MDI PGPMPT Oct 13

MDI GurgaonFRM

Presented By

Roll Number Name

13PT2- Ankur Sethi

13PT2-30 Tushar Sharma

13PT2-33 Vineet Chauhan

Part Time Post Graduate Programme in Management Batch : October 2013 , Term 6

NSEL: A Case Study

Date: 03 March 2015

About NSEL

History:• Started in October 2008 as a national level,institutionalized,

electronic, demutualized and transparent spot exchangePromoters:

• Financial Technologies India Ltd (FTIL) and National Agricultural Cooperative Marketing Federation of India (NAFED)

• Nature of Spot Trade:• Under spot contract, trade must be completed in 11 Days (T+11)• Deemed to be out of FMC regulation by a small notification in 2007 by the

Department of Consumer Affairs. This exemption was given specifically for one-day duration contracts. (T+2)

Financial Technologies

NSEL MCX

About NSEL

Purpose: ● Transform the rural economy by allowing farmers/sellers and

processors/exporters/traders to meet and exchange produce electronically

● Provide a platform for auction and trading of agricultural products, bullion, metal and energy both in physical and also in electronic forms.

● Designed to help buying and selling commodities , paying cash for and receiving goods on the ‘spot’, with the added feature of being electronic.

● try to reduce the cost of inter mediation and improve market efficiency, thereby

● helping farmers realize the price without increasing the consumer's priceFeatures:• Unregulated. Didn't come under the scrutiny of the Forwards Market

Commission (FMC), being a Spot market .• Exchange stood guarantee as buyer and seller didn't know each other

Seller comes to an exchange-designated warehouse and give his goods

Goods are tested and verified for quality and weight

Seller gets a warehouse receipt (WR) that is used for electronic trading

Seller sells on the exchange and the receipt is transferred to the buyer

Buyer goes to warehouse to get delivery or to retain it for selling

Trade Process for Spot Exchange

• Under the guise of spot trading, NSEL was offering forward trading facility to investors without proper margin and settlement systems.

• NSEL allowed trading on its platform without verifying whether the seller had stocks, in effect allowing short sales by members.

The FMC Enquiry: • FMC found that the contracts traded on the exchange for which the settlement

period exceeded 11 days were non-transferable specific delivery contracts, which were violating the provisions of Forward Contract Regulation Act, 1952

• Unsettled payouts as on July 29, stood at around Rs 5400 crore

• Demutualization concept was found to violated altogether as NSEL was found to be an entity owned by the Financial Technologies promoted by Jignesh Shah.

• The forward contracts in the beginning involved some set of commodity stockists selling warehouse receipts to investors for immediate payment. These investors also entered into buyback arrangements by selling back the commodity to stockists after 25 to 35 day periods ignoring the forward markets regulation act making risk free returns.

The SCAM

• NSEL offered Forward (T+25 and T+36) Contracts, which was illegal

• Some of these contracts were so-called “naked” contracts — no underlying commodity.

• Arbitrage Opportunity: One could ‘buy’ the T+2 contract and ‘sell’ the T+35 contract and the difference in prices gave one nearly 13.5 percent per year, annualized

• This return was Risk Free and Guaranteed by involvement of exchange. • The brokers and NSEL generated high revenues due to these trades for 2 years. The

profits of NSEL shot up from Rs. 30 Crores per year to Rs. 120 crores per year

• The price gap between the contracts continued and thus commodity prices also started moving up.

• Just 24 members of the exchange, called Planters or Processors or Borrowers existed. These members owned plants that processed commodities, some of which were only in papers

The Modus Operandi

Example: NK Proteins owned a plant to process castor seeds in Kadi, Gujarat. The contract – the Kadi Castor Seeds contract – was settled at an NSEL warehouse located inside the Kadi plant of NK Proteins. Processors like NK Proteins (and there were 23 other such members) were on the other side of the trade. They would sell at T+2 and buy back at T+25, offering huge returns.

Source: Dalalstreetbulls.com

The Modus Operandi

• Brokers assured investor's returns more than that of what the banks could offer. • Investors started taking bigger contracts and on a regular basis.• The Department of Consumer Affairs noticed this and sent a notice to the NSEL saying

that it can't run such type of contracts and that it will fall under the radar of the FMC.• NSEL closed down all contracts greater than T+10 in period. As a result, the arbitrage

opportunities closed down.• This triggered panic among traders, many of who rushed to close their positions. The

exchange, as a result, had to defer settlements.• News broke out that there was no stock in the godowns of NSEL • Investors demanded back their money which the NSEL was unable to repay.• Also, they did not have stock which they could sell and settle the investor's demands.• More than Rs 5,500 crore was due, • There was neither the money nor the underlying ‘spot’ goods to settle trades by over

15,000 investors

The Crash and The Crisis

Jignesh Shah He was practically the highest beneficiary because of the huge profit of Rs.125 crores (approx.) earned by NSEL during FY 2012-13 that the value of the shares of Jignesh Shah in FTIL shot up manifold giving him the benefit of a spectacular market capitalization of his investment in FTIL running into thousands of crores of rupees.

Brokers Brokers provided wrong information to investors about the availability of warehouses and stockBrokers gave investors bogus warehouse receipts issued by NSEL, assuring them that the goods had been delivered, verified and valued at a certified warehouse.Brokers acted as clearing and forwarding agents as well

The FMCThe FMC also has played a dubious role in the scam as the ex chairman of FMC Mr.B.C. Khatua (whose son is employed with FT group) knew about NSEL's application for registration of NTSD (paired) contracts but neither accepted nor rejected them.

The Facilitators of the SCAM

Remote control: Behind the corporate veil, the management and governance of NSEL was practically carried out by Jignesh Shah through the vehicle of FTIL. Vanishing act: Jignesh Shah has been named as one of the key management personnel in all the annual reports of NSEL until financial year 2011-12. It appears that Jignesh Shah has got himself excluded from the list of key management personnel (in 2012-13) to distance himself from NSELBlame game: FTIL and Jignesh Shah have tried to shift the entire blame on the former Managing Director, Anjani Sinha for committing. On the contrary The Board of Directors of NSEL showered praises on Anjani Sinha for the performance of the company in FY 2011-12 .This shows that he was aware of the activities of NSEL and supported the performance of the management and the business model and practices that were being followed by NSEL management. Abuse of position: Jignesh Shah, as the promoter of FTIL and NSEL has misused his position to create a confidence in the minds of the participants regarding the legitimacy of the business and its operations in the exchange platform of NSEL. Shah consciously used his position to represent to the public at large about the attractive features of the contracts being traded on NSEL platform while taking no steps to introduce any effective governance mechanism

The Jignesh Shah Chapter

The government, in October last year ordered the merger of NSEL with its parent firm Financial Technologies (India) Ltd. Although the shareholders have objected and appealed against it.

The Finance Minister in his 2015-16 Union Budget speech indicated the merger of the Forward Markets Commission with SEBI which is expected to strengthen the regulations in the commodity future markets.

Recent Happenings

References

www.wikipedia.comhttp://www.dalalstreetbulls.com/http://www.investmentz.co.in/http://www.business-standard.com/www.thehindubusinessline.comwww.capitalmind.inwww.dnaindia.com

Unanswered Questions

● How did central government allow NSEL to not follow demutualization rule? ● How did FinancialTechnologies become the major stakeholder in the exchange?● If the central government wanted the electronic spot exchanges in the country, why was

there no regulators regulating the contracts traded with T+2 settlement period which were spot contracts.

● Is there no governing body responsible for spot contracts. If the scale of scam is so widespread, why there is no regulator for spot exchanges.

● How was liquidity not ensured by the regulators when considering the introduction of the spot exchanges?

● How is that only few members of the exchange did the actual business for so long years?● How did NSEL prevent the regulators from faking the contracts with warehouse receipts

These questions point out at the inefficiency on the complete system and accountability should be put upon:

● The FMC● The Finance Ministry ● The Central Government and other ministries ● The promoters

Lessons learnedDo I know the product?

Invest only in those commodities whose fundamentals you understand. 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.

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).

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.

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?