Another One Bites the Dust

Armed with a degree in Engineering when he first took up a job with the Bombay Stock Exchange, he would never have thought that his aggressive ambition could land him behind the bars some day. The long arm of the law finally caught up with Jignesh Shah, the ‘Exchange Magnate’ leading to his arrest in the multi-crore NSEL scam. Though the man is disgraced today, the fact and the credit that he built a state-of-the-art organisation that literally put India on the world map of the commodity markets cannot be taken away from him. But as they say, it is easy to reach the top, but the real challenge lies in staying there. That truly summarises of what has come on to Shah today.

The meteoric rise of the man pales in comparison to his dramatic and quick fall. Even as Shah was just about beginning to find a foothold across the value chain of Exchanges, having launched equity trading on the MCX SX, one among the many organisations that he built over the years faltered badly. The Rs.5500 crore NSEL payout crisis not only shook the foundations of the Financial Technologies group promoted by Shah, but also tarnished his image and repute built painstakingly over the years as a first generation entrepreneur.

The story of this heist camouflages in the garb of entrepreneurship an intriguing fact about corporate India. There may be numerous arguments against generalising a situation and making a blanket statement about the intent of our entrepreneurs, but there are an equal number of instances which prove that wealth creation is a chain completed first by success which gradually gets transformed into greed for more and eventually leads to failure.

The NSEL drama which has drawn the curtains on the presumably illustrious career of Jignesh Shah saw nearly 13000 investors lose a humungous Rs.5500 crore bringing back memories of the first organised stock market scam perpetrated by Harshad Mehta way back in 1992. Ironically, Shah’s professional life began exactly after Mehta’s ended and it now stands the risk of meeting a premature death just in the prime of age as that of Mehta. The only underlying difference between both these stories is that of the asset class involved. All else including the methodology is almost the same.

Shah’s story holds many lessons for aspiring entrepreneurs who would be feeding their ambitions on examples like his. This is a story of an over ambitious entrepreneur who branched out of his family business to create a world class organisation only to go down the dumps, thanks to greed that overcame ethics with success.

The Early Days

Coming from a family of traders who traditionally dealt in metals and chemicals Shah’s life began in the by-lanes of the bustling business district of Kalbadevi in Mumbai. Shah was a fairly intelligent student holding good academic credentials right from the beginning. Among the top five in school, Shah had a very clearly identified career path on his mind right from the beginning. An engineering degree was to be followed up by higher education in the US and finally culminate into the setting up of his own business.

The Professional Turn 

Coming from a family of traders who Shah is reportedly an avid reader of books traditionally dealt in metals and chemicals and his first brush with commodities too Shah’s life began in the by-lanes of the came with that habit of reading. After bustling business district of Kalbadevi in putting in a few years at the BSE and having Mumbai. Shah was a fairly intelligent equipped himself with the knowledge of After having completed his engineering, Shah joined the BSE which was at that very time commencing its automation process. The seeds of starting and running an automated Exchange would have taken roots in Shah’s mind at that very time. An opportunity to join the Exchange at a time when the capital markets had been roiled by the Harshad Mehta scam, in hindsight seems to be God sent opportunity for Shah. For a person who held a technical background an opportunity to understand the nuances of the financial trades executed at an Exchange are phenomenal. Transactional knowledge, liquidity and the many other facets of stock exchanges obviously would have come clear to him during his stint at the BSE. According to reliable sources, Shah was a part of the team that was entrusted with the task of studying systems operating in the developed markets.

The Genesis of Financial Technologies

Shah is reportedly an avid reader of books and his first brush with commodities too came with that habit of reading. After putting in a few years at the BSE and having equipped himself with the knowledge of markets and technology to support markets, Shah finally started off his own firm to provide technology to markets. Financial Technologies was Shah’s brainchild formed in 1995. A business that took off with just Rs.5 lakh in capital took off well in a technology starved financial world. Shah’s focus was primarily on products than on services.

What started in a small office, started surviving on various ancillary services and at times even being funded out of Shah’s own pockets. Every bit of the business was new. Technology in capital markets was new, brokers were confused as much as they were sceptical about the whole new system of trading that was being thrown at them. This probably gave the start up an edge in terms of filling in the gap that existed between the broking community’s understandings of the whole thing.

Transaction processing automation is what Financial Technologies (FT) prospered on. Competing with foreign companies like TIBCO which was catering to some Indian clients, FT continued to establish itself strongly in the Indian capital markets with the NSE having empanelled it for the distribution of the product.

Shah’s tryst with commodities

The failure of the organised syndicate appointed by the government to set up a commodity exchange paved the way for Shah to try his hands at it. From among the various applicants including the international exchanges, NSE and BSE, there were 16 applications including all major stock exchanges and a consortium of ICICI, NSE, NABARD and LIC. Four names including ICICI, MCX, NMCE (National Multi Commodity Exchange), Ahmedabad and NBOT (National Board of Trade) of Indore, were the ones the FMC shortlisted. The final list however was devoid of MCX and NCDEX.

Launching MCX was not an easy task for Shah. Continuous follow ups on the rejection with various authorities including the economic advisor, secretary, joint secretary and the minister and backed by the World Bank consultant’s report which sought to allow all four shortlisted candidates, so as to ensure a healthy competition. But on 14th February 2003, MCX reportedly made it to the list of approved institutions. Thus began a journey of creating India’s identity in commodity market trading. On his way up Shah used some very ingenious methods of creating a market for commodities. Tying up with trade bodies to ensure transactions, designing indigenous contract designs as opposed to adopting foreign ways and methods were some of the ideas that helped the exchange quickly scale up its operations.

While the commodity exchange scaled newer heights, Shah’s ambitions took further wings with the group wanting to get into an equity trading bourse as well. After a lot of struggle, that dream too became true and the group’s equity bourse MCX SX finally got the necessary approval to begin equity trading in July 2012. Good times lasted only a year from there and exactly in July 2013 the NSEL scam broke out.

The Problem Begins

To put things in perspective, here is what happened. NSEL a sister concern of the Financial Technologies group was launched as a platform for spot trading of commodities way back in 2008. It was formed under a notification issued by the Ministry of Consumer Affairs, Food and Public Distribution division of the Government of India. After obtaining license from various state governments under the APMC Act, NSEL started launching farmers’ contracts. According to some large investors with whom DSIJ has constantly been in touch with, ever since the crisis erupted, representatives of stock brokers started aggressively canvassing the products launched by the exchange to investors by making presentations and representations about ‘100 per cent risk-free investments in spot trading’ through the NSEL. The pitch for the sale of the products was that the exchange was a government-regulated trading platform. Believing in these representations, investors began investing in commodities.

Transactions were three-pronged in nature – with sellers of commodities on one side, forward buyers on the other and the investors in between who were actually funding the transaction. On settlement, the buyers would pay the differential (which usually came at a premium to the spot price) and settle the contracts. The eventual payout would ensure that the financiers or investors got their money. What the investors made was more than a decent amount of interest on the transaction they actually financed.

All was well until at the end of July 2013, when matters got out of hand, and the Exchange under the directions of the Ministry of Consumer Affairs, suspended trading and launch of new contracts indefinitely. The amount involved in unsettled payouts as on July 29, 2013 stood at around Rs.5500 crore. The staggering amount sent shockwaves throughout the market circles.

The Blame Game

NSEL was not a lending institution, but a platform for buying and selling of commodities. A person selling a commodity would be paid by the exchange upon taking delivery of the commodity to the NSEL-designated warehouse. Simultaneously, another purchaser undertakes to buy that commodity after paying a certain margin to the exchange, whereby the delivery of the goods and payment thereof happens at a later date at a slightly higher rate to the spot sale price. Thus, each transaction is in effect a buying and selling transaction.

According to aggrieved investors, NSEL’s claim that all the monies are with the ‘borrowers’ was a grossly erroneous statement. There are no borrowers, but only buyers and sellers in the said transactions. If the subsequent buyer fails or refuses to take delivery of the commodity contracted, the exchange would be able to sell the contracted quantity to another buyer and at the same time forfeit the margin money deposit of the failed buyer.

That sounded logically correct. But remember, there are not just buyers and sellers, but also a third category of players involved in these transactions – the so-called ‘investors’ or actually the financiers of these margin buying transactions. These are the very people who are today fighting to get their “hard earned” money back. So much for the interest that these financing propositions brought in for the investors!

NSEL’s Flip-Flop: Spilling The Beans

While the aggrieved investors cried hoarse for their money to be paid back, NSEL or rather the Financial Technologies Group as a whole got into a mess created by its own flip-flops. This obviously suggests that all isn’t really well, as it is being made out to be.

From the amount lying in the Settlement Guarantee Fund (SGF), which drastically came down from an initial claim of around Rs.839.53 crore to just Rs.65 crore between the day the crisis erupted and August 5, 2013, there had been absolutely nothing that can lend credence to what the NSEL officials had been reporting in public.

Another most important point about this whole episode was the collateral in the form of physical commodity stocks as contracted. Overwhelming quantities of sugar and metals as well as other commodities including rice and paddy had been found on record. The practical feasibility of the quantity held was completely out of sync with reality. We, at Dalal Street Investment Journal, visited two of the warehouses then located off Mumbai, but met with little success in getting a physical verification done on account of security reasons. Statistics about the location of other warehouses and their capacities to hold quantities mentioned were also found to be off the normal range of possibility.

Hopes, Promises, Schedules & Reschedules

The most important point in all this was the repayment of the monies due to the concerned investors. The NSEL management had given a schedule of repayment, according to which every Tuesday (commencing August 20, 2013) would see a payout of Rs.174.72 crore for the first 20 weeks and Rs.86.2 crore for the next 10 weeks. But as expected, the exchange failed in the very first payout, having distributed just around Rs.92 crore against a commitment of Rs.174.72 crore. As the calendar flipped between July 29 and August 20, each passing day had only added to the worries of NSEL, and in turn of the Jignesh Shah-led Financial Technologies Group.

The Missing Money Trail

A case which would have been very easy to understand and resolve took an inordinately long time in settling down. The basic worry was about the missing trail of the money involved. Investors had paid the money they had contracted to pay at the time of taking positions. This money had obviously found its way out of the custody of the exchange into the hands of the parties which are today being asked to pay.

Exchange officials whom DSIJ spoke to kept on stressing on the fact that sale of collateral is the only way out and that it would yield the desired result. But this contention too has fallen flat on its face, particularly after the failure of the payouts.

Moreover, NSEL’s own attitude towards the whole thing has been rather shoddy. The Financial Technologies Group has always been media savvy when it comes to corporate communications and interactions with the media. But this time has been different – a distinct deviation from its usual self.

Avoiding media is one thing, but avoiding law enforcing and investigating agencies just another. The long arm of the law has finally caught up with Jignesh Shah who today finds himself behind bars. Investigating authorities have sounded out the bugle on those who have been a part to the whole scam by arresting Shah. Whether Shah would be able to absolve himself of the blame will be an interesting thing to watch. For now it is important that the money trial be established fast and investors be paid back in order to restore confidence among investors. The financial and capital markets are poised at a very important stage today. Any confidence building measure will go a long way in strengthening the overall ecosystem of the country. While investigations go on, we will keep a close watch on the developments in this case.