15 February 2018

Accessing India's Capital Markets - ASIFMA

Please register for what promises to be a good event - ASIFMA Conference "Accessing India’s Capital Markets".  http://asifma.org/events/

13 February 2018

Plan to end derivatives trading abroad is fraught with common sense

I have a piece in today's Economic Times on how it makes sense for NSE/BSE to end giving up their market share to their competitor and the outrage by some is just noise:

Self destruction is not a high principle
The last few days saw some interesting Chinese whispers where media reported some sort of fatwa by the market regulator SEBI to the exchanges to stop the trade of Indian indices in foreign exchanges. Based on these ‘facts’ opinions flew easy. Terms like de-globalisation, regressive, protectionist were offered. One commentator even argues that it would tempt MSCI index, a much followed international emerging market index to cut its India weightage. Another syndicated piece quotes someone as saying that this will in fact adversely impact the onshore market. In fact, the move is sensible. The comments are alarmist and simply wrong. If there is some high principle of killing your own business, perhaps that high principle has been compromised. There is no reason, India and Indian exchanges should not act in their self interest if current reality demands such a change.

Imagine if a corporate entity were to email a list of its vendors and customers on a daily basis to its nearest competitor. Really, this is what was happening. While BSE/NSE have shared data and branding for a fee when foreign exchanges were not competitors, now the very same entities are direct competitors. Now the loss to business is greater than the fee received from the foreign exchanges for data feeds and thus requires rethinking from a competitive landscape perspective. This is Adam Smith’s self interest and common sense, not some nationalist conspiracy theory of protectionism.

As the regulator has clarified, there has been no direction to the exchanges to stop any trading in foreign exchanges. Mainly because that is not how it happens, as SEBI has no power to ban trading in overseas exchanges and attempting that would plainly be silly. At most the regulator could have convened a meeting and nudged the exchanges to act, which really is in their own interest.

The only handle Indian exchanges have over overseas exchanges trading of Indian products is the data based on which trades take place. So, for instance, the Singapore exchange’s trading the Nifty futures would depend on the data of the index and also the data of the individual stocks comprising of the index to trade the contracts. If this data were stopped, there is a likelihood that the trading would become out of whack and inaccurate. A similar outcome is likely in single stock futures of Indian companies which have recently been announced by SGX and were probably the root cause of the action.

In other words, the life blood of several products, in particular the SGX Nifty contract, is the data feed of the prices of the underlying and to a limited extent the branding of Nifty itself. The Singapore exchange is clearly more competitive in terms of costs and taxes with no STT, stamp duty, capital gains tax etc. But it is wrong to compete with Singapore or Dubai in terms of lower taxation, though there is merit in some rationalisation of investment taxes as the RBI governor recently pointed out. India cannot and should not compete with tax havens or the likes for a race to the bottom of taxation. We simply can’t afford that.

The key issue is commercial in nature. Though the numbers are not published, one can assume that the revenue from brand lending of Nifty and the data feeds is less than the lost revenue from bringing the trades onshore. Thus, the decision to restrict trades would have been taken by NSE in its self-interest. Similarly, nothing would be achieved unless other exchanges cooperated, as the same component stock’s price could be obtained from BSE.

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Having said that, the task would be far more difficult if not impossible if the restriction were sought to be extended to currency derivatives. Any products which are not dependent on onshore data would not be impacted and there is no way to regulate or prohibit the same. However, such products are primarily highly competitive with little or no profits.


Finally, the end game for the exchanges is unclear, but there does appear to be some regulatory nudge towards the GIFT city SEZ. That is no bad thing, as that jurisdiction has exchanges which are owned by BSE and NSE, they offer a far lower tax impact and there is a policy reason to incentivise those rather than foreign owned trade venues. The very fact that the Singapore exchange lost nearly a tenth of its value on Monday’s early morning trade (and BSE gained) shows the impact on its profitability by its losing the index derivatives business. If SEBI does something to develop the Indian markets as it is mandated to do under its preamble, it is no bad thing. If the exchanges did anything else, it would breach their fiduciary duty to their own shareholders.


02 February 2018

Budget 2018: How Finance Minister Arun Jaitley has made interesting changes to financial regulations


I have a short piece in today’s Financial Express on the impact of the budget on financial regulations. Linked here and quoted below:

Budget 2018: The Budget attempts to juggle the competing interests of various people to maximise political, fiscal and economic capital. The Budget has made some interesting changes to financial regulations.

The Budget 2018 attempts to juggle the competing interests of various people to maximise political, fiscal and economic capital. The Budget 2018 made some interesting changes to financial regulations. First, the reintroduction of capital gains tax was a negative for capital formation in the public markets. But an introduction of a ‘grandfathering’ clause protects gains made till the Budget’s introduction. In other words, if shares of a listed company were acquired 10 years ago at Rs 10 and its price on January 31, 2018 was Rs 1,000, the cost of acquisition would be considered as Rs 1,000 and not Rs 10. In a shrewd and sophisticated word play, the bill does not provide any benefit of capital loss if the shares were sold at say Rs 900 in March 2018. The extent of tax losses because of the exemption in the last year alone was close to a staggering Rs 3.75 lakh crore. With the zero tax treaties going away, both domestic and foreign investors will now pay capital gains tax, though at the concessional rate compared to capital gains on almost all other asset classes. 
The second major proposal in the bill is of incentivising the corporate debt market. There are huge benefits of expanding the corporate debt market. It is far more transparent, with disclosures, frequent mark to market, and oversight by a rating agency. By comparison the loan market is opaque and incentivises suppression of default where both the borrower and lender benefit by the omerta code of silence. Much of the NPA problem we see today is a result of the festering of the wounds not exposed to the rigours of transparency of the public markets, causing deep systemic issues within the banking system. The bond market is also a natural shock absorber, where risk can easily be transferred to those who are better placed to assume it.
Third, there are many kind words for various funds like alternative investment funds (AIFs), infrastructure funds, real estate funds and venture capital funds. Similarly, there are soothing words for the growth of fintech. The words will, however, need to translate into action. Currently, many forms of funds face absurd tax claims where funds raised by investee company are treated as profits. Similarly, certain kinds of AIFs investing in listed equity do not get proper pass through treatment of tax or certainty of taxation. Several fintech platforms have faced regulatory heat.
The fourth announcement is with respect to the creation of a unified regulator in the international finance centre at Gujarat. This is useful, since creating a competitive offshore financial centre requires quick adaptability and a modular design of development for which the large monolithic regulators RBI and Sebi are not fully equipped. They are more adept at restricting and regulating rather than promoting and developing. Additionally, what works onshore often does not work in the offshore market.
Fifth, there is a significant change in the enforcement process at Sebi. With pending proceedings expected to last over a decade, there was a need to streamline multiple proceedings. The bill takes a major step in consolidated duplicative processes at Sebi.


17 January 2018

Segregation of advice from distribution - simple, attractive but wrong

I have a piece in today's Economic Times where I argue that the complete segregation of advice from distribution of mutual funds and financial products is neither possible, nor desirable. Here is the link and below is the full piece:

Segregation of advice from distribution – simple, attractive and wrong

SEBI has come out with a third consultation paper on segregation of advice from selling of mutual funds. The fact that SEBI has not implemented the first two proposals is a good sign that the regulator is thoughtful and open to suggestions. It needs a bold step to altogether abandon the project of segregation of the two functions, which is simple, attractive and obvious. But wrong.

The context of the paper is SEBI’s current position where it allows distributors of mutual funds to provide incidental advice without a separate registration as an ‘investment advisor’. The current paper, which from its grammar seems to override the earlier more detailed proposal, proposes a clean segregation of advice from distribution of mutual funds. An advisor represents the investor and should not get a commission from the mutual fund. A distributor by contrast is an agent of the mutual fund and is entitled to a commission from the fund for ‘selling’ it.  The paper seeks to prohibit the advisor from selling and the seller from advising. This prohibition includes relatives for individuals and affiliates (including subsidiaries and parent companies) for corporate entities. The paper also suggests that the distributors continue with their current obligation to ensure sale of appropriate products to investors.

There are 5 birth defects with implementing the proposals. First, investment advice as a stand alone business is not viable in the Indian context. Of the few hundred who are registered as advisors, nearly every one of them, has a separate distributor license housed in a corporate entity or with a close relative. Mandating an absolute ban on advice would almost certainly mean that registered advisors will abandon their registration and retain their distribution license. This will be a disservice to investors who will be deprived of proper advice. Banks and other large institutions will probably abandon advice as the fee income is negligible compared to their commission income. This may change in another decade, but it is a very distant reality today.

Secondly, the prohibition on relatives, from undertaking advice when another is providing distribution will almost certainly be unconstitutional. It is difficult to imagine any court upholding a ban on a profession merely because a husband or a brother in law is carrying out another legitimate business which SEBI finds to be somehow in conflict even though both are completely independent. Indeed, many distributors today have husband-wife combinations for providing advice too, but prohibiting one when both are qualified, registered and regulated would be impermissible.

Thirdly, the very definition of suitability, which SEBI seeks to continue to impose on distributors, will mean advice. Thus prohibiting advice while mandating suitability is a contradiction in terms. A good advisor would always first find out the profile of the client, for instance the age, income, risk appetite, retirement plans, insurance needs, education of children goals, tax impact and many other things before advising the client. Once this is done a good adviser will advocate a diversified portfolio, diversification of assets being one of the only free lunches in the financial world. In other words, there is no such thing  as a mutual fund advisor. One can only be a good financial advisor if one allocates assets between equity (mutual fund, listed, unlisted securities), debt products, insurance, real assets, gold etc. If SEBI’s aim is to mandate advising only with respect to mutual funds, it is doing a great disservice to investors. All holistic advice must necessarily advice investment in different asset classes, different time horizons and different assets within each asset class for it to qualify as being suitable and in investor interest. This remains true whether such advice is provided by an advisor, a distributor or other persons who provide  incidental advice.

Fourth, connected to the previous point, it is impossible to sell any financial product without conducting a suitability check and provide some level of advice. A distributor today reaches out to remote towns, does the leg work of KYC and other documentation, provides risk profiling and basic advice before an investor is willing to invest in funds. A prohibition to provide advice to distributors would almost amount to regulatory mandated mis-selling and fraud in financial products. Not a goal SEBI is seeking to achieve.

Fifth, and very importantly, the concept of pure advice is a highly elite product. Even upper middle class investors rarely use such advice. Smaller investors almost by definition cannot afford a Rs. 5,000 per year or 20,000 per year advisory fee when they are starting a monthly systematic investment plan of Rs. 500 per month. The product is mainly suited for HNIs or Ultra HNIs. The only country in the world which has experimented with a segregation of such kind is UK, a developed and rich country. Even there, the regulator’s own study of the move after 3 years shows how millions have been left unattended and orphaned of advice  because of the segregation of advice.

The unintended consequence of this ‘removal of conflict’ will in fact be a removal of all advice in India, a steep increase in actual and opportunity costs, mandatory misselling products to clients. The approach proposed should be replaced instead by a robust enforcement against mis-selling by SEBI, which is in fact not prevalent. Almost the entire misselling occurs in insurance based investments and in selling of stock derivatives, both of which have attained epidemic proportions. SEBI should follow the advice of its own International Advisory Board as also the Sumit Bose Committee which have recommended against implementing this move in the near future. In fact, it should work towards expanding the scope of incidental financial advice, as there is no such thing as mutual fund advice. In this case, SEBI should avoid the Occum’s razor that the simplest explanation is the best suited.