Sucheta Dalal :Allowing PN Mischief to Continue - (MONEY LIFE Issue 6 Nov 08)
Sucheta Dalal

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Allowing PN Mischief to Continue - (MONEY LIFE, Issue 6 Nov 08)  

October 22, 2008

Exclusive news, the stories behind the headlines and the truth between the lines


Edited by - Sucheta Dalal


Allowing PN Mischief to Continue

Lobbyists for foreign institutional investors (FIIs) crowed with joy when the Securities and Exchange Board of India (SEBI) decided to reverse its decision to cap the issuance of Participatory Notes (PNs), a move that was then seen as a precursor to eliminating investment through this non-transparent route by the end of 2008. (PNs are financial paper issued overseas by foreign brokerage firms to investors who are otherwise ineligible to invest in the Indian market. PNs represent a package of underlying Indian stocks or derivatives). The policy reversal removed restrictions on issuing PNs where the underlying asset is a derivative and also scrapped the condition that PNs cannot account for more than 40% of the total assets held by an FII in India.


Did SEBI’s board fail to notice that the move was unlikely to ‘pep up’ the market or revive ‘sentiment’ since foreign investors were pulling out of India mainly to meet redemption pressure overseas? There is already plenty of headroom for the issuance of more PNs for investors who wanted to take that route, after the 44% market correction since SEBI announced curbs on their issuance in 2007. 


Funnily, nobody but the retail investor seems agitated about the double standards in continuing to insist on strict and cumbersome Know Your Customer compliance requirements for domestic investors and permitting lack of transparency in foreign investment. Naturally, the assumption is that the government and its regulators want to protect the identities of those who send money out of India on a round-trip back into the Indian market via tax havens such as Mauritius, the Cayman Islands or Switzerland.


A former banker cynically told us that it does not surprise him that the PN route is being widened. He suspects the rupee is headed past Rs50 to a dollar. It helps all those who need to bring money back to India to fund the forthcoming general elections.


Having taken the decision to remove restrictions on FII investment, SEBI makes a feeble attempt to ward off criticism by saying that the entire ‘framework’ governing FII investment needs a comprehensive review and it will put out a consultative paper for public comment. Seeking public opinion almost seems like an after-thought in this case.


Record Launch

The Sensex had crashed 700 points and the mood was rather sombre, but the irrepressible Jignesh Shah was bubbling with confidence at being the first bourse to cross the regulatory divide and be permitted by SEBI to start a currency exchange. The first two were launched by the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) just weeks earlier and, according to Shah, India had set a world record by launching three exchanges in quick succession. MCX also bowled over its broker constituency with a message of good wishes from the legendary Leo Melamed, chairman emeritus of the Chicago Mercantile Exchange. MCX is already hot on the heels of NSE, which is the market leader mainly because of its one-month lead time. MCX reported a Rs301 crore turnover on 13th October to NSE’s Rs506 crore, while the BSE’s currency trading seems headed for oblivion after MCX started operations. As far as turnover goes, the numbers reported by the leading exchanges are still small, mainly because of the global financial turmoil, but things are bound to change. The financial crisis will probably force global regulators to acknowledge the dangers of OTC exchanges with huge counter-party risks as opposed to formal ones, where trades are cleared through clearing houses where the exchange guarantees settlements and mitigates counter-party risk.


Interestingly, now that MCX is in commodities, the Ahmedabad-based National Multi-Commodity Exchange, in which the Anil Dhirubhai Ambani Group has a 10% stake (which will soon increase to 26%), has announced plans to enter the currency market by year-end.


IPO Grading

Like the issue of PNs, SEBI is also keen to revisit the grading of IPOs introduced in April 2007. On 2nd September, chairman CB Bhave said that “SEBI would review the IPO grading concept as it has received both positive and negative responses to the practice.” As we said earlier, there is a strong lobby of market intermediaries who do not want IPO grading, while investors want it to continue with modifications like not allowing companies to choose the rating agency and having ratings paid out of Investor Protection Funds lying with the stock exchanges. The global financial turmoil since September will probably keep the primary market dormant for a while. So SEBI must use the time to ensure that the debate about gradings takes place in the public domain first and not at the Primary Market Advisory Committee where barely two members represent retail interests. Meanwhile, it can consider the findings of a study by professors Saikat S Deb and Vijaya B Marisetty who have analysed the “Information Content of IPO Grading” for its effectiveness and whether it has led to more informed decision-making by investors. An analysis of 159 IPOs has led them to conclude that underpricing of IPOs was lower in the post-grading regime (this coincided with the peak bull run), that retail investors have shown more interest in good quality IPOs with higher grading and that the IPOs with higher grading also attracted higher liquidity and lower risk in the post-issue period.


Now that academic research has confirmed the efficacy of the rating process, we expect two reactions. First, complete silence on the grading issue until the IPO market revives (this may take a long time if fears of a global recession come true) and, second, an attempt by lobbyists to discredit the study. Watch this space, we will monitor the developments for you.


ICICI Bank: Damned for Success

For the second time in the past few years, ICICI Bank seems to be paying a price for its rapid growth. A few years ago, depositors panicked when its ATMs in some cities of Gujarat went dry over a long weekend. This time, with financial markets in turmoil, the Bank seemed in danger of being crushed by malicious rumours that seemed deliberately directed at driving the stock down, to profit by shorting the stock. The panic-generating messages were zapped across the country in a matter of hours and the media exacerbated the situation (especially the leading business channel) through baseless speculation and dire predictions. The Bank has done well to track the culprits and file a police complaint against those who initiated the malevolent action. By doing so, the Bank is signalling that it will retaliate when its business and reputation is damaged for short-term speculative gains. At the time of writing, the situation seems to have stabilised with the combined efforts of the Reserve Bank, the finance ministry and the rating agency, Standard & Poors (S&P), which confirmed ICICI’s sound fundamentals. S&P issued a media release iterating the Bank’s ‘strong market position’, ‘adequate financial profile’, ‘healthy capitalisation’ and ‘satisfactory loan quality and diversification’.


CEO KV Kamath must now insist on an investigation by SEBI into the hammering of its stock price which seems to be at the root of its troubles. The Bank must also reflect on the many factors that make it more vulnerable than others (including smaller and weaker private and foreign banks) and initiate long-term actions to protect itself from such attacks.


-- Sucheta Dalal