NSEL yet to give details of settlement guarantee fund: FMC

There has been a regulatory vacuum in spot commodity exchanges, says Ramesh Abhishek, chairman, Forward Market Commission.

In an interview to CNBC-TV18 he informed that three spot exchanges were exempted by the government under Section 27 of FCRA to conduct forward trading in one day contracts. This was done to boost volumes so that their economic viability improved. However many conditions were laid. Also Read: Commodities mkt faces risk of default; FT may see more pain
Last year, FMC was empowered to seek information from the exchange and the recent interim order of the government that NSEL should not launch any fresh contract was actually in response to a report sent by FMC, he added.
FMC found NSEL was not following conditions such as no short selling and hence reported the matter to the government last year.
MD of NSEL said yesterday the value of the stocks in its warehouse as collaterals is worth Rs 6200 crore; whereas the liability of payment to those who have invested is Rs 5400 crore and it also has a settlement guarantee fund of Rs 800 crore.
However, Abhishek said that a detailed report on the same will be submitted today. "NSEL is very confident that they will be able to honor their obligations of all the open contracts. We will analyse that information and we will advise the department of Consumer Affairs accordingly," he added. Below is the verbatim transcript of Ramesh Abhishek’s interview on CNBC-TV18 Q: Who was supposed to be regulating NSEL because clearly there seems to be a lapse in regulation else things could not have come to this pass if there was a regulator who was monitoring the situation?
A: As we have clarified many times there is a regulatory vacuum with respect of spot exchanges. Three spot exchanges were exempted by the government under Section 27 of FCRA to conduct forward trading in one day contracts. This was done to boost volumes so that their economic viability improved. However there were many conditions also like they cannot do short selling etc and we were seeking information about their trades and as required we are advising the government. Q: I take your point that you were not directly responsible but surely because the market has been talking about some of these lapses for a while. Could you not have alerted the government at an earlier point that some of these practices of the spot exchange where inevitably going to lead the exchange into trouble because if you had despite it not being your responsibility we could have averted this fiasco?
A: As we were empowered last year to seek information from the exchange, we started seeking information in specific formats and when we got their reports we actually found that this exchange was violating some of the conditions like no short sell, delivery of the outstanding positions after 11 days and we reported to the government and actually government has taken action on that and the recent interim order of the government that they should not launch any fresh contract was actually in response to the report that we had sent. Q: By when did you figure out that they were offering a product which was violating every norm, this Badla like product?
A: We found that the short selling condition was not being followed by this exchange. Our understanding of short sell is that a seller must have goods in his position before he sells on the platform and also our understanding was that all the delivery should have been made within 11 days. So this we had reported to the government last year and then the government has taken action on that after examining all the pros and cons. Also after taking into account the explanation of the exchange. This is the interim order of the government while a final view is going to be taken by the government soon. Q: So do you have any sense of who has financial responsibility right now because if you look at the margin which is available to NSEL and the settlement guarantee fund, it clearly does not cover the Rs 5000 crore plus kind of gap which is in place right now. What is your understanding of who is liable for feeding this gap because Financial Times the promoter seem to believe that it is not their liability?
A: We have asked NSEL for some information about how they are planning to honor their settlement obligations. The department of consumer affairs had asked this yesterday and we are going to get this information and the other relevant details today.
Yesterday MD of NSEL was called to the commission to do some explaining and he told us that the value of the stocks which are in the warehouse as collaterals is worth Rs 6200 crore whereas the liability of payment to those who have invested or whatever is Rs 5400 crore and they have a settlement guarantee fund of Rs 800 crore. We have also asked them as to what is the composition of this settlement guarantee fund because from the fund you cannot pay one client or member from the margin of another member.
You can only pay people, defaulting members cannot be compensated from this fund unless there are some funds in that settlement guarantee fund which are not to be returned to any member. So all this information we have asked today.
_PAGEBREAK_ Q: What was NSEL’s response to this specific question on the utilization of the settlement guarantee fund?
A: They will give us the details of the settlement guarantee fund as to what are the components of this fund. Most of this might consist of the margins deposited by members. As you know the margins deposited by members are to be returned to the members as the settlement takes place. So how much of that can be used for settling the claims of defaulting members is something that we have asked them. Q: Did they tell you what this Rs 6200 crore of collateral that they are holding, what it comprises of specifically?
A: The detailed report will come and as we all know the exchange is squarely responsible for the quantity and quality of the stocks that they have held as collateral because otherwise what is the role of an exchange if they cannot guarantee settlement, if they cannot ensure the quality and quantity of goods which is held in their warehouses that is the main role of the exchange, they have to guarantee and honor all the settlement obligations. Q: Was it your understanding that this stock or inventory collateral might be liquidated to cough up the money for the settlement?
A: What they have told us is that first of all those buyers they told us there are 23 entities that are holding this Rs 5400 crore which they are supposed to return by way of payment to the exchange. They will first ask them to pay the money and if they are not able to pay then they have to be declared defaulter as per the bylaws of the exchange. After that there will be a question of liquidating those stocks by way of auction by the exchange and do their payouts. Q: If they are correct and they have Rs 6200 crore of collateral and Rs 800 crore of settlement guarantee fund, why would NSEL have caused this panic by stopping trading and payout?
A: One of the reasons they gave us is the recent government order created uncertainty in the market and that is why the trading interest was lost. So we have pointed out that the obligation of the exchange to settle their contracts cannot depend on a perpetual trading on the exchange because it has many other implications that unless people reinvest by way of rollover of their position or there is fresh infusion of funds, the exchange cannot honor its settlement obligations. That is not acceptable because it has many serious consequences and implications. Q: And you are sure that Rs 6200 crore of collateral does exist because there is not an independent warehousing agency who is monitoring this in this case? It is a group company of NSEL?
A: It is the responsibility of the exchange solely to ensure that the quantity and quality of goods which have been mentioned in the contract and the stocks are there. I hope they have ensured through whatever mechanism they have and soon we will find that out. But it is definitely the responsibility of the exchange and those who are running it to settle all their obligations by way of this or by any other means. Q: Is there a fear of default because that is the fear everybody is articulating or not. From what you heard from the NSEL and what you have seen from the profile of these 23 entities, do you think there is a genuine fear of default?
A: At this point I don't think we should have any such apprehension. The NSEL is very confident that they will be able to honor their obligations of all the open contracts and they are going to give us all the detailed information today. So we will analyse that information and we will advise the department of Consumer Affairs accordingly. Right now we are waiting for the detailed feedback. Yesterday they could not give us the information because time was short so they have promised to give it today. Q: What started the problem? Finally we will come around to that once the dust settles on dealing with the immediate problem, I think some hard questions will come up on what led to this in the first place. Do you think NSEL was running a scam like operation with an assured return product which is the root of the problem and which has brought us to this day today?
A: The exemption was given to them under FCRA and it was given to two other exchanges so that through a daily net settlement facility the volumes increase and it increases their economic viability that was the purpose so that they can provide an electronic pan India platform for trading in agricultural commodities and that will benefit farmers too, which was the purpose of it.
But it had strong stringent conditions also. So if those conditions are followed then there will be much less risk than what could be through forward trading in unregulated entities. Right now we want to focus on the ability and the commitment of the exchange to honor their settlement obligations and that is really the first priority now that money should be paid to those who have put their money there and it should be recovered from those who are supposed to pay. So right now we will focus on that.