Prevent conflict of interest in commex ownership, trading

A Comparison of China and India’s progress has become a favourite pastime. However, it may be imperative for us to take a look at the growth of the Chinese commodity futures market from the legal environment, regulatory environment, supervision and by public opinion. Akin to India, no foreign money is allowed to participate in the Chinese market.

China’s commodity futures market dates from a trading program at the end of 1980s. As with any new venture, dozens of exchanges sprung up and speculation and market abuse were widespread. China tried to grab the industry by the scruff of the neck first in 1994 when the State Council took over 50 futures exchanges and turned them into 15, delisting a host of contracts. The changes of 1994 helped but it didn’t fix the market. So the State Council made a second attempt in 1998. Most of the 15 surviving exchanges were closed, restructured or merged, leaving the three that still control commodities trading today. 

Shanghai Futures Exchange, which was formed from a merger of the Shanghai Metal Exchange, Shanghai Foodstuffs Commodity Exchange and Shanghai Commodity Exchange, began life in its new legal form in December 1999. The other two are Dalian Commodity Exchange and Zhengzhou Commodity Exchange. Most of the contracts were scrapped while 12 were allowed to survive.

The script looks similar in India. However, the rationalisation of the number of exchanges is yet to start. 

While the first three new-generation exchanges were demutualised initially, the control management and equity structures of the new exchanges are more mutual in nature. A new game is being played... new commodity exchanges are wrapping ribbons around watermelons, tossing them out from 50-storied windows. In this game, you are a winner only if you take your money out before the melon hits the pavement. 

The rush of the “new” has seen the “mutualisation” been taken to the other extreme. It seems that there is a school of thought which is not convinced about the merits of demutualisation in exchanges. The exchanges that view demutualisation as legal manoeuvres are courting suicide. Why? It is one thing to have a mutual exchange and another to tell the world that it is a demutualised exchange. Market always smells the rat first. 

We must remind ourselves that as participants on commodity exchanges, Goldman Sachs and some other large financially powerful actors had turned the once-solid market into a speculative casino internationally. Commodities trading subsidy of Goldman called J Aron got hedge limit exemptions under CFTC’s nose... Moreover, Goldman also owned 10% stake in the Chicago Climate Exchange. There’s was also a $500-million Green Growth Fund set up by a Goldmanite to invest in green tech. The list goes on... all in the name of “arms length’s distance”. Well, you might say, “who cares?” Do we need to import worst practices of the international commodities market? 

Financial infrastructures such as commodity exchanges cannot be left alone in the hands of large financial groups to promote, manage and control while their sister concerns are into active client-based or proprietary trading and other financial services. It is one thing to make strategic investments in a commex but another to promote, control and run an exchange. The adoption of a modern corporate governance approach is essential to create the correct commex environment for growth and enhancing the value for market participants. International experience has demonstrated that things are never at an arm’s length distance and financial groups always gear up for opportune moments for market manipulations. Can the reins of the exchanges be left to large financial power houses in India to repeat the international story with an added dimension of commodity exchange ownership? 

Published in The Economic Times