A sudden turn of events has brought a functioning commodities market to a crashing halt. How did the National Spot Exchange function? Here is a Moneylife interview with NSEL’s top management with verbatim answers
National Spot Exchange (NSEL), promoted by Financial Technologies (FT), is in news for alleged violation of norms and is struggling to ensure a smooth closure of existing contracts. Sometime back, we had asked how NSEL functioned, its business model, security of its traders and its warehousing facilities. We started by asking an entity called Indian Bullion Market Association, which sounds like an association, but is a registered member of NSEL and promoted by NSEL.
Moneylife: The trend in prices on the NSEL seem to indicate an arbitrage between T+2 and T+25, directly linked to cost of money and geared to yield a return of around 14%. In fact, leading PMS companies have openly told us that this is a way of earning risk-free money with a yield of around 14%. Is this true?
NSEL: In physical trade, a trader or stockiest buys from mandi on cash payment and supplies to a mill, getting his payment from the mill after 15-25 days (varies from commodity to commodity and place to place). If the supplier insists for cash payment, the mill applies a CD (cash discount of 2%). Hence, the interest rate prevalent in physical trade of commodity varies from 24% to 30% per annum. Compared to that, on NSEL, the cost of money involved in procurement has come down to 15%, which is beneficial to the processor. On the other hand, traders get a comfort of risk free environment, because of risk management and clearing house services provided by the NSEL.
Moneylife: Why the trading volumes for the T+2 contract and the T+25 contract are identical in many cases?
NSEL: In T+2 contracts, farmers, producers and traders sell commodities for delivery on T+2 days and they get payment on T+2 days. The actual users, processors and exporters, buy commodities in T+25 contracts, make payment on T+25th day and get delivery. An investor buys the commodity in T+2 contract and sells the same in T+25 contract. As a result, trading volume for T+2 and T+25 is identical. All such trades are backed by physical delivery of goods and warehouse receipts. To simplify this for your understanding, let’s take the global model of LME of T+90 days that covers 95% of physical trade in non-ferrous metals, as an example. Producers, consumers and intermediaries use this LME forward for their consumption, financing and hedging requirements. There is, however, a big lacuna in India-the set up does not address the key pillars of spot, forward and futures and does not complete the linkages of any commodity ecosystem. In India, we have tried to develop this in few agricultural commodities, so that the model can be tested on pilot basis.
Moneylife: How is the price of a product, even if it opens at high and closes on low, the same or almost the same?
NSEL: In the spot market for agricultural commodities, prices do not keep on changing, because there is no speculative element. Prices are influenced by mandi auction and once the auction is over, prices do not change much. Volumes are linked to arrival of commodities at our centre and they are not connected with price fluctuation or change in open, high, low, close, as mentioned by you. We do not find any intra-day trading in most of the agricultural commodities. The reason is that once a farmer, producer and trader has sold the commodity, he has no intention to buy it back but in delivering it and receiving his money. Similarly, once an actual user, exporter and processor has bought the commodity, he does not intend it sell it back, because he needs the commodity for processing or export. In brief, spot market of agricultural commodities do not function like a typical financial market, rather they function as electronic agricultural produce market committee (APMC), where flow of a commodity in a single day is from farmers to trader to end user and not vice versa.
Moneylife: Are we correct in our understanding that there is a single counter party for each specific contract?
NSEL: In agricultural commodities, the market structure is such that on sale side, there would be hundreds of sellers, while the buy side will consist of a few processors and exporters, who are interested in procuring commodities from an area that is not too far from his plant.
Moneylife: For raw wool, castor seeds, steel and paddy, which are the counter-parties involved?
NSEL: In castor seeds, all the large exporters of castor oil-Jayant Agro Organics, NK Proteins and AWN (a joint venture promoted by Adani Wilmer group) are our members. On sale side, large number of traders, commission agents and farmers are involved. Gujarat Agro Industries, a Gujarat government company is also our member. Similarly, in raw wool, ARK Imports, which imports raw wool from Australia, processes it and sells it to garment producers, is our member. In Paddy, Dunar Foods International, Vir Food, Namdhari Foods International Ltd, Namdhari Rice and General Mills Ltd, which process and sell rice in domestic market as well as international market, are our members. These names are only illustrative in nature. NSEL has a membership base of over 800 members, consisting of large government companies such as MMTC (Minerals and Metal Trading Corp, PEC, State Trading Corporation (STC), NAFED, RAJFED, Gujarat Agro Industries Corp, Food Corporation of India (FCI), Cotton Corp of India (CCI), APMARKFED, farmers’ societies, large broking houses and a number of corporates.
Moneylife: Where are your warehouses located? What is the process of inspecting the warehouse and ensuring that goods are actually stored there?
NSEL: Most of our warehouses are located near arrival centres. NSEL has, till date, launched 668 contracts on its platform. For launch of every contract, the Exchange issues a circular, which is available on our website and addresses of each warehouse have been specified. Further, there are service level manuals (SLMs), which are in existence for last five years. On a daily basis, goods come or go out and such movement of goods from warehouses is much more as compared to those in warehouses of futures market.
Moneylife: Are warehousing receipts (WRs) issued by the Exchange? Why do some investors tell us that they simply do not get warehousing receipts that can be pledged with banks?
NSEL: We have implemented electronic Warehouse Delivery and Management System (eWDMS) at NSEL. This system keeps track of all deliveries and warehouse receipts issued, discharged, surrendered, transferred and pledged. In case of physical warehouse receipt, we face problem because of time involved in sending receipts from one place to another and then receiving it back, if the buyer sells in between. For instance, NSEL is based in Mumbai and all WRs are generated from a centralized server based in Mumbai. Let us say a member is based at Kolkata, his franchise is based at Jaipur and the client is based at Jodhpur. In this case, if NSEL sends a warehouse receipt to its member at Kolkata, he will send it to his franchise at Jaipur and the franchise will send it again to his client at Jodhpur. This entire process will take at least 8-9 days. If the client sells such WR back on NSEL platform while the WR is still in transit, the entire thing would become a mess. Hence, we evolved a mechanism to sort out this issue.
When a client buys a commodity, we send an allocation letter to him by fax or scanned copy by mail on delivery date, while the WR is captured in eWDMS system. If the client sells it back, he is required to communicate the WR number and we mark his delivery based on the information provided. However, we are further working on automating the issuance of allocation letters.
We have provided web access to our members to access eWDMS directly from their location, so that paper work and courier/ fax work can be avoided. Besides, some members, who buy agri-commodities on our platform and are not interested in selling it back soon, send us requests for warehouse receipts and we provide physical receipts to them. Such members are also able to pledge WRs with the bank. However, in case of frequent buying and selling, movement of physical warehouse receipts is practically not feasible. At present, NSEL is operational in 16 states in India, providing delivery-based spot trading in 56 commodities across 192 delivery locations. The e-series has seven commodities available for trading. During FY2012-13, NSEL recorded a turnover of Rs2.95 lakh crore.
Moneylife: Would you also give us a break up of the outstanding position of a set of commodities traded on the exchange - for instance e-gold, raw wool, paddy, castor seeds etc and how many parties holds positions in each?
NSEL: In spot exchange, there is no outstanding position carried forward to the next day. Intra-day trading is possible, but all outstanding position at end of day are marked for delivery, which implies that seller has to give delivery and buyer has to take delivery. If the seller fails to give delivery, the Exchange conducts short delivery auction on T+2 day. For instance, at end of a particular day, there are thousands of investors holding buy and sell positions in e-gold and all these positions are settled by delivery on T+2.
Moneylife: Could you give us the locations of warehouses for each product and the process of inspection / regulation, if any?
NSEL: As explained, location of warehouses is given in the circulars issued for launching contracts for trading and subsequent circulars issued in continuance thereto, for adding new warehouses, which are available on our website. The Exchange avails the services of professional warehouse management companies such as Brink’s Arya, Group 4, Sohanlal & Co and National Bulk Handling Corp (NBHC) for managing warehouses. Brink’s Arya is a part of Brinks USA, duly approved by LBMA for handling delivery of gold and silver. At some locations, where these professional companies do not have warehouses, we have put our own work force to manage warehouses for agricultural commodities. We have complete Management Information System (MIS) of all these warehouses. Issuance and transfer of WRs and discharge thereof, is handled from our central office. Besides, we have our inspection team to visit these warehouses regularly.
Moneylife: What are the activities and objectives of Indian Bullion Market Association (IBMA)? Is it a sub-broker of the exchange? What is its ownership structure? Why is it called an association?
NSEL: IBMA was setup to represent matters relating to bullion trade and industry on the physical side, before various authorities and ministries, who are involved in policy formulation. This role has now been extended to agriculture based commodities. The futures market’s views regarding policy formulation are being represented by several national and regional level commodity exchanges. It, however, lacked adequate representation by physical market participants (to which futures market is an adjunct). Due to this gap, physical market participants did not have enough say in policies formed by state governments, warehousing regulators and ministries related to commodities.
While physical markets are the largest employment generators, these markets are small and fragmented, consisting of participants speaking regional languages, who may not be able to articulate policy amendments. They function without any institutional set up, suffer from poor infrastructure and lack professional representation.
This leads to a huge gap between the policy and 'on ground' reality. After its formation, IBMA started contributing to policy formation in several ministries such as Ministry of Consumer Affairs (MCA), Ministry of Agriculture and Ministry of Finance. These ministries have also accepted and invited us in many official committees to represent physical trade.
IBMA is not a sub-broker but a member of the Exchange (NSEL). It has around 130 bullion dealers and jewellers from across the country as its shareholders. PEC Ltd (formerly Project & Equipment Corporation of India Ltd), a government company, is also its shareholder. It was conceptualized and called an 'Association' because it was promoted by NSEL in a cooperative structure along with various stakeholders such as small jewellers and bullion traders, with an aim to work as an aggregator.
Just as National Agricultural Cooperative Marketing Federation of India Ltd (NAFED), Haryana State Cooperative Supply and Marketing Federation Ltd (HAFED) and marketing federation (MARKFED) function as aggregators for providing market linkage to small and marginal farmers through a network of societies; NSEL provides market linkage to large number of constituents in 18 states that is registered in, with their respective state authorities and regulatory agencies.
In addition to making representations on behalf of physical market participants, policy makers and market linkages services, IBMA also offers various services to its members such as sourcing of material, clearing and forwarding (C&F).
Inside story of the National Stock Exchange’s amazing success, leading to hubris, regulatory capture and algo scam