The NSEL scam has opened a big can of worms about the integrity of the entire regulation and supervision infrastructure, including the efficacy of the slew of independent regulators set up over the past 25 years.

After the Harshad Mehta scam of 1992, the National Stock Exchange (NSE) came into being, conceived and implemented by the late Dr RH Patil who combined sharp commercial sense with strong public spirit. The NSE, a professionally-run bourse, emerged as the best model to ensure fair and transparent trading systems. This seemed in line with global thinking that ‘professionals’ are ideally suited to run exchanges—not trading members and brokers who often take decisions that are self-serving. From there, it was a short step to thinking that high salaries for ‘professionals’ and linking their incentives to the profits earned by the bourses, would keep them focused on ensuring higher returns for shareholders, year after year. The next phase was to assume, as happened all over the world, that exchanges are commercial entities that could be promoted by entrepreneurs and made to compete.

So, over the next 25 years, we have seen the evolution of three different models of exchanges. The Stock Exchange, Mumbai (BSE) which was a broker-run club for over a century of its existence, was forced to turn into a professionally-run bourse by a series of regulatory changes.

The NSE was set up as a professionally-run bourse promoted by large institutions and banks. The game-changer was supposed to be the now-discredited, entrepreneur-led private model that was aggressively pushed by Jignesh Shah who grabbed the opportunity for private players to enter the commodity derivatives space. This former BSE employee from its technology department first succeeded with Financial Technologies (FT) which captured the market for brokers’ front-office software. He then made a success of the Multi Commodity Exchange (MCX) and went on to set up exchanges abroad, to position himself for a bigger role as an institution builder.

However, the Rs5,600-crore scam in the National Spot Exchange Limited (NSEL) may have ended those dreams. It has also opened a big can of worms which raises questions about the integrity of the entire regulation and supervision infrastructure, including the efficacy of the slew of independent regulators that have been set up in the financial sector.

For instance, the ministry of consumer affairs allowed NSEL to operate outside the purview of the commodities regulator; the ministry of corporate affairs (MCA) which allowed the creation of entities that gave the illusion of being public sector organisations or associations; the depositories which entered into dematerialisation agreements and various regulators, including the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and Forward Markets Commission (FMC), who ought to have questioned NSEL’s operation but chose to keep quiet. The same regulators found the FT group fit to run commodity and currency derivatives and equity trading bourses.
The professionally-run model is also creating fissures. On 23rd October, The Mint reported that a set of global private-equity (PE) firms has raised several pertinent questions about the NSE as well as India’s regulatory flip-flops with regard to the listing of bourses. The Mint quotes the letter as saying “These frequent changes in the regulatory fabric are arbitrary and unfair to investors and create a lot of uncertainty.” The investors claim to have invested in the NSE after the Justice Kania committee report which recommended listing of bourses. This report was overturned by the Bimal Jalan committee appointed by SEBI during chairman CB Bhave’s tenure. The Jalan committee’s recommendations were rejected by SEBI with a new set of rules. It is widely believed that these flip-flops were influenced by the two warring bourses—the NSE and MCX.

After the NSEL scam, there has been a flurry of actions, dictated by the finance ministry which is now in charge of administering the FMC, the commodities regulator.

In a directive, the FMC has asked that the articles of association of MCX be amended to ensure that no shareholder director is made a permanent director. It has also asked all directors of the FT-MCX group, including Jignesh Shah (its non executive vice chairman), to step down and has appointed a team of independent directors to run the bourse independently. Jignesh Shah has bought time until 30th October and may be examining his legal options.

There is also a contract with Financial Technologies guaranteeing that it cannot be removed as a technology partner for 33 years, failing which the bourse will have to pay a compensation of Rs1,800 crore. The contract itself raises some questions. Did the FMC, RBI and SEBI know there was such a contract guaranteeing FT’s business arrangement? FMC, as the primary regulator of MCX, ought to have objected to such a contract. RBI and SEBI, which permitted MCX-SX to launch the currency-derivatives segment, long before Jignesh Shah’s bruising court battle to force SEBI to allow him to start equity trading, seem to have missed the contract too. Did they fail to understand it, or was it deliberately hidden from them?

In fact, various media leaks suggest that SEBI permitted MCX-SX to launch currency trading even though the finance ministry had repeatedly raised questions about it being ‘fit and proper’ to acquire shares in the Vadodara bourse. Ironically, the 2007 letter was written by MS Sahoo, a director in the finance ministry who became a whole-time member of the SEBI board after a brief consulting assignment with the NSE.

There is also the fact that MCX-SX was given permission to trade currencies by the same SEBI top brass which had charged him with dishonesty when it came to permitting him to launch equity trading. Unfortunately, the dirty war between the NSE and MCX-SX, as well as the partisan approach of the regulator under CB Bhave’s chairmanship, had muddied the waters leading to a complete lack of clarity about whether Jignesh Shah was being wrongly persecuted or was up to tricks himself.

What Now?
Various regulatory actions following the NSEL scam seem designed to discourage listing or private ownership of bourses, marking a significant change in policy that is entirely dictated by the massive and embarrassing scam. In effect, just after India’s first independent regulator, the Securities & Exchange Board of India, celebrated 25 years of its existence, we are at the crossroads again. But can such far-reaching policy changes be made without any plan or public discussion? What happens to the PE funds and other high net worth investors who bought NSE shares on the expectation that it will be listed? Or the questions that they have raised about its gilded management? Will the next step for MCX be a delisting of its shares? Or being overseen by a randomly-chosen board?
The letter written by a law firm on behalf of PE funds accuses the NSE of making very moderate dividend payouts to investors while sitting on a cash pile of over a billon dollars. At the same time, top management salaries are not linked to performance and are sky-high. NSE’s vice chairman Ravi Narain’s last known gross remuneration was an stupendous Rs7.88 crore and managing director Chitra Ramakrishna also has among the highest paycheques in corporate India. Will the NSE be allowed to continue as a secretive, professionally-managed, unlisted entity with the support of key finance ministry bureaucrats and public sector entities?

Clearly, it is time for some fresh thinking on the future of bourses and this cannot be done by any single regulator or through a series of openly partisan committees. Ideally, this should have been the work of a group like the FSLRC (Financial Sector Legislative Reforms Commission). Unfortunately, with three of its key directors writing dissent notes to the report, the FSLRC’s two-year effort at the cost of over Rs8 crore is correctly buried, before it raised many uncomfortable questions about who exactly was dictating its recommendations. We now need fresh thinking on the regulation of bourses, but it is unlikely to happen before the next general elections, even as many fatwas with far-reaching consequences are being issued daily.

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]