FTIL and NHBC are the two key related-parties to which monies have been paid by MCX for the exchange technology solutions and warehousing, respectively, says a report from PwC

Auditing firm PricewaterhouseCoopers (PwC), in a report had said Multi Commodity Exchange of India Ltd (MCX) entered into agreements with related trading parties and paid around Rs709 crore to its erstwhile promoter, Financial Technologies India Ltd ( FTIL) and other group companies without following a proper documentation process.

Following the Rs5,600 crore payment crisis in National Spot Exchange Ltd (NSEL), last December, commodity market regulator Forward Markets Commission had appointed PwC for auditing books of MCX. PwC was asked to examine if NSEL subsidiary Indian Bullion Markets Association (IBMA) and another FTIL subsidiary, National Bulk Handling Corporation (NBHC), traded on MCX.

PwC, in the report, which was released partially by MCX, alleged other inconsistencies and gaps in the way the commodity exchange processed related-party transactions and expressed doubts whether these agreements were conducted on an arm’s length basis.

FTIL, which set up MCX in 2003 but no longer controls the Exchange even while holding a 26% stake, rejected the PwC report. It said it will take legal action against the bourse and PwC for painting a wrong picture in the report.

The PwC report said: “FTIL and NHBC are the two key related-parties to which monies have been paid by MCX for the exchange technology solutions and warehousing, respectively. MCX also entered into related-party transactions with other FT group companies for various ancillary services.”

The PwC audit said that “there are various gaps and inconsistencies noted in the way MCX processed related-party transactions.” The commercial terms and conditions agreed by MCX with related parties were not substantiated by any underlying market benchmarking or competitive bidding process, the report said.

“Additionally, there was limited or no supporting documentation available to evidence the existence, adequacy and robustness of price discovery mechanism which may have been adopted by MCX. Therefore, it is not possible to conclude whether various related party agreements and transactions were indeed conducted on an arm’s-length basis,” the report said.

Officials of FTIL took active part in the affairs of the MCX, including trading, the special audit report has said.

“In various instances, key management personnel of MCX such as ex-CFO, Head-Information Technology, ex-Chief Compliance Officer stated that the decisions were directly taken and instructions received from the ‘Chairman’s office (FTIL)’ or the ‘MD & CEO office’,” said the audit, prepared by PwC.

The audit report, forwarded to stock exchanges by MCX, also found 676 additional entries or individuals who were directly or indirectly related to the MCX or FTIL Group, FTIL key management personnel or their immediate family members by being common directors or shareholders.

In particular, select entities or individuals were allowed to indulge in illegal wash trades, which allows a member to take a position without any intent to execute the transactions.

According to the report, it appears that MCX surveillance activity may not have been commensurate with the steep pace of growth of the exchanges over the year. It also said that there was no formal mechanism to share information on related parties between the membership department and the secretarial department. Therefore, abnormal trades of identified parties were not scrutinised thoroughly, it said.

“This review identified 15,131 instances of trades aggregating to approximately Rs1,856.56 crore where the same party placed buy and sell orders within 60 seconds of each other resulting in no change in the positions. Additionally, in 1565 instances aggregating to approximately Rs1181.72 crore, the buyers and seller were part of the same group of companies who placed orders within five seconds of each other resulting in no change of position within the group,” it said.

The report also mentioned that two members who were debarred by SEBI in July 2006 continued to trade on MCX between September 2006 and December 2011 though the FMC issued a circular mandating that members debarred by other exchanges should not be allowed to trade on commodity exchanges. Name of such member has been removed from the report placed in the public domain but it says that one of these two members was “a member with the highest turnover on MCX in the year 2004.”

The audit agency said that MCX emerged as a significant customer for FTIL by driving about 25% of latter’s revenue. MCX paid approximately Rs649 crore to FTIL on various agreements and transactions. “In spite of this, it does not seem that MCX was able to enjoy adequate bargaining power against FTIL at the time of negotiating the technology support agreements,” the report said adding that contractual terms and conditions forming part of agreements between FTIL and MCX appear to favour the former.

“Under the existing contractual terms and conditions, MCX appears to be contractually bound to FTIL for an unprecedented long tenure ranging between 22 and 50 years with a provision of automatic renewal for up to two similar terms. Further, the termination clause in certain contracts grants termination rights only to FTIL whereas the contracts were silent about MCX’s right of termination,” the report said.

An executive summary of the audit report was sent to the stock exchanges by the MCX. The report was prepared on the orders of commodities market regulator Forward Market Commission. The report is yet to be independently verified by the company.

Jignesh Shah-promoted FTIL is the promoter of MCX and crisis-ridden NSEL.

“At this stage, the company neither agrees nor disagrees with the contents thereof and does not have any opinion on the same and takes no responsibility of the contents or makes no inferences thereon as the same are yet to be independently verified by the company,” MCX said while forwarding the report.

In 1,565 instances aggregating Rs1,182 crore, the buyers and seller were part of the same group of companies who placed orders within five seconds of each other resulting in no change of position within the group.