The NSEL scam only happens to be the biggest of the multiple scams that have hit the commodities markets, thanks to poor regulation
Prime minister, Manmohan Singh, likes to blame all the lapses of his government on ‘coalition dharma’. Well, in addition to the long list of scams and dubious decisions that have rocked the nation, the lax regulation and supervision of commodity futures markets is another example of the wanton disregard of public interest to appease a powerful political ally.
Over the past month, it has become increasingly clear that what happened in the National Spot Exchange Limited (NSEL) is clearly a Rs5,600-crore scam. Jignesh Shah, promoter of the FT-MCX groups, admits as much, but blames the now sacked managing director Anjani Sinha for defrauding him.
What is not in doubt is the thorough mismanagement of the whole business of spot commodities trading. But NSEL chairman, whose son-in-law Nilesh Patel’s company owes Rs950 crore to the bourse, strains our credulity when he claims ignorance.
Remember, India had banned futures trading in commodities for over 40 years. It was re-started in 2003 with the clearance of four newly minted commodity futures bourses and, almost immediately, the impact of poor regulatory framework, disempowered regulator, sloppy supervision and the lack of checks & balances was apparent. Multiple scams and scandals began to hit the sector with regularity. The NSEL scandal only happens to be bigger than all the previous ones. Consider this:
• Earlier this year, Kailash Gupta, the founder of the National Multi-Commodity Exchange of India Ltd (NMCE) was arrested for alleged money-laundering and cyber crime. In 2011, he had been stripped of his voting rights and directorship following a fraud. This action itself was taken after several other irregularities had been detected as far back as 2006. He is accused of having illegally paid tens of crores of rupees to entities belonging to his family and his children and was personally accused of having manipulated rubber prices. Mr Gupta held a 30.18% stake in NMCE through his company Neptune Overseas. And, here is the first flaw. While the government is at pains to ensure that no single entity owns over 5% of any exchange, this precaution was ignored while re-starting commodity futures trading, despite the fact that any speculation or price-rigging in commodities has a deleterious impact on the economy.
• In 2007, the National Commodities and Derivatives Exchange of India (NCDEX) stripped its CEO Narendra Gupta of key functions following allegations of irregularities and a dubious settlement in urad and chana trading with a sudden change in contract prices. Justice PN Bhagwati had headed a probe committee to investigate the matter. NCDEX has been set up as a professional bourse with the National Stock Exchange (NSE) and ICICI Bank among its key promoters.
Did the government not realise that there would be problems? In fact, prime minister Atal Bihari Vajpayee had flagged the issue at the launch of NMCE itself, when he said, “I would like the regulatory system for commodities exchanges to be strengthened to create confidence among all stakeholders.”
Soon thereafter, the bourses began to emulate the capital market by putting in place all the structures that lend confidence to investors—logistics facilities, modern warehousing with dematerialised and tradable warehousing receipts (WRs) and trade guarantees. But these seem to be just a smokescreen.
The Forward Markets Commission (FMC) itself was partially empowered, but continued to be controlled by the clueless ministry of consumer affairs, instead of following the logical course of bringing it under the ambit of the finance ministry and SEBI (Securities and Exchange Board of India) which have developed some expertise in dealing with speculation, insider trading and trading-related fraudulent practices.
A key factor in the NSEL scam is that the warehouses, which were supposed to stock the products traded through warehousing receipts (WRs), seem to be empty. Most of these warehouses are located within the premises of key members/borrowers of the NSEL. How did this happen?
We learn that the Warehousing Development and Regulatory Authority (WDRA), an independent regulator (that was born out of the warehousing statute in 2007 but became operational only in 2010), granted accreditation to eight private warehouses. Did someone grant accreditation to NSEL’s warehouses? Did it not matter that all of them seemed to be under the control of its largest member-borrowers? Has anyone been questioned? What was the role of National Bulk Handling Corporation, also owned by the Financial Technologies group which set up the initial warehouses?
Interestingly, WDRA’s website (wdra.nic.in) shows that the regulator is empowered to punish entities that issue fake or duplicate with imprisonment of up to three years or a fine that can extend to four times the value of the goods and a combination of the two.
The website, however, shows no linkage to NSDL (National Securities Depository Limited) and CDSL (Central Depository of Shares Limited) which handled NSEL’s WRs. But NSEL’s website says that warehouses empanelled with the Exchange would sign an agreement with CDSL and they alone could issue WRs to holders of commodities.
These could then be traded on a separate e-auction system. WDRA ought to have been responsible for checking whether the WRs held in the depositories were backed by physical stock. Why is it not even in the picture yet? There is another issue. WDRA has the power to inspect and punish. But does it regulate depositories? This is a question that I raised six years ago when over half the new businesses that NSDL ventured into were outside the supervision of SEBI.
It is only a couple of months ago that NSDL has split its operations, but clarity over the regulation and supervision of its many business is still missing while CDSL continues to float unchecked in NSDL’s shadow.
Many of the issue pertaining to commodities trading would have been sorted out if FMC were brought under SEBI, in line with an idea mooted in 2003-04. A third post of a whole-time director at SEBI was also created specifically to supervise the commodity markets.
But, all of a sudden, Sharad Pawar, the then minister for agriculture as well as minister for consumer affairs, did an about-turn and went back on his earlier support for the proposal. Looking back, it seems most likely that the commodity market-players influenced this change.
After all, NSEL was set up by a simple exemption granted by the ministry of consumer affairs, allowing it to function outside the supervision of FMC and undertake a financing operation with ready-forward transactions under the guise of facilitating delivery-based spot trades.
Strict regulation and control of commodity markets is a must in India because the consequences of manipulation, especially of food grains, oil and other essentials, affect the entire population. Instead, commodity futures bourses were regulated with a light hand.
Even today, there is little clarity about specific inspection and regulation of various intermediaries such as depositories, warehouses, inspectors or accreditation agencies. Unlike the capital market, promoters of commodity exchanges have been allowed a significantly higher equity stake (of 26%) and also hold significant stakes in member entities without clear Chinese walls.
But let’s not be under the illusion that poor supervision and confused regulation is limited to the commodities market or the FMC. Forex derivatives, which are under the joint watch of SEBI and the Reserve Bank of India (RBI), operate in a similar regulatory vacuum, where some key brokers are allowed to whip up artificial trading volumes, hold a significant stake in the bourse and dominate management decisions. It is another issue that is waiting to blow up, like NSEL.
Sucheta Dalal is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected]
Investors are again paying for ignoring the big picture
Institutional investors, who are...
Petrol price hiked by Rs2.35 per litre and diesel by 50 paisa, excluding state levies, effective midnight today
The government on Saturday raised the price of petrol by Rs2.35 per litre and diesel by 50 paisa a litre, excluding state levies.
The increase in rates, which are excluding local sales tax or VAT, are effective from Sunday, Indian Oil Corporation (IOC), the nation's largest oil marketing company, said.
Earlier, M Veerappa Moily, minister for petroleum & natural gas had made a case for an appropriate increase in price of diesel, kerosene sold under public distribution system, and domestic LPG.
Moily, in a letter sent to prime minister Manmohan Singh, and finance minister P Chidambram had urged them to take corrective steps to check the deteriorating financial health of the oil marketing companies (OMCs) due to mounting under-recoveries (loss incurred by companies) for selling these products at a controlled price.
"…consistent rupee depreciation has a severe impact on the under-recovery of the OMCs and consequently on their financial health. If the present position persists, the total under-recovery would reach to a level of Rs1.80 lakh crore in the current financial year as compared to Rs1.61 lakh crore during the financial year 2012-13," Moily said in letters separately written to the prime minister and finance minister.
The Cabinet Committee on Political Affairs on 17th January decided to increase the diesel price in the range of 40 paisa to 50 paisa a litre per month (excluding VAT), sell diesel to bulk consumers at market price, and cap on subsidised domestic LPG cylinders to nine annually.
In spite of seven increases in diesel price since 18 January 2013 totalling Rs4.25 per litre, the current under-recovery is Rs12.12 a litre. At present, the companies incur a monthly under-recovery Rs6,204 crore on the sale of diesel. “At the current level it will take around 20 months to eliminate this loss provided there is no further increase in the international price of diesel and rupee-dollar exchange rate, the Minister said.
The monthly loss on PDS kerosene is Rs2,398 crore, and domestic LPG Rs3,058 crore.
However, with the significant depreciation of rupee against dollar since April 2013, the under-recovery burden is likely to become much higher, the Minister said adding that it is estimated that every rupee depreciation against dollar increases under-recovery on sale of diesel, PDS kerosene, and domestic LPG by about Rs7,900 crore annually.
"If we consider the average price of India crude basket at $110 a barrel and the average exchange rate at $66 for the balance financial year, the under recovery of OMCs will increase to an unsustainable level of Rs1.68 lakh crore. If the price of international crude oil increase to $115 a barrel the under-recovery will reach to around Rs1.81 lakh crore," the Minister said.
The upstream assistance – ONGC, Oil India – and GAIL (India) is expected at Rs70,500 crore, The remaining under-recovery of Rs97,500 crore can be met from either the Budgetary support from government or appropriate increase in fuel price, the Minister had said.