(Image source from: Everything about the $Billion NSEL Scam})
The Bombay High Court has granted a bail to Jignesh Shah in the Rs 5,600 crore NSEL scam. Jignesh Shah is the founder of Financial Technologies (India), which established the hugely successful Multi Commodity Exchange of India (MCX).
Economic Offences Wing (EOW) of the Mumbai police had arrested Jignesh Shah in May for his alleged involvement in the billion dollar NSEL scam.
The scam was unravel in August, 2013 following a payment crisis faced by his group company National Spot Exchange Ltd (NSEL). By July end, the payment crisis blew into a full-fledged scam affecting almost 18,000 investors, who lost millions because of the financial irregularities.
NSEL scam
NSEL scam is the biggest after the Harshad Mehta scam, involving the notorious BSE security scam of 1992. So what is the NSEL Scam all about? Here is a simple outline of the billion dollar scam.
The NSEL, which stands for National Spot Exchange Limited, is owned by Financial Technologies that also owns the MCX. NSEL is a Spot market and operated without regulation because it does not fall under the scrutiny of the Forwards Market Commission (FMC).
The entire scam took place as NSEL was trading on Agri-Commodity products. NSEL launched contracts of T+2, T+3,... T+35 . But laws forbid spot exchange to launch contracts beyond the settlement of T+11. Now T+2 means the the settlement of the contract (between buyer and seller) will take place after 2 days of trade, T+3 means the trade will be settled in 3 days and so on.
How did it work?
Let's illustrate the mode of settlement through a commodity – Basmati rice. There will be many contracts that run on Basmati rice. Suppose a contract in a T+2 is trading on Rs. 2,780 and the one on T+35 is trading on Rs. 2,829.7. The price difference comes from factors like time value of money, seasonal cycles, and other factor. Contract that are of long-term are priced higher than the short term contract.
The NSEL trade operated on a simple method of buying the T+2 contract and selling the T+35 contract. What a dealer did was that he bought the T+2 contract at Rs. 2,780, settled it (or took delivery) on the 2nd day, while the commodity was stored in the NSEL warehouse and delivered it to the person ge had sold the T+35 contract -settled on the 35th day at Rs. 2,829.7. That way he made a neat return of 13.5% annualy and completely RISK-FREE .
What went wrong?
Problem started when the brokers of NSEL started selling products to investor's assuring higher returns than banks. The investors took the opportunity to enrich themselves through the spot exchange trade. They undertook bigger contracts and invested regularly. This resulted in high revenues for brokers and NSEL for 2 years. During this period NSEL's profit grew from Rs. 30 crores to Rs. 120 crores annually.
Commodity prices started to move up supported by the price gap between the contracts (say buying at T+2 and selling at T+35).
The investor's activity was noticed by Department of Consumer Affairs, which sent a notice to the NSEL. The Consumer Affairs Department told NSEL that such contracts would come under the scrutiny of the FMC. After that NSEL closed contracts that were greater than T+10. This reduced the opportunities for arbitrage.
Soon, news spread that NSEL godowns had no stock and buyers were being handed out fake warehouse certificates of the commodities that they had bought. None of the investors actually take delivery of goods and the entire business was pure speculation, the fact was entirely unnoticed.
The scenario had not been anticipated by NSEL. Now investors began to demand their money back, which the NSEL is not able to pay. To make matter worse, NSEL doesn't even have the stock of commodities that can be sold to settle the investor's demands. Initially Financial Technologies had assured investors that they would sell the stock in godowns to repay them. Now that it has become clear that there are no stocks, investors are left in a lurch with no hope of recovering their losses.
Click here for List of Borrowers who cheated Investors
(AW: Pratima Tigga)
