Short selling ban

Apparently, SEBI has asked FIIs to reverse their short positions in the overseas markets - though there appears to be no official word from them. After crying myself hoarse over the past three days on CNBC, defending the practice of short selling, I made the final argument today - that banning short selling is not just bad economics but bad politics.

Even assuming the regulator has the jurisdiction to give such directions to FIIs, even if we are to ignore the moral argument against the regulator playing with market levels, even assuming the efficacy of banning pessimism from the markets, accepting the reduced efficiency of the markets, I think the worst thing about the ban is that it will reduce the cushion of short covering as every short must result in a subsequent purchase. Thus beyond a few days, the investors will face even more downward pressure assuming all other things being equal.

Even after the announcement of the ban (rather the reversal of offshore short positions), the markets fell, thus giving the announcement a miss (the screen oracle has spoken). This is probably because at Rs. 1000 crores (Rs. 100 billion) of short positions (which is only a small fraction of the market turnover -even of a single day), the short covering will get overwhelmed by plain and simple sell orders  - (Wednesday alone saw an FII sale of Indian securities in that region) and short positions in the Futures and Options markets - making the markets less efficient, more likely to fall even more steeply and FIIs more suspicious of further ad hoc actions by the regulator making them flee even faster from our market.

Update: Those who came in late - the word 'apparently' in the first line needs to be underlined, SEBI 'sources' apparently deny the offshore short winding up directive. Will the real SEBI stand up?

Update: I have written a short piece in today's Times of India explaining in plain terms why any restriction on short selling is not a good idea. 

My favourite quote of the day is: "How can you ban something which is not allowed". This is true of course, except for the small sliver of off shore securities shorted which are now sought to be banned/reversed.

Short sellers and regulators

I just saw this posting at 'Foreign Policy blog' about the north Korean dictator and it reminds me of regulators and short sellers in todays markets around the world - read it to draw the analogy:

"Kim was watching a special match between Kim Il-sung University -- his own alma mater, which was celebrating its 62nd anniversary -- and Pyongyang University of Railways. According to an insider, after realizing that several of the Kim Il-sung University players were sporting long hair, Kim declared it to "look disgusting," and said "I can't tell if this is men's soccer or women's soccer."

His mood grew steadily worse until the end of the first half, at which point he announced he would not be watching the rest of the match. Whether he was actually watching from the stadium or on television is unknown.

Shortly after the incident, a notice was posted in workplaces across the country banning long hair for men. Staff at Kim Il-sung University were witnessed carrying out particularly stringent checks."

PS: It isn't clear whether his team was losing at this point of time or not.What do you think?

Petrol subsidy - revisited

I was surprised to see a piece by Mr. Swaminathan S.A. Aiyar, noted columnist, in today’s Times of India advocating that fuel prices should not be reduced. The piece is once again written on an assumption that the government has been subsidising fuel prices over the past year - which as I wrote on my blog on 11^th Sept 08 is a myth.

My personal take as a green enthusiast is to keep the petrol prices high and also in these trying times there is no real choice but to keep prices high – so I do support high prices, but at the same time let us not be delusional about calling this a subsidy.

Since petrol prices have reduced dramatically since my last post on the subject, here are the revised estimates of the ‘subsidy’ being handed out.

Present price of Petrol in the US ($/gallon): 2.8

Taxes in US (per gallon Federal+State): 0.31

Net price of petrol excluding taxes $/gallon: 2.49

Net price of petrol excl taxes in $/litre: 0.658

Net price of petrol excl taxes in Rs/litre: Rs. 32.2

(Note: 1 gallon [US, liquid] = 3.785 liters

1 USD = 49 Rupees)

I'm paying Rs. 54/liter in Gujarat - that's net tax of Rs. 21.8 per litre (up from 15.53/litre on 11 Sept) or 67.5% (up from 40% on 11 Sept) tax on top of the price – I don’t know what combination of taxes are imposed by the center and the state, but clearly there is no subsidy to the consumers. At 8 cents a litre (Rs. 3.92 per litre), petrol is subsidized in Venezuela.

Economist positive on India

The Economist thinks that things will turn out well in the medium and long term for India, once the current global meltdown settles down. Here is an excerpt.

"All of this might mean that once the dust settles, India is likely to re-emerge as an attractive investment destination. At least in the short term, growth in India's flagship IT-services sector is likely to slow because of the financial-sector crisis. But the rupee's depreciation will help to shore up the profitability of IT and other exporters. More importantly, Indian IT companies, as well those in other industries, are stepping up acquisitions. Strong growth in the past few years has given Indian companies the financial muscle for large acquisitions, just as the global slowdown is putting good international companies on the market. 

...

Both Indian companies and regulators recognise that India cannot escape the global meltdown. However, Indian companies are looking for opportunity in the crisis, while regulators remain on standby to ease conditions as much as possible. That, perhaps, is as much as anyone can do in the current situation."

PS: The jillion dollar question though is when will the international dust settle? 

Ranbaxy deal - no block deal

See my previous post on the sale of shares by Ranbaxy to Daiichi. It appears that the two parties could not place a bulk deal order on the exchange as the differential in price negotiated and the current market price is a huge number. So burning through the order book may not be viable, (see my previous post for explanation of the lingo and context) though I still think burning through will be cheaper than paying Rs. 1000 crore (Rs. 10 billion) in capital gains taxes.

The option of a block deal is not available as the rule only permits a 1% variation in negotiated price compared to the market price. Block deals are over the counter trades in securities which are only reported to the market (in effect as they don't enter the order book). SEBI has rightly rejected an application to exempt the parties from the 1% variation rule which applies to all those who wish to use the block window. Can't really have it both ways - don't want to use the bulk trade order book because it is expensive and seek a special exemption from the regulator contrary to the regulations. The choice is between paying the capital gains tax or using the bulk route - take your pick.

Though in these times, the Finance Ministry would be happy getting a sum of a thousand crores by way of tax.

See news report on the SEBI denial of special case exemption.

PS: Actually the differential between the two or three routes possible is not very large in this case, as sale by a corporate entity is liable to Minimum alternative tax (in the range of 11%). As much of the stake is held in corporate entities's names rather than the Singh familiy in individual names, the difference between long term capital gains tax (also in the region of 11 %) and MAT payable would not be substantial.

Wrong-headed hunting of short sellers

Just when you thought the Indian securities regulator was smarter than it's Pakistani and US counterparts, it has blown the lid by sending intimidating letters (my interpretation) to Foreign Institutional Investors (FIIs) seeking information on overseas short positions and synthetic short positions. See news report.

For the record, Pakistan stopped all sales of securities below a floor level in August when the index fell beyond 'tolerable' limits. The SEC has made various attempts to ban short selling even though it accounted for only 2-4% of trades and it is now clear that the stocks on which bans were placed suffered more than the ones on which there were no such prohibitions. See an academic study. The nature of short selling is so poorly understood even amongst financial regulators, it is sad. In fact, it would not be an exaggeration to say that we would have fewer bubbles like the present one, if shorts were allowed to puncture such bubbles in time (they are not allowed to do so in dozens of countries because of wrong perceptions). I would recommend as required reading for all regulators a judgment by Justice Posner (now even more famous with his blog on law and economics) called Sullivan vs. Scattered 47 F.3d 857 (it should be available in public domain).

Perhaps we just need to call some FIIs and behead them, so as to make an example of people who are selling 'too many' securities. Does that sound like a perfect recipe for inviting further inflows of capital, which we now so badly need? My two bits are that SEBI is pushing FIIs out by intimidating them at this time - there is nothing whatsoever wrong with shorting onshore or offshore, and if we think we can become prettier by breaking the mirror, not only will be not be prettier, we'll get some shrapnel of flying glass.

See my previous blogs criticising the SEC actions and other posts relating to short selling. 'America's SEC fights dirty' and 'Jury out on US short selling rule'. See the Economist article also criticising the US move.

Update (20 Oct): My assumption above in the second line is accurate. See PR of SEBI of today and also NDTV interview of SEBI Chairman, CB Bhave.

Pay revision of regulators - downward revision?

Looks like the pay of regulators is on its way down. Here is a brief recap of the facts. The Board level members of the regulators today get a pay equivalent to an assistant secretary, the Chairperson gets the pay of a secretary (the exception being the Reserve Bank of India (RBI) governor). By contrast the staff of the regulators (I can speak of RBI and SEBI for certain) gets a pay which is higher in comparison to government pay. While I don't know the history of when this occurred in the RBI, SEBI follows this higher pay structure of RBI (with a few differences) at the staff level.

The 6th Pay Commission recommended that the Board level members (whole time members of the Board) of five regulators be paid a higher salary disconnected with governmental pay, the government has accepted something different. See page 40 of a chart which contains the Pay Commission recommendation and the decision of the government.

The Commission's recommendation was to give a pay of:
a) Rs. 150,000 per month to members and Rs. 200,000 p.m. to the Chairperson where a car and house are provided.
b) pay Rs. 250,000 per month to members and Rs. 300,000 p.m. to the Chairperson where a car and house are not provided.

This is indeed generous from today's pay structure levels.

However, what was accepted was:
a) pay Rs. 250,000 per month to members and Rs. 300,000 p.m. to the Chairperson where a car and house are not provided.
b) Incumbents can choose between present pay (say around Rs. 25,000 pm) with car and house or higher pay without house and car.

This pay structure is not at all generous and is weird because it is silent about new member/chairperson's choice of car/house i.e. what happens if the new appointee wants the car and house?

Let me explain the financials in some more detail, a house in Mumbai in a respectable south Mumbai area (3 bedrooms - in areas where the regulators today in fact stay, so this is not a hypothetical) would cost upwards of 200,000 rupees per month. To afford that, a person must earn approximately Rs. 300,000 before tax is paid. This is not possible within the revised pay structure. Add to this the cost of buying one's own car, and the option without car and house looks attractive only to those who are already rich and who already own a property/car in Mumbai. Hardly a means of attracting talent from the market into the regulator. A rational person who is not rich, would choose an option where a car and house is provided by the regulator and is faced with the choice of a vacuum - what does he get if he/she so chooses? No answers in the revised pay scale. I think the government needs to relook what it has accepted - and it ought to accept the recommendations of the Commission instead of making this semi cooked meal if it is serious about attracting market talent to the regulatory bodies.

Conspiracy theorists will immediately jump and claim that this is a conspiracy of the bureaucrats to limit pay of others below their own. My take is that it is just a poorly thought decision and can easily be corrected.

Note: the five regulators are Telecom Regulatory Authority of India, Insurance Regulatory and Development Authority, Central Electricity Regulatory Commission, Securities and Exchange Board of India and the Competition Commission of India

Competition in exchanges and OTC markets

Manish Sabharwal has another good piece in the Economic Times on competition in the exchange and OTC space.

Update: Just saw the contrary view from the above by SEBI Executive Director MS Ray in the online Mint.

Non profit Initial Public Offering

The 11th Sept 08 edition of the Economist (subscription required) has a piece on a charitable organisation 'Do Something' raising public funds in a manner similar to a corporate public offering. The organisation Do Something is raising US $8 million by way of an IPO (the public raising has no expenses which will be paid from the proceeds). The stated purpose of the IPO is to provide significant Social Return on Income (SROI). Here is an excerpt from the paper which explains the philosophy behind the capital raising:

"The IPO prospectus, put together by Do Something’s board of chief executives and technology entrepreneurs, contains the usual market data, a description of the 15-year-old organisation’s activities, an overview of the competitive landscape and bold claims about its qualities (“Do Something is also one of the most efficient organisations in the United States”), all designed to convince investors that it can achieve its ambitious goals. The only thing that stops it from being a typical IPO prospectus is the absence of any pledge to make a profit. On the contrary, the opening boilerplate explains that “units offered in conjunction with this prospectus represent a perpetual interest in Do Something; this interest is strictly philanthropic, with no provision for cash returns at any time.”

The natural question is why do an IPO when the fundamental principles of profit motive and capital appreciation are taken away from the capital raising process. Here are some of the key reasons:
a) A charitable organisation typically spends substantial time and effort to raise funds which often get exhausted in a few months at most and then the cycle of raising funds restarts - distracting management from its core task at hand and instead making them spend valuable time trying to raise money for short term needs. The IPO allows raising of long term capital, allowing such focus.

b) The organisation will be more transparent with quarterly performance and financials being exposed to the 'shareholders'. There will also be closer and more transparent meeting of the shareholders with the management.

c) If the charter provides, the shareholders can remove management for non performance or other such reasons.

d) The IPO process improves M&A activity in charitable bodies - take the example of cancer research. If a person's spouse has died of the dreaded disease, it is likely that the person would create a small charitable foundation for cancer research. With a few thousand dollars, the money isn't going to go too far in terms of output of research - but if several dozen or hundreds of such bodies were to merge, the scale would allow serious funding/research to take place. An IPO would enable such bodies to merge using the currency of securities. I believe the process in the US is not very complex for achieving this.

While Do Something is not a pioneer in the field of an IPOs for a charitable organisation, it is perhaps for the first time that it has opened itself to change in management by shareholders and thus injected a new level of governance structure in the opaquely run charitable world.

CEO of Do Something, Nancy Lublin is a friend and fellow YGL.

Investment in stock exchanges - limits enhanced

While the press has not yet reported on it, there is another big news from the SEBI Board meeting of today. See the SEBI Press Release (no direct link - click on the PR of 6th Oct). See my previous post on 6th Sept which in turn refers to my three previous blog posts on the issue. Again arguably a step in the right direction, but the quantum is inadequate from a governance of exchanges perspective. In fact I have argued on my 26th August post that a 15% limit is worse for investors than a 5% limit to the extent that they have no voice in the governance of the exchange but can lose 15% instead of 5% of the capital. I.e. the only reason a sophisticated financial institution would invest 15% in an Indian exchange would be a) it loves throwing away money without any control on how it is thrown away or b) in expectation that the limit will slowly be increased further by SEBI/Government.

There could of course be unhealthy pacts between the brokers collectively and the 15% investor allowing defacto control of the exchange to such investor - but that would militate against both the putative limit of 15% and the attempt to demutualise control out of the hands of the brokers.

See my posts of 9th August and 10th August also.

Participatory Note policy reversed

Newspapers report that the PN policy brought about by SEBI in October 07 to restrict foreign inflows and thus inflation, has been reversed by SEBI in its Board meeting today. This is a welcome move, even though both moves were reactive rather than strategic from the perspective of foreign exchange management by the government. See the SEBI Press Release (no direct link - click on the PR of 6th Oct).

PS: Percy Mistry khush hua.

PPS: The RBI has injected Rs. 200 billion by reducing CRR of banks by 50 basis points today. This should help the liquidity parched economy.

Emergency Economic Stabilization Bill of 2008

If you are looking for the actual US senate approved financial rescue bill here it is - see pages 2 to 112.

CNBC debate on 'what wins now' - from the World Economic Forum's summer Davos

At the Annual Meeting of the Young Global Leaders (and the Meeting of the New Champions) held in Tianjin, China last week, I was part of the following debate.

What wins now? - What should be the key driver for business leaders right now in light of the recent financial crisis – Passion, Power, Purpose or Profit? hosted by CNBC, Europe.

John Bryant (left) and Sandeep Parekh at the debate

The debate is divided into four parts.

The Panellists

Passion: John Hope Bryant, CEO Operation Hope

Power: Prof Sandeep Parekh, Indian Institute of Management

Purpose: Vikram Akula, CEO SKS Microfinance

Profit: Geoff Riddell, CEO Zurich Financial Services Global Corporate

The Special Invited Guests

Selina Lo, CEO, Ruckus Wireless

Shai Agassi, CEO, Project Better Place

Zhang Xin, CEO, SOHO China Limited

Pan Shiyi, Chairman, SOHO China Limited

Justin Mallen, CEO, Silk Road Telecommunications

The broadcast show

The show will be first broadcast on Friday October 3rd at 23.00 CET to more than 340 million homes worldwide. It will subsequently be available for viewing online from the week beginning 13th October at CNBC.com from the Europe programming page: http://www.cnbc.com/id/27096357

Removing the prohibition on OTC derivatives in securities

The Economic Times of 24th Sept 08 carries my piece recommending removal of the prohibition on OTC derivatives in securities. This is a very simple process of deleting one circular issued by SEBI in May of 2000 - there is no need to either modify the regulations or the statute to effect this - though given its importance, it may need to be discussed by the full Board of SEBI.