The NSEL (National Spot Exchange) by deferring settlements has brought focus on markets where regulators are absent or are not being stringent on enforcing rules. The settlement amount is pegged at around Rs 5000 crore, according to various media estimates. The NSEL was forced by the government to stop trading in many contracts leading to the settlement crisis as players were not given time to cover their positions.
NSEL is not regulated by the FMC (Forwards Markets Commission) that regulates the commodity futures exchanges. NSEL was not regulated by any other market regulator and the fact that the Department of Consumer Affairs had to pull up NSEL for contract violations, suggest that the exchange was loosely regulated.
SEBI, the capital market regulator is not involved directly in the commodity markets but the fact that the promoters of commodity exchanges including listed entities such as Financial Technologies and NSE (National Stock Exchange) come under the SEBI authority makes the regulator indirectly involved in commodity exchanges. RBI is involved on the banking side of the business as banks deal with the brokers and exchanges.
The regulators are all working together to sort the NSEL settlement issues. However the regulators cannot prevent any loss incurred by an investor who is involved in transacting in the NSEL. The promoters will get away with fines and warnings and the big speculators/ traders and brokers may be able to absorb losses as they would have made enough money by moving illiquid and non transparent commodity markets. The small trader, speculator and investor will suffer losses and some of them may sink under losses.
The NSEL issue is applicable to all markets where there are no regulators present. Un regulated products carry huge risk as seen by the ponzi schemes that have collapsed in recent times such as chit funds, real estate investments, turkey farms etc. The investor in these products has no recourse to either the regulator or even the law in many cases. Needless to say that the perpetrators of such ponzi schemes are the ones who laugh all the way to the bank though some of them are brought to justice.
Un regulated or loosely regulated markets are not exclusive to India. China is facing a huge crisis in the form of "Shadow Banking" where unregulated investment products have accounted for a parallel lending market that has in turn led to asset bubbles and over investments. The collapse of many hedge funds globally post the 2007-08 credit crisis has led to huge losses for many investors. Many other countries have seen ponzi schemes collapse or bubbles burst in unregulated markets leading to extensive losses to investors.
The NSEL issue brings to fore the risk of investing in unregulated markets. One market that is unregulated but is the flavour of the day is real estate. There are many investment products floated with real estate as the underlying investment. Private equity funds, PMS products that involve both equity and debt of real estate companies and even some mutual fund schemes that have real estate as the underlying theme. Investors should be well aware of the risks to products with an unregulated market such as real estate as the underlying investment.
Similarly, investors should either stay out of investments in products where the underlying market is loosely or not at all regulated or should carry out even due diligence in the products to understand the risk return trade off.
Let the speculators/ traders and big investors make or lose money in unregulated markets. You will only get the end bits if you play it right but you will end up losing heavily if you play it wrong.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.