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CHAPTER 1

NATIONAL SPOT EXCHANGE LIMITED

1.1 INTRODUCTION

National Spot Exchange Limited (NSEL) is the national –level, institutionalized, electronic,

transparent spot trading platform for commodities. It is a structured market place, set-up to

transform the commodity market by way of reducing the cost of intermediation and thereby

improving marketing efficiency. Its state-of-the-art technology facilitates risk free and hassle free

purchase and sale of various commodities. NSEL provides customized solution to farmers,

traders, processors, exporters, importers, arbitrageurs, investors and other stakeholders pertaining

to commodity procurement, storage, marketing, warehouse receipt financing, etc.

NSEL commenced “Live” trading on October 15, 2008. At present, NSEL is operational in 16

States in India, providing delivery-based spot trading in 52 commodities.

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1.2 OVERVIEW

o India’s No. 1 Commodity Spot Exchange with a commanding 99% market share

in the electronic spot market segment

o o Promoted by Financial Technologies Group and NAFED

o Introduced India’s first Commodity Investment product in demat form called e-

Series.

1.3 Mission:

To develop a pan-India, institutionalized, electronic, transparent Common Indian Market

offering compulsory delivery-based spot contracts in various agricultural and non –

agricultural commodities with a reduce cost of intermediation by improving marketing

efficiency and, thereby, improving producers’ price realization coupled with reduction in

consumer paid price.

1.4 Objectives:

The main objective of NSEL is to develop a vibrant electronic spot market in various

commodities and to offer a value proposition to different segments of the commodity

ecosystem. The idea is to reduce cost of intermediation and create an electronic linkage

between buyers and sellers across the country. The Exchange provides counterparty

guarantee in terms of quantity, quality and payment. Hence, the participants get a safety net

against credit risk and counterparty default.

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1.5 HIGHLIGHTS

o o Operational in 47 commodities including castor seed, gold, silver, cottonseed

wash oil, castor oil, wheat, RM seed and soybean

o Over 711 registered members as on 31st March, 2012

o E-Series: e-Gold, e-Silver, e-Copper, e-Zinc, e-Lead, e-Nickel, e-Platinum

o NSEL began spot delivery contracts for agri commodities such as soybean,

chana, wheat, mustard and coriander seeds at Guna in Madhya Pradesh

1.6 KEY BENEFITS

o Facilitates trading in standardized contracts of various agricultural commodities

o Reduce counterparty risk and defaults

o Farmers can sell produce by paying marginal brokerage as compared to that

being paid to each intermediaries

o Amendments in the APMC Act will save 40% of food that gets wasted in

absence of due processing

o o NSEL will strengthen the supply chain and efficient procurement mechanism

1.7 SERVICES OFFERED

o Selling - NSEL provides an electronic trading and auction platform to sell commodities.

o Procurement - Bulk buyers can procure the agri-commodities directly from farmers

through electronic platform provided by the NSEL.

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o Warehousing - NSEL provides warehousing facilities for various commodities and also

facilitate to sell it through the electronic platform to the bulk buyers and millers situated

across the country.

o Investment - NSEL provides investment instruments. E-series products launched by

NSEL can be bought by the investors for accumulation in the demat account, just like the

shares in the equity market.

o Arbitrage - A trader can do arbitrage using different prices available for the same

commodity.

1.8 BOARD OF DIRECTORS

Mr. Shankarlal Guru – Chairman

Mr. Jignesh Shah - Vice Chairman Also, Vice Chairman - MCX, Founder of FTIL

Mr. B D Pawar – Director Also, Director – CITA

Mr. Ramanathan Devarajan – Director Financial Technologies Group

Anjani Sinha, MD & CEO

1.9 PROMOTERS

A. Financial Technologies (India) Ltd. (FTIL)

 

FTIL is a global leader in creating and operating technology-

centric, next generation financial markets that are transparent,

efficient and liquid, across multi asset class, including equities,

commodities, currencies, energy and bonds among others. It is a

company listed on BSE and NSE.

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B. National Agricultural Cooperative Marketing Federation of India Ltd. (NAFED)

 

NAFED is the national level farmers federation registered under

Multi State Co-operative Societies Act. It was set –up on 2nd

October, 1958 to promote co operative marketing of agricultural

produce to benefit the farmers.

1.10 MAJOR ACHIEVEMENTS

2013 Agreement with Hadher Group of establishments LLC, Abu Dhabi, UAE for Joint

business development and marketing in commodities

NSEL and SBI have tie up for the collateral Management Services

2012 Signed an MoU with Belarusian Universal Commodity Exchange (BUCE), thelargest

Commodity Spot Exchange in Republic of Belarus for developing bilateraldeals between

India and Eastern European countries, especially Republic of Belarus, Russia, Ukraine.

2011 Signed an MoU with Govt. of Gujarat under “Vibrant Gujarat 2011”

2009 Commenced cotton procurement in Andhra Pradesh under Price Support Scheme (PSS)

operation on behalf of Nafed

2008 Signed an MoU with the Gujarat Agro-Industries Corporation Ltd. (GAIC) to create a

strategic alliance for development of agri-business and providing an electronic market

platform in the State

2007 Signed an MoU with IL&FS for common service centers being setup under National

E-Governance Project to be connected to NSEL project

2005 Incorporated as a company limited by shares under the Companies Act, 1956

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1.11 USPs OF NSEL

Provides an effective method of spot price discovery in various commodities in a transparent

manner

Provides a market where farmers/producers/importers/Government companies can sell their

commodities and realize proceeds at the best prevailing price in a risk-free manner

Offers a market where the processors, end-users, exporters, corporates (both private and

Government) and other upcountry traders can purchase commodities at the most competitive

price without any counterparty and quality risk

Provides investment instruments in commodities for retail investors and HNIs

Offers a transparent market where investors and arbitrageurs can invest money in buying

various commodities across the country without going through the physical market hassles

Provides authentic spot price of various commodities that can be used by the futures market

as the benchmark price for settlement of their contracts on the date of expiry

Helps the futures exchanges, Forward Markets Commission (FMC) and the Government in

achieving the target of compulsory delivery in all agricultural produce by way of creating a

linkage between physical market and futures market

Promotes grading and standardization of agricultural produce and facilitates warehouse

receipt financing to farmers and traders by financial institutions

Creates a market for trading in negotiable warehouse receipts, both in physical and electronic

form

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CHAPTER 2

CRISIS

2.1 BRIEF

On 1 August 2013 National Spot Exchange (NSEL) suspended trading of all contracts, other than

e-Series and deferred the settlement, sparking fears of cash crunch and default of payment in

the Financial Technologies - promoted commodity bourse. The exchange has blamed the

government for the structural changes it has instructed a few weeks back for creating market

disequilibrium whereas other sources believe NSEL was required to be deliver commodity

physically instead the exchange facilitated use of electronic warehouse receipts, enabling

investors to avail of the arbitrage, without taking physical possession of goods. The flaws in

contracts and insufficient underlying stocks to cover liabilities leading to financial crisis.

On 5 August 2013 NSEL suspended the trading of E-series leading to the complete shutdown of

the exchange after widespread media news of likely ban on e-series by the government.  The

reason for suspension of trade on the exchange website was:

"We have not yet received government order, but as abundant precaution, we will not

commence trading in e-Series at 10:00 am. We will check with the authorities to find out the

facts. In any case we will fully comply with Government order." 

Due to the suspending of trade in the e-series silver and gold the fate of money invested by small

and very small investors is hanging in the balance.

The FMC has asked Jignesh Shah of Financial Technologies (promoter of NSEL) to take

responsibility of payout to the investors.

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The first payout from borrowers on NSEL to 148 broker members, representing 13,000 investors,

was unsuccessful with the exchange managing to recover Rs 92.12 crore against the Rs 174.72

crore it was supposed to pay out every week for the next five months beginning August 20.

Nine of the two dozen borrowers who defaulted are NK Proteins, ARK Imports, LOIL Overseas

Foods, Lotus Refineries, NCS Sugars, Spin Cot Textiles, Tavishi Enterprises, Vimladevi

Agrotech, Yathuri Associates. Of these, NK Proteins has the highest liability of over Rs 900

crore.

Other officials who were removed from their positions along with Sinha are Amit Mukherjee

(assistant VP, business development), Jai Bhaukhundi (assistant VP, market operations),

Maneesh Chandra Pandey (manager - business development), Santosh Mansingh (assistant VP -

market operations), HB Mohanty (assistant VP - market operations) and Shashidhar Kotian

(CFO). However, the exchange has not sacked Sinha and the other officials who will now assist

PR Ramesh, a former Sebi official, who has been appointed "officer on special duty" to exercise

all powers of the CEO.

The Criminal angle to the whole scam has come under scanner and EOW Mumbai police has

already started investigating the NSEL scam.

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2.2 CAUSES OF THE CRISIS AT NSEL

The current problem at the National Spot Exchange Limited (NSEL) is one of a liquidity

mismatch and not a solvency crisis, feels Deena Mehta of Asit C Mehta Investment

Intermediaries.

Causes the crisis at NSEL

Deena Mehta explains the current problem at the National Spot Exchange Limited (NSEL) is one

of a liquidity mismatch and not a solvency crisis, feels Deena Mehta of Asit C Mehta Investment

Intermediaries

Following a change in rule by the Department of Consumer Affairs, NSEL stopped trading in all

contracts, other than the e-Series contracts. "National Spot Exchange (NSEL) has suspended

trading of contracts, other than e-Series contracts till further notice. It has also decided to merge

the delivery and settlement of all pending contracts and deferred the same for a period of 15

days. Consequently, the positions outstanding in the contracts will be settled by way of delivery

and payment after expiry of 15 days," the NSEL said in a release late Wednesday evening. 

This has sparked concerns of defaults among traders, as some players may not be in a position to

raise cash quickly enough to settle their trades.  NSEL chief executive Anjani Sinha told CNBC-

TV18 that his bourse has enough physical stock to cover all trades, even if some members

defaulted.  “From the numbers it appears that the position is comfortable. Only issue is that the

stocks may have to be liquidated or sometime needs to be given to the financers to pay,” said

Deena Mehta.  “That is why exchange has asked for a 15 day time and they hope to either collect

the money or they will sell the stocks. Even if they sell the stocks there is sufficient cushion

available to absorb the loss. So now it is a question of liquidity,” she said. 

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Q: Can you just summarise for us if a great deal of brokers are impacted probably because they

are not getting payment from National Spot Exchange (NSEL)?

  A: Please first understand was has happened. There was a Badla like situation which was

happening in the spot exchange; that means people who had agricultural goods they used to get

finance through the spot exchange mechanism. Around Rs 5,000-6,000 crore of finance has gone

to these people. Last few days there have been certain circulars which have been issued by the

spot exchange, by Forward Markets Commission (FMC) in particular saying that these kind of

contracts are not really legal contracts.   These are 30-day forward and maximum allowed is a 1-

day forward contract and not 30-day. So exchange came back saying that we will go for a 10-day

forward contract where as per the FMC guidelines you can give delivery after 10 days. This

whole thing created a confusion in minds of the investors.   So the contracts which should get

rolled over, they stopped getting rolled over and the producers who took the finance had to give

the money instantly because their rollovers were not happening. So they are not able to arrange

cash so quickly, as a result of which when people started releasing the Badla the money was not

forthcoming.   Lot of brokers went and met the exchange today and what has been given to

understand is that there is about Rs 1,200 crore of extra stocks which is there over and above the

financial commitments which are there and plus there is a Rs 900 crore margin. So from the

numbers it appears that the position is comfortable. Only issue is that the stocks may have to be

liquidated or sometime needs to be given to the financers to pay. That is why exchange has asked

for a 15 day time and they hope to either collect the money or they will sell the stocks. Even if

they sell the stocks there is sufficient cushion available to absorb the loss. So now it is a question

of liquidity.

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Q: If the collateral is more than what the outstanding positions are, should there be a financing

problem or will the financing problem get over quickly, will the exchange be able to make good

payments?

A: Yes from the numbers which have been told definitely it is only time which is required to

liquidate the stock and get the money. So there appears to be a liquidity issue more than capital

returning issue. As things stand I think they need to arrange for liquidity and 15 days time should

be sufficient give or take a few days but majority of the money I think should start coming within

15 days time from the numbers which have been quoted by the exchange.

  Q: So are you saying that because it is difficult to liquidate those warehouse receipts which

were given as collateral, people could be selling stocks now to arrange for some immediate cash?

A: Correct. So people who have taken finance they have to convert these stocks into liquid and

return it to the financers. Now this is going on from almost three years so the money has been

remaining in the system. Now that the financers are withdrawing all of a sudden, it would take

some time for the people, the stockiest who have given goods to liquidate and give the money or

arrange finance elsewhere. So as of now it appears to be more of a liquidity issue.

Q: Is that satisfactory that 15 days is the outer limit and they will try to ensure their members

give you the money earlier?

A: Yes, it is a good statement which has come because there has been lot of confusion

prevailing since morning, a lot of clients are calling up. So, I think people should be patient and

this problem should be resolved as quickly as possible.

Q: Do you think there could be a problem of liquidation of physical stocks?

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A: India’s agricultural market is huge, we have got so many agricultural produce marketing

committees (APMCs) and crores of rupees worth of trades are happening. So, I do not see a

major problem in liquidation of these stocks and what would be required to be liquidated will be

a smaller fraction. The entire stock need not be liquidated because the brokers themselves will

liquidate and they will give money to the exchange. So,  exchange forcefully as he said that

auctions will happen in the end, they will give week to 10 days time for people to come and pay.

I don't see so much stock getting liquidated.

Q: Do you think therefore this problem will blow over?

A: The way the stocks of Motilal Oswal Financial Services and others are going down, it is quite

funny because they have put their client’s money and they are not going to lose the money that

the share prices are going down. People have not understood the context that these are the people

who have financed the market, they have to receive the money and give it to their clients, they

have not defaulted. So, why should their share prices go down.

Q: Do you see any regulatory issue in this entire saga of NSEL?

A: Yes, definitely. There is regulatory issue because landing in such a situation shows that the

exchange and regulators are not seeing eye to eye otherwise why should this confusion happen.

This is something which has been going on for two-three years and today the regulator says this

is not how it should be happening because we have given the permission only for one day and

the company is doing it for 34 days. So, there appears a mismatch in what the regulator expects

and what is happening.

Q: Is it true that larger brokerages have largely wound down their exposures and it is a large

number of smaller brokerages that are exposed to you?

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A: No, everybody has been reducing their exposure and it is not the brokers who are reducing,

the clients have been saying that there is confusion and that they don't want to be part of it. So, it

has a lot to do with the clients wanting to withdraw money and I don't think many brokers have

actively said that they shouldn’t square off even after the 10-day circular which came saying that

it can be squared off for 10 days. However, clients have been feeling uneasy because of the

confusion which prevails and we are not able to give a straight answer to our customers to what

is right and what is wrong.

Q: In the next 15 days, once all the inventory has been liquidated and people have been paid

back, then do you see NSEL functioning in the same way as it was, what changes do you expect?

A: NSEL has got two products, one is the Demat product where one can buy gold, silver. The

other product is finance business which was going on which has been under cloud. So, for that

business I think the exchange must take specific written permission from FMC and then only

launch further contract. Once they get a written permission from FMC, then I think people will

come back because funding of agricultural commodities conceptually it is a very good idea. So,

people would come back given proper regulatory framework for doing it..

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CHAPTER 3

NSEL IS IN A SPOT LIGHT

What's the chaos all about?

For higher returns, many wealthy investors, companies and even PSUs put money in a strange

product hawked by wealth managers. Now they fear the money is stuck.

What was the deal like?

An investor would lend money for 25-30 days against receipts of commodities stocked in a

warehouse. All transactions happened on the National Spot Exchange, a platform to match

investors (or lenders) and borrowers. The returns were as high as 14-15%.

So, it was like a co raising fixed deposits?

Yes and No. Since the transactions happened on a spot exchange, borrowers and lenders entered

into a pair of contracts for every deal. First, there was a three-day contract that said within two

days of signing it, the investor will lend the money and the borrower will handover a warehouse

receipt. Simultaneously, they entered into a 26-day contract, which said 25 days after cutting the

deal, the borrower will pay back a pre-agreed amount and get back the receipt. The difference

between the money lent and paid back captured the interest return. But, after the music stopped,

many felt the exchange was no different from a finance company.

Why these elaborate arrangement?

The respectability and legitimacy of an institution like a licensed stock exchange made all the

difference. No HNI investor would have lent crores to unknown commodity trader or unheard of

companies with few lakhs of capital. But since the exchange was guaranteeing the trades, they

had no problem.

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How was the money deployed?

The money borrowed was rarely paid back after 26 days. On the contract's expiry, the borrower

just paid the interest to the lender and the two parties would roll over the positions by entering

into a new but similar contracts. This would go on for months. This was similar to the now

banned badla finance, once the lifeline of stock markets.

How did it fall apart?

In end July, the government directed NSEL not to issue any new contract. A new contract does

not mean a new product - even rolling over existing contracts call for entering into new

contracts. This brought all trades to a halt. FMC had warned the exchange a year ago, but the

latter felt it would find a way out.

Why can't borrowers repay the money?

Some may have parked the money in illiquid assets like properties. There are also fears that

commodity stocks in warehouses may be much lower than what the receipts claim. Unlike chit

fund investors, the borrowers in NSEL contracts are wealthy investors who may go after the

brokers and the exchange. There are 13,000 investors (or lenders) and 25 borrowers.

What happened on Tuesday?

The word is out that less than Rs 100 crore has so far been paid by the borrowers against a

liability of Rs 5,500 crore. What happens on Wednesday will be crucial: FT, the promoters of

NSEL, and its founder Jignesh Shah will have to submit a firm repayment schedule to

the Forward Markets Commission. If Shah tries to buy time or sound unconvincing on

Wednesday, all hell will break loose.

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CHAPTER 4

THE CRACKS IN NSEL

Fri, Sep 06 2013. Mumbai:

 The Motilal Oswal firm’s transition to adulthood now includes an imposing problem as well: it

has a total exposure, made up largely of client positions, of Rs.263 crore to National Spot

Exchange Ltd (NSEL), one of entrepreneurJignesh Shah’s commodity bourses that is in the

midst of a Rs.5,572-crore payments crisis.

Chairman and managing director Motilal Oswal is now one of the fiercest critics of Shah and his

group of companies, which includes two listed firms, Financial Technologies (India)

Ltd (FTIL) and Multi Commodity Exchange of India Ltd (MCX). FTIL owns 99.99% of

NSEL. Oswal’s firm and some other large brokers are even advising clients to be careful while

doing business on the group’s larger commodity futures exchange, MCX. The level of distrust

among the broking and trading community is so high that some have approached MCX’s much

smaller rival, National Commodity and Derivatives Exchange (NCDEX), to launch contracts that

are similar to the former’s specifications so that they can move business out of MCX.

The NSEL crisis has gone much further than causing a mere credibility crisis for Jignesh Shah.

There has already been significant collateral damage, and things are likely to get worse. Four

independent directors on the FTIL board have quit. Six directors on the MCX board have

submitted resignations. In a worst-case scenario, regulators may take away the group’s right to

run any exchange business in the country. Besides, Shah may have to sell personal assets to

make good the losses of NSEL customers. NSEL has thus far paid back Rs.292 crore to

investors, of which Rs.177 crore has come as a loan from FTIL.

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Before it suspended trading on 6 August, NSEL was India’s largest commodity spot exchange.

But it permitted some low net-worth clients extremely large exposures, and failed to ensure that

the warehouse receipts being traded on its platform were genuine. While there is no official

estimate, the government and investors have concluded that the actual stock in the exchange’s

designated warehouses is just a fraction of the value of warehouse receipts that were traded.

Fraud allegations

Key stakeholders allege that the NSEL crisis isn’t merely a case of poor risk management, but

involved fraud. “Based on all the information coming out on NSEL now, it is evident the

exchange management and its promoters were misleading us from day one,” Oswal says. “They

misled us by showing auditor statements regarding the stocks. Their intention has clearly been

fraudulent, and demonstrates that the organization was not built on any moral values or

principles.”

Ramesh Abhishek, chairman, Forward Markets Commission (FMC), the regulator for

commodity futures exchanges, says, “The NSEL crisis has now entered criminal domain—it’s

clear that stocks are either not there or are a fraction of stated levels. This means there has been

suspected forgery, cheating and money laundering. We had, therefore, requested the government

for a multi-agency probe.”

FMC was asked by the government to supervise NSEL’s settlement process in early August.

Ever since, the regulator has found that the exchange and its directors were making inconsistent

and false statements (see box), and suspected that the group is not making the best efforts to

ensure settlement. On 20 August, FMC threatened Shah and other NSEL directors, in an official

letter, that it would declare them as not “fit and proper” to run any recognized commodity futures

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exchange if they do not take complete responsibility for the settlement of outstanding trades at

NSEL. To make things clear, it spelt out that this meant that Shah and the other NSEL directors

would not be permitted to be a director or own any part of MCX. FTIL, in which Shah is the

largest shareholder, currently owns a 26% stake in MCX.

“We are serious about our letter, which stated NSEL’s promoters’ and directors’ ‘fit and proper’

status is at serious risk,” Abhishek says. “Having said that, given the seriousness of the matter, as

well as the fact that the group has exchanges regulated by other agencies, we will take a

collective view on the matter.”

FTIL didn’t respond to emails sent on 26 August. But in a press conference on 28 August, Shah

said, “Neither me nor Financial Technologies has done anything unethical or improper. Both me

and the company are ready to undergo any scrutiny or anything which is required to be done.”

Government role

There is widespread criticism from trading firms and investors that scrutiny by the Indian

government has been lax and that action against NSEL and its directors has been delayed. While

the crisis erupted on 31 July, it was only on 27 August that finance minister P.

Chidambaram announced the appointment of two committees to probe the NSEL crisis.

“One working group formed by the government is headed by the director of enforcement, and

has representatives of the income tax department, revenue intelligence, Reserve Bank of India,

Sebi (Securities and Exchange Board of India) and FMC,” Abhishek says. “This shows the

seriousness with which the government is looking into the matter.”

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Government action was delayed because FMC bought the exchange’s initial version of the

problem—that it was merely facing a liquidity crisis. NSEL assured FMC it had adequate stock

of commodities in its warehouses, adding that its members needed time to make payments.

About two weeks later, it became clear that most members had no intention to pay and that there

was barely any stock in the warehouses. After FMC realized this, it wrote to its overseer, the

ministry of consumer affairs, suggesting, among other things, that the finance ministry be

requested to get involved in the probe to trace the money trail. The inter-ministerial

communication appears to have added to the delay. Even so, the criticism of the government is

understandable—after all, since the regulator suspected fraud, four weeks provide ample time for

those involved to cover their steps.

This isn’t the first instance where the government has been found wanting on the NSEL issue. 

Oswal says, “The government also has to take some blame since it gave the exchange a special

exemption from regulatory oversight. Besides, it had received a report from FMC almost a year-

and-a-half ago, but it slept on it.”

Prakash Javadekar of India’s main opposition party, the Bharatiya Janata Party (BJP), alleged

in the upper House of Parliament in August that NSEL had close links with a minister in the

central government.

Experts say the root of the crisis lies in the special exemption NSEL got from regulatory

oversight.

Various conflicts of interests have now come to light (see box), which could have been easily

avoided with regulatory oversight. “This episode makes it amply evident that when it comes to

the exchange business, one can’t rely on a self-discipline mechanism. There is no incentive for a

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private enterprise to adequately invest in risk management,” says a securities market expert, who

did not want to be identified.

Allegations of political interference have been made against the group before. K.M. Abraham, a

former Sebi board member, wrote to Prime Minister Manmohan Singh in 2011 that there was

pressure from the then minister of finance, Pranab Mukherjee (now India’s President), to

explore a compromise in Sebi’s position on MCX Stock Exchange’s application for trading

equities.

His letter said Sebi chairman U.K. Sinha had made similar requests to buy peace with the

finance ministry.

Abraham had rejected MCX’s application in 2010, saying that the applicants were not fit and

proper because, among other things, “they had not adhered to fair and reasonable standards of

honesty that should be expected of a recognized stock exchange”.

The finance ministry, then, had made its own complaint against Abraham to the Prime Minister’s

Office (PMO), saying he “committed serious misconduct and exhibited conduct unbecoming of a

member of the service” and making three specific charges.

The PMO later rejected each of these charges and absolved Abraham, although it’s not clear

what action it took on Abraham’s charges.

The FT group and MCX-SX took legal recourse and received a favourable judgement from the

Bombay high court. Sebi initially challenged this in the Supreme Court, but later arrived at a

compromise with the exchange.

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This was long after Abraham finished his tenure at Sebi. Sinha, who approved the exchange’s

equity trading licence in July 2012, will now be forced to look at the “fit and proper” status of

the group afresh, owing to the FMC’s observations on the crisis.

Jignesh Shah

Meanwhile, Jignesh Shah, 46, has been attempting to distance himself and FTIL from the crisis.

NSEL’s chief executive officer, Anjani Sinha, said in a statement on 14 August that his

management team and he were solely and directly responsible for all operations, including

screening of parties, warehouse management, risk management and other related company

matters. Trading firms and investors quickly reacted, saying this was a ploy to make Sinha the

scapegoat and absolve Shah of his responsibilities.

Shah, on his part, told FMC on 13 August that he had concerns about the quantity and quality of

the stock in NSEL’s warehouses. In other words, he was only beginning to get a feel of NSEL’s

real problems. But the regulator noted that Shah himself had said only a month prior, on 10 July,

that NSEL offered the highest level of safety for participants as it had over 100% stock as

collateral (managed by an independent collateral manager), 10-20% as margin money and was

backed by 100% of post-dated cheques from participants.

FMC’s letter, signed by deputy director Chalapati Rao, concluded, “This reflects the complicity

and/or the incompetence of NSEL’s board members to govern an exchange.”

“It’s unlikely that Jignesh Shah didn’t know much of what’s happening at NSEL and that he was

misled completely by the exchange’s management team—especially given the way the FT group

is structured and runs,” Hirander Misra, co-founder and chief executive officer of London-

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based Global Markets Exchange Group, says. “Former exchange officials from the group have

said that practically every budget proposal has to be signed by him.”

Oswal says, “How is it even possible that such large transactions happened without the

knowledge of the NSEL board and its holding company, FTIL?”

After a long hiatus, Shah appeared before the media on 28 August and said, “We are also

victims; it’s very important that investors, brokers and the exchange work together.”

In private meetings with investors and brokers, Shah had already suggested that they work

together as a group in recovering dues from defaulting members.

In response, FMC’s Abhishek says, “If you call yourself an exchange, then you should do

adequate risk management and ensure settlement. NSEL can’t get away from the responsibility

of standing guarantor against counter-party risk by telling investors and trading members ‘We’ll

go together after the defaulting firms.’”

This provides market participants a rather disconcerting glimpse into how Shah views the role of

modern day exchanges and clearing houses. In an early August press conference, Shah even said

it was incorrect to say NSEL had an obligation of Rs.5,500 crore. “The exchange is a platform…

the pay-in obligation is of the planters (defaulting members),” he said.

The head of a large domestic trading firm says, “It is the exchange’s role to ensure adequate

stock as collateral and collect adequate margins. Besides, it should not have encouraged the

seemingly unending roll-over of positions.”

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‘Shah’denfreude

News of Shah’s woes have reached overseas markets and regulators such as the Monetary

Authority of Singapore, which regulates his group’s Singapore Mercantile Exchange (SMX).

Some overseas market participants say they are not very surprised by the current problems faced

by FTIL.

John J. Lothian, a Chicago-based commodity trading adviser and a member of the US

Commodity Futures Trading Commission’s technical advisory committee, says, “Some friends

of ours, who are industry vendors, had very bad experiences with the FT Group, which did not

pay the entire contracted amount to our friends despite the work being completed. We had

written a commentary about the lack of respect by the FT Group for contracts and how that was

likely to be their demise. As a result, we are not really surprised with the NSEL crisis.”

Patrick L. Young, a Europe-based expert on exchanges and market structure, says, “What I term

“Shahdenfreude”—a feeling of shameful joy at the downfall of FTIL/MCX/NSEL founder

Jignesh Shah—has infused global markets. There is a spirit of antipathy towards the plight of

Shah, sometimes verging on the positively vitriolic. Over the years, a number of people feel Shah

has played somewhat fast and loose in various dealings and, consequently, there is little

sympathy for his current plight, regardless of the many notable achievements of his business

empire.” Schadenfreude is German for pleasure derived from the misfortunes of others.

Shah has carefully nurtured his public image and that of his group. He told Business

Standardnewspaper in a previous interview that he favoured the Mercedes-Benz car because he

believed it projected the “right image” and insisted that all his senior executives get suits made

with the finest fabric from Gabbana, a clothier popular with the business community.

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He made no secret of his ambition. In an interview with Business Standard in 2005, Shah said:

“We will create billion-dollar stories out of million-dollar ones. We are players in a high-speed,

high-stakes game, we can’t stop now.”

Shah is well known in the global exchange industry, thanks in part to the success of MCX and

owing to the large number of overseas exchanges FTIL has invested in. The group boasts of nine

exchanges in India, West Asia, Singapore and Africa, making it the owner of one of the largest

networks of exchanges. Clearly, he was a man in a hurry. FTIL had humble beginnings, starting

in 1995 as a small technology products firm. But it quickly picked up steam and soon had a

majority share in trading technology in the domestic market. Shah started his career as an

employee of BSE Ltd, but always wanted to run large exchanges. His break came when the

group won a licence to launch a commodity futures exchange. MCX attracted volumes largely

because of the latent demand for commodity trading. Besides, the shrewd design of its contracts

helped, as they were similar to the most popular commodity contracts traded in the US. A large

part of trading on the exchange occurs in the late evening session, which coincides with the US

market timings, enabling traders to engage in arbitrage. MCX’s success attracted large investors

as well, which helped the group’s cash flow. Later, when exchange stocks were in great demand

globally, the group launched a number of overseas exchanges.

Overseas exchanges

“The FT group is known to be very aggressive in its dealings, and until the NSEL episode, this

approach seemed to work well in its Indian operations. But it hasn’t had the same success

abroad,” Misra of Global Markets Exchange Group says.

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Among its overseas ventures, Shah’s group has tasted success only with Dubai Gold and

Commodities Exchange (DGCX), whose volumes have more than doubled in each of the past

two years.

But its role here has been largely limited to that of a financial investor.

The exchange’s operations have been managed by Dubai Multi Commodities Centre since 2007,

said a person at the exchange on condition of anonymity. DGCX even replaced FTIL’s trading

platform last year. In short, FTIL can’t take much credit for DGCX’s success, although its stake

in the exchange will fetch it much more value than its other overseas ventures.

FT tried a big-bang launch for its Singapore Mercantile Exchange (SMX), initially even

managing to hireLeo Melamed, former chairman of the Chicago Mercantile Exchange (CME),

as chairman of its advisory committee. But Melamed resigned within a month owing to

controversy about a conflict of interest with CME, where he was still a director. SMX hasn’t

really taken off, and has witnessed a string of exits by senior personnel. Its volumes in July were

a fraction of those recorded by DGCX.

Business as usual?

On 3 August, SMX issued a press release saying it was business as usual and that NSEL’s

problems wouldn’t affect its operations. But market participants beg to differ. Lothian says,

“Trading firms had reservations earlier and the NSEL crisis only makes things worse.”

A moot question here is if liquidity will shift from MCX, since there are no worthy alternatives

in the non-agricultural commodities space. On 26 August, NCDEX, encouraged by traders’

requests, launched new gold and steel contracts, which together account for half of MCX’s

turnover. It even cut transaction charges sharply. Misra, who was chief operating officer at pan-

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European multilateral trading facility Chi-X Europe when it successfully captured share from

incumbents such as London Stock Exchange and Deutsche Borse, says, “Many trading firms

would be reluctant to be associated with the group’s exchange ventures after this (the NSEL

crisis). While today there may not be any decent alternative to MCX, over time, that can

change.”

Whether by accident or design, almost all of the group’s domestic exchange businesses have

been hit by regulatory or government measures. MCX’s volumes have fallen by over 40% since

July after the finance minister introduced a transaction tax on all non-agricultural commodities

futures trading. MCX-SX’s currency derivatives segment was hit in July, when the central bank

and Sebi instructed exchanges to cut position limits in the segment.

There are faint whispers that the group’s recent woes have to do with the change in political

winds—Mukherjee left active politics to become the country’s president about a year ago and

was replaced in the finance ministry by Chidambaram.

On the other hand, it can be argued that there has been a transaction tax for equities trading for

years, and that the finance ministry was only correcting this anomaly. The clampdown on

currency derivatives appears to be guided by the central bank’s concerns about the rupee’s sharp

depreciation against the dollar. MCX-SX’s entry into the equities segment six months ago hasn’t

exactly set Dalal Street on fire—volumes are a fraction of both National Stock Exchange and

BSE Ltd, despite a scheme to incentivize liquidity providers.

In addition to all this, effective 2 September, FMC has doubled margin requirements for gold,

crude oil, silver and natural gas contracts, which together account for about two-thirds of MCX’s

volumes. With double the capital requirement, volumes are expected to fall sharply, for the

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second time in three months. FMC has also directed commodity futures exchanges to transfer an

amount equivalent to 5% of its gross revenue in the past five years to the settlement guarantee

fund. This will entail a large cash flow impact for MCX.

All of these problems together pose severe challenges to the group; but the NSEL crisis has put

its survival at stake. If the government’s probe concludes there was complicity by the promoters

and directors, Shah will get embroiled in legal battles, and risks losing his empire. But even if

complicity is not proved, as FMC’s letter puts it, the directors’ competence to run an exchange

will be questioned. This, again, will put Shah’s exchange ventures at risk, although FTIL’s

technology business and other non-exchange related businesses may survive.

Misra says, “Firms should be careful to always stay on the right side of certain boundaries

because, before you know it, you may be too far out and can’t escape regulatory scrutiny. In the

end analysis, while there is a thrill of running ahead fast like a hare, it’s those who exercise

discretion, like the tortoise, who often win the race.”

CONFLICTS

— National Spot Exchange Ltd (NSEL) permitted trading of warehouse receipts on its platform.

It has emerged that a number of warehouses are controlled by the very people who bought the

warehouse receipts and owe the exchange funds. Now, many of these members are not paying,

nor is there adequate stock to make good the exchange’s and investors’ losses.

— NSEL’s largest clearing member, Indian Bullion Market Association (IBMA), is majority

owned by NSEL, which in turn is 99.99% owned by Financial Technologies (India) Ltd. IBMA

also traded on another exchange promoted by the group, MCX (Multi Commodity Exchange).

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— Shreekant Javalgekar, chief executive officer of MCX, served simultaneously on the boards

of MCX, NSEL and IBMA. He resigned from the boards of NSEL and IBMA in August.

— The promoter of NSEL’s largest client, NK Proteins, which owes Rs.970 crore, is related to

Shankarlal Guru, chairman of the exchange. Guru resigned after the crisis erupted in August.

— NSEL’s auditor, Mukesh P. Shah and Co., is run by a relative of Jignesh Shah.

— The government official who signed off the special regulatory exemption for NSEL was later

employed by MCX Stock Exchange (MCX-SX) in an advisory role. FTIL and MCX have a

majority economic interest in MCX-SX through equity shares and warrants.

INCONSISTENCIES AND MISLEADING STATEMENTS

— Jignesh Shah tells FMC on 10 July that NSEL has 100% stock in warehouses against open

positions of members. NSEL’s CEO Anjani Sinha reiterates this soon after the crisis becomes

public on 1 August, stating the exchange has stock worth Rs.6,200 crore. According to news

reports, surveys by the income-tax department later showed there was little or no stock in the

warehouses.

— Sinha states on 1 August that the exchange has a settlement guarantee fund of Rs.850 crore,

and later revises it downward to Rs.65 crore and ultimately to only Rs.5 crore.

— Shah tells FMC on 10 July that the exchange has collected 10-20% margins from members.

According to exchange data released on 29 August, the difference between the gross outstanding

of members who have pay-in obligations and the net outstanding amounts to Rs.692 crore. The

net obligation is after adjusting for margins, charges and pay-ins. NSEL has received pay-ins

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of Rs.105 crore, which still leaves an amount of Rs.587 crore as margins, the whereabouts of

which are not known.

— NSEL said on 4 August that members will pay in 94.5% of their obligations, or Rs.5,288

crore, in 20 weeks. It then said on 14 August members will pay 78% of obligations over a 30-

week period, with the remaining amount expected to be recovered through a sale of members’

assets. It should have collectedRs.524 crore by end-August; instead, members had paid

only Rs.110.75 crore until 31 August.

— A government initiated co-operative, Nafed, is projected as a co-promoter of NSEL, despite

making only a token investment of Rs.1,000. NSEL’s total share capital stands at Rs.45 crore,

with FT bringing in the balance.

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BIBLIOGRAPHY

Newspaper:

Economics Times

Magazine:

Business Standard

Websites:

http://www.moneycontrol.com

http:// www.livemint.com

http:// timesofindia.indiatimes.com

http:// www.ftindia.com

http:// www.nationalspotexchange.com

http:// profit.ndtv.com

http:// www.epw.in

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