The NSEL Scandal

Posted On Monday, Aug 26, 2013


The NSEL saga has been another serious blow to investors confidence in financial markets. Investors already suffering from high inflation, shattered by global / local uncertainty and poor returns from most of the asset classes were attracted towards arbitrage products offered on the NSEL platform offering high returns. However, in reality, these returns were too good to be true.

NSEL was potentially offering arbitrage products on agri commodities wherein investors could at one hand buy the spot contract and sell the deferred day contract (maturing somewhere between 25-40 days) and thereby making double digit annualized returns with no assumed price risk as both the buy and sell legs were taken simultaneously. Several brokers were selling the National Spot Exchange Ltd`s pair contracts as 100 per cent risk-free investment products offering double digit returns.

The end does not justify the means. In the first place, the spot exchange was offering a forward contract. Any contract that trades and has settlement exceeding 11 days is classified as a forward contract. The arbitrage trade that was in operation was actually made up of two trades / contracts done simultaneously i.e. one with a short maturity (two days) and the other with a little longer maturity (25-40 days). While the first leg of the contract matures immediately and then the investor is reliant on the counterparty to fulfill its obligation by paying in funds and taking delivery of the underlying commodity. The payment crisis is evident of the fact that there was a severe dearth of adequate underlying commodity, audits/ valuations, exposure limits and certain other procedural and risk management mechanisms. Further as reported, financial engineering by some selfish market participants took advantage of the mechanism to short sell. The problem evolved further on account of regulatory gaps. A more focused regulatory oversight would have prevented this blow up from happening by mandating strict risk control measures. However, this does not absolve the exchange of its moral and ethical responsibilities.

There are still certain question marks on how the current payment crisis would be resolved. If there`s adequate stock, then why is it not being liquidated and money being raised to repay. In this electronic world, why is it that the exchange takes so much time in even declaring the amount of stocks lying in their warehouses? What caused the settlement guarantee fund to shrink from Rs.800 crores to just Rs. 60 crores as reported in the media?

I do not have the answer as to how the crisis would be resolved, but allegations and question marks have been floating abound.

In today`s interlinked financial markets, a crisis at one end is enough to seed doubts in investors mind in similar spectrum of products though they may differ in every possible aspect. NSEL was a spot exchange trading in commodities and hence every financial product dealing in commodities is being scanned through investor`s lenses.

Gold ETF`s could potentially be on the investors worry list. The biggest issue with NSEL was a regulatory vacuum. However, Gold ETFs are very well regulated by SEBI. There have been a host of measures that have been guide lined by SEBI right from valuation to underlying commodity specifications to mandatory audit of the underlying commodity gold backing Gold ETF units.

The major difference in the NSEL and Gold ETFs lies in the structure of their operations. In NSEL, two counterparties enter into agreement to buy and sell the underlying commodity and the buyer is dependent on the seller to deliver the underlying commodity and transfer the underlying commodity ownership from the seller to the buyer / investor. However, in Gold ETFs the fund receives gold of the specified quality, quantity, from LBMA (London Bullion Market Association) accredited refiners and that has not moved out of the vaults custody after imports. Only after confirmation from the custodian of the receipt of the gold, the fund then instructs Registrar to create and issue units to the Authorised Participants who can then sell to buyers / investors on the exchange platform. This mechanism makes it fool proof indeed. So first the underlying commodity is delivered which is then converted to demat units and then onwards sold to buyers / investors as opposed to NSEL mechanism where trades takes place first and then the underlying commodity is delivered.

Moreover let me tell you more about how we manage your investments in the Quantum Gold Fund (ETF)*.

With regards to the assurance of value of the ETF, we ensure that each Quantum Gold Fund (ETF)* unit is adequately backed by physical gold. We acquire the physical gold before we commence the creation of the equivalent ETF units under the in kind structure as explained above. The physical gold is sourced strictly from refiners accredited by the London Bullion Market Association. Each gold bar that the custodian accepts on behalf of the fund is verified and substantiated by legal documents stating information on origin, purity certificate, and import details.

The gold also gets physically verified on a regular basis. The custodian`s daily physical holding statement submits details of each bar we hold, while the auditors physically check the gold on a monthly basis. Also there is a statutory audit being conducted by the statutory auditor every six months as prescribed by SEBI.

Other than these checks, our team at Quantum also visits the vaults every month to personally verify the holdings. For the fund holdings, I can at any point in time tell you what would be holdings under the Quantum Gold Fund (ETF)* unlike NSEL which took so many days just to disclose their underlying commodity held in warehouses. We also disclose the quantity of gold held in the fund in the factsheets made public at the end of the month. The gold held by the fund is completely insured as well.

Dear reader, by now you would have got clear idea about Gold ETFs. Still, if you have any queries, we would be more than happy to rest your doubts at bay.

We hope the NSEL crisis gets a fair resolution soon and investors be paid back their money. The current crisis has flared from issues surrounding the agri products on NSEL popularly known as arbitrage products. On the other side of the periphery lies another range of products called the e-series products offered on NSEL platform where the buyers / investors can hold the underlying commodity in demat form and can convert it into demat form when desired by paying a small conversion fee. The government has currently halted trading in the e series as well until the probe is complete. On account of investor reaction to the ban in trading, the exchange had to provide an option of either continuing to hold commodity in demat form or else take physical delivery of the underlying commodity. We hope that the exchange is in the position to fulfill the conversion of the demat holdings to physical if a large number of holders opt for it and it does not lead to further intensification of the current payment crisis the exchange is facing.

We also hope that no such crisis occurs in the future that endangers investor`s hard earned money. There needs to be enough regulatory and control mechanisms that should be set up to oversee every aspect of the financial markets to avoid crisis in the future. Also, even Investors should do their home work and not be lured just by returns. Whenever you hear about earning returns that are too good to be true, please do raise all risk related questions and thoroughly study the markets involved.

Take your investment decisions rationally...


Data Source: Bloomberg, World Gold Council

Disclaimer, Statutory Details & Risk Factors:
The views expressed in the Article are the personal views of the Fund Manager of Quantum Gold Fund. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This Article is meant for general reading purpose only and is not meant to serve as a professional guide/investment advice for the readers. This Article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. The Sponsor, The Investment Manager, The Trustee, their respective directors, employees, affiliates or representatives shall not be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this Article. Please visit – to read scheme specific risk factors.

Above article is authored by Quantum.

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