The recent arrest of the chair man of Financial Technolo gies India Ltd, t he operator of National Spot Exchange Limited ( NSEL), Jignesh Shah, has sharpened focus on the sophisticated end of the business dynamic. This has been an issue that came to the fore in August last year, but the only thing a layman has understood is t hat this was an alle ged financial fraud of Rs 5,600 crore. HT tries to simplify the issue.
WHAT WAS NSEL SUPPOSED TO DO?
All market exchanges want to raise money from the public. The Bombay Stock Exchange (Sensex) and the Nifty raise money by having companies list on a platform where people buy their shares and in effect give the owners (promoters) money, hoping to exit when they think the share prices have risen high enough.
The NSEL, when set up in Mumbai in 2008, was meant to be an electronic marketplace for large quantities of commodities such as sugar, rice, cotton bales, steel and copper.
Sellers of commodities could bring goods to a warehouse operated by the exchange, which ensured quality, and issued a receipt.
The seller then placed this receipt on the exchange in an electronic for m and buyers could bid for the receipt, entitling them to the goods, giving them wider access to the market.
The trouble started for the exchange when it, as the medium for transaction, allowed people to trade in receipts without giving physical delivery of the commodity, for days ranging from 11-36.
This was allowed despite the fact that the settlement of a contract had previously been capped at 11 days.
For a cautious investor, this should have sent alar m bells ringing as in effect, people were trading only in receipts without any verification as to whether the commodity actually existed in warehouses.
MATTERS COME TO HEAD
Soon, the consumer affairs ministry ordered a probe into the contracts being traded on the NSEL. It was felt that allowing any delivery settlement beyond 11 days was akin to futures trading, which can often be driven by speculators rather than by genuine buyers and sellers.
WHAT IS A FUTURES CONTRACT?
A 'Future' is a contract to buy or sell an asset for a specific price at a pre-determined time, which means that instead of acting as an electronic marketplace, NSEL might have been trying to gain due to the fluctuation in rates of the underlying commodity, something it was not allowed to do, under the rules.
MEMBERS LOST HEAVILY
Spot exchange members who bought into contracts that have since been suspended, have been struggling to get their money back as there is no physical stock against the receipts. The exchange has also failed to stick to the schedule mandated for repayment, after the alleged fraud came to light.
HOW WERE INVESTORS TRICKED?
A typical investor was a high net worth individual. He was told that by buying the receipt, he would earn
13-14% over the short ter m (till the expiry of the contract). So, he was being asked to take a cut to facilitate what was perceived to be a genuine transaction of a commodity over a regulated exchange like the NSEL. However, with the warehouse empty, as was bor ne out later, most were left with worthless receipts.