Towards a forex derivative safety net

Soon credit rating agencies will have to factor in solvency of customers before they evaluate and grade banks for their financial stability.

Here are a few more skeletons falling off the cupboard of ICICI bank – customers taking it to court for alleged mis-selling of derivative contracts. Obviously the bank will plead the customer was fully aware of his downside risks while entering the contract. Unless the parties settle for out of court settlement, it could lead to a protracted legal battle.

But I suggest a few measures the banks could take before they enter into complex derivative contracts with customers –

Enter into contracts only with customers that have relationships with the bank for over 5 years;

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Begin relationships with smaller sized contracts – say $ 100,000 ; every year the deal size can go up by 2x;

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Go by net worth linked limits for contract sizes – say aggregate exposure should not exceed 25% of customers’ net worth;

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Banks should make provisions for net exposure on a risk weighted average basis, of about 50% of negative outcome on the day of entering the contract;

All contracts should carry personal guarantees of MD /CEO and all executive directors of the customer to make good the losses to the bank if the customer defaults on its obligations under the contract;

RBI should set up a neutral authority –someone like a Notary Public- to endorse the fact that the bank has explained all possible outcomes of a derivative contract and the customer has completely understood all its risks and grant a certificate to this effect. This NOC should be a pre-condition for entering into a derivative contract. The fact of obtaining of NOC and the extent of its risky exposures should be informed to stock exchanges by the customer where it is listed within 3 days of grant of NOC by RBI.

Update : More spillover – Sundaram Brake Linings v. Kotak Mahindra Bank

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Making compliance less PITA

One the most mundane acts that enterprises do everyday is compiling reams of data for compliance purposes. The data painfully extracted and filed, not much attention is paid to it until its time for the next filing. Many CFOs have often rued this fact and some have even confided the futility of this effort. I remember asking them “why don’t you just go use that information for your business purposes as well?”

To which, I am yet to get a convincing reply.

I recently found Brian Scheld and Sean Culbert of IBM debating the same question. I am glad there are like thinkers. Excerpts -

"Slowly, financial institutions have come to the realization that successfully competing in an accelerated, data-clogged business environment requires an enterprise capability that permits them to quickly access, integrate and deliver data that can be used to make lightning-fast decisions related to regulatory compliance, risk management, customer retention and profitability. The trend is called convergence, and it refers to an enterprise-wide alignment of governance, policies and processes to enable the quick and efficient sharing of business information among multiple stakeholders."

"...In essence, data convergence can help financial services institutions link their overall business strategies to their enterprise risk-management strategies by offering a graduated path from basic information-based regulatory compliance to a tighter management of business processes and risk, and then to fully optimized performance and value creation."

Friendly rip-off

So you’re puzzled why your trades in T segment always face “technical snags” and the shares never get delivered on the 3rd day. Here is why.

Every transaction in the ‘T’ group has to compulsorily result in deliveries; the buyer or seller cannot square off his position intra-day. Often, many sellers are unable to meet their delivery obligations for a variety of reasons. Unlike in other segments, T segment stocks are not auctioned. The seller’s positions are *closed out* by levying a 20% penalty on the seller that gets credited to the buyer, to make up for non-delivery. So if you buy a stock for Rs.100 on Monday and the seller fails to deliver, on Wednesday, you’ll get a credit equaling 20% of its Tuesday’s closing price. If that is Rs.90/-, you'll get a credit of Rs.108/- (120% of Rs.90)

Here is where the *friendly* broker rips you off. On the settlement day, the broker gets the details of his pay-in and pay-out obligations on his work station from the exchange at 1:30-2:00 pm. Occasionally he will find that some of the purchase positions of his clients in ‘T’ group shares have been closed out, and the prices of those shares are now trading at a price lower than what his client had bought them for. He then buys those shares at low prices and credits them to your account. In the process, he gets to pocket the Rs.18/- differential credit from closed out positions that originally belongs to you.

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Now you know how brokerages quickly get into billion $$ leagues....

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The box needs fixing

So Deloitte runs a survey on the potential return for PE firms in India, going forward. It says Global private equity firms are expecting lower returns from India in the next six months as a booming economy and stock market drive up valuations. The basis ? Callow statements like this - “There is no more low-hanging fruit. India has been discovered. We will see more moderate – 20-25 per cent – returns going forward.”

The PE firms can do with a bit of open mind and flexibility. They have to innovate and adapt. You can’t make money in India by just transposing the same business process that are followed in the US or Europe. Result – they keep whining on their clichéd gripes (a) ban on leveraged buyouts (b) families that own businesses are reluctant to sell (c) restriction on issue of convertible preference shares and other regulatory impediments.

That puts me in a mood to quip.

Take gripe (a) – leveraged buyouts are banned. So what? That's why we didn’t have a credit crisis and points to a credible lending process that insulates Indian banks from global crises. The fact that doubtful debt can’t be bundled with a good credit risk and palmed off to unsuspecting bond investors is a sign of systemic maturity. [Indian banks faced a crisis 10 years back when most of our PSU banks had high NPAs because major borrowers didn’t repay. They siphoned the funds to build their personal assets even as their companies were going broke. Now that's plugged].

On gripe (b) families don’t sell out - because they feel one of them will be shortchanged in the process by the dominant share owning family member. Search for recent scuffle at Patni (computers) and Bajaj (Auto) families. The strategy here for PE firms is to get upclose with the family and broach the subject thro an investment banker that is close to the management. Choose the wrong messenger and you lose the deal. For that you need someone that is pretty much clued in… Why not me? Yeah, You can try.

The gripe (c) is on choice of instruments. Yes, convertible preference shares have been banned in construction and real estate since PE firms took that route to breach the FDI limits prescribed for the sector. PE firms lent against convertibles and the money was never repaid. In effect it was indirect infusion of equity since the loans were convertible into common stock. They used that to jack up their stakes in real estate companies that had huge land banks. You try to break a law and you're sure to be canned. But they can pitch for specific projects. Use a strategic investor, that is a professional consulting / EPC firm that can capitalize (thereby part-fund) the project cost. There are several other ways but then I can't blog everything here. I need to make a living too, pal....

If you are creative enough, there are ways to have the cake and eat it too… I’ll tell you what’s the problem. Investment banks don’t innovate. They just want to ride the coat-tails of their colleagues in the west. No, I am not asking you to start thinking out of the box. If one has to do that often, then the box needs fixing. It's a bit like walking between raindrops, agreed. Or a closer parallel will be learning to drive on a pot-holed road without getting a flat tire way too often. The day you get it right, you'll sight opportunities here all the more.

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It's like yesterday once more...

Remember that sweet song by carpenters "it's yesterday once more"?....

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Most of my leads come from my friends in Investment Banking circles. I guess it’s got to do with their internal policies that do not allow cold calling. Freelancers like me are always game if there’s a deal at the other end, we’ll only be too happy to go the extra mile and kick some butt. The deal eventually will flow to those who gave me the lead and I get paid for the lead conversion into a paying client. Cool.

A couple of weeks back I got a whiff of Subhash Chandra’s ICL developing cracks and is hurriedly looking for Private Equity infusion. I couldn’t believe what I heard. ICL is a nascent concept, has a good format that when priced optimally will give BCCI a run for the money. Where did they screw up?

Today I find, ICL has been facing trouble raising team, ground and on-air sponsorships with several companies – Bisleri and Axis Bank among them – pulling out. As a result, ICL hasn't yet been able to sign any sponsorship deals yet. But for God’s sake, why can’t ICL host its matches from say, Australia or England and beam it into Asian subcontinent…? It can beat BCCI wrath and win the sponsors as well…can’t it? ICL stands a better chance of roping in overseas brands as well…

Subhash Chandra, in the past has had mixed luck. He had hit it off with Zee TV, Citi Cable and slightly off track Essel Packaging but failed in a slew of ambitious ventures like Agrani Satellite program after poaching a few scientists from ISRO. Those were my early days in the business and were almost open source case studies. They gave me some early perspectives into big business that no B-School faculty could ever have imbibed.

I might thank all those experiences for bringing me to where I stand now. It saved me that gouge of a B-School fee in the process…. :)

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GSM lottery for landline operators

News – GSM add 5.7 million users in October. Competition says "Congratulations" - and they mean it.

How about putting up some cell infrastructure and attending to call drops…? If they don’t do that soon, the mass user buildup will soon lead to a windfall for landline operators like BSNL / MTNL. This will be that odd instance when wireline telcos feel happy even as mobile competition notches up number of subscribers.

I’ve had a pretty bad experience throughout last week. None of my upcountry calls went through. Finally I made it through my wireline phone. I am sure this is the experience for most others too.

Get your act together GSM guys… Otherwise all those stratosphering valuation numbers you’ve notched would just be vapor in no time…! Can you afford that…?

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