Payment crisis at NSEL: Basics explained

By Simplus Information Services | Yahoo! Finance India Fri 30 Aug, 2013 2:38 PM IST

Over the past one month, the investing community was stunned by a severe payment crisis in the National Spot Exchange of India (NSEL), an electronic trading platform where producers and traders could buy and sell agriculture and industrial commodities. Ripples of the crisis was felt not just in the commodities market but even in the stock market, where shares of NSEL promoter group companies saw a major sell off. Regulatory authorities including Forward Markets Commission (FMC), Agricultural Produce Market Committee, regulate NSEL. They are working over-time to salvage the Rs 5600 crore settlement crisis. Here are some pointers that explain the situation: 1) Genesis of the problem

On July 23, NSEL issued a directive to its members that all contracts have to be settled within 11 days or a (T+10) basis and that too on payment against delivery basis. Settlement of a contract happens when the buyer gets delivery of the commodity and the seller gets the money. It also restricted traders from putting buy or sell trades at the same time to square off the exposure to the market. 2) What was the impact This caused panic where most traders were interested only in longer term contracts. There were contracts that could be settled even 30 days after the trades were done. Soon after the new rule was announced trading volumes dried up on the exchange as traders failed to roll-over positions and demanded settlement of trades. This forced NSEL to suspend trading in most contracts and put a 15day moratorium on settlement of existing contracts. 3) How NSEL messed up? NSEL was set up as a spot exchange where farmers and industrial producers could sell commodities to traders through an electronic trading platform. According to the rule, all spot contracts should

settle within 11 days ie (T+10 basis; trading plus 10 days). Sellers were required to deposit physical commodity in the NSEL warehouse. However, NSEL was offering contracts over T+10 settlement cycle. It allowed buyers who could not pay for commodities they bought more time and sellers who could not deliver commodities sold on time. This amounted to forward trading, which is in violation of NSELs mandate. But interestingly, these longer-term contracts became very popular. The NSEL turnover rose to over Rs 3 lakh crore from a meagre Rs 2182 crore in 2009, its first year of operation. In fact, NSEL was taking advantage of a regulatory gap. Being a spot exchange NSEL was regulated by the Agricultural Produce Market Committee (APMC), a board set up by state governments. The forward trading in commodities come under the domain of Forward Market Commission (FMC), a more stringent regulator. Under the guise of spot trading, NSEL was offering forward trading facility to investors without proper margin and settlement systems. 4) Who is hit? Over Rs 5600 crore trades remain unsettled. About 15,000 investors have to receive funds from the exchanges. Half of these investors are small investors. Several leading brokering house like Motilal Oswal, Indian Infoline, Geojit also suffered as their clients had exposure to the tune of Rs 700 crore.

5) Is there a solution? On August 14, NSEL submitted a detail plan to FMC to clear dues to investers over a period of seven months. Under the plan, NSEL committed that it will settle investors claim on a weekly basis by collecting money from its members. But it seems the scheme is not working as expected. The second week into the scheme, NSEL has managed to collect only 104.21 crore as 349.44 crore committed earlier. The failure of the members to meet their pay-in obligation means investors who have to receive Rs 5600 crore from NSEL will have to wait longer than the seven months to get their dues.