Opinion

The long and short of it

M. R. SUBRAMANI | Updated on August 07, 2013 Published on August 02, 2013

Red hot scam.

The National Spot Exchange was masquerading as a futures exchange. And, the government and regulators were sleeping at the wheel.

Three years ago, when the Forward Markets Commission (FMC) held a regional commodity exchange meeting in Kolkata, a few members complained of trading that allegedly went beyond spot transactions on the National Spot Exchange Ltd (NSEL). The then Commission Chairman B. C. Khatua said his officials would look into their complaints.

Nothing happened thereafter until July 9 this year when the Minister for Food and Consumer Affairs, K. V. Thomas, issued a statement that the Centre will take action against NSEL for violating spot trading rules. Three days later, his Ministry sought an undertaking from the exchange that it would not launch further contracts involving settlement periods beyond 10 days, which technically tantamount to forward transactions.

On July 15, the FMC issued a notice to NSEL to stop launching any such contracts until further orders. The next day, the exchange told the Department of Consumer Affairs that it would abide by the directive. In fact, these actions were a culmination of a show-cause notice issued by the Department a year ago.

SPOT OF THE MATTER

Then, things begin to take a turn for the worse with some investors beginning to cut their trade exposures on NSEL.

On July 23, NSEL cut the delivery, payment and settlement period to 10 days, but the Government did not give its approval to the changed system. Further, the exchange also cut its transaction fee to Rs 20 for Rs 1 lakh from Rs 100.

The central question was --- why should anyone place trades in the spot exchange when they can do so in the futures market?

In a futures market, when you take a position, you are supposed to pay only the margin money. Moreover, there’s no guarantee that if you can make the investment, you will get the produce physically. Nor is there any certainty of making a profit.

But over here, the investment is made on the spot and delivery of the produce is guaranteed immediately. Further, brokers, it is said, were even giving assurances on returns on investment, ensuring profits.

What, then, were the objections to NSEL’s operations that, at one point, clocked a daily turnover of Rs 600 crore? Well, in a spot market, you buy or sell for immediate cash settlement – which was not happening on the exchange.

Instead, NSEL, which has around 1,000 members, was offering contracts that could be settled over a period of 25-40 days. This even led to some investors selling without actually having stocksIf the NSEL was a spot exchange, why did it offer such contracts? In particular, how could it offer a sell contract? This is naked short-selling, traders say, because sales are being done without the seller holding any underlying commodity! In a spot transaction, no sales can happen without a buyer, including a stockist, but here such sales were being allowed.

Things got worse when NSEL suddenly suspended all contracts, except the e-series that offer gold and base metals, on July 31. It led to brokers queuing up before the headquarters seeking settlement, leading to the exchange deferring payments to the tune of Rs 5,500 crore.

These, in a nutshell, are the crux of the NSEL crisis. But there are few other questions that remain unanswered.

REGULATORY LAPSE

Were the States silent to the happenings on the NSEL? Why?

The other unanswered question is, why didn’t the Department of Consumer Affairs or the FMC alert the States on these issues? When the Ministry of Food and Consumer Affairs issued a show cause notice a year ago, why didn’t it stipulate any time frame for NSEL to act on?

Likewise, when members of futures exchanges objected to NSEL’s operations three years ago, why didn’t the commodities markets regulator swing into action?

Again, a section of trade begs to differ. While a deal is put through based on the price prevailing on a particular day, it is not unusual for giving time for settlement or payment to take place. Such flexibility is always allowed to buyers for making payments to sellers.

There are, however, some objections to the NSEL’s trading. In particular, the objection is to extending of credit to processors since it was sort of leading to rise in prices and even illegal trade.

Thus, if a processor buys say, 100 tonnes of castorseed for which he needs cash. He, then, tries to find a financier. In this case, the processor could be asked to sell his produce at say Rs 1,000 a tonne.

Then taking into the interest rate, 15 per cent per annum for example, the processor is then asked to execute an order offering to buy the produce at Rs 1,012.50 a tonne in 35 days. The deal, that gives the processor 25-40 days time, is done based on warehouse receipts. Besides, the exchange itself offered guarantee for the stocks.

The objections here are that a higher price has been fixed based on the interest payable and not taking the fundamentals into consideration. Then, since the trading was based on a warehouse receipt there was no guarantee on the product’s quality. A section of trade feels in some cases the stocks didn’t even exist.

There are a few who justify the process, though, saying that lending to processors is legal.

The point is that the lender faces a great risk since processor holds the stocks in the event of selling and agreeing to buy later.

Markets are agog of some defaults in the castorseed market, where most of such deals have reportedly happened.

EXPLANATIONS GALORE

NSEL’s CEO Anjani Sinha said that the exchange had stocks in warehouses besides money in the exchange’s settlement guarantee fund.

Detractors, however, are questioning if the stocks are really there?

Eyebrows are also being raised over the deferment of payment.

According to Sinha, the trade was suspended on July 31 to reconcile and find out details of payment. Until then, the trading has taken place.

The problem here is if all settlement for trades before July has been made, how the amount totals Rs 5,500 crore. Why should there be deferment in all commodities if there is no problem?

Two weeks ago, Sinha said the issue had been solved and fresh contracts would be introduced this month. There are again questions over this. If the issue has been solved, why is the Government yet to clear the T+10 contracts that allow settlement in 10 days.

Detractors of the NSEL say that with the NSEL defaulting, there is a big question mark over the Government allowing T+10 contracts. They also wonder why the exchange has not sought legal remedy if it was right.

A section of the trade that sympathises with NSEL says that the latter, more particularly its parent — Financial Technologies — had already had a spat with the SEBI that was resolved only recently.

With MCX, the commodity futures arm of Financial Technologies, doing well, the exchange officials would not want to take on either the Government or the FMC.

In all, there are too many questions that beg answers.

Published on August 02, 2013
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