In the wake of the Rs 5,600 crore payment crisis at National Stock Exchange (NSEL), the Arvind Mayaram led special team has recommended doing away with spot exchanges at least till the time a proper regulatory framework is created for their operation.

Comparing the performance of the spot exchanges in the country to the futures contracts, which have been “performing better”, the four-member special team has recommended reconsideration for the need of spot exchanges.

"The need for and utility of spot exchanges when there are already well functioning futures exchanges, will need to be examined from first principles viz. the value the spot exchanges add to the real sector through its activities; the profile of investors/participants of these trades; the extent to which it facilitates better price discovery and reduces cost of intermediation, etc," according to the panel’s 17-page report.

This is the closest a babu can get to calling the spot exchanges redundant by hinting at the need to reconsider them.

Besides questioning the need for existence of spot exchanges, the panel has also suggested that the government’s funds or the tax payers’ money should not be used to repay investors, who lost out money in the NSEL crisis, as they were well aware of the risks they were taking.

The special team was constituted by the government in August after NSEL suspended operations on July 31 comprising secretaries of the revenue department, consumer affairs department and corporate affairs ministry led by economic affairs secretary Arvind Mayaram. The team submitted its report to the government on September 20.

The report, which is presently being reviewed by various regulatory agencies and the government, has listed out over 30 possible violations of various laws that went on unchecked at the spot exchange.  Pointing that various sections of the Indian Penal Code, 1860, Companies Act, 1956, Forward Contracts Act, 1952, Warehousing (Development and Regulation) Act, 2007, Prevention of Money Laundering Act, 2002 and Income Tax Act, 1961 had been openly flouted in the absence of regulatory oversight, the special team has suggested that criminal proceedings should be initiated against NSEL and its board of directors including its promoter Jignesh Shah.

While the panel has ruled out the possibility of the crisis having any major systemic impact, it has clearly attributed the fallout to the regulatory vacuum created by the decision undertaken by the department of consumer affairs in 2007 to provide conditional exemption to NSEL (and all one-day forwards contracts) from the provisions of the Forward Contracts (Regulation) Act, 1952.

The question then is not ‘whether or not we need spot exchanges?’ But why did the department provide such conditional exemption? And the department has a ready explanation— to facilitate the setting up of spot exchanges in the country.

In comparison to the futures market, which has been operating since 1875, spot exchanges are new entrants in India’s commodities trading business. The government figured that for future exchanges to continue to do well, development of spot or physical exchanges was critical.

"The underlying view was that setting up of electronic spot exchanges would create an alternative marketing channel which would facilitate a transparent system of direct marketing with no credit risk or quality risk," says the report.

It was after the 2007 department of consumer affairs notification that three spot exchanges— NSEL, NCDEX Spot Exchange and National Agricultural Produce Marketing company (APMC) began operations in India.

The spot exchanges were free to carry out operations without any regulatory oversight but this freedom was subject to various conditions including— no short sale by members of the exchange, delivery of commodities for all outstanding positions of trade on the same day, procuring licences from each state before beginning commodities trading there, furnishing trade data as and when demanded by the centre or a ‘designated agency’, which remained unclear till the government roped in the forward markets commission (FMC) in February 2012 to function as the designated agency.

So in essence, once the exchanges procured a licence from a state government to begin trading in commodities in the respective states, it was a free reign for them. The alleged irregularities in the functioning of NSEL came to light when it started making abnormal earnings since late 2010.

According to the panel report, the monthly turnover of the spot exchange which did not exceed Rs 10 crore in its first month of operations (October 2008), went up to Rs 25,000 crore in April 2013 as it touched the highest point of around Rs 45,500 crore in March 2012. It was this sudden spike in trade volumes and monthly turnovers that attracted the attention of the FMC and discovered that NSEL had not fulfilled the first two conditions imposed by the department of consumer affairs.

"In the absence of a framework for regulatory oversight, NSEL misinterpreted the conditions relating to short-selling and the definition of spot transactions," the panel has said.

It was not as if the issue of absence of a regulator to overlook spot exchanges has emerged out of the blue after the payment crisis broke out at NSEL. The issue was first flagged in May 2011, during a meeting of the sub-committee of the Financial Stability Development Council (FSDC). However, nothing came out of it. It was only after an RTI query was filed with the FMC in July 2011 about the regulatory vaccum surrounding NSEL that the FMC approached the department of consumer affairs following which it was appointed the designated agency in February 2012 to probe trade data and check for irregularities.

As of now only four senior executives of NSEL including former CEO Anjani Sinha have been arrested by the police. Meanwhile Shah, the promoter of Financial Technologies which holds 99.9 percent stake in NSEL, continues to enjoy his freedom and convenience to shift the blame on to NSEL’s senior executives distancing himself from the day to day operations of the exchange.

As authorities contemplate which one of them would go first on calling it game over for Shah, it would be worthwhile for the government to actually think of bringing sensitive things like spot exchanges under a regulatory framework instead of doing away with them.

How the crisis unfolded

June 2007: Department of consumer affairs issues notification providing conditional exemption to spot exchanges from the purview of the FCR Act to facilitate establishment of spot exchanges.

October 2008: NSEL begins trading in commodities with monthly turnover of just about Rs 10 crore in the first month.

February 2012: Forwards market commission (FMC) appointed designated agency by the department of consumer affairs giving it authority to monitor trade data of spot exchanges. FMC directs NSEL and NCDEX to submit month-wise trade data following which it informs department of consumer affairs (DCA) that the conditions imposed by it had been overlooked at NSEL.

March 2012: Monthly turnover goes to all time high of Rs 45,500 crore.

April 2012: DCA seeks explanation for allegations made against it by the FMC

July 12, 2013: DCA directs NSEL to submit undertaking that it will not issue any fresh contracts till further instructions and all the existing contracts to be settled on due dates July 31. 2013: NSEL announces suspension of trading in all contracts (except trading in e-contracts which was later suspended on August 6). The spot exchange has been able to repay only a few hundred crore rupees out of the total outstanding of Rs 5,600 crore to its investors.

Till October 28, 2013: Police have arrested four senior executives of NSEL including former CEO Anjani Sinha.