The narrative of 'Too Big To Fail' is of the Robert Ludlum variety, where there is no Jason Bourne, but frantic CEOs and CFOs jet setting to make deals to save organisations, or rather themselves
Alan Greenspan had taken pride in his mathematical prowess, but admitted that the business of collateralised debt obligations (CDOs) had quite stumped him. It is not surprising that the subprime crisis became a financial crisis. And investment banks, hedge funds, banks, regulators and the media took the centre stage as rescue operations were conducted with mixed success to save institutions and the credibility of the system. Too Big to Fail does not go too much into how the crisis took place, but succinctly summarises its genesis. It deals with the manoeuvres involved in sorting out the mess, and is in a different genre.
Andrew Ross Sorkin’s book reads like a novel, and the reader can sense déjà vu. The narrative is of the Robert Ludlum variety, where there is no Jason Bourne, but frantic CEOs and CFOs jet setting to make deals to save organisations, or rather themselves. A layman could pass this off as finance pulp fiction, but as Sorkin says in the beginning, it is based on 500 hours of interviews with over 200 people involved in the crisis, including Wall Street CEOs, government officials, investors, lawyers and accountants.
By the third page, Sorkin tells us what the next 500-odd pages are going to be, as Jamie Dimon of JP Morgan, who is the pivot in this saga says, “We need to prepare right now for Lehman Brothers filing… and for Merrill Lynch filing… and for AIG filing… and for Morgan Stanley filing… and potentially for Goldman Sachs filing.” This sums up the crisis, though the central theme is Lehman, with the others thrown in to make the picture complete. Dick Fuld, Lehman’s CEO, is the protagonist who tries to save the institution. Lehman tries everything possible to survive, as its glamorous CFO, Erin Callan, juggles $6-billion exposure to CDOs with a provision of $200 million convincingly.
Hank Paulson, then US treasury secretary, is in the midst, and given his links with the investment banking fraternity, is their ally. They all work hard to bail out Lehman, which otherwise seemed too big to fail. They also seriously consider converting it to a bank so that it would have access to the discount window. Negotiations go on to sell it to Bank of America, while KDB (Korea Development Bank), with a modicum of intrigue, becomes a potential partner.
Meanwhile, John Thain of Merrill Lynch wants to sell 9.9 per cent stake to Bank of America, which insists on 100 per cent. The 16th floor of AIG is the next venue for the drama that unfolds with a bailout being discussed; with the Federal Reserve finally taking 79.9 per cent stake and providing a line of credit of $85 billion after convincing President George W. Bush.
Morgan Stanley is linked with financial services firm Wachovia. Once rumors of its exposure to AIG surface, shorting results. The drama heightens when Deutsche Bank sends feelers that it is a solid counterparty. This gradually leads the way to Mitsubishi paying up $9 billion for its stake, after Dimon refused assistance on grounds of it jeopardising J.P. Morgan’s future. Goldman Sachs quietly converts itself to a bank. So does Morgan Stanley.
Sorkin adeptly steers across organisations, going into details of the problems and behind- the-scene activities. Timothy Geithener of the Fed is a strong character who tries to orchestrate mergers for Goldman Sachs and Morgan Stanley. Ben Bernanke has to act against the shadow of the Depression, when it was felt that the Fed did not do much. Then there is ubiquitous short seller David Einhorn, a hedge fund manager who shorted Lehman’s shares and publicly questioned its accounting. Interestingly, the crisis converted business hostility into camaraderie, as 11 institutions get together to create an extra $100 billion for them, as the inevitability of Lehman sinks in.
In all, the story is illuminating as it highlights the strong links between the financial sector, the Fed and the US treasury department. We invariably find that those working with the government or regulators had once been frontrunners heading these big financial institutions. Is this why they are better able to appreciate the crisis, or is there an incestuous relationship between these two? The reader has to decide on this. They all got relief through the government’s troubled asset relief programme eventually. We also get to see the murkier side of how firms present results with clever masquerades that disguise the facts until the crisis unfolds.
Andrew Ross SorkinFor film buffs, Gordon Gekko provided the intrigue in the movie Wall Street in 1987, which was also famous for Black Monday. We now see the potential of this real drama translate to celluloid in Hollywood once again in the upcoming Wall Street II.
Author Details:
Andrew Ross Sorkin is The New York Times’s chief mergers-and-acquisitions reporter and a columnist. He is also the editor of DealBook, an online daily financial report he started in 2001. A bachelor in science from Cornell University, he has broken news of major M&As such as Chase’s acquisition of J.P. Morgan and HP’s acquisition of Compaq.
Thursday, October 28, 2010
Story Of A Street Smart Exchange: Business World Book Review: 6th February 2010
The focus of 'For Crying Out Loud' is on the transition of CME from an open outcry to an electronic platform during 1996-2006
By Leo Melamed
With open positions of $1.1 billion valued at $1.1 trillion, CME, known as a house that pork bellies built, did not have a single default during the financial crisis. Amazing? Yes. Leo Melamed in his semi-autobiographical book For Crying out Loud extols his belief in economist Milton Friedman’s ‘tyranny of the status quo’ that kept CME constantly innovating and improving. The degree of adaptability shown in terms of product response, alliances and fundamental business platform is quite remarkable for an organisation that is over a century old.
While the focus of the book is on the transition of CME from an open outcry to an electronic platform during 1996-2006, Melamed links the success to its inherent dynamism in responding to circumstances. He highlights the importance of John Maynard Keynes who said “when the facts change, I change”. This philosophy has been instrumental in bringing about change in the otherwise traditional institution.
CME was an exchange known for farm products and pork bellies. But today, it is a powerhouse in the financial future and options (F&O) segment. It has faced the challenges posed by its main competitor CBOT with alacrity. CME’s innovative live cattle contract was matched by CBOT’s carcass beef, which was improved by the ‘dressed beef’ contract of CME.
In the 1980s, CME replied to the launch of Nasdaq Index on CBOT with the S&P Index; and the victory of CBOT to launch Dow Jones was matched with 24-hour electronic trading in a mini S&P contract. Ironically, CBOT merged with CME in July 2007.
The author attributes the success of CME to a combination of four factors: leadership, technology, personnel and luck. While the first three are understandable, luck was manifest in US President Richard Nixon’s decision to move the dollar off gold, which, in turn, made the dollar market extremely volatile and boosted F&O trading in currencies. Stable currency environment, which was the rule under the Bretton Woods agreements, did not otherwise provide a sound basis for currency trade.
CME’s journey to become an electronic exchange through Globex was an adventure. With the shareholders against a disruption of the status quo, electronic trading started with post-traditional trading hours before gaining final acceptance. Here, the author shows human frailty as exhibited by the mind’s reluctance to change from the status quo in spite of the accompanying benefits.
Competition from LIffe in London, American Futures Exchange and Cantor Financial Futures Exchange (where US Treasuries and euro-dollar contracts were traded) provided the impetus. CME had hired Mckinsey for a roadmap, which, asked the exchange to go in for complete e-trading and demutualisation. A revived Globex, experimented with the chemicals F&O contracts on its electronic B2B platform.
The next level of innovation was in going public in 2002, and the ultimate push to convert to e-trading came when Eurex got the permission from CFTC to operate in the financial F&O segment in the US. Melamed attributes the wake-up call to three cross-currents: globalisation, capitalism and micro-dynamism. He also terms the financial crisis a grey swan as it was driven by the over-the-counter (OTC) derivatives markets, which could have been different if routed through exchanges.
The author, however, is noncommittal on whether the days of the trading pit are over. Going ahead, he sees the emergence of 2-3 mega futures exchanges and the integration of the securities and futures markets. That is the big picture waiting to emerge.
The story of CME is pertinent for India from the point of view of commodity exchanges. The revival of futures trading in commodities helped create electronic exchanges, making India a leader in e-trading. The lead was taken by the National Stock Exchange in the 1990s; it had the advantage of not having the baggage of history. Hence, it became one of its kinds in the world, where people could trade from home. While many were sceptical whether the trading community would accept this form of business, its inevitability was vindicated when the Bombay Stock Exchange too went electronic. In a way, India can take some pride in being ahead of times.
Leo MelamedAuthor Details:
Leo Melamed is an attorney and an active futures trader. He is currently chairman emeritus of CME Group, the world’s largest futures and options exchange, and CEO of consulting firm Melamed and Associates. Melamed has been an adviser to the US Commodity Futures Trading Commission. His books include Leo Melamed on the Markets, The Tenth Planet and Escape to the Futures.
By Leo Melamed
With open positions of $1.1 billion valued at $1.1 trillion, CME, known as a house that pork bellies built, did not have a single default during the financial crisis. Amazing? Yes. Leo Melamed in his semi-autobiographical book For Crying out Loud extols his belief in economist Milton Friedman’s ‘tyranny of the status quo’ that kept CME constantly innovating and improving. The degree of adaptability shown in terms of product response, alliances and fundamental business platform is quite remarkable for an organisation that is over a century old.
While the focus of the book is on the transition of CME from an open outcry to an electronic platform during 1996-2006, Melamed links the success to its inherent dynamism in responding to circumstances. He highlights the importance of John Maynard Keynes who said “when the facts change, I change”. This philosophy has been instrumental in bringing about change in the otherwise traditional institution.
CME was an exchange known for farm products and pork bellies. But today, it is a powerhouse in the financial future and options (F&O) segment. It has faced the challenges posed by its main competitor CBOT with alacrity. CME’s innovative live cattle contract was matched by CBOT’s carcass beef, which was improved by the ‘dressed beef’ contract of CME.
In the 1980s, CME replied to the launch of Nasdaq Index on CBOT with the S&P Index; and the victory of CBOT to launch Dow Jones was matched with 24-hour electronic trading in a mini S&P contract. Ironically, CBOT merged with CME in July 2007.
The author attributes the success of CME to a combination of four factors: leadership, technology, personnel and luck. While the first three are understandable, luck was manifest in US President Richard Nixon’s decision to move the dollar off gold, which, in turn, made the dollar market extremely volatile and boosted F&O trading in currencies. Stable currency environment, which was the rule under the Bretton Woods agreements, did not otherwise provide a sound basis for currency trade.
CME’s journey to become an electronic exchange through Globex was an adventure. With the shareholders against a disruption of the status quo, electronic trading started with post-traditional trading hours before gaining final acceptance. Here, the author shows human frailty as exhibited by the mind’s reluctance to change from the status quo in spite of the accompanying benefits.
Competition from LIffe in London, American Futures Exchange and Cantor Financial Futures Exchange (where US Treasuries and euro-dollar contracts were traded) provided the impetus. CME had hired Mckinsey for a roadmap, which, asked the exchange to go in for complete e-trading and demutualisation. A revived Globex, experimented with the chemicals F&O contracts on its electronic B2B platform.
The next level of innovation was in going public in 2002, and the ultimate push to convert to e-trading came when Eurex got the permission from CFTC to operate in the financial F&O segment in the US. Melamed attributes the wake-up call to three cross-currents: globalisation, capitalism and micro-dynamism. He also terms the financial crisis a grey swan as it was driven by the over-the-counter (OTC) derivatives markets, which could have been different if routed through exchanges.
The author, however, is noncommittal on whether the days of the trading pit are over. Going ahead, he sees the emergence of 2-3 mega futures exchanges and the integration of the securities and futures markets. That is the big picture waiting to emerge.
The story of CME is pertinent for India from the point of view of commodity exchanges. The revival of futures trading in commodities helped create electronic exchanges, making India a leader in e-trading. The lead was taken by the National Stock Exchange in the 1990s; it had the advantage of not having the baggage of history. Hence, it became one of its kinds in the world, where people could trade from home. While many were sceptical whether the trading community would accept this form of business, its inevitability was vindicated when the Bombay Stock Exchange too went electronic. In a way, India can take some pride in being ahead of times.
Leo MelamedAuthor Details:
Leo Melamed is an attorney and an active futures trader. He is currently chairman emeritus of CME Group, the world’s largest futures and options exchange, and CEO of consulting firm Melamed and Associates. Melamed has been an adviser to the US Commodity Futures Trading Commission. His books include Leo Melamed on the Markets, The Tenth Planet and Escape to the Futures.
The Money Manager’s Trapez: Book Review in Business World: 19th June 2010
Vinh Q. Tran focuses on how to preserve capital value while lowering risk factors to earn money when the markets are “upside down”
Market Upside Down: How to invest profitably in a shrinking economy
By Vinh Q. Tran
Predicting the future is hazardous. besieged as it is with mistaken signs and distorted rear view mirrors, made foggier with the passage of time and emotion. These words of Vinh Q. Tran summarise the substance of his book as he guides investors into doing the right thing with their money even in the wrong times.
In Market Upside Down, Tran’s attention is directed primarily to those who may be saving for post-retirement and would like to preserve their capital value and earn something above it. More importantly, they would like to lower their risk as much as possible. The focus is, hence, on how to earn money when the markets are “upside down”.
Tran manoeuvres your thought process through the beta curves (market risk exposure) and alphas (excess returns over the market adjusted for beta) to warn us against some common fallacies that we make while investing. A rising market is a no-brainer because you would gain at some time.
But Tran believes that this will not always hold if the downward cycles last longer — which is uncertain — and one gets caught at this time when searching for liquidity. Tran gives his version of the financial crisis, and feels the resuscitation packages have not taught us our lessons, and institutions may be engendering a new one.
This, combined with the fact the hegemony of the US dollar is eroded, means things could change drastically anytime. This view may change today in light of the Greek and Euro crisis where the dollar has once again become important, albeit by default.
Tran’s suggestion is that those who rely on stockmarkets after retirement should not enter the market as ‘strategists’ thinking the ‘bull run’ has begun. In the past cycle after the tech rally, the Dow had returned to the start after a sharp fall of 44 per cent. So, the concept of mean reverting can catch the investor in this trap.
Tran’s analysis of US markets shakes the shibboleths that have been held sacred. The first of them is that one cannot take the position that one can never lose in the long run, as the period is not defined. This is a major blow for your investment advisor who makes such a loose statement.
The second is the theory that stockmarkets are an inflation hedge. It works only in half the number of observed cycles, which shatters the image that has been held all along.
The third myth is that cost averaging yields optimal results. This debunks our own concept of systematic investment plans. This is quite a revelation that can leave the small investor wondering what to do as we are told that SIPs are the way out for an apprehensive investor.
The fourth myth broken is that risk and return go together. This questions the basis of the wisdom spewed in textbooks that correlates the two in terms of a trade-off. And the fifth one is an even greater blow to the theory of finance: VaR (value at risk) does not work as the Dow has recorded losses of 30 per cent or more very often. This comes as a shocker for the normal curve and its theories.
Further, few funds have a beta substantially lower than or greater than one, and few really outperform the market. We need to watch the regular analysts’ reports more closely to look beyond those numbers when they talk of the fund beating the market.
Finally, believing that the market is mean reverting could be an error as the time points can never be known.
In that case, how much should we put in stocks? One option is to think of how much of our wealth are we willing to lose. Now, just double it and put it in stocks. Another idea is to simply subtract our age from 100 and keep that proportion in stocks. These thumb rules are worth pursuing.
Tran suggests that we follow the policy of absolute return strategy where we diversify across equities, bonds, commodities, etc. in relation to our age profile. While this is again common-sense, the book should be viewed more as a reminder of moving towards ‘sanity’ while “we try and discern the contours of a vague outline”.
The book is recommended for all those who are attracted by the benefits of the market — often reiterated by our investment advisors. But reading this twice may make a first timer remain on the periphery of the market.
Author's Details:
Vinh Q. Tran has worked as a money manager for Morgan Stanley, Bank of America and Aetna Life and Casualty for 20 years. He has taught advanced investment as adjunct professor of finance at New York University’s Stern School of Business, and is the author of Evaluating Hedge Fund Performance. Tran holds a Ph.D. and MBA in finance from George Washington University.
Market Upside Down: How to invest profitably in a shrinking economy
By Vinh Q. Tran
Predicting the future is hazardous. besieged as it is with mistaken signs and distorted rear view mirrors, made foggier with the passage of time and emotion. These words of Vinh Q. Tran summarise the substance of his book as he guides investors into doing the right thing with their money even in the wrong times.
In Market Upside Down, Tran’s attention is directed primarily to those who may be saving for post-retirement and would like to preserve their capital value and earn something above it. More importantly, they would like to lower their risk as much as possible. The focus is, hence, on how to earn money when the markets are “upside down”.
Tran manoeuvres your thought process through the beta curves (market risk exposure) and alphas (excess returns over the market adjusted for beta) to warn us against some common fallacies that we make while investing. A rising market is a no-brainer because you would gain at some time.
But Tran believes that this will not always hold if the downward cycles last longer — which is uncertain — and one gets caught at this time when searching for liquidity. Tran gives his version of the financial crisis, and feels the resuscitation packages have not taught us our lessons, and institutions may be engendering a new one.
This, combined with the fact the hegemony of the US dollar is eroded, means things could change drastically anytime. This view may change today in light of the Greek and Euro crisis where the dollar has once again become important, albeit by default.
Tran’s suggestion is that those who rely on stockmarkets after retirement should not enter the market as ‘strategists’ thinking the ‘bull run’ has begun. In the past cycle after the tech rally, the Dow had returned to the start after a sharp fall of 44 per cent. So, the concept of mean reverting can catch the investor in this trap.
Tran’s analysis of US markets shakes the shibboleths that have been held sacred. The first of them is that one cannot take the position that one can never lose in the long run, as the period is not defined. This is a major blow for your investment advisor who makes such a loose statement.
The second is the theory that stockmarkets are an inflation hedge. It works only in half the number of observed cycles, which shatters the image that has been held all along.
The third myth is that cost averaging yields optimal results. This debunks our own concept of systematic investment plans. This is quite a revelation that can leave the small investor wondering what to do as we are told that SIPs are the way out for an apprehensive investor.
The fourth myth broken is that risk and return go together. This questions the basis of the wisdom spewed in textbooks that correlates the two in terms of a trade-off. And the fifth one is an even greater blow to the theory of finance: VaR (value at risk) does not work as the Dow has recorded losses of 30 per cent or more very often. This comes as a shocker for the normal curve and its theories.
Further, few funds have a beta substantially lower than or greater than one, and few really outperform the market. We need to watch the regular analysts’ reports more closely to look beyond those numbers when they talk of the fund beating the market.
Finally, believing that the market is mean reverting could be an error as the time points can never be known.
In that case, how much should we put in stocks? One option is to think of how much of our wealth are we willing to lose. Now, just double it and put it in stocks. Another idea is to simply subtract our age from 100 and keep that proportion in stocks. These thumb rules are worth pursuing.
Tran suggests that we follow the policy of absolute return strategy where we diversify across equities, bonds, commodities, etc. in relation to our age profile. While this is again common-sense, the book should be viewed more as a reminder of moving towards ‘sanity’ while “we try and discern the contours of a vague outline”.
The book is recommended for all those who are attracted by the benefits of the market — often reiterated by our investment advisors. But reading this twice may make a first timer remain on the periphery of the market.
Author's Details:
Vinh Q. Tran has worked as a money manager for Morgan Stanley, Bank of America and Aetna Life and Casualty for 20 years. He has taught advanced investment as adjunct professor of finance at New York University’s Stern School of Business, and is the author of Evaluating Hedge Fund Performance. Tran holds a Ph.D. and MBA in finance from George Washington University.
The Psychology Of Money Making: Book Review in Business World 1st November
'The Invisible Hands' focuses on 10 hedge fund managers, who succeeded to prosper during the height of the financial crisis with adaptive strategies
One class of professionals who flourished after the financial crisis is authors who wrote myriad books on the subject. Invariably, most of the books have been worded with clever hindsight as they eloquently pontificate on what should or should not have been done.
Steven Drobny steers away from such bromides and brings in a breath of fresh air in this book — his second. Drobny starts by highlighting the concern of real money funds, such as pension funds, which went bust during the crisis on account of investment decisions going awry. Instead of dissecting what went wrong, he focuses on 10 hedge fund managers, who succeeded with adaptive strategies.
Two things stand out in this book: first, these wizards go as anonymous investors, and the second is that their thoughts come out through meticulously prepared interviews. Refreshingly, the interviews are quite easy to read as the style is conversational. It is, hence, not without the touch of literary irony that Drobny has titled his book the invisible hands.
An important lesson emerging is that the pain of investment losses is not linear and there is a kink after which one is forced to change behaviour. Therefore, short-term investment performance has consequences for the long-term investor. Drobny concludes that it is easier to be a proprietary trader as you know your risk and losses, and are prepared for it. But, the same does not hold for a fund manager who is working on other people’s money.
Drobny talks a bit on the questions that we keep posing in these crazy markets. Should we hold illiquid instruments with higher returns? Do we deal with instruments where we can exit easily? To hedge illiquidity, do we need to stay liquid? Is holding cash actually cheap when the chips are down? Should it be commodities or equities or bonds or currencies, or something of everything: if so, then how much of each? Does the Sharpe ratio (risk-adjusted return) matter?
Drobny’s book dwells on portfolio construction, investment and risk management. But there are evidently no clear answers and the 10 invisible investors go with a different set of names, which adequately capture their approach to investment. The ‘house’, for instance, kept several hundred positions open at any point of time, while the ‘philosopher’ went behind the numbers and looked at economic fundamentals to create models of potential outcomes in terms of probabilistic expectations.
The ‘bond trader’ made sure that he never had a situation where redemptions created a deluge. The ‘professor’ was an adventurer who scoured the world for trading ideas and translated them into risk-reward outcomes. Cogent risk management involves using the ‘titanic funnel’ to estimate maximum loss. The professor, in fact, thinks Indian markets are hot, because with half the investment ratio of China, India trails in gross domestic product growth by just about a percentage point.
The ‘commodity trader’ goes on hard fundamentals and believes that speculation can work in the short run, but never in the long run. He worked on buying volatility when it was cheap to earn asymmetric payoffs. The ‘commodity investor’ was a long-run bull who managed risk by hedging large tail risks and worked on triangulated conviction — a complex thought where a simple theme is run across a matrix of assets after studying the micro and macro aspects. Risk management is through diversification, direction (long or short) and duration (commodities are long and equity short). The ‘commodity hedger’, a lady this time, uses stringent risk management collars on all large trades which would have actually saved the real money funds substantial looses.
Then there was the ‘equity trader’, who took a risk-based approach when managing real money portfolio, and would aim to get the best beta. Changing the style of operation every six months, typified what Drobny has called the ‘predator’ who ensured that you never find out how he operates, and hence stays ahead in the race. In 2008, he abandoned value considerations, reduced exposures, and settled for cash. Typically, he makes money on the long side and uses the short side to manage risk. Lastly, the adaptable investor is the ‘plasticine macro trader’ who gets various ideas, and then manages risk by being malleable and flexible.
Each of them had their favourite investments such as residential estate in the US, inflation linked debt, sub-Sahara, Latin America, currencies, crude oil, soya bean, gold and oil. One of them with a touch of humour went on to say that all he needed was a Bloomberg terminal!
By talking to the winners themselves and getting them to answer queries on asset allocation, Drobny makes the book extremely informative and readable. For those not too familiar with the nuances of finance, there are help boxes that help you meander through the labyrinth of jargon, so that the reader can navigate the pages as successfully as the invisible hands did with their terminals.
Author Details:
Steven Drobny is co-founder of Drobny Global Advisors (DGA), an international macroeconomic research and advisory firm. Drobny has worked with Deutsche Bank’s Hedge Fund Group in London, Singapore and Zurich. He holds a master’s degree from the London School of Economics and Political Science. His first book is Inside The House Of Money: Top Hedge Fund Traders On Profiting In The Global Markets.
One class of professionals who flourished after the financial crisis is authors who wrote myriad books on the subject. Invariably, most of the books have been worded with clever hindsight as they eloquently pontificate on what should or should not have been done.
Steven Drobny steers away from such bromides and brings in a breath of fresh air in this book — his second. Drobny starts by highlighting the concern of real money funds, such as pension funds, which went bust during the crisis on account of investment decisions going awry. Instead of dissecting what went wrong, he focuses on 10 hedge fund managers, who succeeded with adaptive strategies.
Two things stand out in this book: first, these wizards go as anonymous investors, and the second is that their thoughts come out through meticulously prepared interviews. Refreshingly, the interviews are quite easy to read as the style is conversational. It is, hence, not without the touch of literary irony that Drobny has titled his book the invisible hands.
An important lesson emerging is that the pain of investment losses is not linear and there is a kink after which one is forced to change behaviour. Therefore, short-term investment performance has consequences for the long-term investor. Drobny concludes that it is easier to be a proprietary trader as you know your risk and losses, and are prepared for it. But, the same does not hold for a fund manager who is working on other people’s money.
Drobny talks a bit on the questions that we keep posing in these crazy markets. Should we hold illiquid instruments with higher returns? Do we deal with instruments where we can exit easily? To hedge illiquidity, do we need to stay liquid? Is holding cash actually cheap when the chips are down? Should it be commodities or equities or bonds or currencies, or something of everything: if so, then how much of each? Does the Sharpe ratio (risk-adjusted return) matter?
Drobny’s book dwells on portfolio construction, investment and risk management. But there are evidently no clear answers and the 10 invisible investors go with a different set of names, which adequately capture their approach to investment. The ‘house’, for instance, kept several hundred positions open at any point of time, while the ‘philosopher’ went behind the numbers and looked at economic fundamentals to create models of potential outcomes in terms of probabilistic expectations.
The ‘bond trader’ made sure that he never had a situation where redemptions created a deluge. The ‘professor’ was an adventurer who scoured the world for trading ideas and translated them into risk-reward outcomes. Cogent risk management involves using the ‘titanic funnel’ to estimate maximum loss. The professor, in fact, thinks Indian markets are hot, because with half the investment ratio of China, India trails in gross domestic product growth by just about a percentage point.
The ‘commodity trader’ goes on hard fundamentals and believes that speculation can work in the short run, but never in the long run. He worked on buying volatility when it was cheap to earn asymmetric payoffs. The ‘commodity investor’ was a long-run bull who managed risk by hedging large tail risks and worked on triangulated conviction — a complex thought where a simple theme is run across a matrix of assets after studying the micro and macro aspects. Risk management is through diversification, direction (long or short) and duration (commodities are long and equity short). The ‘commodity hedger’, a lady this time, uses stringent risk management collars on all large trades which would have actually saved the real money funds substantial looses.
Then there was the ‘equity trader’, who took a risk-based approach when managing real money portfolio, and would aim to get the best beta. Changing the style of operation every six months, typified what Drobny has called the ‘predator’ who ensured that you never find out how he operates, and hence stays ahead in the race. In 2008, he abandoned value considerations, reduced exposures, and settled for cash. Typically, he makes money on the long side and uses the short side to manage risk. Lastly, the adaptable investor is the ‘plasticine macro trader’ who gets various ideas, and then manages risk by being malleable and flexible.
Each of them had their favourite investments such as residential estate in the US, inflation linked debt, sub-Sahara, Latin America, currencies, crude oil, soya bean, gold and oil. One of them with a touch of humour went on to say that all he needed was a Bloomberg terminal!
By talking to the winners themselves and getting them to answer queries on asset allocation, Drobny makes the book extremely informative and readable. For those not too familiar with the nuances of finance, there are help boxes that help you meander through the labyrinth of jargon, so that the reader can navigate the pages as successfully as the invisible hands did with their terminals.
Author Details:
Steven Drobny is co-founder of Drobny Global Advisors (DGA), an international macroeconomic research and advisory firm. Drobny has worked with Deutsche Bank’s Hedge Fund Group in London, Singapore and Zurich. He holds a master’s degree from the London School of Economics and Political Science. His first book is Inside The House Of Money: Top Hedge Fund Traders On Profiting In The Global Markets.
The Proverbial Contest: Book Review of Super Power in Business World
The Proverbial Contest
Raghav Bahl's Superpower? is a 50-50 game that provides a defensive Indian view of why we are better but does not weave a cogent analysis out of the multiple threads
By
India is good, but can never get as ‘sexy’ as China. It is a land of contradictions. We make good hotels, but will not bother about getting the road to the entrance right. We speak impeccable English, but are xenophobic. And so on. This is the starting point of Raghav Bahl’s journey into the now-clichéd India-China debate. Are we better than China? If China has bridges and roads, we have a young populace and speak English. The book, which makes the more patriotic Indian feel good, is a 50-50 game.
Bahl continues this comparison throughout. There are slices of history, politics and religion thrown in. Religion, though, seems incongruous; neither Hinduism nor Confucianism is akin to the Protestant ethic that, according to sociologist Max Weber, had influenced growth under western capitalism. The relations with the US also have their place somewhere. Reams have been churned out by the likes of Financial Times, The Economist and the IMF on the subject. Does Bahl have anything new to offer?
His analogy of hare and tortoise is novel. But a bit puerile at times, as we lose track of which one is ahead of the other. On infrastructure, China scores. We do better with language, legal system, entrepreneurship, stockmarket, etc. Often, western analysts are condescending about India, and talk of lost chances and the fact that China is bigger and more open. Bahl feels we are actually not that far off and it is a matter of time before we can get there, provided we want to.
The book is full of examples of what China ‘has’ and does ‘not have’. Its non-democratic government gets things done easily, and the success is manifest in economic data. Land acquisition is clear in China, but a hindrance in India where it comes in the way of progress. But China’s growth, which is based on investment and exports, may not be sustainable. People do not consume, but save, and hence India scores over China. We have three engines — liberalisation’s children, women consumers and rural economy. Chinese banks have been forced to lend and their non-performing assets could be higher than stated. Besides, its data is unreliable. It is a classic case of four ‘un’s — unstable, unbalanced, uncoordinated and unsustainable.
For every success story in China, there is also a Google or Danone or Rio Tinto. Also, China’s growth model after the Cultural Revolution has pushed entrepreneurship back, with the state solely controlling production. Foreign brands using China as an outsourcing hub is a mirage.
Though Bahl says India’s strengths have to be harnessed, he does not connect the dots. For example, he talks a lot on India’s young population, against China’s ageing. Concurrently, he shows how our social infrastructure, especially mass education, lags China. So, what is the use of such a large youth class, which will take to streets? Further, he says our robust financial system helped us escape the Lehman crisis. The truth, critics would say, was that we were too scared to innovate and self-eulogies are not tenable. China’s model has worked without the strength of English. Hence, it is not a limitation.
Bahl’s portraits are at times blurred, given that the hare and tortoise have different expressions of feeling at the end of each chapter. It would have been interesting if a roadmap was drawn, especially since the objective appears to have been to leverage these advantages. The action points could have covered those that can be done and should be done, but not immediately attainable given the limits of democracy.
The epilogue has just three pages, where the author blows hot and cold over everything. The disparaged Chinese set-up suddenly ends up having the ‘drive’ that India should not miss. And the much-touted democracy in India may not mean much. To play safe, Bahl comments that it is ‘advantage China’ though the odds are on ‘India’. Can you guess what that means?
So, how could one rate the book, which says things we know already? It provides a defensive Indian view of why we are better than what we thought by looking at an oft-debated issue with an Indian flavour. But it does not weave a cogent analysis out of the multiple threads. Nonetheless, it leaves the reader with the sense of feel good. India Inc. has endorsed the book, as one deciphers from the praises on the cover. And one hopes it has understood the India tilt in Bahl’s book correctly.
Raghav Bahl's Superpower? is a 50-50 game that provides a defensive Indian view of why we are better but does not weave a cogent analysis out of the multiple threads
By
India is good, but can never get as ‘sexy’ as China. It is a land of contradictions. We make good hotels, but will not bother about getting the road to the entrance right. We speak impeccable English, but are xenophobic. And so on. This is the starting point of Raghav Bahl’s journey into the now-clichéd India-China debate. Are we better than China? If China has bridges and roads, we have a young populace and speak English. The book, which makes the more patriotic Indian feel good, is a 50-50 game.
Bahl continues this comparison throughout. There are slices of history, politics and religion thrown in. Religion, though, seems incongruous; neither Hinduism nor Confucianism is akin to the Protestant ethic that, according to sociologist Max Weber, had influenced growth under western capitalism. The relations with the US also have their place somewhere. Reams have been churned out by the likes of Financial Times, The Economist and the IMF on the subject. Does Bahl have anything new to offer?
His analogy of hare and tortoise is novel. But a bit puerile at times, as we lose track of which one is ahead of the other. On infrastructure, China scores. We do better with language, legal system, entrepreneurship, stockmarket, etc. Often, western analysts are condescending about India, and talk of lost chances and the fact that China is bigger and more open. Bahl feels we are actually not that far off and it is a matter of time before we can get there, provided we want to.
The book is full of examples of what China ‘has’ and does ‘not have’. Its non-democratic government gets things done easily, and the success is manifest in economic data. Land acquisition is clear in China, but a hindrance in India where it comes in the way of progress. But China’s growth, which is based on investment and exports, may not be sustainable. People do not consume, but save, and hence India scores over China. We have three engines — liberalisation’s children, women consumers and rural economy. Chinese banks have been forced to lend and their non-performing assets could be higher than stated. Besides, its data is unreliable. It is a classic case of four ‘un’s — unstable, unbalanced, uncoordinated and unsustainable.
For every success story in China, there is also a Google or Danone or Rio Tinto. Also, China’s growth model after the Cultural Revolution has pushed entrepreneurship back, with the state solely controlling production. Foreign brands using China as an outsourcing hub is a mirage.
Though Bahl says India’s strengths have to be harnessed, he does not connect the dots. For example, he talks a lot on India’s young population, against China’s ageing. Concurrently, he shows how our social infrastructure, especially mass education, lags China. So, what is the use of such a large youth class, which will take to streets? Further, he says our robust financial system helped us escape the Lehman crisis. The truth, critics would say, was that we were too scared to innovate and self-eulogies are not tenable. China’s model has worked without the strength of English. Hence, it is not a limitation.
Bahl’s portraits are at times blurred, given that the hare and tortoise have different expressions of feeling at the end of each chapter. It would have been interesting if a roadmap was drawn, especially since the objective appears to have been to leverage these advantages. The action points could have covered those that can be done and should be done, but not immediately attainable given the limits of democracy.
The epilogue has just three pages, where the author blows hot and cold over everything. The disparaged Chinese set-up suddenly ends up having the ‘drive’ that India should not miss. And the much-touted democracy in India may not mean much. To play safe, Bahl comments that it is ‘advantage China’ though the odds are on ‘India’. Can you guess what that means?
So, how could one rate the book, which says things we know already? It provides a defensive Indian view of why we are better than what we thought by looking at an oft-debated issue with an Indian flavour. But it does not weave a cogent analysis out of the multiple threads. Nonetheless, it leaves the reader with the sense of feel good. India Inc. has endorsed the book, as one deciphers from the praises on the cover. And one hopes it has understood the India tilt in Bahl’s book correctly.
Don’t stop those flows: Financial Express: October 28 2010
The torrent of FII flows into the country has once again germinated the debate on imposing a tax on capital inflows. We have countries like Brazil and Thailand that have resorted to taxing them and RBI has been trying to make the right sounds, though admittedly the same has not been spoken of as yet. The pressure is palpable, given that the interest rates in the West will remain benign for most part of 2011, which will mean that capital inflows will come for some more time and hence cannot be looked at as being a temporary aberration. What really is the right way to go about it?
We need to separate the two issues here—capital inflows and their impact on the currency. The former has an impact on the latter but they need to be addressed independently. Let us ask the question as to whether we need capital inflows today. The answer is a big ‘yes’ because we are running a current account deficit that will move towards the 3.5% mark this year. This is so because our trade deficit is widening, which is a good sign, since imports of the non-oil variety are increasing. Also with the US or rather some parts of the US talking tough on outsourcing, software receipts will be impacted, leading to a larger current account deficit.
The best way of tackling these deficits is through higher capital inflows. FDI would come in the normal course as would NRI funds. The ECB market is still regulated by RBI, which means that the FIIs have to provide support in some form. This is the beginning part of the Tobin tax story. These funds have been pouring into the country creating problems on rupee appreciation. There are two reasons put forward for controlling these flows. The first is that this is perceived as hot money that could reverse any time, which is destabilising. The second is that they are creating problems on the currency side, which, in turn, has monetary policy implications. In the last two decades or so, there have been only two instances when there were net outflows from the country in FY99 and FY09. Therefore, to assume that these funds, which cumulate to around $114 bn, would dispel smells of paranoia, especially if we believe in the India growth story.
Are these numbers alarming? Getting in, say, around $20 bn in 6 months is not really a large amount, given our balance of payments situation. While our foreign currency reserves are high at $270 bn, we must realise that our import cover ratio (4 months is around $120 bn) is also rising, as is our external debt, which was $273 bn in June 2010. Therefore, we cannot really get smug about these inflows because we need them.
Now the more serious issue for us is the appreciation of the rupee. More capital inflows lead to appreciation of the currency and while the text book says that we should let the rupee strengthen, the world does not operate that way. China has been recalcitrant with the renminbi and our trade competitors are holding back their currency from strengthening, which means that we have to follow suit or else our exports would slide.
Now, if we accept that we need the dollars, which is not hot money, but do not want the appreciation, the best way out is for the RBI to mop them up. Currently, with deposits growing slower than credit, there is a liquidity crunch, which is being made good by these dollars. Assuming that this equation balances, then RBI should buy the dollars to ensure that the currency is stable.
The economic argument here is that money supply increases will be inflationary and a chaotic paradox for RBI, which is hiking rates to control demand-pull-monetary forces. But we have a countervailing move that can be invoked, in the form of issuance of MSS bonds. Our budget included Rs 50,000 crore of such bonds for the year and hence should be used to counter these flows. The cost will be the interest component that the government will have to bear, which at an average rate of 8% would work out to Rs 4,000 crore a year.
The takeaways are that if we believe in the 10% growth story, we should allow unhindered capital inflows. These funds would support liquidity in the system when it is scarce. RBI intervention subsequently is advisable to hold the currency through the MSS sterilisation process. The cost is not really high considering that we get the best of the capital flows as well as a stronger rupee in an imperfect inward-looking economic world.
We need to separate the two issues here—capital inflows and their impact on the currency. The former has an impact on the latter but they need to be addressed independently. Let us ask the question as to whether we need capital inflows today. The answer is a big ‘yes’ because we are running a current account deficit that will move towards the 3.5% mark this year. This is so because our trade deficit is widening, which is a good sign, since imports of the non-oil variety are increasing. Also with the US or rather some parts of the US talking tough on outsourcing, software receipts will be impacted, leading to a larger current account deficit.
The best way of tackling these deficits is through higher capital inflows. FDI would come in the normal course as would NRI funds. The ECB market is still regulated by RBI, which means that the FIIs have to provide support in some form. This is the beginning part of the Tobin tax story. These funds have been pouring into the country creating problems on rupee appreciation. There are two reasons put forward for controlling these flows. The first is that this is perceived as hot money that could reverse any time, which is destabilising. The second is that they are creating problems on the currency side, which, in turn, has monetary policy implications. In the last two decades or so, there have been only two instances when there were net outflows from the country in FY99 and FY09. Therefore, to assume that these funds, which cumulate to around $114 bn, would dispel smells of paranoia, especially if we believe in the India growth story.
Are these numbers alarming? Getting in, say, around $20 bn in 6 months is not really a large amount, given our balance of payments situation. While our foreign currency reserves are high at $270 bn, we must realise that our import cover ratio (4 months is around $120 bn) is also rising, as is our external debt, which was $273 bn in June 2010. Therefore, we cannot really get smug about these inflows because we need them.
Now the more serious issue for us is the appreciation of the rupee. More capital inflows lead to appreciation of the currency and while the text book says that we should let the rupee strengthen, the world does not operate that way. China has been recalcitrant with the renminbi and our trade competitors are holding back their currency from strengthening, which means that we have to follow suit or else our exports would slide.
Now, if we accept that we need the dollars, which is not hot money, but do not want the appreciation, the best way out is for the RBI to mop them up. Currently, with deposits growing slower than credit, there is a liquidity crunch, which is being made good by these dollars. Assuming that this equation balances, then RBI should buy the dollars to ensure that the currency is stable.
The economic argument here is that money supply increases will be inflationary and a chaotic paradox for RBI, which is hiking rates to control demand-pull-monetary forces. But we have a countervailing move that can be invoked, in the form of issuance of MSS bonds. Our budget included Rs 50,000 crore of such bonds for the year and hence should be used to counter these flows. The cost will be the interest component that the government will have to bear, which at an average rate of 8% would work out to Rs 4,000 crore a year.
The takeaways are that if we believe in the 10% growth story, we should allow unhindered capital inflows. These funds would support liquidity in the system when it is scarce. RBI intervention subsequently is advisable to hold the currency through the MSS sterilisation process. The cost is not really high considering that we get the best of the capital flows as well as a stronger rupee in an imperfect inward-looking economic world.
Investors guide to equitable information : Economic Times: 28th October 2010
grade is not only a recommendation to buy but only an evaluation of the fundamentals of a company going in for an initial public offering.
When the idea of equity grading was first proposed in the late 1990s,it was dismissed by critics as being a good theoretical,though fantastical,concept.
The purpose of rating equities was to provide the potential investor with a view if a company was fundamentally sound.
More than a decade down the line,IPO grading has caught on and sounds a capital idea in a market that is characterised by information asymmetry that becomes even more acute given the imperfections in the market.What exactly are we talking of
The capital market is booming today,and since a rising stock index is a prerequisite for buoyancy in the primary market,this is the right time for companies to raise money.
Prior to reforms,shares had to be priced according to a preset formula of the Controller of Capital Issues.
With reforms,this institution was abolished and free pricing became the norm as innovations such as book-building with price discovery invoked within a band becoming popular.
While this is good in a market economy where companies could get the premium that the fundamentals demanded,many fly-by-night operators raised money to later disappear or get into sick mode,leaving the investors holding junk paper.
The situation is not dissimilar to the information system in the second-hand car market lemons where the issuer knows how good the company is but the investor does not have much to go on.
This is the idea behind the concept of IPO grading that the creditrating agencies have offered to investors.
The grading is based on a thorough study of fundamentals of the company,its financials,prospects,promoters,industry profile,etc.
The grades,between 1 and 5,tell the investor about the fundamentals of the company seen at this level.
This is of particular importance for companies going for an initial public offering (IPO) where the public has limited knowledge of the unit.
The information is drawn from documents filed with the regulator.
But a layman cannot really make much of this bundle of literature.
Hence,a credit rating agency bridges this information gap with a grading.
However,a grade is not a recommendation to buy but only an evaluation of the fundamentals of a company going in for an IPO.
The problem today is that it has been interpreted as being a recommendation to purchase a security and,hence,the evaluation of the grading has been juxtaposed with the market price.
This is a typical manifestation of investor frailty where one ends up interpreting any view as an advice.
This would not be the right way to go about it as markets move up and down based on a mlange of factors that often may not have a bearing on the performance of the company.
Therefore,it has been taken to be analogous to the concept of equity research done by investment banks and brokers who give a trading call: buy or sell.
The debate today is that if the IPO grading system is not going to be tested against the market,then does it serve any purpose.
It is pertinent to note that once we move away from the scheme of intermediation and enter the market,the transition is into the world of unknown where the investor only gets to see what the issuers want you to see.
In case of a bank,one puts money as a deposit.
The bank has the skills to bridge the information gap and has the risk-taking ability to actually lend onwards to the borrower.
The cost of intermediation is high at times,but that is the price that the ultimate saver pays for security.
Once in the market,the risk and returns are borne by the investor.
This is where the credit-rating agency comes into the frame.
The rating given for debt or the grading to an IPO is an evaluation of either the servicing ability of the issuer or the fundamental strength of the company.
This view,which is not an advise,is given independently by a specialist body and,hence,provides an additional input to be taken by the investor before putting in money.
It is not a certification of the price being right or not.
Now,is this product a useful one This can be examined from both the ends.
Based on counter-intuitive reasoning,that companies are going for grading and not complaining given that it is mandatory,meaning they see value in the exercise.
From the investors point of view,she gets the analysis in one number and can use this to judge if the pricing is right as the grading is done before the price is fixed.
Also,the test of the grading is not in the market price but the overall performance of the company;as prices vary depending on extraneous conditions.
And the market is the final judge of the agency that has its reputation at stake.
Therefore,any evaluation of the IPO grading process should work on the premise that it is the grading of the fundamentals that is done even before the price is fixed by the issuer.
Else,one could come to an erroneous conclusion if it is taken to be an investment advisory service.
To quote Ayn Rand,Contradictions do not exist.
Whenever you think you are facing a contradiction,check your premises.
You will find that one of them is wrong. This should be the spirit behind viewing such a product.
When the idea of equity grading was first proposed in the late 1990s,it was dismissed by critics as being a good theoretical,though fantastical,concept.
The purpose of rating equities was to provide the potential investor with a view if a company was fundamentally sound.
More than a decade down the line,IPO grading has caught on and sounds a capital idea in a market that is characterised by information asymmetry that becomes even more acute given the imperfections in the market.What exactly are we talking of
The capital market is booming today,and since a rising stock index is a prerequisite for buoyancy in the primary market,this is the right time for companies to raise money.
Prior to reforms,shares had to be priced according to a preset formula of the Controller of Capital Issues.
With reforms,this institution was abolished and free pricing became the norm as innovations such as book-building with price discovery invoked within a band becoming popular.
While this is good in a market economy where companies could get the premium that the fundamentals demanded,many fly-by-night operators raised money to later disappear or get into sick mode,leaving the investors holding junk paper.
The situation is not dissimilar to the information system in the second-hand car market lemons where the issuer knows how good the company is but the investor does not have much to go on.
This is the idea behind the concept of IPO grading that the creditrating agencies have offered to investors.
The grading is based on a thorough study of fundamentals of the company,its financials,prospects,promoters,industry profile,etc.
The grades,between 1 and 5,tell the investor about the fundamentals of the company seen at this level.
This is of particular importance for companies going for an initial public offering (IPO) where the public has limited knowledge of the unit.
The information is drawn from documents filed with the regulator.
But a layman cannot really make much of this bundle of literature.
Hence,a credit rating agency bridges this information gap with a grading.
However,a grade is not a recommendation to buy but only an evaluation of the fundamentals of a company going in for an IPO.
The problem today is that it has been interpreted as being a recommendation to purchase a security and,hence,the evaluation of the grading has been juxtaposed with the market price.
This is a typical manifestation of investor frailty where one ends up interpreting any view as an advice.
This would not be the right way to go about it as markets move up and down based on a mlange of factors that often may not have a bearing on the performance of the company.
Therefore,it has been taken to be analogous to the concept of equity research done by investment banks and brokers who give a trading call: buy or sell.
The debate today is that if the IPO grading system is not going to be tested against the market,then does it serve any purpose.
It is pertinent to note that once we move away from the scheme of intermediation and enter the market,the transition is into the world of unknown where the investor only gets to see what the issuers want you to see.
In case of a bank,one puts money as a deposit.
The bank has the skills to bridge the information gap and has the risk-taking ability to actually lend onwards to the borrower.
The cost of intermediation is high at times,but that is the price that the ultimate saver pays for security.
Once in the market,the risk and returns are borne by the investor.
This is where the credit-rating agency comes into the frame.
The rating given for debt or the grading to an IPO is an evaluation of either the servicing ability of the issuer or the fundamental strength of the company.
This view,which is not an advise,is given independently by a specialist body and,hence,provides an additional input to be taken by the investor before putting in money.
It is not a certification of the price being right or not.
Now,is this product a useful one This can be examined from both the ends.
Based on counter-intuitive reasoning,that companies are going for grading and not complaining given that it is mandatory,meaning they see value in the exercise.
From the investors point of view,she gets the analysis in one number and can use this to judge if the pricing is right as the grading is done before the price is fixed.
Also,the test of the grading is not in the market price but the overall performance of the company;as prices vary depending on extraneous conditions.
And the market is the final judge of the agency that has its reputation at stake.
Therefore,any evaluation of the IPO grading process should work on the premise that it is the grading of the fundamentals that is done even before the price is fixed by the issuer.
Else,one could come to an erroneous conclusion if it is taken to be an investment advisory service.
To quote Ayn Rand,Contradictions do not exist.
Whenever you think you are facing a contradiction,check your premises.
You will find that one of them is wrong. This should be the spirit behind viewing such a product.
The enduring metal: 23rd October 2010 Indian Express
Gold has always been an enigma for investors all over the world. India is, of course, the world’s largest consumer of the metal — Indians have traditionally invested in gold more as a necessity driven by social compulsions. But now it has also become an attractive
investment option, since it’s viewed as a natural hedge against inflation. At a more academic level, it’s also a substitute for the dollar.
The price of gold has been increasing sharply in the last couple of months to cross $1,300 an ounce and analysts have not ruled out its touching the $1,500 mark in near future. The question is whether this trajectory will continue upwards or whether it will stabilise and then drift downwards after a while.
The price of any product is driven by demand relative to supply, and gold is no exception to this rule. At the moment, demand is moving faster than supply and that’s pushing up prices. Look at the demand side. Conventional demand has increased as more people are moving towards gold as an asset class. The weakening dollar is the economic justification and the rising price of gold on its own is creating further demand for this class of users. Second, the gold exchange traded funds have been busy buying gold and accounted for around a third of the physical demand for gold in Q2 of 2010. On the back of these purchases of gold, financial products are then offered in the market for investors. The third category of entities which demand gold are the consumers who buy jewellery, where demand has been rising, albeit moderately. Therefore, it’s the investor class, more than the consumer class, which has really driven demand.
How about supply? The World Gold Council has stated that supplies are more or less fixed in terms of what is mined annually — which is valued at around $200 billion. Q2 had witnessed a supply valued at around $40
billion. Central banks have also been active in the gold market. In the past, gold was held as a non-remunerative asset and central banks preferred to invest their surpluses in bonds rather than gold. It may be recollected that, not long ago, the fear that such sales may depress prices had led central banks of Europe to impose restrictions among themselves on the sale of gold. However, after the financial crisis there have been doubts cast on the US economy and the strength of the dollar. Hence, it’s not surprising that central banks have gone back to acquiring gold instead of selling it — a change in role from a supplier to an active buyer in the market.
In this scenario, where are gold prices headed? Gold has a direct relation with the dollar. As long as the dollar weakens, investors will move to gold, and the correlation here is as high as between 80-90 per cent. The dollar is weakening against the euro in the range of around 1.35-1.40 and this scenario will probably persist given that the US economy is shaky while the euro region is
relatively better off. However, a strong euro may not work in favour of the eurozone, and there would be resistance to the extent to which the dollar can fall. Therefore, this particular factor may not persist for too long.
Besides, the US is trying to lower its deficits, which could also help to strengthen the dollar.
This leaves the other factors at play — central banks and funds. Central banks are still in shopping mode and funds would leverage the conditions to keep their incomes ticking. Gold is traditionally a good investment option and gives returns between 15-18 per cent and can be positioned somewhere between government bonds and the stock market. This interest will always remain and hence the price may not really recede and would tend to stabilise even after global adjustments occur. As long as there is scepticism about the world monetary order, interest in gold will remain strong.
What does it mean for us in India? India, though the largest consumer of gold, is a price taker. This means we take the price that’s determined on COMEX. The prices would replicate global trends, which in turn are influenced by our demand. With income levels increasing and high inflation prevailing there has been a tendency at the margin for households to look at gold progressively — though there is not much evidence of substantially higher imports of gold by India. There will hence be a tendency for the prices to move up during this festival season.
investment option, since it’s viewed as a natural hedge against inflation. At a more academic level, it’s also a substitute for the dollar.
The price of gold has been increasing sharply in the last couple of months to cross $1,300 an ounce and analysts have not ruled out its touching the $1,500 mark in near future. The question is whether this trajectory will continue upwards or whether it will stabilise and then drift downwards after a while.
The price of any product is driven by demand relative to supply, and gold is no exception to this rule. At the moment, demand is moving faster than supply and that’s pushing up prices. Look at the demand side. Conventional demand has increased as more people are moving towards gold as an asset class. The weakening dollar is the economic justification and the rising price of gold on its own is creating further demand for this class of users. Second, the gold exchange traded funds have been busy buying gold and accounted for around a third of the physical demand for gold in Q2 of 2010. On the back of these purchases of gold, financial products are then offered in the market for investors. The third category of entities which demand gold are the consumers who buy jewellery, where demand has been rising, albeit moderately. Therefore, it’s the investor class, more than the consumer class, which has really driven demand.
How about supply? The World Gold Council has stated that supplies are more or less fixed in terms of what is mined annually — which is valued at around $200 billion. Q2 had witnessed a supply valued at around $40
billion. Central banks have also been active in the gold market. In the past, gold was held as a non-remunerative asset and central banks preferred to invest their surpluses in bonds rather than gold. It may be recollected that, not long ago, the fear that such sales may depress prices had led central banks of Europe to impose restrictions among themselves on the sale of gold. However, after the financial crisis there have been doubts cast on the US economy and the strength of the dollar. Hence, it’s not surprising that central banks have gone back to acquiring gold instead of selling it — a change in role from a supplier to an active buyer in the market.
In this scenario, where are gold prices headed? Gold has a direct relation with the dollar. As long as the dollar weakens, investors will move to gold, and the correlation here is as high as between 80-90 per cent. The dollar is weakening against the euro in the range of around 1.35-1.40 and this scenario will probably persist given that the US economy is shaky while the euro region is
relatively better off. However, a strong euro may not work in favour of the eurozone, and there would be resistance to the extent to which the dollar can fall. Therefore, this particular factor may not persist for too long.
Besides, the US is trying to lower its deficits, which could also help to strengthen the dollar.
This leaves the other factors at play — central banks and funds. Central banks are still in shopping mode and funds would leverage the conditions to keep their incomes ticking. Gold is traditionally a good investment option and gives returns between 15-18 per cent and can be positioned somewhere between government bonds and the stock market. This interest will always remain and hence the price may not really recede and would tend to stabilise even after global adjustments occur. As long as there is scepticism about the world monetary order, interest in gold will remain strong.
What does it mean for us in India? India, though the largest consumer of gold, is a price taker. This means we take the price that’s determined on COMEX. The prices would replicate global trends, which in turn are influenced by our demand. With income levels increasing and high inflation prevailing there has been a tendency at the margin for households to look at gold progressively — though there is not much evidence of substantially higher imports of gold by India. There will hence be a tendency for the prices to move up during this festival season.
A clearer route for foreing banks: 21st October Financial Express
The choice is really between operating as a branch of an entity that is incorporated overseas or functioning as a subsidiary of the same. The former means that they operate in the current manner where there are apparent barriers to expansion. They pay higher corporate tax rates but have it easy when meeting the preemption norms in the form of priority sector lending. The subsidiary route would imply that they would work like any domestic bank, except that the equity holding would be different.
The issue has come up for two reasons. RBI, for its part, would like to be better able to regulate foreign banks in the country considering the role they could play, given their financial strength. But the financial crisis showed that there is a major risk in the current model wherein the branch would be jeopardised in case the overseas parent had severe problems. This could be destabilising at the limit for the domestic banking system. Therefore, from the point of view of risk management, RBI would prefer to have better oversight over their operations.
As far as foreign banks are concerned, they would like to expand their operations in the country but are constrained in terms of the number of branches that they could set up as the rules are clear—not more than 12 branches a year as per the WTO agreements. There are 31 foreign banks operating in the country with 310 branches as of March 2010—with 75% being held by 5 banks. The market is vast and they do have the skill sets to reach out and expand their business in rural India, provided they are allowed to do so. The current regulatory environment may be considered to be inhibiting.
From the point of view of the banks, the subsidiary route would help them expand their business, which would probably apply to these 5 banks. They would get more operational flexibility and can push forth their business plans. Further, they would be able to grow inorganically through M&A activity, which is not available currently. Therefore, there would be certain gains for them in operating as a subsidiary as their market share increases. Also, given the financial strength of the parent company, they would be able to bring in the requisite capital to support their enhanced operations. In fact, given that there would be more new private banks operating in the interiors, the foreign banks would get left out from this business and would, hence, find the subsidiary route a convenience.
However, what is not clear is whether or not there would be the encumbrance of priority sector lending the way it is defined for Indian banks. There will probably be no concession here, which means that they would perforce have to go into the rural interiors and cater to the agriculture, small scale industry sector, weaker sections, etc. Currently, they get away with 32% ratio, which also includes export finance. Also, the tax rules governing capital gains or stamp duty are not quite clear when they convert from a branch to subsidiary, which will have to be examined before taking a decision. The DTC, however, has addressed the issue of corporate taxation, which used to be at a higher level for foreign companies, which will be restored to that for domestic companies.
RBI would also have to provide clarity on the listing requirements for such subsidiaries as there would be stipulations for new private banks. A public offering would be good for the country as domestic shareholders could get a slice of the benefits of the operations of these banks. This would be a major consideration for banks, which would want to convert to a subsidiary. Management issues would probably not be a major issue as the branches too operate with an Indian management and changes would only be at the fringe.
Setting the stage for the expansion of foreign banks is pragmatic but given that they are heterogeneous, all may not prefer the subsidiary route. Ideally, they should have the right to choose the route. They would have, to use the cliché, to decide to be or not to be a subsidiary.
The issue has come up for two reasons. RBI, for its part, would like to be better able to regulate foreign banks in the country considering the role they could play, given their financial strength. But the financial crisis showed that there is a major risk in the current model wherein the branch would be jeopardised in case the overseas parent had severe problems. This could be destabilising at the limit for the domestic banking system. Therefore, from the point of view of risk management, RBI would prefer to have better oversight over their operations.
As far as foreign banks are concerned, they would like to expand their operations in the country but are constrained in terms of the number of branches that they could set up as the rules are clear—not more than 12 branches a year as per the WTO agreements. There are 31 foreign banks operating in the country with 310 branches as of March 2010—with 75% being held by 5 banks. The market is vast and they do have the skill sets to reach out and expand their business in rural India, provided they are allowed to do so. The current regulatory environment may be considered to be inhibiting.
From the point of view of the banks, the subsidiary route would help them expand their business, which would probably apply to these 5 banks. They would get more operational flexibility and can push forth their business plans. Further, they would be able to grow inorganically through M&A activity, which is not available currently. Therefore, there would be certain gains for them in operating as a subsidiary as their market share increases. Also, given the financial strength of the parent company, they would be able to bring in the requisite capital to support their enhanced operations. In fact, given that there would be more new private banks operating in the interiors, the foreign banks would get left out from this business and would, hence, find the subsidiary route a convenience.
However, what is not clear is whether or not there would be the encumbrance of priority sector lending the way it is defined for Indian banks. There will probably be no concession here, which means that they would perforce have to go into the rural interiors and cater to the agriculture, small scale industry sector, weaker sections, etc. Currently, they get away with 32% ratio, which also includes export finance. Also, the tax rules governing capital gains or stamp duty are not quite clear when they convert from a branch to subsidiary, which will have to be examined before taking a decision. The DTC, however, has addressed the issue of corporate taxation, which used to be at a higher level for foreign companies, which will be restored to that for domestic companies.
RBI would also have to provide clarity on the listing requirements for such subsidiaries as there would be stipulations for new private banks. A public offering would be good for the country as domestic shareholders could get a slice of the benefits of the operations of these banks. This would be a major consideration for banks, which would want to convert to a subsidiary. Management issues would probably not be a major issue as the branches too operate with an Indian management and changes would only be at the fringe.
Setting the stage for the expansion of foreign banks is pragmatic but given that they are heterogeneous, all may not prefer the subsidiary route. Ideally, they should have the right to choose the route. They would have, to use the cliché, to decide to be or not to be a subsidiary.
Of paramount importance: Financial Express: October 14, 2010
The news about Paramount Airways and Oriental Insurance Company is interesting as it opens up a debate on a larger question on credit cover in the form of credit insurance. This is even more relevant, given the backdrop of the financial crisis, which has brought credit risk to the forefront. A debate is necessary, even though there have not been many instances of such defaults leading to turmoil in the financial sector.
The case is quite straightforward. We have an airline company that took a guarantee from a set of banks against which it bought fuel from oil companies. These loans were covered by an insurance company for credit default. Now the company is unable to pay, invoking the guarantee, which means that the banks have to pay the oil company. The banks, in turn, claim the loss on the account from the insurance company. As a result, Irda has decided to do away with such credit insurance schemes until a regulatory structure is put in place. The problem is significant because the insurance company did not reinsure these loans. Reinsurance would have helped diversify the risk across more players.
Credit insurance schemes are generally used for foreign trade and not commonly used by banks to cover defaults on their books. Banks covering credit risk is not uncommon in countries like the US where insurance can be procured on loans. AIG had to pay banks when the CDOs failed, and the rest as they say, is history. Credit default swaps can also be used, wherein the third party picks up the risk in exchange for a fee—the swap spread.
In India, RBI has published guidelines for CDS for bonds to make the market more robust. However, bank loans are not covered. Thus, credit insurance does appear to be a fairly good form of financial engineering for diversifying risk and expanding business—for the borrower, lender, guarantor and cover provider. This way banks would be better able to lend or provide a guarantee when loans are on the borderline.
Irda has recently barred insurance companies from selling such policies as it felt that the market is not transparent and has little regulatory oversight. The participants from different segments covering different financial arenas has led to a regulatory overlap. The concern is that insurance companies may not be sufficiently equipped to evaluate such loans when providing a cover. The system can, therefore, be gamed by intermediaries who could get the borrower to actually pay the premium to the insurance company, embedded in the bank guarantee cost for the bank. Hence, the risk from one sector would get transferred to the insurance segment, jeopardising the balance sheets of these companies. There has been reason for separating the banking sector from the insurance sector and while this concept of credit guarantee would work well in good times, it could be destabilising in times of crisis.
From a bank’s point of view, this raises issues of the quality of credit appraisal. Banks that are insured would be tempted to be more liberal in credit appraisals, knowing that the insurance company is there to back it up. In fact, the reason for a bank's intermediation job is that it bridges the information asymmetry between savers and borrowers, and takes on risk based on its superior credit skills, earning a spread on the money. If they were to go back to the insurance company, however, then they are not efficient.
Theoretically, insurance companies should insure any product that carries risk. But, when there are efficient derivative markets that price risk well, insurance companies should not participate—they are not equipped to gauge this risk. Alternatively, insurance companies could hone their skills and have a proper line of business where credit is insured.
A solution here is to take recourse to the CDS market and allow a bank to get cover from it. This implies that RBI should open the CDS market for bank loans as well, possibly in the second stage of expansion.
The case is quite straightforward. We have an airline company that took a guarantee from a set of banks against which it bought fuel from oil companies. These loans were covered by an insurance company for credit default. Now the company is unable to pay, invoking the guarantee, which means that the banks have to pay the oil company. The banks, in turn, claim the loss on the account from the insurance company. As a result, Irda has decided to do away with such credit insurance schemes until a regulatory structure is put in place. The problem is significant because the insurance company did not reinsure these loans. Reinsurance would have helped diversify the risk across more players.
Credit insurance schemes are generally used for foreign trade and not commonly used by banks to cover defaults on their books. Banks covering credit risk is not uncommon in countries like the US where insurance can be procured on loans. AIG had to pay banks when the CDOs failed, and the rest as they say, is history. Credit default swaps can also be used, wherein the third party picks up the risk in exchange for a fee—the swap spread.
In India, RBI has published guidelines for CDS for bonds to make the market more robust. However, bank loans are not covered. Thus, credit insurance does appear to be a fairly good form of financial engineering for diversifying risk and expanding business—for the borrower, lender, guarantor and cover provider. This way banks would be better able to lend or provide a guarantee when loans are on the borderline.
Irda has recently barred insurance companies from selling such policies as it felt that the market is not transparent and has little regulatory oversight. The participants from different segments covering different financial arenas has led to a regulatory overlap. The concern is that insurance companies may not be sufficiently equipped to evaluate such loans when providing a cover. The system can, therefore, be gamed by intermediaries who could get the borrower to actually pay the premium to the insurance company, embedded in the bank guarantee cost for the bank. Hence, the risk from one sector would get transferred to the insurance segment, jeopardising the balance sheets of these companies. There has been reason for separating the banking sector from the insurance sector and while this concept of credit guarantee would work well in good times, it could be destabilising in times of crisis.
From a bank’s point of view, this raises issues of the quality of credit appraisal. Banks that are insured would be tempted to be more liberal in credit appraisals, knowing that the insurance company is there to back it up. In fact, the reason for a bank's intermediation job is that it bridges the information asymmetry between savers and borrowers, and takes on risk based on its superior credit skills, earning a spread on the money. If they were to go back to the insurance company, however, then they are not efficient.
Theoretically, insurance companies should insure any product that carries risk. But, when there are efficient derivative markets that price risk well, insurance companies should not participate—they are not equipped to gauge this risk. Alternatively, insurance companies could hone their skills and have a proper line of business where credit is insured.
A solution here is to take recourse to the CDS market and allow a bank to get cover from it. This implies that RBI should open the CDS market for bank loans as well, possibly in the second stage of expansion.
How much am I worth: DNA October 13, 2010
Irony seldom escapes the characters on the economic stage; and when the issue pertains to one’s own well-being, Adam Smith’s free market self-interest or Ayn Rand’s virtue of selfishness prevails.
And why not, since we all want to partake a portion of the wealth of success. It was not a long time back that the prime minister asked private sector honchos to be abstemious in their remuneration. Now, all the MPs have gone ahead and given themselves a rise in their salaries.
When Lehman became a euphemism for the greed that the private sector represents, government officials ascended the high horse to say how they were different and that the private sector stinks when it comes to remuneration. Now, we have the RBI as well as the public sector banks arguing for parity with the private sector. What is one to make of it considering that each segment thinks that it deserves the hike and, as a corollary, the others don’t?
The extremes in salaries are stark. US Fed chairman Ben Bernanke takes home $200,000 per annum while European Central Bank president Jean-Claude Trichet earns $500,000.
Bank of England chief Mervyn King has package of $450,000 while Japan’s Masaaki Shirakawa is paid $400,000. Our own RBI governor Duvvuri Subbarao gets the rupee equivalent of around $30,000. In contrast, in 2009 Goldman Sachs was reported to have had a wage bill of $16.2 billion for 32,500 workers, giving an average of $498,246 — half a million dollars per head!
Clearly, the regulated take home larger pay cheques than the regulators, though the latter admittedly have greater powers. The question is how are salaries to be fixed?
In a free economy, salaries should be the function of the owners or shareholders. If it is the private sector, it is the proprietor or the shareholders. This holds just like it does for, say, a household where it determines the salary to be paid to the maid or watchman or driver. However, structures are amorphous here.
Most big companies have shareholders and even an owner-driven company may not really have a majority. Salaries are fixed by the owner on the premise that the majority has voted for it but the majority never really gets together to take a decision and hence the process of salary determination remains fuzzy.
At times it ends up with the owner, who is the management, also appointing the board which ratifies one’s own salary.
This should be treated as an internal affair but it becomes a public concern if bailouts have to be invoked when things go awry. The crisis did not stop at the financial sector, where public money was involved, but also overflowed into manufacturing, which then brought to the fore the issue of executive pay.
When it comes to the government, it is even more complicated. There are hierarchies where a bank chief is at the level of a secretary and one cannot go up without the other doing so. Hence, either all salaries have to move up, or all stagnate. The public sector enterprises are better placed even though there is government ownership, as here the CEOs get better pay packets, which can range between Rs30-40 lakh per annum, though this is still lower than that in the private sector.
Now, there is a strong case for salary revisions in the public sector banks, especially when they perform as well as those in the private sector. But there is a conundrum. A just way of going about it is to increase all salaries by x%.
This is democratic but allows free riders to benefit. It is actually the middle and senior levels where personnel can move to the private sector quite easily and the threat of attrition is real. There are a number of IAS officials who have gotten lucrative deals in the private sector to become heads of commodity exchanges or infrastructure companies. A number of private banks took in public sector officials and have grown really well.
However, does an executive, who is two years away from retirement, deserve a private sector salary? Yes, if the organisation is doing as well as its private counterpart. Critics aver that there are few public sector employees who find jobs after they retire. Salary hikes are needed to prevent attrition and the present system of backdoor increases through the recruitment of consultants with fixed tenures is not sustainable.
The solution is really to leave it open to the companies or banks to decide their pay packets which should be linked to profitability. This will create a problem for the bureaucrats as there is no profit and the incentives must be linked with performance in terms of expense management or implementation of projects.
As a corollary, the grades should be delinked from the bureaucracy charts. This would also mean that banks must have their own system of picking their CEOs with the ministry being out of the picture. This is the only way to make it work and should hence be looked at holistically.
And why not, since we all want to partake a portion of the wealth of success. It was not a long time back that the prime minister asked private sector honchos to be abstemious in their remuneration. Now, all the MPs have gone ahead and given themselves a rise in their salaries.
When Lehman became a euphemism for the greed that the private sector represents, government officials ascended the high horse to say how they were different and that the private sector stinks when it comes to remuneration. Now, we have the RBI as well as the public sector banks arguing for parity with the private sector. What is one to make of it considering that each segment thinks that it deserves the hike and, as a corollary, the others don’t?
The extremes in salaries are stark. US Fed chairman Ben Bernanke takes home $200,000 per annum while European Central Bank president Jean-Claude Trichet earns $500,000.
Bank of England chief Mervyn King has package of $450,000 while Japan’s Masaaki Shirakawa is paid $400,000. Our own RBI governor Duvvuri Subbarao gets the rupee equivalent of around $30,000. In contrast, in 2009 Goldman Sachs was reported to have had a wage bill of $16.2 billion for 32,500 workers, giving an average of $498,246 — half a million dollars per head!
Clearly, the regulated take home larger pay cheques than the regulators, though the latter admittedly have greater powers. The question is how are salaries to be fixed?
In a free economy, salaries should be the function of the owners or shareholders. If it is the private sector, it is the proprietor or the shareholders. This holds just like it does for, say, a household where it determines the salary to be paid to the maid or watchman or driver. However, structures are amorphous here.
Most big companies have shareholders and even an owner-driven company may not really have a majority. Salaries are fixed by the owner on the premise that the majority has voted for it but the majority never really gets together to take a decision and hence the process of salary determination remains fuzzy.
At times it ends up with the owner, who is the management, also appointing the board which ratifies one’s own salary.
This should be treated as an internal affair but it becomes a public concern if bailouts have to be invoked when things go awry. The crisis did not stop at the financial sector, where public money was involved, but also overflowed into manufacturing, which then brought to the fore the issue of executive pay.
When it comes to the government, it is even more complicated. There are hierarchies where a bank chief is at the level of a secretary and one cannot go up without the other doing so. Hence, either all salaries have to move up, or all stagnate. The public sector enterprises are better placed even though there is government ownership, as here the CEOs get better pay packets, which can range between Rs30-40 lakh per annum, though this is still lower than that in the private sector.
Now, there is a strong case for salary revisions in the public sector banks, especially when they perform as well as those in the private sector. But there is a conundrum. A just way of going about it is to increase all salaries by x%.
This is democratic but allows free riders to benefit. It is actually the middle and senior levels where personnel can move to the private sector quite easily and the threat of attrition is real. There are a number of IAS officials who have gotten lucrative deals in the private sector to become heads of commodity exchanges or infrastructure companies. A number of private banks took in public sector officials and have grown really well.
However, does an executive, who is two years away from retirement, deserve a private sector salary? Yes, if the organisation is doing as well as its private counterpart. Critics aver that there are few public sector employees who find jobs after they retire. Salary hikes are needed to prevent attrition and the present system of backdoor increases through the recruitment of consultants with fixed tenures is not sustainable.
The solution is really to leave it open to the companies or banks to decide their pay packets which should be linked to profitability. This will create a problem for the bureaucrats as there is no profit and the incentives must be linked with performance in terms of expense management or implementation of projects.
As a corollary, the grades should be delinked from the bureaucracy charts. This would also mean that banks must have their own system of picking their CEOs with the ministry being out of the picture. This is the only way to make it work and should hence be looked at holistically.
Look beyond FCRA amendments: Financial Express: 5th October 2010
The possibility of the Forward Contracts (Regulation) Act (FCRA) being amended raises some interesting issues in the context of financial markets in India. There is, of course, the question of what this means for the commodity market. But, at the broader level, it also provokes some introspection of the regulatory issues in the financial space.
The immediate euphoria is in the commodity markets, as the constituents have been hoping for the same for quite some time now. What this means is that if Parliament passes these amendments, then the FMC would become autonomous and could bring in the changes that are needed to galvanise a market that is quite lopsided today. The immediate thoughts that strike us are that the market can expect options and indices to be introduced soon. Also, the FMC will have more powers to control the markets, though admittedly, the FMC and market have functioned well so far without such explicit power being given to the FMC.
Once the amendment is passed, four questions may be posed. The first is whether FMC, being an independent regulator, will really help the cause? The FMC will have to gear up and hone its skills to understand the market and defend it. Being independent is one thing, to act independently is another. Suppose prices of chana or sugar were to increase sharply leading to high food inflation, can the independent FMC stand up and tell the government to lay off? Second, the issue of regulatory overlap is still not addressed. It may be recollected that the FMC had given permission to FIIs and mutual funds to trade in non-agricultural commodities several years ago. Yet their own regulators have not allowed this action. Will the FCRA amendment address this issue?
Third, while options sound good, the prospects for business per se are quite limited. Today, globally, around 10% of energy contracts, 7-8% of metals and almost nil of agriculture trading are in options. One should not overstate the case of farmers using options, considering that they have yet to trade in futures and trading in options on futures (which is what it will be) will be even more daunting for them. Fourth, commodity indices are not widely traded on exchanges unlike stock indices, which should curb the enthusiasm on the business front.
The second set of issues is institutional, which has to be addressed at some point in time. Today, there are a plethora of regulators in the financial markets: RBI, Sebi, FMC, Nabard, Sidbi, Irda, PFRDA, CEA, APMCs, etc. There are evidently no answers to the question of whether there should be more or fewer regulators. The Raghuram Rajan committee pitched for fewer while there is another school of thought that argues that specialisation is better than creating a behemoth that loses touch with reality—the same debate as with centralisation or decentralisation and empowerment.
The issue is more about the players being caught between different regulators. Today, financial products stretch across markets and regulators, which create potential conflict. Electricity is under CEA but FMC runs the derivatives market, which can involve delivery. The same holds for any physical commodity or ETF where the underlying has a different set up from the derivative product. Physical gold is not regulated but futures are under FMC but the ETF falls under Sebi. If it is a physical product, APMCs regulate, say, wheat, while the derivative is under FMC and we could have the ETF being traded on NSE under Sebi? The Ulips created their own controversies with Sebi and Irda coming to the discussion table. Banks can operate through subsidiaries in the stock market but on their own can sell mutual funds products but not deal directly as they deal with deposit money, which is RBI’s domain. Forex derivatives impact currency markets but come under Sebi though technically this is okay since RBI deals with physical currency, which does not come into the picture now. Also, the institutions have different capital structures. RBI allows 40% ownership for individual entrepreneurs while Sebi has a 5% ceiling for exchanges. FMC gives time for shareholding patterns to evolve while Irda provides a longer window.
Therefore, the broader issue is that while there is merit in having more regulators with specialisation, we need to iron out these conflict zones so that markets can evolve with minimum upheavals. Currently, there is excess caution being exercised to ensure that risk from one segment does not spill over to another when the players are the same. This has led to a certain level of intransigence between regulators, which has been compounded by the differences in ministries overseeing these departments. The next stage of regulatory reform should logically be in this area before moving down to the markets per se. That will be pragmatic and useful.
The immediate euphoria is in the commodity markets, as the constituents have been hoping for the same for quite some time now. What this means is that if Parliament passes these amendments, then the FMC would become autonomous and could bring in the changes that are needed to galvanise a market that is quite lopsided today. The immediate thoughts that strike us are that the market can expect options and indices to be introduced soon. Also, the FMC will have more powers to control the markets, though admittedly, the FMC and market have functioned well so far without such explicit power being given to the FMC.
Once the amendment is passed, four questions may be posed. The first is whether FMC, being an independent regulator, will really help the cause? The FMC will have to gear up and hone its skills to understand the market and defend it. Being independent is one thing, to act independently is another. Suppose prices of chana or sugar were to increase sharply leading to high food inflation, can the independent FMC stand up and tell the government to lay off? Second, the issue of regulatory overlap is still not addressed. It may be recollected that the FMC had given permission to FIIs and mutual funds to trade in non-agricultural commodities several years ago. Yet their own regulators have not allowed this action. Will the FCRA amendment address this issue?
Third, while options sound good, the prospects for business per se are quite limited. Today, globally, around 10% of energy contracts, 7-8% of metals and almost nil of agriculture trading are in options. One should not overstate the case of farmers using options, considering that they have yet to trade in futures and trading in options on futures (which is what it will be) will be even more daunting for them. Fourth, commodity indices are not widely traded on exchanges unlike stock indices, which should curb the enthusiasm on the business front.
The second set of issues is institutional, which has to be addressed at some point in time. Today, there are a plethora of regulators in the financial markets: RBI, Sebi, FMC, Nabard, Sidbi, Irda, PFRDA, CEA, APMCs, etc. There are evidently no answers to the question of whether there should be more or fewer regulators. The Raghuram Rajan committee pitched for fewer while there is another school of thought that argues that specialisation is better than creating a behemoth that loses touch with reality—the same debate as with centralisation or decentralisation and empowerment.
The issue is more about the players being caught between different regulators. Today, financial products stretch across markets and regulators, which create potential conflict. Electricity is under CEA but FMC runs the derivatives market, which can involve delivery. The same holds for any physical commodity or ETF where the underlying has a different set up from the derivative product. Physical gold is not regulated but futures are under FMC but the ETF falls under Sebi. If it is a physical product, APMCs regulate, say, wheat, while the derivative is under FMC and we could have the ETF being traded on NSE under Sebi? The Ulips created their own controversies with Sebi and Irda coming to the discussion table. Banks can operate through subsidiaries in the stock market but on their own can sell mutual funds products but not deal directly as they deal with deposit money, which is RBI’s domain. Forex derivatives impact currency markets but come under Sebi though technically this is okay since RBI deals with physical currency, which does not come into the picture now. Also, the institutions have different capital structures. RBI allows 40% ownership for individual entrepreneurs while Sebi has a 5% ceiling for exchanges. FMC gives time for shareholding patterns to evolve while Irda provides a longer window.
Therefore, the broader issue is that while there is merit in having more regulators with specialisation, we need to iron out these conflict zones so that markets can evolve with minimum upheavals. Currently, there is excess caution being exercised to ensure that risk from one segment does not spill over to another when the players are the same. This has led to a certain level of intransigence between regulators, which has been compounded by the differences in ministries overseeing these departments. The next stage of regulatory reform should logically be in this area before moving down to the markets per se. That will be pragmatic and useful.
Look beyond FCRA amendments: Financial Express: 5th October 2010
The possibility of the Forward Contracts (Regulation) Act (FCRA) being amended raises some interesting issues in the context of financial markets in India. There is, of course, the question of what this means for the commodity market. But, at the broader level, it also provokes some introspection of the regulatory issues in the financial space.
The immediate euphoria is in the commodity markets, as the constituents have been hoping for the same for quite some time now. What this means is that if Parliament passes these amendments, then the FMC would become autonomous and could bring in the changes that are needed to galvanise a market that is quite lopsided today. The immediate thoughts that strike us are that the market can expect options and indices to be introduced soon. Also, the FMC will have more powers to control the markets, though admittedly, the FMC and market have functioned well so far without such explicit power being given to the FMC.
Once the amendment is passed, four questions may be posed. The first is whether FMC, being an independent regulator, will really help the cause? The FMC will have to gear up and hone its skills to understand the market and defend it. Being independent is one thing, to act independently is another. Suppose prices of chana or sugar were to increase sharply leading to high food inflation, can the independent FMC stand up and tell the government to lay off? Second, the issue of regulatory overlap is still not addressed. It may be recollected that the FMC had given permission to FIIs and mutual funds to trade in non-agricultural commodities several years ago. Yet their own regulators have not allowed this action. Will the FCRA amendment address this issue?
Third, while options sound good, the prospects for business per se are quite limited. Today, globally, around 10% of energy contracts, 7-8% of metals and almost nil of agriculture trading are in options. One should not overstate the case of farmers using options, considering that they have yet to trade in futures and trading in options on futures (which is what it will be) will be even more daunting for them. Fourth, commodity indices are not widely traded on exchanges unlike stock indices, which should curb the enthusiasm on the business front.
The second set of issues is institutional, which has to be addressed at some point in time. Today, there are a plethora of regulators in the financial markets: RBI, Sebi, FMC, Nabard, Sidbi, Irda, PFRDA, CEA, APMCs, etc. There are evidently no answers to the question of whether there should be more or fewer regulators. The Raghuram Rajan committee pitched for fewer while there is another school of thought that argues that specialisation is better than creating a behemoth that loses touch with reality—the same debate as with centralisation or decentralisation and empowerment.
The issue is more about the players being caught between different regulators. Today, financial products stretch across markets and regulators, which create potential conflict. Electricity is under CEA but FMC runs the derivatives market, which can involve delivery. The same holds for any physical commodity or ETF where the underlying has a different set up from the derivative product. Physical gold is not regulated but futures are under FMC but the ETF falls under Sebi. If it is a physical product, APMCs regulate, say, wheat, while the derivative is under FMC and we could have the ETF being traded on NSE under Sebi? The Ulips created their own controversies with Sebi and Irda coming to the discussion table. Banks can operate through subsidiaries in the stock market but on their own can sell mutual funds products but not deal directly as they deal with deposit money, which is RBI’s domain. Forex derivatives impact currency markets but come under Sebi though technically this is okay since RBI deals with physical currency, which does not come into the picture now. Also, the institutions have different capital structures. RBI allows 40% ownership for individual entrepreneurs while Sebi has a 5% ceiling for exchanges. FMC gives time for shareholding patterns to evolve while Irda provides a longer window.
Therefore, the broader issue is that while there is merit in having more regulators with specialisation, we need to iron out these conflict zones so that markets can evolve with minimum upheavals. Currently, there is excess caution being exercised to ensure that risk from one segment does not spill over to another when the players are the same. This has led to a certain level of intransigence between regulators, which has been compounded by the differences in ministries overseeing these departments. The next stage of regulatory reform should logically be in this area before moving down to the markets per se. That will be pragmatic and useful.
The immediate euphoria is in the commodity markets, as the constituents have been hoping for the same for quite some time now. What this means is that if Parliament passes these amendments, then the FMC would become autonomous and could bring in the changes that are needed to galvanise a market that is quite lopsided today. The immediate thoughts that strike us are that the market can expect options and indices to be introduced soon. Also, the FMC will have more powers to control the markets, though admittedly, the FMC and market have functioned well so far without such explicit power being given to the FMC.
Once the amendment is passed, four questions may be posed. The first is whether FMC, being an independent regulator, will really help the cause? The FMC will have to gear up and hone its skills to understand the market and defend it. Being independent is one thing, to act independently is another. Suppose prices of chana or sugar were to increase sharply leading to high food inflation, can the independent FMC stand up and tell the government to lay off? Second, the issue of regulatory overlap is still not addressed. It may be recollected that the FMC had given permission to FIIs and mutual funds to trade in non-agricultural commodities several years ago. Yet their own regulators have not allowed this action. Will the FCRA amendment address this issue?
Third, while options sound good, the prospects for business per se are quite limited. Today, globally, around 10% of energy contracts, 7-8% of metals and almost nil of agriculture trading are in options. One should not overstate the case of farmers using options, considering that they have yet to trade in futures and trading in options on futures (which is what it will be) will be even more daunting for them. Fourth, commodity indices are not widely traded on exchanges unlike stock indices, which should curb the enthusiasm on the business front.
The second set of issues is institutional, which has to be addressed at some point in time. Today, there are a plethora of regulators in the financial markets: RBI, Sebi, FMC, Nabard, Sidbi, Irda, PFRDA, CEA, APMCs, etc. There are evidently no answers to the question of whether there should be more or fewer regulators. The Raghuram Rajan committee pitched for fewer while there is another school of thought that argues that specialisation is better than creating a behemoth that loses touch with reality—the same debate as with centralisation or decentralisation and empowerment.
The issue is more about the players being caught between different regulators. Today, financial products stretch across markets and regulators, which create potential conflict. Electricity is under CEA but FMC runs the derivatives market, which can involve delivery. The same holds for any physical commodity or ETF where the underlying has a different set up from the derivative product. Physical gold is not regulated but futures are under FMC but the ETF falls under Sebi. If it is a physical product, APMCs regulate, say, wheat, while the derivative is under FMC and we could have the ETF being traded on NSE under Sebi? The Ulips created their own controversies with Sebi and Irda coming to the discussion table. Banks can operate through subsidiaries in the stock market but on their own can sell mutual funds products but not deal directly as they deal with deposit money, which is RBI’s domain. Forex derivatives impact currency markets but come under Sebi though technically this is okay since RBI deals with physical currency, which does not come into the picture now. Also, the institutions have different capital structures. RBI allows 40% ownership for individual entrepreneurs while Sebi has a 5% ceiling for exchanges. FMC gives time for shareholding patterns to evolve while Irda provides a longer window.
Therefore, the broader issue is that while there is merit in having more regulators with specialisation, we need to iron out these conflict zones so that markets can evolve with minimum upheavals. Currently, there is excess caution being exercised to ensure that risk from one segment does not spill over to another when the players are the same. This has led to a certain level of intransigence between regulators, which has been compounded by the differences in ministries overseeing these departments. The next stage of regulatory reform should logically be in this area before moving down to the markets per se. That will be pragmatic and useful.
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