‘Give me Rs 5 lakh today, I will get you a return of 15 per cent in one year’. This was the assurance given by some brokers as they took money from investors to trade in contacts on the National Spot Exchange Ltd.

Though it was a spot exchange, NSEL allowed forward trades with settlement cycles extending upto 35 days. As the regulator spotted this and asked the exchange to wind up its contracts, NSEL couldn’t meet its payment obligations. There was not enough cash in the settlement guarantee fund or equivalent value of stock in the warehouse. Today, more than 15,000 investors are stuck in NSEL’s contracts not knowing when they will get the money back. Also, with no proof of the broker’s ‘guarantee’ and also no contract note on the trades they did, these investors are stuck without recourse.

There are lessons for investors here. Ask yourself the following four questions before making an investment.

Do I know the product?

Invest only in those commodities whose fundamentals you understand. A lot of unsolicited advisory is available on many commodities from gold to castor seed today.

Some brokers market these as ‘innovative’ products. A good number of investors who had bet on raw wool contracts in the NSEL weren’t even aware of how wool is produced or its market price. In obscure commodities, such as raw wool or castor seed - the other most traded commodity on the NSEL, it is easy to rig prices as very little information on them is available publicly.

So, before you pick a commodity for investment, ask your broker for the product note which will have specifications on the quality of the commodity, its settlement cycle and physical delivery conditions.

This could give you some idea of the product and help spot any anomaly. Also, do not bet your money on a product whose working you are unable to comprehend. In NSEL’s case, for instance, any investor who had understanding of a spot market wouldn’t have fallen for assured returns. One, in an exchange where price is market driven, returns cannot be guaranteed. Two, settlement here happened after 30-40 days, which is very unlike spot market contracts.

Do I know the broker?

Before you part with your money, do some homework to ascertain the credentials of the broker. See if he is registered with the Securities Exchange Board of India (if he facilitates equity trading) or the Forward Markets Commission (if it is commodities).

One way to check the genuineness of your broker is to see if he confirms your trade every day through a contract note, sends you copies of the ledger periodically and doesn’t insist on a Power of Attorney. Note that according to regulations, signing a PoA with a broker is not compulsory; it is left to the choice of the investor. Also, find out whether trades go through a recognised exchange.

The FMC says that trades in commodity futures that happen in exchanges outside its ambit, are illegal. The other problem with unregulated exchanges is that they may not have a robust system to check speculative trades or offer protection against the risk of counter party default. This is just what happened with NSEL’s investors as the exchange couldn’t pay for the defaulting members.

Who is the regulator?

Be it the Saradha chit fund scam or NSEL, both throw up the need for a regulator. A regulator not only keeps a check on wrongdoings by players, but also listens to and resolves investor grievances.

In the absence of a regulator, players will operate by their own loosely-knit bylaws which may not hold them responsible for any misdeed. This makes the position of an investor very unsafe. So, before you make investments, find out if it’s a regulated market and understand how the grievance redressal mechanism works.

What is the risk?

Every investment has its share of risk. The higher the return, the higher will be the risk. So, when a broker assures risk-free return, one should question it — what is his modus operandi to fetch that return? Does he have a Plan-B if the original plan backfires? In the lure for easy money, investors seem to have closed their eyes to the risks involved in NSEL’s products. Also, note that the FMC doesn’t allow commodity brokers to offer portfolio management services. So, if a broker offers to manage your money in commodities, don’t fall for it.

>rajalakshmi.sivam@thehindu.co.in

Before picking a commodity to invest in, ask your broker for the product note which contains all specifications of the commodity.

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