NSEL’s Scam – A Spotlight on Regulation of Electronic Spot Exchanges

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Excerpts...

NSEL provided a platform for farmers to sell their produce on its trading platform. A farmer after harvesting the crops approached a designated warehouse of NSEL. At the warehouse, the quality of the harvest was tested and a warehouse receipt was issued as an acknowledgement that the harvest was stored at the warehouse. The farmer then approached a registered broker of the exchange and quoted his expected price on the exchange platform. If he got a favorable price, he sold the harvest and received the money from the exchange after paying the requisite commission to the exchange and to the broker.

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Starting in the year 2010, NSEL’s performance had increased significantly. By the end of December 2012, the turnover of NSEL alone had reached a record level of Rs.21,76,431.3 million while the exchange had a market share of about 99.99% in spot trading operations “The turnover of NSEL was always in our radar. Initially, we were perplexed at the growth – the swashbuckling growth if one may call it – and were wondering what we were lacking,” said Seshan . ....

A series of investigations by different investigating agencies revealed interesting facts about NSEL’s operations. During the year 2010, it was observed that the exchange’s turnover was low and generated very little in the way of revenue to NSEL as well as to the other participants. In order to overcome the situation, the management of NSEL endeavored to introduce a trading practice with different settlement periods (T+2 and T+25) “The initial performance of the exchange (NSEL) was rather poor and somewhere in 2010 it launched a paired series of T +2 and T +25 contracts in contravention of the conditions of the exemption.” An Extract from the Report submitted on NSEL Scam by Arvind Mayaram, Secretary, Department of Economic Affairs, GoI . ....

There was continuity in the transactions until deviations were found in their operations. But the situation turned volatile when the exchange was asked to stop executing the controversial trades during the year 2013. After the crisis broke out, the NSEL management took up the responsibility of settling the dues and announced a detailed settlement calendar. But right from the first settlement date, NSEL failed to settle the dues as per the schedule. .....

The scam at NSEL served as an eye-opener to the policy makers of agriculture markets. In a country like India, operating an integrated agriculture marketing system was a challenging task. Given the scenario, the market participants believed that spot exchanges alone could not achieve such a high level objective.Though ESEs were capable of providing high-level sophisticated technology to integrate the agricultural markets, they were in need of support from the governments in terms of making better policies suited to the market requirements......

Exhibit I: Investment Profile of NSEL Products
Exhibit II: Risk-Return Profile of NSEL’s Investment Products(As Promoted by a Brokerage Firm*)