Now that Jignesh Shah has been arrested — the 10th arrest in the Rs 5,600 crore National Spot Exchange Limited (NSEL) scam — attention has shifted to the brokers involved in marketing NSEL’s illegal products. As a commodity exchange, NSEL’s job was to act as a platform over which traders could buy/sell commodities. The way things turned out, however, NSEL had created its own financial products with minimum assured returns. None of the brokers selling NSEL’s products were unaware of this reality. Which is why, when the NSEL scam broke last year, Finance Minister P. Chidambaram was quick to point out that no one who was investing in NSEL was a babe in the woods. How the products worked — and that’s how the returns were guaranteed — bears repetition. Trader A sold wheat, say, to trader B; trader B, in turn, sold this wheat back to trader A, but at some time in the future — the difference in the price was the interest rate. All contracts were executed simultaneously, to ensure all parties had legal paperwork to protect their interests.
As in the case of Sahara and Saradha, and several others in between, there was a big regulatory failure. Sahara was prevented from raising funds from the public by the RBI, but managed to find a new instrument to do so — the beauty of the scheme was that, technically, it was also out of the purview of Sebi. It was pure luck that Sebi happened to chance on the fund raising long after it had occurred. In Saradha, to escape Sebi’s regulation, the fund-raising was disguised as collections for real estate transactions — that there was little real estate to back the deposits, however, escaped everyone’s attention. Given that there is a high level coordination committee on financial markets to ensure such activities don’t fall between the cracks, the fact that none of the scams got picked up is telling.
Unlike Sahara and Saradha, however, in the NSEL case, sections of the government were unusually helpful. NSEL is a spot exchange, so all transactions have to be settled on the spot. A change by the consumer affairs ministry in June 2007 made it possible to design financial products. This allowed NSEL to act like a futures exchange for all practical purposes, but since it was a spot exchange, it was outside the purview of the Forward Markets Commission. That is, it was totally unregulated. At some point, the spotlight needs to be turned on how this was allowed to happen, and why no one noticed.