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Jignesh Shah Image Courtesy: FTIL
The ‘selectively censored’ summary of the report of special audit of MCX has created ripples in the media. Several dailies have splashed stories about the questionable related party transactions between MCX and its parent company Financial Technologies (India) Limited (FTIL) disclosed in the Summary. 
FTIL group founder Jignesh Shah, contested the findings of special audit conducted by PricewaterhouseCoopers (PwC) in interview with a pink daily published a few days before his arrest by the Mumbai police for his alleged involvement in the frauds relating FTIL subsidiary, National Spot Exchange Limited (NSEL).
FTIL has also issued a detailed rebuttal to the findings of summary of special audit.  FTIL’s rebuttal has to be taken with a pinch of salt as the full report of special audit has not been put in public domain. The Forward Markets Commission (FMC), which commissioned the study, must put the full report in public domain to enlighten all stakeholders of the financial markets.
FTIL’s contention is that technology-centric transactions between FTIL and MCX were in the public domain. It says these were disclosed in the red herring prospectus of MCX in February 2012. What FTIL has not disclosed is that vital agreements were signed when MCX was 100% owned by FTIL. And these agreements and the consequent transactions were thus initially not in the public domain.
Nevertheless, the NSEL scam and related controversies about FTIL group could have been prevented had all the stakeholders cared to read the aborted draft red herring prospectus (DRHP) that MCX filed in February 2008. DRHP and the annual reports of FTIL and MCX gave a fairly good indication of the Mr. Shah’s dubious revenue model of creating a durable umbilical cord between FTIL and the exchanges-owning subsidiaries/associate companies.
These documents also gave inkling about the corporate strategy of FTIL group. The strategy included clever affiliation with the financial legends and the reining big names of the finance world. The documents also gave an idea of the trouble that was brewing for FTIL group. 
Hardly any stakeholder including the media at that time cared to aggregate critical information about FTIL group available in the public domain and raise relevant issues. This columnist had, however, raised some of the issues that figure in PwC report in an unpublished article written in October 2010 for a magazine. The magazine that commissioned the write-up, never published it.
After reading the PwC report’s summary, I felt that I should publish the unpublished article including an inset to drive home the point that some stakeholders looked the other way, some appeared indifferent and others peddled rave stories about the now disgraced King of exchanges.
The following unpublished article might bring clarity to the NSEL-MCX-FTIL scam and necessitate a larger probe into the collective failure of all stakeholders:
                                      The king of exchanges opens many battle fronts
The dream run for globalised financial markets entrepreneur-cum-innovator Jignesh Shah has hit bone-shaking speed breakers on the home turf. The hurdles might slow down his flight to dizzy heights of growth, wealth and success. And if challenges worsen, they might signal his downslide.
Shah, however, takes gauntlets in stride and has the knack of proving skeptics wrong. Having spread his eggs in different baskets, he might cushion emerging domestic setbacks with overseas business. He thus continues to enhance the global presence of his Financial Technologies (FT) group by spawning one exchange after another in different countries and regional markets.
Domestic challenges are becoming decisive battle for Mr. Shah, who catapulted from being an information technology engineer at Bombay Stock Exchange (BSE) to the fabled list of India’s richest hundred prepared by global magazines such as Fobes in a short span of 15 years.  
The domestic hurdles include regulatory fiats, four-year delay in launch of initial public offer (IPO) by MCX, the multi-commodity exchange which is showcase of FT group’s dazzling success  in spawning diverse exchanges,  loss-incurring step-down subsidiaries, associates and joint ventures (JVs) and fierce competition from existing and new entrants in the exchanges business. 
The share of cumulative losses of subsidiaries, etc. for the FT group flagship company Financial Technologies (India) Limited amounted to Rs 273.34 crore as per an audit report dated 11 August 2010. 
On such entity named Safal National Exchange of India Limited (SNX), a joint venture with Mother Dairy, has permanently ceased operations, according to MCX annual reports for 2008-09 and 2009-10. The JV was touted as electronic spot market for horticultural commodities that was to be developed later as national integrated produce market in an exchange format.  
The tussles between belligerent Mr. Shah and regulators and between Shah and his competitors have brought to focus poor governance of financial markets and chinks in the systems that crafty businessmen can cash in on with plenty of advice from legal luminaries.
The tussles are increasing shifting to the quasi-judicial and judicial system and the corridors of powers.  The markets are watching whether the Government would muster political will and prudence to bring uniformity, coordination and transparency in diverse governance for different market segments. These include equity and debt markets, commodity and underlying financial markets, currency markets, electricity trading markets, banks and non-banking financial companies.
Everyone is waiting for next move by FT group against Securities and Exchange Board of India (SEBI) that rejected its application for grant of permission to take equity trading by MCX Stock Exchange (MCX-SX), a company jointly promoted by FTIL and MCX on 23 September 2010.  Would FT approach Securities Appellate Tribunal (SAT) or go back to Mumbai High Court against 
Market watchers are wondering whether MCX-SX has some clinching proof to back its allegations that it was SEBI officials that verbally led it up the garden path, a complex capital restructuring scheme for MCX-SX to comply with SEBI requirement for stock exchanges’ shareholding norms called SEBI (Manner of Increasing and Maintaining Public Shareholding in Recognised Exchanges) Regulations (MIMPS). SEBI order found this restructuring non-compliant with MIMPS regulations.  
SEBI order was preceded by unprecedented verbal and written allegations by MCX-SX against SEBI and its top officials. MCX-SX has alleged that SEBI conceived MIMPS regulations to favour two finance ministry-backed bourses, NSE and OTCEI and later discriminate against it. It has listed specific instances of discrimination in a detailed annexure to its reply to SEBI show-cause notice 
dated 30 August 2010 mooting rejection of its application. 
SEBI itself revealed its tough stance against MCX-SX in its show-cause notice in which the former claimed that the latter’s conduct “lacks honesty.”
In another annexure to its reply, MCX-SX has elaborated How SEBI pushed MCX-SX to capital reduction path and later became indifferent and discriminatory towards it.
It remains to be seen whether SEBI would sue MCX-SX for slurring its image or merely treat them as outburst by a disgruntled applicant. 
Prior to the SEBI order, MCX-SX was already nursing grievances against the regulator for denial of permission to start interest rate futures (IRF) trading.
The rejection of MCX-SX application seeking permission to deal in interest rate derivatives market, equity, futures & options on equity and wholesale debt segments and all other segments permitted to the BSE and NSE is not only a big setback to both MCX-SX and its two promoters FTIL and MCX. 
The loss-incurring MCX-SX might perhaps find the going tough as a lame-duck exchange competing against the mighty BSE and NSE. Shah’s former employer BSE has also sown seeds of fresh competition against MCX-SX by co-promoting United Stock Exchange (USE) to deal in various formats of foreign currency trade such as currency futures, currency derivatives and currency options. 
Dwindling prospects for MCX-SX is likely to cast its shadow on its co-promoter MCX’s proposal to revive plans for initial public offer (IPO). MCX had twice earlier filed its draft red herring prospectus (DRHP) with SEBI in March 2006 and in February 2008.  
The delay in MCX’s IPO has had a spillover impact on its parent FTIL as is evident from Auditor’s observations in FTIL’s annual report for 2009-10. Auditors stated: “the company proposed to divest part of its investments aggregating 3,600,000 equity shares of MCX at a price at which MCX proposed to make a public issue. …Due to unfavourable conditions, the issue has been postponed to a later date. The investments in 3,600,000 equity shares continue to be disclosed by the company under current investment based on intention of lending.”
FTIL has diluted its stake in MCX from 100% in September 2003 to 31.18% by March 2010 by selling shares in different lots to institutional and corporate buyers at different prices. It can hold up to 26% in MCX under the revised equity guidelines issued by Forward Markets Commission (FMC). 
Through MCX, FTIL has shown how to create a fortune from the business of promoting and nurturing exchanges and make them captive markets for its IT products even after substantial equity dilution. 
MCX issued 15 million equity shares of face value of Rs 10 each to FTIL in two phases as payments for the right to use software developed by the latter for former. 
MCX issued these shares to FTIL under two software development agreements (SDAs), each of 50 year tenure, which can be extended automatically by 49 years thereafter.  
FTIL would thus control MCX through its software umbilical cord for generations to come in a sphere where technology becomes dated within few years.
 In its annual report for 2009-10, FTIL itself has assumed estimated “useful life” of technical know-how and software as six years for depreciation and amortization accounting. 
MCX is on the record as having stated that these software purchases were not “independently valued.” But FTIL earned or would earn a fortune from these shares-for-software transaction if one reckons the hefty premium at which sold MCX shares to certain investors. 
MCX promoters, for instance, sold shares that were sub-divided into shares each of face value Rs 5, at a price ranging between Rs 525 to Rs 577 per share during September-December 2007.
The share-for software deal between Parent company and subsidiaries/associates and joint ventures are referred to as related party transaction under the Companies Act. 
Such transactions between FTIL and the exchanges promoted by it are expected to come under the gaze of discerning investors and analysts when MCX files DRHP with SEBI. Such transactions would give an insight into the revenue earning model adopted by FTIL in its business of promoting exchanges and exchange-related downstream companies.
FTIL’s latest annual report, however, claims that “As a matter of strategy to promote and invest in new joint ventures in domain area and as a matter of policy, your company carries out transactions with related parties on arms length basis.”
The business relations between FTIL and MCX are wide and complex. The former signed a five-year, comprehensive IT infrastructure and software services agreement with latter with effect from 1 October 2007. 
Under this, MCX is required to pay a fixed fee of Rs 10 million per month in addition to a variable fee of 10% of the gross transactions fee. The variable fee is subject to revision by mutual consent at the end of 33 months. 
On 1 Oct 2005, the two companies had signed 20-year software development agreement under which FTIL has supplied risk management system and related services for Rs 10 crore. 
FTIL has developed similar technical bonding with its other subsidiaries, associates and joint ventures, thereby creating a durable and assured source of income. 
This is an enviable revenue model that many IT technologies would dream to secure their future for 50 years! Many a shareholder would thus continue to value FTIL shares as durable, prized investment. 
As and when FTIL promoted exchanges and other companies come with their respective IPOs, the diligent investors and regulators are bound to take hard look at related party transactions between FTIL and the entities promoted by it.
As it is, MCX is partly complying with FMC’s two major norms – accounting and maintenance of Investor Protection Fund and Settlement Guarantee Fund (SGF).
The auditors have dealt with MCX’s substantial deviations from these norms in the annual reports of both MCX and FTIL.
The companies clarified to auditors that MCX have represented to FMC for modifications in these norms. FMC had directed MCX in 2006-07 to put all monies earmarked for SGF into a separate account. Income earned on these accruals should also be credited to SGF and not used for any other purpose other than meeting the commodity trade settlement obligations.
Pending decision from FMC on MCX’s submissions, Rs 408.20 crore collected from MCX members as contribution towards SGF is disclosed as current liability in the exchange’s financial statements. The income earned from this money is, however, credited to MCX’s profit and loss account.
According to an analyst, both MCX and FTIL would have to take a hit on their respective profits if FMC insists on deposit of income on SGF money into SGF account. 
Adding fuel to this uncertain situation is growing intensity and width of the competition in the commodities exchange business following increase in the number of national commodity bourses to five from three.
The latest entrant in this business is Kotak Mahindra-promoted Ace Derivatives & Commodity Exchange. Experience shows that unfettered competition in any sector not only enlarges the market but also cuts into the market share and profitability of existing players to varying degrees.
FMC has, however, been checkmating tariff (transaction charges) war among bourses ostensibly in the overall long-term interest of the commodities trading. 
This, is, however, not the case with stock exchanges that regulated by SEBI.
Loss-incurring MCX-SX has thus been feeling the heat of fee waiver by NSE on currency derivatives trade. The former dragged latter before Competition of India, alleging abuse of dominant position by NSE. 
The challenge before Shah, group chairman and CEO of FT group, is to not only win legal battles but to also alter regulatory terra firma in such a way that it does not hurt his exchange-spawning revenue model.
The Government, on the other hand, has acted at snail’s pace in aligning diverse regulatory framework for exchanges for different markets, leaving enough scope for shrewd entrepreneurs to create exchanges to make fortune and to take resort to regulatory arbitrage.
Investopedia, an authoritative financial portal, describes this as: “A practice whereby firms capitalize on loopholes in regulatory systems in order to circumvent unfavorable regulation. Arbitrage opportunities may be accomplished by a variety of tactics, including restructuring transactions, financial engineering and geographic relocation. Regulatory arbitrage is difficult to prevent entirely, but its prevalence can be limited by closing the most obvious loopholes and thus increasing the costs associated of circumventing the regulation.”
                                              Affiliation with big names is FTIL’s mantra
What have legends such as Chanakya of Arthasastra fame, Premchanad Roy, the uncrowned cotton king of trading during the Raj era and Sir Seewoosagar Ramgoolam, the father of nation of Mauritius have in common?
They and other legends of finance as well as existing leading lights of financial world share space in the 2009-10 annual report of Financial Technologies (India) Limited (FTIL), the flagship company of FT group that has earned a name for itself by promoting 10 greenfield exchanges at home and abroad a clutch of other companies that have vital linkages with exchanges. 
The full-page photographs of financial legends have created an aura of global financial vision and innovation around FTIL. The aura gets strengthened by brief letters or write-ups on issues such as financial inclusion penned by existing big names of financial world such as M.V. Kamath, non-executive Chairman ICICI Bank. 
Apart from full-page photographs of six legends of ancient and modern finance, FTIL carries the letters from nine financial industry experts along with their photographs. The photographs and letters have nothing to do with annual financial statements and performance of FTIL, its subsidiaries, associates and joint ventures that figure in the annual report. They just generate a halo around Financial Technologies group.
FTIL’s quest to associate itself with the names that matter is visible elsewhere too. In the Corporate brochure on FT group titled ‘Future of Financial Markets’,  it has quoted US President Barack Obama as saying “Nor is the question before us whether the market is a force for good or ill. Its power to generate wealth and expand freedom is unmatched, but … without a watchful eye, the market can spin out of control and that a nation cannot prosper long when it favors only the prosperous.” 
FTIL has adopted a multi-facet approach to build its image of a technology-driven company that likes to bring about innovations in financial markets. It is concerned about mass markets and masses. And it is in tune with fashionable concepts such as financial inclusion and corporate social opportunities (CSO). 
The company has nurtured a high profile through a slew of global and national alliances, rave stories in the media and by bagging numerous global and national awards and accolades.  
 As put by the company, its vision is to “Create a market for masses to build unprecedented shareholder value through a non-linear business model that will transform economies, empower the common man and change lives.”
The vision also envisages building  “next-generation, tech-centric, regulated markets that are more affordable, accessible to propagate the benefits of ‘price transparency’, ‘efficient transaction’, ‘risk hedging’ and ‘structured finance’ to the masses –helping to unlock value from the middle and bottom of the pyramid.”
The third element of its corporate vision is “Create and operate the largest exchange network connecting deep, vibrant and liquid financial markets in the fast-growing economies of Africa, Middle East, Central Asia, India, China and other Asian countries.”
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