As a result, the supplier could utilise the money earned in the first tranche of the trade for financing working capital requirements while the investor could execute an arbitrage trade which offered 1% to 2% of returns over the duration.
In effect, the ownership of the commodity just changes hands on paper without involving a change in possession. Sugar, castor seed, paddy and raw cotton were amongst the 11 commodities on which these trades gained popularity. The extent of money involved in these trades ballooned as most of the times the positions were rolled over for another trade cycle and lenders collected the interest amount from each preceding trade.
What led to the crisis at NSEL?
While the NSEL’s financing product had gained popularity since 2010, it was in February 2012 that the government got wind of such trading activity and asked the FMC to look into the matter. The FMC found a number of irregularities, most importantly violations of the FCRA Act due to trades with settlement periods of more than 11 days and effective short-selling in the spot market. Based on this, the consumer affairs ministry issued a show-cause notice to NSEL in April 2012.
Eventually, in mid-July this year, the ministry asked NSEL to give an undertaking that no fresh contracts would be launched till further instructions and all existing contracts would be settled on the due dates of less than 11 settlement days. However, nearly a week after submitting the required undertaking on July 31, NSEL announced that trading in all contracts other than e-series contracts will be suspended. At the same time, delivery and settlement of the pending contracts were deferred by 15 days.
So, why did NSEL suspend all settlements?
NSEL cited “market disequilibrium” as a reason for postponing the settlement of R5,600 crore of outstanding contracts. It argued that abrupt changes in policy had created uncertainty and doubts about continuity of trading on the exchange resulting in a sudden withdrawal of participants from the market.
However, market observers say that the decision was taken after an increasing number of commodity producers that used the NSEL platform for working capital