NSEL Crisis - Billion Dollar Lesson - Important Learning for All Decision Makers

Analysis of NSEL Crisis - Billion Dollar Lesson 

Important Learning for all from NSEL Crisis

By:

Vijay Sardana

Disclaimer: Views are personal and not representing any organisation or association.

National Spot Exchange Limited is a company with a business interest as commodity exchange. In any commercial transaction in company or in exchange there are many players those who are responsible for ensuring successful transaction. NSEL crisis clearly highlights that many gaps were exploited by insiders and by people responsible for safe guarding the interests of all stakeholders while running the exchange.

Let us analyses what is the learning for business managers and policy makers from the NSEL exchange.

According to NSEL website following is the operating procedure of spot exchange.

NSEL Operating Guidelines from their website	What went Wrong and Why?
Trading
1.    National Spot Exchange is providing an online screen based trading system, which can be accessed through VSAT, leased line or internet.	This online system is a good concept to ensure transparency in dealing and recording the transactions on real time basis. Technology is enablers and facilitator as transaction recording tool. From this crisis, one thing is clear technology cannot substitute the ethics, honesty and morality of managers’ action and behaviors. Promoters and Shareholders must develop systems beyond technologies. Learning: Once again managers, not technology, betrayed the trust.  Do we have systems to cross check what our managers are doing in field? Do we have 360 degree feedback system to ensure that what is reported to promoters is actually happening on ground? Most of the companies do not have this system. Check about your company.
2.    Exchange has launched daily expiry contracts for Gold, silver and various agri-commodities, which can be traded from 10 am to 11.30 pm.	It is true that transaction needs linkage with the spot market, but transaction time up to 11:30 PM was not in line with stated objective. Learning: Are we doing business in odd hours which is not in line with common practices? If yes, keeps extra vigil on the transactions happening during that time.
3.    The positions outstanding at the end of the day, will result into compulsory delivery. But during the day, the transactions of offsetting nature will be netted off and delivery will be executed only with respect to the net quantity outstanding at the end of the day.	The key aspect of Spot exchange was “Delivery” of the goods. This was the key function of spot exchanges. The fact is this vital aspect of the transactions i.e. delivery to warehouses were compromised. Learning: The question is what is the system to check delivery happened was or not? It appears that the person responsible for ensuring delivery in warehouses and the person dealing with sellers must be same.  This is conflict of interest and a very common practice in corporate world. Classic examples are Quality and Production head, negotiation team and finance team is common, person giving sales scheme is also response for clearing the bills of schemes, sales manager is responsible for handling consumer complaints. There are no phone numbers of senior management available in case anyone wants to file a complaint about mall practices practiced by company managers. Very often convenience and seniority comes in between in development of robust and fool proof system. Is this good for your company?
4.    All the terms relating to quality specifications, place of delivery, date of delivery and other conditions will be specified by the Exchange in advance and all contracts executed on the system would be on the basis of such terms only.	Specifications and terms of trade are customized to benefit certain section of trade. Why specifications are not in line with nation laws. Learning: Any deviation from the established national standards should not be deviated just because of commercial consideration. This is a dangerous trend because the freedom to deviate can be misused by managers responsible for procurement and deliveries. Why we get poor quality material in organized retail chains? Think about it. To know the facts study the modus operandi between suppliers and buyers in agriculture commodities. Any deviation means someone is having extra illegitimate financial gain at the cost of ultimate beneficiary very often they are either customers or shareholders.
Delivery, Clearing and Settlement
5.    All trades executed on a day will be netted off at the end of the day as per the weighted average price of last 30 minutes. The profit / loss arising would be settled on the basis of MTM on the next day.	This is an accounting activity in books. What was the mechanism to cross-check with stocks? In case of NSEL it was all controlled by one person and according to reports he was the trusted man of the promoters. Learning: There must be more than one source of information to cross the facts. These two sources must not have common areas of interest. In case of conflicting signals or inputs it is the duty of the promoters to look into it, with an assumption that promoters themselves are not party to the crime or manipulation. These must be a system where Board of Directors must take a written report from the CEO or MD during the board meeting about the number and types of complaint received with their action taken report and also to tell the board action plan to avoid repeat of this type of complaints in future.
6.    The net sellers have to give delivery by way of depositing goods in the Exchange designated warehouses / storage tanks as specified in the Circular.	This was violated many times by many players. This failure indicates that whole chain of command was corrupt. Learning: Companies must develop a system to undertake surprise audits of their own internal systems. This should be done with the help of people those who are beyond the area of influence of the people incharge of the activities to ensure objectivity and fairness in investigation. Promoters must develop network of informers at grass root level about their company’s activities in the field. This can provide very vital inputs on real time basis before the disaster can happen to company either legally or commercially, either by law enforcement agencies or by competition.
7.    The buyer's account will be debited by the Exchange and delivery order will be handed over to them after ensuring that payment is through and Payout will be credited to the seller's account.	This is a regular financial function. It seems the auditing teams failed to detect the mismatch between physical stocks and the amounts credited. This can happen only if auditors are in hand in glove with decision makers. Learning: Many companies have tendency to have auditors which can be “managed” for window dressing of balance sheets and related documents. Businesses where cash transactions are a common norm these are common practices. Commodities, construction, real estate, retailing, trading, etc. are some sectors where cash transaction is very high.  Please note who the auditors are for these companies and their professional standing. This can also give you indication what is happening in such companies.
8.    In case the seller fails to give delivery, the position will be auctioned / closed out at the risk and cost of the seller separately. In case the buyer fails to make payment, the buying position would be auctioned by the Exchange at the risk and cost of the buyer.	This was the major flaw in the whole episode. Only paper receipts were issues without getting the material in warehouses. When these were reported to the management, management chose to cross-check with the person who was blamed for his fraud. Obviously, no manager will say he has committed the fraud. Promoters ignored the complaint in the name of “trust and faithfulness”. Learning: Trust and Faithfulness is important but cannot be more important than facts on ground. If any management ignores the facts under any pretext in that case it is matter of time that any company or organization will be heading for disaster. Good working relation is must for growth of companies, but facts based objective decision making should not be considered as hindrance in efficiency management practice. People are important but efficient and responsive systems are more important to ensure sustainable growth of any organization. Please think about it.
Risk Management, Margining and Surveillance
9.    The Exchange is using various tools for risk management, margining and surveillance to ensure market integrity.	The Risk Management, Margining and Surveillance tools developed were not used or not effective. This is a clear message that top management was not keen to put systems in place. Learning: Mistakes can happen any time anywhere in business processes, what is important is do we have system to identify the weaknesses in the system so that these should not be covered-up by managers responsible for doing the activities in the ground. Managers have tendency to hide themselves from accountability of mishaps. The job of top management is to develop systems to expose these mishaps and rectify the system as soon as possible to prevent it from happening. Sub-standard products, adulterated product, poor service quality, frequent breakdowns or accidents in factories are common examples of system breakdowns in organizations. These incidences also reflect the mindset of top management.
10. All positions outstanding in the market would be subject to margin payable by both buyers and sellers. However, if the sellers have deposited goods in the Exchange designated warehouses, margin will not be applicable on such positions.	The margins payable by buyers and sellers should be studies carefully. Are these linked to business realities or other considerations? Learning: Please study margins, incentives, commissions and schemes given by your company. Are these in line with the trade practices or not. If they are higher or lower than the market norms, identify who all were involved in these decision making practices. What all facts were used in deciding this policy? Are you getting desired results from these decisions? Are the same people involved in approval those who proposed the scheme? These questions will give you some answers. Make sure same people should not be in the money loop. This loop must have different players with complete independence. This means you have to develop a system to protect your cash outflow.
Settlement Guarantee Fund
11. The Exchange will guarantee performance of all contracts executed on the Exchange platform. For this purpose, the Exchange will maintain a settlement guarantee fund. Notwithstanding default of any member, the payout will be declared as per the Exchange schedule.	This was a statutory requirement but not maintained as per requirement. Learning: Why statutory obligations were compromised by auditors and Board of Directors. Are you meeting all statutory obligations? Please request your Company Secretary to develop a check list of all statutory obligations for all functions.  Please review this list in every Board meeting and ask all the HODs and Auditors to give undertaking that they have personally verified the status of work and information mentioned in the checklist. This will make the whole organization accountable. In case any team leader leaves the organization, he should also sign that what all information he has provided and handed over to the new incharge is correct and in line with the law.
Commodities to be Traded:
12. National Spot Exchange has launched delivery based trading in multiple commodities with multiple contracts. A number of contracts has been designed and customized to fulfill the requirement of farmers, co-operatives, traders and big corporates.	It is the job of the exchange to design the contract. Learning: Deviation from national standard should be discussed with stakeholders in open house. Any deviation from national guideline must be discussed at highest level with written justification for the need of deviation. Any abnormal behavior of high or low movement of demand, price and quantity needs to be closely monitored. Such movements and activities must be under close watch of top management
13. Further, spot contracts would be launched for the commodities traded on futures exchange platform in order to create a market for cash future arbitrage and also for enabling investors to buy Exchange certified deliveries through National Spot Exchange.	This linkage was designed to benefit group company and to encourage speculative trading. The introduction of arbitrage was against the spirit of the Learning: There is no harm in developing products for the benefit of group companies but this is harmful ad very often illegal if they are against the mandate of the primary business objective of the company. Self-Governance Approach is Under Question: NSEL was operating under open policy environment means there was no regulator. In place of maintaining self-discipline they committed massive fraud. This also goes against the spirit of self-governance as always demanded by many industry associations. The NSEL, Satyam etc. and other commercial frauds indicate that temptation of money is more powerful than legal obligations. Should we encourage self-governance in the environment where product and service quality is sub-standard and there is transparency in decision making process? This needs serious debate.

It seems, except promoters, majority in their office and trade was aware that things are not normal in NSEL. Why promoters cages themselves in glass cabin and refused to listen to the messages? This is big question which everyone is asking.

What are the important learnings from NSEL crisis?

·  In place of individual oriented approach there should be systems in the company to minimize conflict of interest between various activities.

·  Many suppliers or buyers will try to corrupt your managers for their vested interests. You should have system to detect this in time and put safeguards in place.

·  Managers’ are human beings. They also have tendency to look at shortcuts for faster success both in terms of finance and stature. You should have 360 degree feedback system to ensure system integrity. Over dependence on any individual can be disaster.

·  Keep your communication channels open. It may be below status for many individuals but good for organizations.

·  Auditors and Board of Directors cannot and should not delegate their statutory responsibility in the interest of organization and their own interest. It is good have to surprise site visits to get familiarity with ground reality.

·  Self-governance is not possible when corporate governance is weak. Till there is strong corporate governance, self-governance should not be even discussed. 

Important: Please do not doubt the integrity of the managers but have a system to ensure accountability and transparency in decision making process and cross-verification mechanism on real time basis with the help of technology..