NSEL: Brokers and trading clients

The Brokers sold the contracts to their trading clients as a structured product in violation of two NSEL circulars dated February 7, 2012 and August 2012 which prohibited promise/guarantee of assured returns by any member, and that is how the popularity of the contracts increased. The volumes in these types of contracts increased only during 2012-13. During 2012-13, the equity markets were not doing well and many brokers and their trading clients started participating in the T+2 and T+25 contracts with a view to make trading profits.
• All the brokers and their trading clients who traded on NSEL are experts and knowledgeable and
participated in the contracts after duly assessing the risks. All the trading clients made financial gains
through trading commodities until July 2013 when the market was halted due to government directions.
• The contracts on NSEL were traded by large listed brokerage houses. These brokers have large legal
and compliance teams and are operating in equity and commodity futures markets as well. These
brokers have participated in NSEL only after exercising due diligence. Brokers pushed client investment in a particular NSEL contract due to higher yield they could get for the clients and higher brokerage they could charge from their clients. Many brokers sold this product as a part of portfolio management and also made loans available where client's paid only 10-20 percent and the balance money was deployed as loan taken by the client from the brokers, which earned the brokers additional return on money lent. The clients got lured due to fixed cost of borrowing and a higher returns against the commodities trading.
• Further, several brokers acted as C&F agents for their trading clients and visited (50 times over a 36
month period) warehouses (of the defaulting members) storing the commodities under intimation of
NSEL for stock verification and never complained or brought to the notice of NSEL about missing or
shortfall in commodities. Further their audit firms have also certified inventories and reported the
same in the annexures to the balance sheets of the respective broking firms.
• The police found that in some instances the broking houses used their clients' accounts, without their (clients') information and consent for doing purchases. The brokers altered the rules for their personal benefit.
• Essentially, a distinct aspect came to the EOW's notice during their investigation, which was also
mentioned in their charge sheet - that a big broking firm assured its trading clients about the security
of their invested money, besides the existence of stocks in the warehouses.
• The defaulting members are operating entities and were having huge bank limits as well. Prima facie it was impossible to detect that irregularities were being committed as the warehouse inspections by market players did not raise any alarms. It appears that many of these defaulters have repaid the banks out of the funds received from trading at NSEL. The defaulting members are willful defaulters.
• Further, these defaulting sellers issued VAT invoices in the name of the trading clients as late as until June 30, 2013.
• Throughout the vilification campaign against the Financial Technologies Group, the impression that
was created was that of innocent trading clients were duped by NSEL and thus needed to be helped
with great urgency. It took more than a year till Hon'ble Justice, in it's Order given on August 22, 2014 in the Criminal Bail Application No. 1263 of 2014, observed as under.

NSEL: The role of employees

The NSEL business was spearheaded and conducted by the MD & CEO, who enjoyed complete autonomy and functional freedom. The role of the top management of NSEL and officials entrusted with different functions and responsibilities is under investigation for any possible lapses and deviances from established practices of risk management and due diligence. While NSEL has now revamped the entire management team, it will comply with any actions required to be taken in case if any involvement of the staff in any action leading to the crisis is established.

Missing stocks at NSEL

Throughout, the FMC maintained that the crisis emerged out of a warehousing problem. In reality, the FMC was provided periodic (fortnightly) information on the stock of commodities held in the
warehouses by the executive management of NSEL. The MD & CEO had repeatedly assured that stock position was comfortable. Even after the crisis, the MD & CEO made public statements that the stocks in the warehouses were more than the value of the settlement. Trading members of NSEL belonging to the public sector have conducted separate inspection of the warehouses, on select basis, through CAG approved auditors and found no shortages or lapse in the warehouses. Additionally, brokers also have visited warehouses nearly 50 times over a 36 month period to confirm stock positions and raised no concern. NSEL statutory and internal audit reports, periodically brought out, also found no deviance or deficiency in this regard. When all these measures have never raised any red flag over the stocks in the warehouses, blaming the NSEL Board and FTIL for missing stocks and attributing motives is plain unjust and unfair. Thus, the action being initiated against the non-executive members of the NSEL Board, FTIL and the promoters of FTIL are not justifiable in this context.
In a meeting FMC held with all the players on August 4, 2013, it was assured by the brokers and The
Defaulters that the money and stocks relating to trades remained adequate. The situation however
drastically changed thereafter. There could be a possibility that once the Government caused sudden
stoppage of business, some of the defaulting members with a view to protect their positions might
have migrated the stocks from the designated warehouses. This further accentuated the liquidity
position leading to default in the settlement. The possibility of banks cutting off their credit lines
without the stocks in place might also have induced them to shift the stocks out of the warehouses.
Such a scenario could be expected in any financial markets business and not just in NSEL. Sudden
stoppage of business will create panic in the market that will lead members to try to get away from
the responsibility and obligations, which happened in the case of NSEL also.

NSEL FACT SHEET

There is an impression created that NSEL has introduced the contracts that came into problem
with a view to make quick profits, which is not the case. A wide range of contracts were traded
at NSEL, including
(a) Farmers contracts,
(b) Auction Contracts,
(c) Forward Auction,
(d) Reverse Auction,
(e) e-Series contracts,
(f ) Traders contracts, and also physical procurement business and LC business. Traders used all these contracts as also paired some of these as an arbitrage strategy
to maximize returns.

BUSINESS
It is also wrong to say that the entire business of NSEL was built on the contracts that came into
problem. During the period 2008-13 NSEL turnover was to the tune of Rs 7,67,000 crore with
volume being more than 1000 crore lots. During this period, it has carried out pay-in and payout
of Rs 2,80,156 crore. It had 147 delivery locations and paid service tax to the tune of Rs 28
crore. It has nationwide spread of 800 members, with 46000 terminals in which 52 commodities
were traded of which 34 were agricultural commodities. It is wrong to say the whole business of
NSEL revolved around the defaulted contract. Out of total 702 contracts launched only 29
(around 4%) contracts were unsettled due to the member defaults.

BUSINESS INCOME AND NOT INVESTMENT
Trading clients were booking income earned from NSEL products as business income which was
being offset with losses. This itself demonstrates that they took it as a business activity involving
buying and selling.

ORDERLY SETTLEMENT OF e-SERIES CONTRACTS
The settlement of the e-Series contracts in gold, silver and other commodities, which involved
approximately 33000 investors, were being conducted in an orderly manner.

CAUTION TO TRADING CLIENTS
NSEL has been giving the brokers with whom it had privity of contract sufficient caution against
advertising fixed or guaranteed return on NSEL platform. Typical to any market, as the trading
clients were making good returns from pairing the contracts, brokers who marketed these
products were not enforcing this discipline and caution while making aggressive sales. Brokers
were even extending financing to their trading clients who were interested in trading of the
contracts through pairing.

PRIVITY OF THE CONTRACT
Privity of the contract is between the brokers who sold the product and their trading clients who
bought it. It is the brokers who marketed and sold the product and identified the trading clients.
The brokers are the ones who should have cautioned them on the risks associated with the
product, in which they failed. It is the brokers who chose the commodity counterparties while
entering into these contracts and who were expected to conduct due diligence.

EXPLANATIONS AND CLARIFICATIONS
NSEL has provided explanation and clarification immediately to the regulatory authorities and
the government on any issues raised by them on any aspect of the operations and business. The
last of such explanation was provided in August 2012. No order was issued following the
submission of the detailed explanation to the show cause notice. Instead a letter from the DCA
in July 2013 to stop issuing fresh contracts unleashed and accentuated the problem.

NSEL crisis: The then management

The then management of the NSEL, which had the privilege of full functional autonomy, was saying as
late as August 2013 that commodities existed in the warehouses. The management at that time was the
sole point of contact with FMC or DCA which had communications of various nature. The Board of the
NSEL, never had any direct contact with the FMC or the DCA as also the latter has never approached or
written to the Board on any concern that they might be having on the operations of the exchange. Even
the show cause notice issued to NSEL was addressed to the then Managing Director and CEO and the
Board was never informed of the same. Neither the DCA nor FMC nor the Broking firms nor the
management ever raised any red flag to the Board that could have alerted them to take any preventive
action.

NSEL crisis: Role of brokers

• Created structured product involving contract for buying and selling of commodities on NSEL platform
• Overlooked the exchange advice to inform risks involved in buying and selling of commodities to the clients
• Aggressive marketing and mis-selling in violation of Exchange's circulars
• Instances of funding clients
• As it was a business involving buying and selling of commodities principals of business income and
offsetting expenses were applied
• Have strong legal and compliance departments that made them aware of the nature of buying and
selling and risks involved
• Active as C&F agents for the Trading clients, they visited warehouses numerous times (nearly 50 times during a 36 month period) and yet not raised red flags any time
• Audit firms of broking firms showed inventories held in trading as annexures in the balance sheets of the respective firms.
• Instances of executing certain orders without client consent (approximately 3,00,000 client code
modifications)
• Did not once raise or bring to the notice of NSEL Board any irregularity
• Majority of the big brokers were C&F agents and verification of stocks on behalf of their clients was their responsibility

FTIL by itself has not committed any breach of governance standards or market abuses. It is a well-run company, with close to 60,000 public shareholders, an accomplished Board and a dynamic management, that has steered this company from being a start-up in early 2000s to one of the most respected and widely regarded technology solutions company that pioneered multi-asset-class trading segments, which stood the tests of competition from global majors such as IBM. Cost-effective and efficient technology solutions enabled Indian financial markets to expand the reach and access nationwide, benefiting millions, including financial institutions, intermediaries, investors and other stakeholders.
Since its inception, FTIL has not received any complaint from exchanges or intermediaries, which are its biggest clients and customers. Even competing institutions used to buy technology solutions from FTIL, which is a testimony for its integrity and business ethics. There was never any regulatory action of any sort though the exchange and ecosystem ventures of the Financial Technologies Group were operating in several regulatory jurisdictions in India and abroad.

FTIL: Fit and Proper?

A cursory glance at the manner in which Fit and Proper guidelines are enforced by the Forward Markets Commission on FTIL shows several inconsistencies. The Fit and Proper order was passed without any independent fact finding inquiry by the FMC. The FMC relied solely upon the audit report of Grant Thornton, which had very limited scope of review within a limited period of time. The Audit report was prepared without Management response (i.e. a completely one sided story) and had a clear disclaimer that it cannot be used for legal purposes which was subsequently changed at the instance of the FMC. The FMC acted in undue haste without giving FTIL and its promoters a fair chance and sufficient time to cross-examine the audit report that led to such drastic action having irreversible consequences.

The following criteria determine Fit and Proper status and how FTIL and its promoters meet them:
FINANCIAL STATUS:
FTIL and its promoters are financially very sound. FTIL has a strong balance sheet with robust reserves and networth.
EDUCATIONAL QUALIFICATIONS OR EXPERIENCE:
FTIL is a pioneering company in designing state-of-the-art financial market solutions and its promoters are not just highly qualified but are considered as visionaries of creating new-generation markets in India and abroad.
ABILITY TO CARRY ON THE REGULATED ACTIVITY COMPETENTLY, HONESTLY AND FAIRLY:
The Financial Technologies Group has multi-asset-class exchanges functioning in international financial centres, such as Singapore, Mauritius, Dubai, Bahrain and Botswana. After elaborate due diligence and assessment of the promoters, the licence for these exchanges are issued by the monetary authorities and regulators of security markets of the respective jurisdictions. Investors in FTIL have received excellent returns in terms of price appreciation and dividend declared for 36 continuous quarters. The Financial Technologies Group's exchanges in India, such as MCX and MCX-SX, are subjected to annual statutory and regulatory audits, which found no problems with the regulatory and compliance standards at the exchanges. FTIL or any of its group companies do not have any claims pending with any of its bankers, lenders, customers, vendors or employees. The IPO of MCX received phenomenal response of mobilizing nearly US$ 7 billion of subscription to an issue size of US$132 million. Leading auditors are engaged to examine the businesses of FTIL and its Group companies. FTIL and its group companies received numerous awards and citations in various international and domestic forums.
REPUTATION, CHARACTER, RELIABILITY AND FINANCIAL INTEGRITY:
The reputation of the promoters is so high that once MCX-SX the new stock exchange promoted by the Group began its membership drive, it evinced unprecedented interest with road shows that received resounding success. The character was without any blemish, focusing on how to expand the sphere of markets in India and reward the investors. Growth and Inclusion was the theme that was promoted for the exchanges, which dominated the character of the group. FTIL and the Group ventures delivered beyond what was promised, demonstrating a high degree of reliability. When exchanges in India used to shut operations briefly during the sun outage, FTIL showed how this could be overcome, which was later followed by other institutions. FTIL promoted MCX-SX reduced the time gap for crediting the clients with money, making it available before the trading time, thus enormously helping the liquidity position of the brokers and clients. On the financial integrity issue, FTIL or any of its Group companies do not have any record of any disputes regarding payments or claims or financial obligation to any of its constituents.
FTIL and the promoters of FTIL fulfill all the criteria of financial soundness, fitness and probity. Yet for a crisis in one of the subsidiaries, hasty and undue punishment is awarded to FTIL and its promoters causing severe damage to the reputation and business prospects of the Financial Technologies Group.

Why FMC is after NSEL and FTIL?

The big issue about NSEL is about its regulation. The Forward Markets Commission, which regulates the commodity exchanges in India, disowned the regulation of the spot exchange saying that it is not under its purview, while, the Department of Consumer Affairs, Government of India through various notifications entrusted the FMC with regulation of spot exchanges and oversight which are core issues that form any regulatory mandate. Assuming for a moment that the FMC is not responsible for spot market business, then why is it so keen on punishing the promoters of NSEL for payment defaults that took place in the private market. In fact, some of the Government committees set up initially to investigate the issue observed that the affected parties were few and niche and this crisis did not cause any systemic problem. In that case what could be the motivation for the FMC to take exceptional and extraordinary interest in this issue?

How various agencies handled the things at NSEL?

The manner in which the accident at NSEL was handled is a cause of concern. The way it was addressed by various agencies, including the regulatory authorities raises far more important issues that could cause anxiety and disquiet for those people who believe in free markets and fair justice. A complete and comprehensive review of the whole episode what contributed to the crisis and how it was managed subsequently – brings into light the importance of balance and maturity in handling crisis such as this, which unfortunately is in severe shortcoming in this case. In democracies and free markets, crises are not uncommon. If the authorities go into excessive overdrive, demolishing everything that is remotely connected with the issue in the name of resolution of the crisis, the image and ability of India to emerge as a major and mature economic power will come into serious doubt and dispute.
There is so much of misconception, misinformation, misreading, misunderstanding and misinterpretation around the whole crisis that it has made it into a sordid drama where players who should have taken the responsibility of finding a solution to the crisis went beyond their brief, leading to a complex situation arising.
The NSEL accident is not something that the world has not known in the past or that has never taken
place. The context of the crisis is also not something so unusual. The question that only comes to mind is how and why there was so much hurry on destroying a vast ecosystem that has great potential to grow and contribute to India’s progress, which was carefully built over long years, in the name of solving a crisis just to fulfill the demands of a few high networth trading clients who themselves are also to be blamed, in the first place, for the crisis to happen?

When the journey of Financial Technologies Group came to a halt

The journey of Financial Technologies Group came to an abrupt halt just because of payment defaults at one of its subsidiaries. Government and regulatory authorities could have surely recognized the power of enterprise that the Financial Technologies Group has built, the impeccable record of conduct it has displayed in public markets, the unblemished achievement of enriching thousands of its shareholders with uninterrupted dividend payout for 36 consecutive quarters, getting accolades and recognition from global and domestic institutions, including multilateral institutions such as UNCTAD, FAO, and should have extended a helping hand to the Financial Technologies Group to overcome the crisis, which could have enabled it to solve the settlement crisis quickly and take the country towards the next generation of growth and development in the financial markets. The world over it is not uncommon for the Government to give temporary and ad-hoc support to institutions in crisis. If the US and European regulators and governments would have adopted the same stance as that of the Indian Government and the FMC, there would not have been anything of US or European finance left by now. Globally, Governments and crisis-hit institutions have always worked hand in hand in solving the problem and enabled both to reach recovery within a short time, which
proved helpful to investors, customers and other constituents of the economy and finance. Unfortunately in the case of the Financial Technologies Group, it was nothing but vilification and witch-hunt from all sides, be it the government or the regulator or the agencies that have pressed it into a corner disabling its power to recover and redress quickly.

Even without assistance and support and despite being under constant and continuous harassment, NSEL is determined to get itself out of the crisis and redress grievances of the claims of trading clients. It is extending cooperation and actively coordinating with the courts and other agencies towards realization of dues from the defaulters that could lead to an early settlement. In all these efforts, FTIL is fully supporting NSEL, both with personnel and finance.

Achievements of Financial Technologies Group

The Financial Technologies Group has created millions of new stakeholders in the financial system, giving opportunities to earn, grow, and seek sustainable livelihoods. It created and nurtured new market segments and expanded the product ranges to serve a multitude of purposes such as investing, hedging and seeking newer opportunities for wealth creation. Governments, regulators and other development institutions from various countries used to visit the Financial Technologies Group to know and learn how it was able to create such a success story of sustainable financial market infrastructure growth and development with such an extensive ecosystem and a large engagement of numerous stakeholders.

Countries were keen to partner with the Financial Technologies Group to replicate the success that the Financial Technologies Group has managed in India, in their respective countries. The whole country expectantly looked at the Financial Technologies Group for leading to new directions of growth and maturity in Capital and Financial markets.

What FTIL did for NSEL?

FTIL extended all support to NSEL to resolve the crisis. As an interim measure, without prejudice loan of Rs 179 crore was given to NSEL to pay the smaller trading clients with exposure upto Rs 10 lakh. The NSEL Board was reconstituted and the management revamped. NSEL extended full cooperation to the investigating authorities, including EOW, CBI, ED as also the Committees that the Government has set up to study the NSEL crisis. FTIL has been supporting NSEL through financial and human resource support to explore various avenues of crisis resolution that are legally possible. NSEL, with support from FTIL, has been taking all measures required legally to proceed against defaulters to recover the money.
FTIL did all what was expected from a responsible corporate when one of its subsidiaries came into a problem.

NSEL and FTIL: The money trail

Extensive investigations were carried out to ascertain whether any money or proceeds from NSEL were diverted to FTIL or any of its promoters. After extensive investigations by the Government and the investigating authorities and a series of interrogations, over the last one year, by specialized agencies such as EOW, ED and CBI it was found that there is no evidence of NSEL or FTIL or its promoters receiving any benefit from the money being exchanged on the NSEL platform. This has also been confirmed by the Bombay High Court order of August 22, 2014.

The question that arises is that when it is established and proven that neither NSEL nor FTIL nor its
promoters are beneficiaries of anything that happened in the NSEL crisis, then why they should be
subjected to unwarranted pain and punishment.

The trail clearly shows money flowing into the account of the 22 defaulters and does not involve the promoters or the management of FTIL. This makes the punitive actions taken against FTIL and its promoters unfair and unjust.

The management of NSEL

NSEL had a Board of Directors consisting of six non-executive directors drawn from different experiences in the agriculture economy and ecosystem. The day to day functioning of the management of the exchange was carried out by the one & only Executive Director i.e. the Managing Director and Chief Executive Officer under the Rules, Regulations and Bye-Laws of the Exchange.

ALL DECISIONS WERE TAKEN BY THE MD & CEO

All financial decisions related to the Exchange were made by him

All the operational & risk management matters for clearing, settlement and deliveries were framed by him

All the contracts were issued through Circular by him

All the Members were inducted by him

All the employee appointments were by him

All the Departmental Heads reported to him

Was supposed to implement the Rules and bye-laws of the Exchange

The business of NSEL

The National Spot Exchange Limited is a limited liability company promoted by MCX in the year 2005 and not by FTIL. Subsequently shares held by MCX and its nominees were transferred to FTIL.

In October 2008, NSEL commenced operations providing an electronic trading platform to willing
participants for spot trading of commodities, such as bullion, agricultural produce, metals etc. Like NSE and BSE, NSEL has its registered trading members, commonly referred to as brokers, who execute commodity trades on the NSEL platform on behalf of and in accordance with the instructions of their respective clients across India.

NSEL recovers Rs 1233 crores from 23 defaulters

National Spot Exchange Limited(NSEL) has recently secured recoveries from 23 defaulters. The defaulters owe a total amount of Rs 4515.93 crore out of which Rs 1233.02 crore has been recovered.
"We have already secured recoveries amounting to Rs 1233.02 crore by way of decree on admission against five defaulters and through injunctions from a total of 18 defaulters with outstanding of Rs 4515.93 crore as of December 31,2015. With this, we have moved another step in right direction, and look forward to similar decrees against other defaulters", NSEL Chief Executive Prakash Chaturvedi said in a newsletter to shareholders.
NK Proteins is the defaulter with the highest obligation of Rs 934.45 crore. It has paid only Rs 35.44 crore as of December 14, 2014. Out of 24 defaulting traders, 2 have almost cleared their dues of Rs 195.75 crore.
NSEL has disbursed Rs 542.99 crore to trading clients. Earlier, NSEL had settled the e-series contracts outstanding up to  98.48% by disbursing Rs 298.52 crore to around 40,000 e-series unit holders directly to their bank accounts. 

Injustice for Financial Technologies

The silent and sincere efforts of the Financial Technologies Group in trying in every manner to resolve the NSEL crisis within the four corners of the law, were overawed by the barrage of criticism, accusations, aspersions, all based on misinformation and misunderstanding that came from all over with no responsible authority trying to explain the real situation.

That is why it is thought that the NSEL/FTIL side of the story needs to be told to the world. For the accident originated/engineered by FMC/DCA and then to payment default(post August 4, 2013) committed by defaulters at one of its subsidiaries, the entire Financial Technologies Group is paying the price. Not only injustice was meted on the FTIL, but added to it are other painful measures such as the hurry to declare promoters not ‘fit and proper’, the vilification campaign, unverified rumours, which have pushed the Group into a corner gasping for a little justice.

The solution given by Ministry of Corporate Affairs, on recommendation of the FMC, is a complete contradiction to the democratic system against the tenets of corporate law. Thousands of shareholders of FTIL will be deprived to enjoy the benefits of wealth creation and the very business that stood against the global competition and sustained success will wither away.

Financial Technologies should be given a chance to explain their stand.