NSEL: A Case of Fraud in Indian Financial Market
Indian capital markets have come a long way since financial reforms of early nineties. The much-needed reforms of 1990s came as a big boost to the economy and in turn furthered investor’s confidence. Establishment of Securities and Exchange Board of India (SEBI) with full statutory powers was another revolution in financial reforms. SEBI helped in removing direct government control, brought transparency, and ensured free access to capital markets to the investors. It has been governing the behaviour of major market participants such as stock exchanges, brokers, merchant bankers, mutual funds quite efficiently. It was also regulating activities such as takeovers and insider trading in an attempt to enhance investor protection. Opening of the capital markets to Foreign Institutional Investors (FIIs) and allowing Indian companies to raise capital abroad by issuing Global Depository Receipts (GDRs) was another step in the right direction. Reforms followed by setting up of National Stock Exchange (NSE) and National Securities Depository Ltd............
The Company
NSEL was one of the four spot exchanges operating in India. The others being NCDEXSPOT, R-NEXT (by Reliance Capital) and National APMC. NSEL was incorporated as a company limited by shares under the Companies Act, 1956 in May 2005. It commenced live trading on October 15th 2008 and slowly extended its operation in 52 different agricultural and non-agricultural based commodities across 16 states in India. The Exchange had organized, structured and state-of-the-art, delivery based market. It aimed to transform the commodity market by way of reducing cost of intermediation and improving marketing efficiency...........
NSEL’s Business Model
In a traditional commodity spot market, both commodities and money gets transferred immediately. NSEL got special notification from Department of Consumer Affairs (DCA), on June 5th 2007 to trade in “One day duration forwards contract”. This notification exempted one day forward contracts of NSEL from the provision of Forward Contract Regulation Act. This exemption on forward trades came with the condition that the respective exchanges should not allow short selling. As per the notification, trading in NSEL can be completed in 2 days (T+2)...........
Starting of the Problem
Everything was running very smoothly till December 2012 when DCA received complaint against NSEL for its involvement in illegal financing. On the basis of the complaint, on July 16th 2013, DCA initiated an investigation and instructed NSEL not to offer any contract of more than T+10 settlement cycles contracts above T+10 are forward contracts and are no longer considered as spot contracts...........
Illegal Financing
Planters knew that the goods that they were selling spot and buying forward on T+30 Settlement would remain at the warehouse only. They were well aware of the fact that the investors would not take possession of the goods and contract would be rolled over...............
Settlement Commitment
After mass default, NSEL announced the detailed settlement plan on August 14th 2013. NSEL stated that it would clear all the dues in the coming 30 weeks. It had notified that the amount received from defaulters would be credited in a separate Escrow Account. And it would be proportionately disbursed to all the pending clients having receivables against their unsettled obligations...............
Manipulations
NSEL officials including Shah were aware that borrowers have stopped making payments. However, they kept the information suppressed. MD and CEO of NSEL, Anjani Sinha (Anjani) in affidavit to the court has quoted “By 2011-12 the scenario was such that if we do not allow rollover, buyer would have defaulted with huge amount.................
Regulatory Action
After massive protest by the investors, NSEL filed case against defaulters. “We have filed a case with the Economic Offences Wing of Maharashtra police against the defaulters, despite repeated pleas, they have not paid their dues,” said an NSEL official. Under pressure from electronic and print Media, authorities came into action. A series of raids and arrests were made by Economic Offence Wing.............
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Consultancy Services
Geogit Comtrades has appointed E&Y to do the “Risk based review for commodity financing business” of NSEL trading. E&Y in its report on September 12th 2013 said that warehouses linked to NSEL are WDRA-accredited and there is limited counter party risk on account of robust risk management system of NSEL...............
Assignment Questions
I. Do you think exchanges like NSEL be allowed to operate in India?
II. What was the modus operandi of NSEL?
III. How could the paired contracts be sold as risk-free contracts?
IV. Who is responsible for the fiasco?
V. Has Government failed in its responsibility? How could it be dealt with?
VI. ....................
