NSEL: Poor Regulation was not by chance

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]

Narain Jagirdar
1 decade ago
All scams in India have political connections and if one probes deeper, this too would be no different, and regulation or lack of it is related to the involvement of these worthies. So far, the scams went unnoticed but with watchful media and alert individuals like you, they no longer are. Instead of regulators to improve, we private citizens, must be more careful and stay away from investing in these.
A Kumar
1 decade ago
Failure of a Commodity Exchange is largely being portrayed as a loss to some investors and the matter sought be closed here.
However overseas investors see an exchange failure in relation to the overall governance, the hollow regulation and increasing likely hood of a total failure of the banking system at some point due to manipulated defaults.
Many investors have declared a lockdown on investment in India.
So far as individual investors were concerned, there were only a few primarily in e-gold and silver, and learn a lesson to keep commodities physically as done in India over centuries.
Vickram Jaitha
1 decade ago
The concept of e-gold was introduced for easy trade and safety. Neither can the NSEL investors trade e-gold nor are they feeling safe. What is the Government doing to protect thousands of investors who have invested in e-gold and e-silver?

The laws and rules that govern NSEL should derive from a simple and straightforward concept : all investors, whether large institutions or private individuals (big and small) should have had access to certain basic facts about NSEL prior to investment and so long as they hold the investments. To achieve this, Government should have insisted on NSEL to disclose meaningful financial and other information to the public. This would have provided a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular commodity like e-gold or e-silver. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions. Unfortunately, this did not happen in the case of NSEL.

The result of this information flow is so important to our nation's economy. To insure that this objective is met, the Government should continually work with the market participants, including especially the investors, to listen to their concerns and to learn from their experience.

The Government must oversee the key participants in NSEL, including brokers and dealers, borrowers, investment advisors, and mutual funds for maintaining fair dealings, and protecting against fraud. Crucial to the effectiveness in each of these areas is its enforcement authority.

The world of investing is fascinating and complex, and it can be very fruitful. It is not a spectator sport.

vivek shah
1 decade ago
It is becoming increasingly apparent that this is another of those scams which has the blessings of Sharad Pawar. This matter too would get a quite burial.
nagesh kini
Replied to vivek shah comment 1 decade ago
Of course it is indeed a massive Mother of All scams beating HM+KP put together and should under no circumstances be allowed to be buried as very big fish and money is involved.
nagesh kini
1 decade ago
This is indeed a classic of poor policing coupled with ineffective enforcement of good laws.
First and foremost those at the helm of affairs were allowed to breach and violate the investment limits with utter contempt and yet allowed to get away blue murder for long.
The Union Ministry for Agriculture & Consumer Affairs is as much guilty for not acting in time and virtually conniving by tacitly condoning all the wrongs.
What's the point in now locking the stable after the horse has bolted?
nagesh kini
1 decade ago
This is indeed a classic of poor policing coupled with ineffective enforcement of good laws.
First and foremost those at the helm of affairs were allowed to breach and violate the investment limits with utter contempt and yet allowed to get away blue murder for long.
The Union Ministry for Agriculture & Consumer Affairs is as much guilty for not acting in time and virtually conniving by tacitly condoning all the wrongs.
What's the point in now locking the stable after the horse has bolted?
Replied to nagesh kini comment 1 decade ago

Its not only ministry of agri and consumer affairs there is hand glow from Finance minister and Prime minister as all the rules of all stock market as well commodity market is violated and institution like sebi and nse bse and nsdl and cdsl are vicariously responsible for this scam and now we going have one more stock market scam in equity sector wherer the officials of sebi nse bse cdsl and nsdl failed to discharge their duty this because the patronage given by finance ministry and Prime Minister as such the present UPA govt is full of scam tainted minister only GOD should punish them now law no commission would solve we citizen of india are scape goat for this scape all our hard earned money is pumped in stock market and these ministers and officals swindle our money and we have left no choice is state of affairs of citizen of india is petiable condition not an single officials of sebi nse bse cdsl and nsdl are above corruption is heart breaking and we have to regret that morale and integrity and honesty and accountabiltiy is lost in present UPA govt
Narendra Doshi
1 decade ago
Well description of the chronology of events. Kudos Sucheta.
1 decade ago

Its not only commodity exchange which has poor administration even the equity market both bse and nse there is no poor and lack of accountability why the brokers refuse to divulge the PMS accounts details and the margin fund which normallly cheated by these brokers and they misuse and lure the innocent investors and POA which is misused by the broker and as such indian capital market and govt institutions like NSE BSE SEBI CDSL NSDL lack accountability all are hand inglow with cheating just like how satyam computers promoter Shri Ramalinga Raju confessed about the cash misappropriation the similar case with Shri Jignesh Shah and he accepted manipulation hence this collapse but the equity market is oldest market and all the stock brokers are chor to core and they knew how to manipulate and sebi and nsdl and cdsl are party to it so as a whole indian stock market has very poor adminsitration and present Finance Minister is an sadist and he is also party to all these scams
Anil Agashe
1 decade ago
It is a big fraud no doubt about that. The press obviously had no inclination of what is happening and perhaps was not even interested till all hell broke.
This was it seems a cozy arrangement as used to be the case with BSE pre-NSE days.
I firmly believe that SEBI was correct in not allowing stock trading on MCX. We do not need more stock exchanges when investor population is declining.
I have no sympathy for those who have lost money in NSEL fiasco. This is not a place for retail investors and MF and Debashish have been saying for long.
There should be no rescue attempted and the guilty mainly Jignesh Shah must be sent to jail.
We always blame politicians and rightly so but we seem to let go the bureaucrats who also must be held responsible.
Replied to Anil Agashe comment 1 decade ago
operational head india
singapore media and channel group

we are really sorry that even the press is silent because the scam is such huge that if we raise any issue our life is at stake by the goondas they have and even the judges of supreme court also are unable to implement their law because if they pass any rule against any policitican their family is at stake and even the police is in the hands of these politician and even if we give complaint no action would be taken and if this issue is brough in the parliament our Prime Minister and Congress president would say we strongly condemn this barbaric attitude and the case would be closed hence as an journalist we have see our family hence this situation in india unlike other countries where we have freedom to raised our voice is now totally lost hence our hands are tied up is the situation is an regrettable situation any how your comment his highly comandable thanks

1 decade ago
It is a good thing that Moneylife is still keeping the NSEL scam alive. Most other media houses have reduced their coverage of this event and like the hundreds of other scams this too would die a natural death. We must pursue this matter till all investors get their money back and the people behind the scam are put behind bars.
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