Crisis and opportunity

NSEL scam shines the light once again on regulatory gaps in the financial system that can no more be ignored

The National Spot Exchange Limited was exempted from regulation for its derivatives trades by the Forward Markets Commission (FMC), the regulator of commodity derivatives markets. It has now effectively defaulted on its obligations. The exchange is reported to be asking for between 15 days to five months to pay back the Rs 5,500 crore it owes. In 1992 and 2000, the Harshad Mehta and Ketan Parekh scams led to the previous crises at the BSE and the Calcutta Stock Exchange. Now, we have a default by the NSEL.

A default by an exchange due to incapacity to make the payment in time, or in full is an extreme failure of financial regulation. An exchange is not an ordinary company. Exchanges are critical financial infrastructure that are at the frontline of enforcing financial regulation. The exchange has a responsibility to see that no trading on its platform is illegal. It is required to monitor and investigate the trading activity of its members. If a trade is illegal, it is the responsibility of the exchange to stop it. The next level is the role of the regulator. If the regulator is not sure that the exchange is able to enforce regulation, that it is "fit and proper" to carry out the quasi-sovereign function, it is no less liable if it has given an exemption to the exchange. In this case, it was the job of the regulator, the FMC, to see that the NSEL does not run an illegal futures market. The role of the regulator needs to be investigated. It is important, therefore, to shift the investigation from the FMC to enforcement agencies such as the CBI and the Enforcement Directorate.

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