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The recent crisis at the National Spot Exchange Ltd (NSEL) and the settlement issue have sparked off a controversy with regard to availability of underlying collateral security (commodity) and its value to pay off the brokers and clients.
It gives rise to a simple question as to when underlying security is under the custody of NSEL in its accredited warehouses, why is there loss or delay in settlement of dues?
The answer lies in non-availability of underlying security, i.e. stocks/commodities, which ostensibly happened due to non-adherence to process laid down for collateral management of commodities, said to be in the NSEL’s certified warehouses, to mitigate risks. Though the settlement guarantee fund of exchanges indemnifies and protects investors, traders, buyers and sellers, the collateral management of commodity (underlying security) as a reference asset is equally essential. However, the available guarantee fund, though only of Rs 800 crore (against dues of Rs 5,500 crore) before July 31, 2013, dipped to Rs 60 crore on August 6, 2013 without any plausible explanation from exchange authorities.
Intriguingly, the Forward Markets Commission (FMC) (the Government-directed agency to supervise the NSEL) was also caught unawares.
A basic objective of collateral management is to mitigate risk. A collateral manager, besides indemnifying the loss/damage of commodity kept in warehouses, provides value-added services by testing and certifying the quality and quantity of commodities stored, particularly agri-produce, cereals and perishable commodities.
Commodity details
The weight of the commodity stored is recorded alongside percentage of variations due to moisture and climatic changes.
This helps ensure that it is tradable or lendable for the period for which its value is assessed. These vital details are usually captured in the warehouse receipts issued by the collateral management service provider. Most commercial banks do not lend without appointing collateral managers to protect their lending, at little extra cost for mitigating the risks involved.
Had investors/lenders in such dealings only insisted that the NSEL deploy a collateral management service provider as an additional risk mitigant, perhaps the present crisis could have been avoided.
Or, at least the goods/produce would have been found available in the so-called accredited warehouses of NSEL.The National Bulk Handling Corporation (NBHC), the leading collateral management company, has categorically denied having handled NSEL’s warehouses except for five facilities. This proves that NSEL had no physical control over the commodities — hence this fiasco.
The NSEL appears to have adopted the old badla system, where positions were kept open and rolled over without tangible security.
The committee formed by the Government will probe each and every infringement by market players and the NSEL. The lesson to be learnt is that lenders, investors and depositors should entrust the management of commodities backed by finance to the collateral manager.
(The author is retired DGM, SBI and presently consultant & Head – Rural Enterprise, NCML)
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