Heads you lose, tails you lose

Instead of becoming a solution for ease of doing business,  leveling  the field can push players to distort it to gain advantage

Regulators are often criticized for not doing enough to create a level-playing field. The switch to paperless and automated trading was to eliminate forgery, induce transparency in transactions and quicken settlement.  Listing agreements aim to make issuers accountable to their shareholders. Disclosures have to be disseminated to all the stakeholders at the same time so as not to discriminate between small and big investors. The policy makers are, in turn, attacked for focusing on the demand side and ignoring the suppliers of paper. Liberalization of the economy has freed most sectors from the need to apply for licences. The goods and services tax regime has reduced the time and cost of transporting goods from one state to another. Many countries and companies prohibit exchanging monetary compensation for resolution from those with powers to dispense clearances and award contracts. Two recent controversies ironically expose the limitations of a symmetrical environment to carry out business. One shines a light on how even the best practices can be exploited. The other is an apt example of how the fear of being left out from the legitimate pursuit of wealth creation can perpetuate the rotten power structure that is sought to be dismantled for being loaded against the small player. 

If the collective weight of the arbitrary allotment of 2G spectrum and coal mines to cronies paralyzed the economy in the waning days of the UPA-2 government, at the heart of another 2009-2014 era misconduct that is grabbing the market’s attention is once again the issue of breach of faith by the custodians of the interests of investors.  After conniving auditors, careless mutual fund managers and selfish promoters, the role of a bourse has come under scrutiny for violating the sanctity of the market. The National Stock Exchange stands guilty of providing some traders 10:1 speed advantage by allowing them to set up their servers in its premises. The Securities and Exchange Board of India has imposed a hefty penalty and banned NSE’s head of regulations, two brokers and two officials with another intermediary from associating or providing services to participants. The period since receiving a whistle-blower’s complaint in 2015 has been marked by the watchdog’s uneven response. The initial indifference turned to reluctant acknowledgement of the problem. The long-drawn inquiry that at times looked like to have hit a dead-end is an outcome of the complexity of the issue. Just like privileged information, unfair access to data to refine trading strategies is becoming increasingly contentious. Such instances often end with a consent agreement, capturing the frustration of the regulator in digging out convincing evidence of malpractices. A fine without admitting to wrong-doing is a face-saving finale.  Till recently it did appear that the Sebi-NSE confrontation was heading in a similar direction. The abrupt indictments were, therefore, surprising. Confirming the suspicion that the case was fast-tracked to achieve a neat conclusion, the appellate tribunal has held in abeyance the crackdown on some of those who have been punished. The market monitor’s discharge of the exchange’s former technology official and business chief also consolidates the position that the dark-fiber network connecting the trading platform’s server with select brokers might be due to ignorance of the gravity of the misstep. 

In a nod to the difficulty in establishing guilt in securities frauds, the US Securities Exchange Commission is seeking a jury trial in a bribery scandal. It will allow investors a scrutiny of the facts marshaled by the plaintiffs and the defendants even though Cognizant Technology Solutions has agreed to pay US$25 million as settlement under the Foreign Corruption Prevention Act for using its Indian construction services provider as a conduit for US $3.64-million bribes for three years from 2012 to local government officials to secure permits and clearances for campuses in Chennai and Pune. An audit conducted by leading law firms in the US and India, with the help of forensic experts from Hong Kong, in 2017 found no evidence of the involvement of the contractor, L&T, or any of its executives. The top brass of the NSE lost sight of the manipulation of technology deployed for superior user experience. The alleged L&T-Cognizant collusion points to the failure to install appropriate mechanism to check the implementation of economic reforms at the grassroots.  Just like marrying sophisticated tools with manual investigation has reduced but not eliminated insider trading, a level-playing field can lead to efforts to make it lopsided to secure advantage.   

-Mohan Sule

Loss of momentum

Regulatory missteps, selfish promoters and lack of accountability of money managers are undermining investors’ confidence

It is not only macro headwinds that can torpedo growth projections. More than the disruptions caused by interest rate movements, currency fluctuations and crude oil volatility, unnecessary interventions on one hand and reluctance to interfere on the other hand by policy makers can destroy shareholder wealth. How to strike the balance between applying the right amount of pressure to ensure that players stick to the rules and the correct force to pull up those who have misused the opportunity presented to them was at the core of the Supreme Court directive striking down the bad loan resolution steps spelled out by the February 2018 circular of the Reserve Bank of India. The ruling prohibits banks from clubbing all borrowers for application of bankruptcy proceedings if debt is not recovered within 180 days after even a day’s delay in the repayment schedule for loans above Rs 2000 crore. Coal to independent power producers, the aggrieved plaintiffs, is monopolized by a public sector entity. The entry of the private sector to ease bottlenecks and inject competition received a setback when the apex court in September 2014 cancelled the illegal allocation of 204 coal blocks. Of the 84 re-allocated through auctions a year later, only 58 went to the power sector, comprising nearly 25% of the over Rs 1100000-crore NPAs.  Purchasers are electricity boards owned by state governments. They offer free or subsidized services. The Ujwal discom assurance yojna or Uday in late 2015 allowed state governments to take on 75% of the debt of the distributors and issue bonds to the lenders as long as the SEBs reduced the technical and commercial losses to 15% by FY 2019. Only seven of the 24 states that opted for the scheme have managed to meet the target. The deficit of the remaining has widened.

The shakeup to cleanse the system has received a setback because of the inability of the policy makers to unshackle the entire value chain in some sectors. Electricity generation has been opened up. Transmission still remains the domain of the public sector, except for some metros. Till the recent thrust on last-mile connectivity under the Saubhagya, the footprint was limited. The problem is not output capability but the reluctance to charge market rates to retail consumers. The result is erratic supply and under-utilization of plant capacity. Just as the attraction of the power generators due to the huge untapped market turned sour on parceling of coal mines to cronies, the lost of pricing power has turned off investors from the telecom sector that has been a victim of arbitrary distribution of spectrum for 2G services. The dominant operators have the volumes but not the margins that differentiate peers. The churn in the aviation sector has reinforced the view that an emerging sector often leads to cannibalization by the participants. Clamping down on cost is difficult as the movement of aviation turbine fuel is uncertain. Passenger load is dependent not only on tariffs but also on routes and the geo-political situation. The need for constant infusion of funds is hampered by promoters’ reluctance to cede control.  

If telecom and aviation operators perpetually grapple with the dilemma of how to keep the users as well as the shareholders happy, there should be no such conflict for fund managers. They are answerable to the investors who surrender their money to them to earn decent returns.  Many factors that influence the value of the underlying assets are beyond control. Estimates do go wrong even after careful consideration of all available data. In such a situation, investors understand that they have to bear the losses. What is difficult to comprehend is when mutual funds fail to stick to their commitment of providing liquidity. Some have announced partial honoring of the fixed maturity plans that are due for redemption as they have given a grace period to a corporate borrower. The episode raises the issue of accountability of money managers in the risk they assume on behalf of investors. As the Securities and Exchange Board of India has linked fees to the corpus, AMCs have no motivation to perform. Their pedigree influences the choice of many investors rather than the track record. The RBI has started categorizing banks as systematically important based on their size. It is time for Sebi to label the top five fund houses as too important to fail. The portfolios of the schemes of these fund houses should be reviewed periodically to assess the basis of the investment decisions. The process might trigger risk aversion and affect returns. That will be a small price to pay to avoid a repetition of the collapse of UTI.

-Mohan Sule