The Ridiculous demand for Nationalisation of NSEL

The government or the regulator may have a role to play to ensure that settlements happen smoothly. And let NSEL fold up, if need be. But there is no need to takeover NSELs liabilities and make it good

Anirudha Dutta
Updated: Aug 15, 2013 02:03:24 PM UTC
JigneshShah_MCX
Jignesh Shah, Chairman and Group CEO, Financial Technologies

It was with dismay I read that Indian brokers have demanded that the government nationalise NSEL, the exchange started by Financial Technologies (FT) (Brokers on the warpath against FT group, NSEL).  I asked a broker, “Are you guys serious?” The response was, “If JS (Jignesh Shah) does not pay up, then he is not fit to run the exchange.  Nationalize MCX too.”

Just after the NSEL fiasco started, Business Standard reporters visited some of their warehouses and found that stocks were much lower than being reported, their values were inflated. Many warehouses had not seen much activity and in one case, if my memory serves me right, the salaries of the security guards had been delayed (Jeera stock at NSEL’s Unjha warehouse pledged to ICICIWarehouses for Jeera stocks tell a different storyThe great vanishing trick). As the reports indicate, some of the stocks may have been spoiled. How much the banks will lose on the pledged stocks is a question that has not yet been asked. The trade guarantee fund has also overnight dwindled.

Proponents of free market, market economy, privatization, less government now want the government to bail them out. So are profits private and losses social, as another friend asked? Brokers were selling risk-free trading products on NSEL and raking in profits. Relationship managers regularly called retail investors to avail of this opportunity. And why not? The managers’ pay is linked to the commissions generated. That’s the nature of financial services business. Readers of “Liar’s Poker” would probably recollect the story where Michael Lewis is egged on by the rest of the desk in London to sell dud corporate bonds, to an unsuspecting French institutional investor.

Brokers claim they do not have proprietary positions and were not funding their clients. But they are worried that their clients will demand money, even as NSEL could delay payments or default. Many brokers knew that something was rotten within NSEL. A few had closed their proprietary positions and stopped funding trades. But by then several retail investors were hooked to 'risk free’ profits. The small investor after all is not always an innocent victim.

Before someone reaches for my neck, let me give an example. A few months ago, a cousin I met over dinner told me that he and his wife trade on NSEL in commodities, to make risk-free profits. I told them that there is no such thing. They, however, had stories of how straw was being converted to gold, bit-by-bit and trade-by-trade. They bought a commodity in the spot market (presumably from the farmer, say rice, and the same was stored in warehouses of NSEL) and simultaneously sold it forward (presumably to an actual user like say a rice miller) for a neat profit. You kept doing this and voila, you had risk-free profits. My cousin and his wife were small investors, but they are also reasonably well-informed. One of them works in a metals/ mining company and was certainly not ignorant. I advised them to withdraw and not to take leverage.

When I checked back with my broker, his response was – “We do not recommend that our clients trade on NSEL. I do not think anything will go wrong immediately, but we have not received satisfactory response either on warehouse stocks or trade guarantee funds.” I told my cousins, that they had better stop trading.

I had forgotten about this conversation, till the NSEL scandal broke last week. Reaching out to my cousins, my worst fears were confirmed – they still had open positions, and are stuck now for payments. They also have e-series contracts on silver, which have been suspended. My broker friend says, many of his clients had wanted to buy these, despite their advice to the contrary.

In any market, greed often drives risk- taking. This has been the case historically, and will always be so. Government bailouts cannot cure this. They will, if anything, only encourage such behaviour. Fear of AIDS and death, for instance, often does not change sexual behavior and this has been the subject matter of research by many economists.

There is also no case for a bailout of brokers. They have to face music from their clients. My broker friends are often at the receiving end of regulators and politicians, in the name of protecting the small investor. But nationalisation of losses is ridiculous. How can it be that my greed is good as long as someone is making money. I have assiduously avoided such products, so why I should I foot the bill to pay out the mythical small investor? The government or the regulator may have a role to play to ensure that settlements happen smoothly. And let NSEL fold up, if need be. But there is no need to takeover NSELs liabilities and make it good.

ULIP schemes have been mis-sold by life insurance companies and their brokers aggressively for many years. Since brokers have not suffered any losses and the retail investor is not organized, no one has yet said that all private life insurance companies be nationalised and losses be made good. But who knows. As Pratap Bhanu Mehta writes elsewhere in Forbes India, “Indian capitalism is the single biggest obstacle to further economic reform. It still inhabits a world of deals rather than rules.”

The thoughts and opinions shared here are of the author.

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