MCX April oil futures row | Brokers discourage trade via exchange, seek margin of 200-400%

Another broker Moneycontrol spoke to echoed a similar sentiment. He asked: “Should the broker stop trading or ask for a margin of over 300 percent if a similar instance happens going forward?”

Only Kishore Narne, Head of Commodity and Currency at Motilal Oswal Financial Services spoke on record on this issue. “Till we get more clarity on the way the settlement in April contract has been carried out and how the same (if price of the next contracts to go sub-zero) would be handled in future, we have decided not to offer crude oil contracts to our clients. No broker or exchange at present can handle such negative prices and no risk management policy can protect clients or brokers in such a future event. We have decided to discourage our clients from taking positions in crude oil contracts to protect them and ourselves. Globally, some brokers like INTL FCStone and Marex Spectron started restricting some of their clients from taking positions in crude.”

Impact of the move on MCX Over 95 percent of all trades in crude oil futures in India pass through the MCX platform. This is the second largest traded contract on MCX after gold in terms of value and highest in terms of volume.

So, how big would the impact be on MCX? The CEO of a broking quoted above said these brokers constitute more than half the volumes in crude oil contracts on the MCX.

What’s Sebi doing about the issue? The Securities and Exchange Board of India (Sebi), a source said, has asked the exchange to allow its software to accept negative prices, so that anybody wanting to enter a negative quote can input the same into the system, which is not possible as of now.

However, Moneycontrol learns that MCX may be unable to tweak its software to handle a negative price settlement in less than two months as they need to first receive it from their software vendor -- 63 moons technologies and then conduct at least three-to-four mock trading sessions with brokers. This is the usual practice that exchanges follow when they carry out any major changes in their systems.

Bone of contention? On April 15, the Chicago Mercantile Exchange put out an advisory over negative prices for certain NYMEX energy contracts. “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,” the advisory stated.

However, there was no such advisory from the Multi Commodity Exchange (MCX) warning brokers before settling contracts in the negative.

Moreover, neither MCX nor its brokers have a software that accepts negative rates to be inputted into the system. A market participant told Moneycontrol that without preparation during a normal trading day, the exchange itself will not be able to settle contracts at a negative price.

How big is the problem?
Over 95 percent of all trades in crude oil futures in India pass through the MCX platform. The contracts are settled on the last day of trading of the MCX crude oil contract using the settlement price of the NYMEX front month contract.

The MCX April contract expired on April 20. Given the restrictions imposed due to the novel coronavirus, or COVID-19, pandemic, trade now halts at 5 pm instead of the earlier 11:30 pm.

The issue arose because the US market opens for trade at 7 pm (IST). WTI opened lower and continued to trade in the negative. So, had our market been open for trade, traders would have had the opportunity to settle/exit their positions.

Now, as per the MCX rules, contracts need to be settled at taking into account the price of the front month contract, i.e. May 2020 in this case, which was trading at a negative $37.63 per barrel around 11:30 pm.

As per an April 21 circular issued by MCXCCL, the settlement price has been arrived at converting the NYMEX crude oil front month contract’s settlement price of a negative $37.63/bbl into Indian rupees, which works out to Rs 2,884 per barrel or lot.

Traders with a long position in the April 2020 contract would now have to pay around Rs1 lakh for every one lot of crude, i.e. 100 barrels, at the MCX quoted closing price of Rs 965 on April 20. This is assuming the person would have paid the full value of the contract.

However, most traders would not have expected to lose the entire value of the contract and are now staring at a loss of over Rs 2.88 lakh.

To gauge the extent of the problem, around 11,000 contracts remained open at the end of the day. Market sources pegged the loss for all long positions around Rs 418 crore.

MCXCCL first announced a provisional settlement at Re 1 by mentioning that the final or differential settlement, if any, would be carried out separately. However, it later froze or blocked the amount against deposits by those brokers who held long positions at close of trade on April 20 to meet the final settlement.