10 things you wanted to know about NSEL crisis

The Rs 5500 crore payment crisis faced by the Financial technologies controlled, National spot exchange ltd has raised several questions. Business Standard brings you some frequently asked questions on the NSEL payment crisis.

1) What is a Spot Exchange? How many spot exchanges are there in India?

A spot exchange is an electronic version of the age-old mandi, where buyers and sellers meet to exchange goods and money. National Spot Exchange floated by Financial technologies, NCDEX Spot floated by the NSE group and R-Next floated by Reliance Capital are the three main spot exchanges.

2) What was the origin of trouble in NSEL?

NSEL offered a pair of contracts, one where settlement happens in two days and a second where the settlement is deferred by 25-50 days. This allowed speculators to make financial returns without actually taking physical possession of commodities.

3) What happens to the underlying commodity?

The commodity is required to be delivered physically under the contract specifications. But the exchange facilitated use of electronic warehouse receipts thereby enabling financial investors to make use of the arbitrage without taking physical possession of goods. For example, the goods which are delivered in the first contract, which is a buy lies in the warehouse itself till the delivery is due on the reverse leg, which is a sell, helping speculators run amok.

4) Who is on the other side of these contracts?

Typically, these are companies which own and operate the warehouses or in premises the stock lies. For example, ARK Imports, which the warehouse operator for raw wool was named as one of the 13 members/ processors, who have offered to pay 5% of their total dues every week. These players benefitted from credit which they got with practically no questions asked. If these companies would go to banks for such huge sums of money, they would be asked to produce balance sheet and other documents. But through NSEL they got easy money.

5) Did NSEL try to stop this round tripping?

Not really. In fact, it made it easier in some contracts. For example, the contract specifications said "Storage Charges are waived off for those members and their constituents, who sell Jeera on JEERUNJH25 out of the delivery receivable against the purchase position of JEERAUNJH2 contracts."

6) What did the government do?

The government asked NSEL to stop this and asked it to wind up. The direction came on July 12.

7) What was NSEL’s response?

Exchange gave an undertaking saying it would do so but asked for 15 days time.

8) Why the sudden suspension on July 31?

The exchange was directed by the government to close out the contracts and settle it immediately on July 31. But NSEL cited "grave emergency" and market "disequilibrium" and deferred the settlement by further 15 days. It later said it wants another five months to settle.

9) Why is NSEL not settling?

There is a fear that the underlying stock is insufficient to cover the liabilities. While the exchange claimed that it had stock worth Rs 6200 crore, independent analysis shows there may be shortfalls. Business Standard visits to godowns also did not show satisfactory results. On one side there are 24 people/companies who have to pay Rs 5500 crore on the other side there are thousands who have their money stuck.  

10) Who is affected?

All people who have exposure to the exchange, brokers, high net worth investors and even companies. Since many of these people also have exposure to other parts of the market such as stocks and the banking system, there could be ripple effects.