Regulatory loopholes allowed brokers to aggressively market National Spot Exchange Ltd (NSEL) products that often lured investors with the promise of returns much higher than investment options like bank fixed deposits, liquid funds and fixed maturity plans.
In one such product note prepared by Ventura Securities, an annualised pre-tax returns of 11-15% was being offered on an NSEL product, which asked investors to take simultaneous and counter positions in short- and long-dated contracts based on 11 commodities.
The presentation describes the combination as an investment product having no price risk and in which the exchange provides counter-guarantee in terms of “ quality of goods, weight and counter party risk”.
“ Brokers who have good understanding of the commodity market through their involvement in the commodity derivative exchanges were the ones who pushed for the NSEL financing model. One such broker had presented this NSEL product to our team,” said a former head of derivatives trading desk at a domestic broking firm.
Along with the high returns promised, a short-term trade cycle, no requirement of a demat account and absence of daily mark-to-market (MTM) adjustments were cited as the key positives of the “NSEL investment product” sold by brokerages to investors with a minimum investment requirement of R2 lakh. Some of these plans date back to May 2012.
The trade mechanism is explained with the example of castor seed that had the longest settlement cycle of 36 business days (T+36), giving an effective return of about 16% in 44 days. Ventura charged brokerage fees of about R890 on each leg of the transaction. Similar products were offered on 10 different commodities with more attractive annualised yields for investment of Rs 7-8 lakh. “Castor seed, sugar, paddy and raw cotton are the products where these kind of trades were quite popular. If the investor committed higher capital of about R7-8 lakh, the brokerage charges would be adjusted to give better yields,” said a trader.
Interestingly, while the NSEL crisis is deemed to be the result of a regulatory vacuum, the product presentation by Ventura securities names the Forward Market Commission(FMC), State Agriculture Marketing Board (SAMB) and Warehouse Development Regulatory Authority ( WRDA) as the entities which regulate NSEL. It also pegged NSEL’s settlement guarantee fund (SGF) at about R290 crore as one of the risk-mitigation rationale.