NSEL as you probably know stands for National Spot Exchange Limited. Recently NSEL was in the news for all the wrong reasons. Here we try to explain what really happened.
It is reported that NSEL has violated many norms that govern these exchanges. Short selling is a process where you sell something that you do not have and is commonly used as a trading strategy. NSEL allowed its members to short sell when this is not allowed on spot exchanges as per regulations. NSEL also launched trading contracts with tenure more than 11 days, which is also not permitted for spot exchanges.
The regulator came to know about these trades and contracts and ordered NSEL to square off the contracts on the same day, which meant NSEL had to pay a lot of money to a lot of investors. NSEL agreed to take these steps but many investors/speculators panicked at this news item and everyone wanted to close their trade on the same day. This meant NSEL had to shell out even more money. Therefore NSEL had to defer payments by some period.
NSEL also announced that trading in all contracts, except e-series contracts were suspended and no new contracts will be launched. This also led to a steep decline in the stock prices of its group companies -Financial Technologies and MCX.
Many speculators were using the exchange to make money. The traders/stockists bought commodities put them in exchange accredited warehouses and then sold these to investors with an arrangement that they would buy back the commodities after ‘n’ days for more money which meant the investors get higher returns. 12%-14% returns were apparently ‘guaranteed’ to the investors. No commodity was exchanged in these trades and that meant that there were no elements of transportation or storage costs. Commodities that were used for these trades were raw wool, castor seeds, sugar and paddy.
It has come to light that there is no one ‘official’ regulator for spot exchanges. The government is drafting new regulations to manage spot exchanges. SEBI has also got into action getting into a probe of the brokers involved in these operations.
Lessons for Investors:
We investors can also learn some valuable lessons here -
- Do not put your hard earned money in investments blindly getting lured by the high returns guaranteed by the brokers.
- Before investing you must understand the product and the rules governing it.
- Do not over allocate money to one asset class.
- Always remember investment is different from speculation and avoid speculation if you do not understand the products.
- You should remember if there is a product that is promising much higher returns than other asset classes like equity, it is quite likely that a higher risk element is involved. It is better to be doubly sure, as there is no such thing like a free lunch.