NSEL: Did Forward Markets Commission's action spook the market?

Several questions were raised in the aftermath of National Spot Exchange Ltd (NSEL) payment crisis. The latest turn of events unfolding in the Bombay High Court in the backdrop of the draft order of the Department of Consumer Affairs (DCA) for the NSEL- Financial Technologies India (FTIL) merger are throwing lights on several grey areas.

The affidavit filed by NSEL in the Bombay High Court goes to the extent of suggesting that the whole crisis, which otherwise could have been averted, if FMC had not taken steps that allegedly spooked the market.

The very crisis of NSEL surfaced due to the abrupt and sudden stoppage of activity by the regulatory authority without allegedly putting a thought on the impact it would have on a wide range of stakeholders dealing with the commodity ecosystem. In a letter dated July 12, 2013, the Department of Consumer Affairs (DCA), pending legal advice, directed NSEL to halt launching of fresh and further contract till further instruction from the concerned authority, and all the existing contracts will be settled on due dates. The DCA acted on the advice given by FMC in a letter written in April 2012. The action of FMC allegedly spooked the market and as a result NSEL had to suspend the trading of all contracts on July 31, 2013.

A graduated and sequenced programme to reduce the impact was always possible, NSEL's promoters appear to have been pushed into a corner to obey instructions without any consultation on how to restore normalcy or order by imposing harsh measures. There were a number of alternatives and options which could have been considered and applied to stem the crisis, but the whole blame is put on the promoters of FTIL, which in fact escalated and aggravated the impact rather than easing the problem or redressal of the grievances.

It would have been advisable to effect the closure in a phased manner so that the stakeholders dealing with the commodity ecosystem were not impacted. It is because of the abrupt manner in which the trade on NSEL was stopped, the payment crisis of Rs 5,600 crore cropped up. The available data shows that payments were received even till June 2013. They stopped only after DCA's direction to NSEL to give an undertaking it would not launch fresh contracts, and settle the existing contracts on their due dates. A gradual halt to trading, would have averted the default of Rs 5,600 crore.

After advising abrupt closing of NSEL to DCA, FMC in contrary to its earlier position, wrote a letter on July 19, 2013 to DCA that the exemption notification is silent on whether the exemption if applicable to all or specific provision of FCR Act. This had been done even after what NSEL states was a repeated correspondence and meetings stated that the exemption notification was a general exemption from all the provisions of FCR Act.

This clearly indicates that on one hand FMC informs the DCA that NSEL was violating conditions, which resulted in DCA issuing showcause notice for closure of NSEL operations, on the other hand FMC did a complete volte face when confronted by the fact that these kind of transactions were being done by NCDEX under the same exemption.

On August 4, 2013, FMC held a meeting with defaulters and brokers in Mumbai. After the meeting, in an interview, a senior FMC official said that defaulters owe all the default money of Rs 5,600 crore and have promised to pay in a phased manner.

As situations unfolded, the DCA, issued a gazette notification on August 6, 2013, empowering FMC to take all actions necessary against all persons including defaulters, brokers, warehouses etc, for recovery. However, has any effective action has been taken against brokers and defaulters for recovery of money from 24 defaulting companies by liquidating their properties to pay back the brokers and 13,000 trading clients of NSEL. Rather, the regulator's has trained its guns more severely on NSEL, even though it is not liable to pay back the trading clients.

In the case of NSDL IPO scam, the Securities and Exchange Board of India literally chased 107 equity broker entities and recovered 25% of the monies due of the total 12 lakh investors. In comparison to this, in the NSEL crisis seven defaulters owe 85% of the total default amount, while 30 brokers account for 70% of the dues. In a nutshell, if FMC wished, it could have chased only 7-10 defaulting entities, but that was not done and it kept the crisis alive.

It is questionable whether FMC, as a market regulator, did anything to solve the crisis which was solvable by failing to act against the 24 defaulters against whom clear trail of monies of trading clients is established. Thus, by making FTIL group the scape-goat, did FMC try to hide its own regulatory inaction.

Questions that FMC's action raises

Why FMC has given step-motherly treatment to FTIL, and why the regulator took actions which allegedly spooked the market?

Despite knowing the nuances and validity of general exemption granted to NSEL, why did FMC abruptly recommend to shut down NSEL operations?

Despite having mandate to take action against brokers and defaulters, why not a single action has been taken against them?

Have FMC's actions killed the FTIL group in total?