be settled at negative or zero values, and that options on these futures contracts could be listed with negative or zero strike prices,” it said in a statement.

MCX, however, did not make any change to its systems or warn members about the limitations of tracking prices below zero.

According to traders and market participants BloombergQuint spoke with, the decision to restrict trading till 5:00 p.m. was not thought out for commodities linked to international commodity prices.

In fact, MCX Clearing Corporation Ltd., while announcing these changes, said on April 15 that the settlement price for the April 20 contracts will be based on the settlement of Nymex Crude contracts on the CME.

Much of the crude carnage on April 20 happened after 5:00 p.m. India time. Domestic traders had no way to close their positions.

Restricting trading on a commodity that’s price is based on CME Nymex Crude would have had its repercussions, said a senior adviser to a stock exchange on the condition of anonymity as the issue involves the regulator. Had the trading been allowed, the person said, investors on seeing crude prices plunge would have closed outstanding positions post 5:00 p.m. and not left it to the CME settlement price.

That decision came on April 21 after the fiasco. The exchange extended trading timings for internationally linked commodities to 11:30 p.m.

Settlement Pain

After the crude ended at negative $37.63 a barrel on April 20, MCX used it and the central bank’s reference rate for rupee-dollar to fix the settlement price: negative Rs 2,860 a barrel. MCX Crude closed at Rs 965 on April 20—a difference of Rs 3,825 from the last traded price on the exchange. Each contract consists of 100 barrels of oil.

On April 21, the exchange said in a circular that because of unprecedented price fluctuation in the international markets in crude oil, the due date rate for futures contract expiring on April 20 is under finalisation.

In the interim, the provisional settlement price for April 20 is considered as Re 1 per barrel for computing members’ obligation, it said. “Differential settlement, if any, on fixation of the final settlement price shall be done subsequently.”

Meaning, the exchange settled the contracts at Re 1 when the closing price was Rs 965. The exchange partly settled the contracts from the margin maintained by traders.

Sellers and clients with short positions, however, suffered losses. At the end of April 20, MCX crude had open or outstanding positions on 11,522 contracts.

Since each such position will have a buyer and seller, there were 11,522 short positions at the time of expiry. By fixing Re 1 as the interim settlement price, traders with short positions stand to lose Rs 330 crore they would have made had the exchange closed the contract at negative Rs 2,860—the price based on CME settlement.

The brokers are arguing inaction by SEBI in protecting the interest of the investors and the settlement price arrived by the exchange of negative Rs 2,860 per barrel. Allowing extended trading and adequate risk management would have reduced the losses for those traders who had long positions.

Emailed queries to SEBI remained unanswered.

MCX, which launched October contract on April 21, has yet to incorporate negative prices in its system despite continuing global markets fears that crude prices could again go below zero.

MCX declined to comment since the matter is sub judice.

A senior exchange official, however, said on the condition of anonymity that it will take some time to incorporate negative prices and MCX is still vulnerable to crude prices falling below zero.

Narendra Wadhwa, president of Commodity Participants Association of India, told BloombergQuint that given the shortcoming, many brokers have put client positions on square-off mode until exchange system is place, as further volatility on crude could again push Nymex contract in negative territory, exposing exchange and members to trading risks.