Initial Private Opinion

Padma Shri Pravin H Parekh

noreply@blogger.com (Sandeep Parekh) — Wed, 25 Jan 2012 12:15:00 +0000

A proud son congratulates his father on being awarded the Padma Shri.

Divestment blues

noreply@blogger.com (Sandeep Parekh) — Wed, 18 Jan 2012 09:23:00 +0000

I have a face-off piece in the Economic Times today - half heartedly defending the stand of government not to dilute its holding in public sector and private sector companies. Here is the short piece (reproduced below). It is a contrarian piece, but interestingly the piece has received the editor's pick of the day at ET's website.

The government can be blamed for many things surrounding disinvestment in public sector units listed on exchanges. Prime among them is the special dispensation around a minimum float of 25% in public hands that applies to all listed companies - with the exception of public sector.

After mandating a 25% public float, the finance ministry diluted the requirement in a quick volte face to 10%. Even this low figure is not complied with and there are public sector companies with over 99% of shares held by the government.

However, one cannot blame the government for the delay in divesting its portfolio of shares held by SUUTIto the public. Clearly, this is a terrible time to raise capital or sell securities. Companies in the private sector have voted with their feet and hardly any IPOs and sale of shares by private equity entities are happening at this time at this valuation.

This is because of the depressed valuations as also the huge volatility in prices even within the depressed markets. The cause of the problem is both national and international. While, it is not possible to argue against the final liquidation of the entity SUUTI, and if possible soon enough, it is also difficult to argue that this should be done, come what may, in the next quarter or two. Clearly, timing is important in the stock market.

And to exit at this time would mean that the sale of public sector shares and private sector shares by SUUTI would both be at highly discounted prices. To look at just one number, PSU stocks have lost nearly 20% value in the last one year.

The top 100 companies have lost around 15%. The numbers look a lot worse for a longer time horizon and they look even worse for companies beyond the top 100. It would make a lot more sense for the government to hold off selling both public and private company stakes.

In that light, transferring SUUTI stakes to a special vehicle is not so bad even if it amounts to pointless jugglery. If the shares belonged to you or me, we wouldn't have sold them. The same standard should apply to 'our' assets.

Also find linked here the other view.

Method of public float compliance - SEBI Board

noreply@blogger.com (Sandeep Parekh) — Sat, 07 Jan 2012 07:51:00 +0000

SEBI announced something major last week pursuant to its last Board meeting. While it sounds a bit arcane, the step is important for both listed companies and its investors.

In plain English, regulations mandate a compulsory minimum public float of 25% for all listed companies (of which public sector listed companies can get away with 10% public float). Public float is that share of shareholding which is not held by the promoters and their control group. Till before 2010, companies complied with various levels of public float (10, 25 or 40%). The finance ministry modified it to make it uniform across non public sector (actually it made it uniform across all listed companies but partially backtracked for public sector companies). To increase the share of public and conversely to reduce the share of promoters, the listing agreement (Clause 40A) of both equity exchanges (BSE and NSE) only provide for certain manner of sale or dilution. The SEBI Board has in short liberalised the manner in which the divestment takes place.

This is good for the company, its promoters and its shareholders - as it eases the manner in which stake can be sold or diluted, the manner would be cheaper and subject to more transparency and lower volatility compared to the existing methods.

Indian exchanges - pole position in the world? Really?

noreply@blogger.com (Sandeep Parekh) — Mon, 26 Dec 2011 11:18:00 +0000

A PwC report seems to think that India will be among the top two destinations for foreign capital to list in India.

Where will the leading listing venues be in the future? Where will newly listed companies come from and what will they be looking for? What are the drivers of change in the IPO landscape? These are some of the questions asked in this report.

38% of respondents think that Indian exchanges will be an important listing destination for foreign companies by 2025

India also scores well with survey respondents, with more than 38% believing that the country’s exchanges will be important listing destinations for foreign companies by 2025.

I'm not too sure the Indian exchanges will remain competitive if the 5% ownership limit is retained (unprecedented anywhere in the world) by our regulator and government. The limit is even more strict for foreign investors - eliminating the scope for any cross border M&A with Indian exchanges - even Indian exchanges cannot acquire foreign exchanges if they seek to pay with equity. Time to wake up and smell our potential.

See my previous piece on the 5% limit - Governance and Ownership in Exchanges.

On a linked note, we have also murdered the market for Indian Depository Receipts with silly rules. See my previous post here.

Brokers can be good banks

noreply@blogger.com (Sandeep Parekh) — Wed, 21 Dec 2011 16:43:00 +0000

I have an opinion piece in today's Economic Times titled: Brokers deserve as fair a chance as banks. Here is the article:

"RBI has come out with a set of draft guidelines for licensing new banks in the private sector. A trial balloon that the central bank launched, proposes sound eligibility criteria such as shareholders primarily being residents of India, a diversified shareholding pattern, transparent holding structures, credentials, expertise showing ability to run a bank and qualitative aspects like high standards of governance and ethics across the corporate group and restrictions on related party transactions.

RBI has got most things right. But we can argue about some details such as whether a minimum capital of Rs 500 crore is too high or too low, whether a stipulated dilution to 15% ownership in 12 years is a good time period, whether the voting cap of 10% imposed on non-promoters is right or not, and whether seeking a listing in just two years is too high an expectation.

However, an area where the central bank has made a big error is disallowing stock broking entities from a licence. The paper states: "Banking is essentially based on fiduciary principles as depositors' money is involved. It, therefore, becomes imperative that the fit and proper assessment framework for bank promoters is much more comprehensive in scope as compared to other sectors.

Any such framework also needs to look into the nature of activities the promoter group of the bank is predominantly engaged in. There are certain activities, such as real estate and capital market activities, in particular broking activities which, apart from being inherently riskier, represent a business model and business culture which are quite misaligned with a banking model.

Post-crisis, there are concerted moves even internationally to separate banking from proprietary trading. More importantly, in India, past experience with brokers on the boards of banks has not been satisfactory." There are several reasons why the above reasoning is not sound.

First, brokers are familiar with the fiduciary principles of client money. In fact, brokers have far more complex and higher standards of fiduciary duties to their customers than banks. Brokers are obliged not only to separate their own money from their clients', but also to segregate one client's property from another's.

Thus, to assume that banks are somehow unique in understanding fiduciary duties is fallacious. Second, brokers are amongst the most heavily regulated of all entities. Sebi has done an excellent job of regulating brokers and has imposed very strict fit and proper criteria on brokers.

Thus, to bar brokers based on fit and proper criteria is wrong, in fact, since brokers have already gone through this continuing and strict eligibility criteria, that ought to be a ground for making such brokers more easily eligible for a banking licence. Third, the central bank's assertion that broking activity is 'inherently riskier' is not correct.

In fact, brokers mainly do an agency business with no inherent leverage at all. While some brokers do lend to clients, the leverage is minuscule and short term. Many brokers do not do any proprietary trades and are completely leverage free. This is in sharp contrast to banks that are highly leveraged. The draft guideline itself says at the conclusion that "Banking [is] a highly leveraged business".

Fourth, brokers do not represent "a business model and business culture which are quite misaligned with a banking model". Not only are brokers well-versed with the economy, the financial and real sectors, but they represent a very similar business model and culture as banks.

Most big brokers (who would be eligible to apply for a bank licence) would have cultures not at all dissimilar to the one at private bank, professional, meritocratic and ethical corporate institutions rather than some cunning, market-manipulating individual stereotype sitting in his Lexus car, the RBI probably has in mind.

Fifth, the RBI's assertion that internationally too there are attempts to "separate banking from proprietary trading" is a reference to proprietary trading that is a principal business. The reference is to investment banking and proprietary desks that could jeopardise the bank's capital, rather than what brokers do.

Finally, to imply that all brokers are avatars of Harshad Mehta is a bit like saying all banks are avatars of the Bank of Karad. Thus, to say that the "past experience with brokers on the boards of banks has not been satisfactory" is not only an ad hominem attack on a well-regulated profession but is based on an assumption that the broker is a human being who sits on boards of banks and creates pointless pollution there.

The fact is that not only are all the big brokers limited companies, rather than individuals whose 1990s' record the RBI is unhappy with, but that many, if not most, of the big banks of India have broking subsidiaries or affiliates. If broking is such a filthy profession, RBI should bar banks from indulging in it. If not, they should not be barred from banking licence."

Proxy advisory firm - recommendation on voting for listed companies

noreply@blogger.com (Sandeep Parekh) — Tue, 20 Dec 2011 07:10:00 +0000

I had been hearing about the proxy advisory firm Ingovern and visited their website to see what kind of voting recommendations they make for Indian listed companies. They give access to detailed reports only to paying clients, but the samples available at http://www.ingovern.com/ are quite fascinating. Do take a look. I believe, that these recommendations would have a material impact on management decision (to propose a vote) even if not a single shareholder votes according to the proxy advice - which is of course a great outcome for corporate governance in India. There is another proxy advisory firm IIAS in India, whose website I couldn't find.

The newsletters of Ingovern can be found on the website of "The Firm" of CNBC.

Managing the investment advisors

noreply@blogger.com (Sandeep Parekh) — Tue, 20 Dec 2011 04:57:00 +0000

Tejesh Chitlangi and I have an op-ed in today's Financial Express titled Managing the Investment Advisor. Here are excerpts:

One comes across several entities rendering investment advice and distributing various financial products such as mutual fund units, insurance products, structured products, amongst others. An investor must decide whether to invest, if so for what quantum, what duration, and when to exit. These and other pertinent questions often need expert advice. The securities market regulator Sebi recently issued a concept paper proposing a broad framework for regulating any entity rendering investment advice in any manner.

Before listing out the proposals for regulating ‘investment advisors’, the paper puts forth norms to resolve conflicts of interest between the issuers of financial products such as banks, mutual funds, insurance companies, etc, and the distributors who sell their products. The conflict arises because distributors receive commissions from the issuer and also fees from investor. To eliminate this conflict, the paper suggests that a person who interfaces with the customer should declare upfront whether he is an ‘advisor’ to the client or is an agent of the issuer. If he declares himself as an advisor, he would be subject to Investment Advisors Regulations requiring high qualifications, registration, compliances and would receive payments only from the investor. On the other hand, if he declares himself as an agent associated with issuer of the product, such person can receive remuneration only from the issuer.

Sebi has borrowed the above conflict resolution mechanism from the UK regulatory regime, but such application of foreign laws in India appears inappropriate. For instance, the UK regime (effective from 2013) is applicable only to distribution of retail products to retail investors, much unlike the uniform application of the proposed law to all financial products and to all investors as proposed by Sebi. Also, the UK regime has ‘basic advice’ exemptions (i.e. advice using pre-scripted basic questions and not detailed advice) wherein advisors would still earn commission from the issuer. No such exemption is contemplated in the Sebi paper.

...

The following are the key concerns. First, the proposals seek to create a self-regulatory organisation (SRO) framework to primarily regulate the investment advisors, who have to seek such SRO’s membership. Till date no entity has registered under Sebi SRO Regulations of 2004 because of onerous provisions, accountability and compliances without any benefits. Even bodies like AMFI (mutual funds’ association) and AMBI (merchant bankers’ association) have not sought SRO registration for these reasons. Regulating investment advisors through an SRO may, therefore, fail. Investment advisors are regulated even today under Sebi portfolio manager regulations but such provisions are not strictly enforced, as Sebi does not have the bandwidth to manage multitude of such advisors. Trying to regulate such advisors across all financial products and across the width of the country under an SRO framework may be ambitious though well meant.

Second, a Sebi-registered SRO would be the first-level regulator of advisors of financial products coming under other regulators such as RBI and IRDA. Though the matters relating to

financial products other than securities shall come under the jurisdiction of the respective sectoral regulators, conflicts will arise as an SRO regulating advisors of the products falling under other regulator’s jurisdiction would still be accountable to Sebi. It is likely that this could cause pointless turf wars between regulators similar to what we saw last year.

Third, the definition of investment advisor under the paper is extremely wide and would cover any investment advice for which consideration is received. This would even cover all Indian private equity advisors which render advice to offshore managers managing overseas funds. Also, it’s unclear if the foreign advisors rendering investment advice to Indian residents would also be brought within the ambit of proposed requirements, even though the advice doesn’t pertain to Indian financial products.

In an attempt to regulate the investors, their advisors, their markets and instruments, Sebi may end up regulating everything on paper but harming investments in the process. Proposing technical concepts and borrowing foreign regulations may not help in this context and are likely to hamper the growth of the financial markets and financial inclusion.

Takeover regulations 2011 - voluntary offers - FAQ

noreply@blogger.com (Sandeep Parekh) — Thu, 15 Dec 2011 13:07:00 +0000

SEBI has today come out with a FAQ on the new takeover regulations of 2011. While there aren't other surprises, SEBI seems to indicated that there are in fact two types of voluntary offers. This is even though there is only one type mentioned in the regulations. The unstated voluntary offer according to the FAQ has the following characteristic:

Minimum offer size is 26% (as opposed to 10% for the prescribed offer)
Maximum offer size is 100% (as opposed to maximum size permissible to non public shareholders)
No restriction on buying before or after the open offer (versus 1 year cooling up prior to and 6 months cooling down after the public offer).

Ideally SEBI should have come out with this in a circular rather than a frequently asked questions section which is purely clarificatory. But it is a useful piece for those interested in making an open offer even when they are not obliged to.

Outsourcing by SEBI intermediaries

noreply@blogger.com (Sandeep Parekh) — Thu, 15 Dec 2011 13:06:00 +0000

SEBI has come out with a detailed new circular today on outsourcing of functions by SEBI registered intermediaries. While it is quite strict in its scope, it doesn't go as far as a departmental paper by SEBI sought to go (virtually seeking to ban much of outsourcing by intermediaries) .

Consent order of SEBI

noreply@blogger.com (Sandeep Parekh) — Tue, 06 Dec 2011 05:01:00 +0000

I have been quoted in today's Hindu Businessline - "Mr Parekh has always held that the consent order process is not transparent. “The final order does not even clearly mention what the allegation was in the first place,” he says."

The quote is accurate (except for the "has always held"), but seems to suggest that I was attacking the consent process wholesale. I was not. In fact, I was talking about a particular case which is why the grammer is "the final order". In fact almost all cases of consent have reasonably set out the charges. At the same time, I do believe that more transparency in both the process and in the final order is welcome or even necessary.

I do strongly believe in the consent process in the Indian securities market and there are areas of distinction between the US system and the Indian:

a) the India statute talks about consent in S. 15T (2) of the SEBI Act (it says that no consent order can be appealled). There is thus a statutory explicit/implicit power available. The US law does not.

b) the Indian process takes places mainly outside the regulatory system - an independent committee headed by a retired judge looks at the charges, evidence and other factors. The US system is secretive and completely in house. This reduces or eliminates the problem of fairness and objectivity.

c) The US settles cases even before fact finding is completed - this is quite unfair. The Indian process prohibits settlement before a complete fact finding is over (unless there is a technical or such violation where the facts speak for themselves e.g. dislcosure violation under takeover regs).

d) Given the above safeguards, I think India needs a consent process desparately - the appellate tribunal SAT is perhaps the only tribunal in India with close to 0 pendency. SEBI orders which typically lagged a violation by 8-10 years have come down dramatically. In fact, other govt. agencies and regulators need to introduce the system.

e) Often the problem is not that violators get away too easily - but that they are dealt with too harshly. In view of criticism, the regulator and the high powered committee could be overly harsh.

US federal appeal court uses photographs in ruling to taunt lawyer

noreply@blogger.com (Sandeep Parekh) — Fri, 02 Dec 2011 23:05:00 +0000

One of the most respected US judge and jurists – Justice Richard Posner has come out with a ruling. Nothing odd about that. Except it has two half pages of pictures. You may think nothing odd about that too – but it’s not a picture about anything in issue. The first photo is of an ostrich with its head buried in sand. The other is of a human being in such a pose. The human being is one of the lawyers in the case – as the judge explains:

“The ostrich is a noble animal, but not a proper model for an appellate advocate.”

Naturally, the lawyer is not particularly happy about this.

Buyback of shares and exemption from takeover regulations

noreply@blogger.com (Sandeep Parekh) — Fri, 25 Nov 2011 06:21:00 +0000

In Raghu H Dalmia vs. SEBI a SAT ruling from last week, the tribunal held that a buy back resulting in an increase in the shareholding of the promoter is not a result of acquisition of shares or votes and such increase in shareholding will not trigger the open offer obligations of an acquirer. I was sitting in SAT on the day this was argued - waiting for my case - so heard the arguments.

The logic of the tribunal was that a buy back where the promoter does not tender his shares (and therefore there is an increase in the percentage shareholding) is not a positive action of acquisition. If there is no acquisition, then there cannot be a trigger event for an open offer. Though the ruling was under the old takeover regulations, it has a huge impact on the new regulations as well. If there is never a trigger resulting from a buyback, the two exemptions provided in the new regulations for buyback will never be required.

SEBI's stated position is:
a) It does not give exemptions - post facto. You must seek an exemption before the trigger occurs. SEBI in the present case rejected the exemption application on this ground alone.
b) It does not permit buyback as a routine exemption from takeover regulations. Unfortunately, SEBI has taken many inconsistent positions with respect to granting of exemptions through the panel route.

SAT's ruling is riddled with holes - and is likely to have an adverse impact on the structure of the new regulations. Here is why:
i) When a company does a buyback, (through a shareholder resolution or a board resolution), a promoter is actively involved in and votes for the buyback. To call a buy back as a passive non-act of the promoter who suffers is inaccurate.
ii) Not only is the resolution a result of the active participation of the promoter, but the promoter shareholding going up itself is a result of the action of the promoter in not tendering his shares in the buyback. Had the promoter chosen to tender his share, his votes can never go up.
Thus, it is grossly unfair to allow a promoter to use the company funds to increase his shareholding in a company and also be exempt from the takeover regulations. This ruling destroys the fundamental substratum of the takeover regulations - both the 1997 and 2011.

Finally, the SAT posed a question, which created some confusion. Imagine a company with a non promoter shareholder holding 14.99% shares (under the old regulations, or 24.99% under the new one). Now imagine that company doing a buyback. Imagine further that the person did not even participate in the shareholder vote or did not even know of the board vote to do the buyback. Imagine that the person did not tender shares or did not tender all shares, would that person be saddled with an open offer. This possibility shocked SAT as SEBI's position implied that such a person requires an exemption.

The answer to this riddle is that the 14.99% shareholder does not satisfy i) above and therefore is not an acquirer as he is not doing any positive act to increase his shareholding. But to put such a person in the same category as another person with control of the company who chooses to move the resolution, uses the company's money to do so and chooses not to tender his shares and thus directly seeks to increase his shareholding is incorrect. It also disturbs the delicate balance the new regulations have placed by exempting only certain types of buybacks - by exempting all buybacks blindly.

Commentary on SEBI Act - Sumit Agrawal and Robin Baby

noreply@blogger.com (Sandeep Parekh) — Thu, 24 Nov 2011 11:41:00 +0000

I am delighted to introduce India's first commentary on the SEBI Act by Sumit Agrawal and Robin Baby. Not only was there no other commentary in this area, but the book is well written - and I think every corporate and commercial litigator should have a copy of this book in her library.

I was delighted to receive one of the first copies and must say that though I was never their mentor generally or for this book - I do feel like one. The reason is that both the authors are the product of the massive recruitment drive we launched when I was at SEBI to go to the top law schools of the country. Clearly this book is an example of the success of that experiment of getting bright young people into governmental/regulatory bodies.

Congratulations.

Big event on definition of control - ends in a whimper. Subhkam Ventures

noreply@blogger.com (Sandeep Parekh) — Mon, 21 Nov 2011 13:23:00 +0000

Everyone amongst the securities/corporate lawyers was waiting for the legal issue pending before the Supreme Court of India (SEBI versus Subhkam Ventures) on whether negative veto rights amount to control under the SEBI takeover regulations. The case was an appeal from the Securities Appellate Tribunal ruling that "every fetter of any nature in the hands of any person over a listed company cannot result in "control" of that person over that company".

Disappointingly, not only has the Supreme Court not decided the issue, but has said that the question of law is open to a future ruling and that the order of SAT shall not be taken as a precedent. So if there was lack of clarity - which everyone was hoping would get clearer, it is now officially as muddled as ever. Here is the SC order:

"Securities and Exchange Board of India ...Appellant(s)

Versus

M/s. Subhkam Ventures (I) Private Limited ...Respondent(s)

O R D E R

This civil appeal is filed against the impugned order by the Securities Appellate Tribunal [`SAT', for short] wherein the SAT has held on the facts of this case that the respondent has not acquired any control in the Target Company and, therefore, not required to make any public offer under Regulation 12 of the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997 [`Takeover Regulations', for short].

During the pendency of the appeal before this Court, an application has been filed by the respondent in January, 2011, whereby it is stated that there have been subsequent developments in the matter as stated therein whereby the respondent had not appointed their Director on Board and had not exercised any such power and they had already sold their stake in the Target Company and had retained only about six per cent shareholding of the Target Company.

Further, it was also informed that a company by name of M/s. Welspun had already acquired majority stake in the Target Company and the said M/s. Welspun had also taken control of the Target Company and, accordingly, complied with the requirements of both Regulation 10 as well as Regulation 12 of the Takeover Regulations.

Keeping in view the above changed circumstances, it is in the interest of justice to dispose of the present appeal by keeping the question of law open and it is also clarified that the impugned order passed by the SAT will not be treated as a precedent.

The civil appeal is, accordingly, disposed of.

No order as to costs.

New Delhi, November 16, 2011."

Takeover regulations - back on track

noreply@blogger.com (Sandeep Parekh) — Mon, 24 Oct 2011 09:23:00 +0000

I have a piece in today's Economic Times titled (the online version has a different name): Takeover regulations, back on track. Here are excerpts:

SEBI has recently notified a new set of regulations for takeover of listed companies. Thankfully, we have a new set of takeover regulations that do not attempt to solve problems of other countries.

Briefly, the current law in India provides for alerting the marketplace to acquisition of substantial shares or control in listed Indian companies. The regulations also provide for a compulsory tender offer for 20% shares from other shareholders once a larger acquisition of shares (or control) is made, typically acquisition of over 15% in a go or over 5% a year once a 15% shareholding is already owned triggers a tender offer. The compulsory tender offer would now get triggered at the 25% level and the offer size must be 26% of the company's equity capital. In addition, those holding over 25%, can acquire up to 5% a year without the open-offer trigger. These changes will impact different kinds of people differently. A key beneficiary would be private equity players who would be able to hold a more substantial shareholding in listed companies. This is good for corporate governance as the interests of private equity players are aligned with that of the minority shareholder.

The law as enacted is at divergence to the advisory committee report that recommended a 100% open offer, in vogue in Europe and some other countries. In other words, it was recommended that where a person acquires control or substantial number of shares, the acquirer must put up as much as five times the amount of money compared to the existing regime of 20% open offer. With the higher cost, there was a possibility of a severe shrinkage of the market for control. In fact, this hypothesis is supported by an annexure to the report itself that shows that over 85% of all offers in the past several years have occurred at the 20% stake level - the minimum mandated.

In addition, a 100% open offer is not a 'global standard' as some people have portrayed it. The most active market for control, the US, does not have a compulsory open offer at all. Equally specious is the argument that not allowing 100% offers would take away the right of shareholders to exit the company. We are talking about publicly-listed companies here and no one is taking away any exit rights of investors. In fact, a bulk of open offers are barely subscribed to because the difference in price between the open offer and the exchange-traded price - which combined with a more tax-efficient sale - is often minimal or negative.

Connected to the previous argument, for people advocating the committee view, is that a less-than-100% open offer would be unfair to minority shareholders. I have argued in Two steps back for takeover rules (ET, August 12, 2010) that a 100% open offer would be grossly unfair to minority shareholders. Such large offers would make acquisitions prohibitively expensive and would desiccate the market for control - leaving shareholders worse off not just in not getting open offers but suffering the worsening of corporate governance as existing promoters entrench themselves further into management of companies.

An import of the provision from some capital-rich western countries is inappropriate given capital scarcity in India. Combined with the restrictive lending standards imposed by the central bank on acquisition debt financing and, we have an uneven playing field for Indian acquirers compared to overseas acquirers who can leverage their balance-sheet without such restrictions. The late chairman of the committee fairly admitted this issue in an interview and thought RBI should resolve this problem. Combine this with RBI's subsequent hardline position reflected in the Sebi's board meeting of July 2011 and this wasn't about to be resolved.
...
There are some problems too with the regulations. A year continues to be defined as one ending on March 31. This allows an acquirer to acquire 10% in two days versus the intention of permitting 5% in a whole year. The biggest issue is that for acquisitions past 25%, gross acquisitions are taken into account to calculate the threshold. So, if a person who owns 30% equity buys 5%, then sells all 5% and then buys 100 shares, he would have triggered open offer requirements even though the addition to his holding is only 100 shares rather than the triggering 5%. This illogical provision can hardly be adequately condemned. As this isn't reflected in board meeting minutes that discussed threshold numbers, this may warrant deletion.

Global Shapers' Community - nominations invited

noreply@blogger.com (Sandeep Parekh) — Tue, 18 Oct 2011 10:05:00 +0000

Global Shapers’ Community – Mumbai chapter

50% of the world’s population is under the age of 27, the majority of whom live in urban areas. With this in mind, we are becoming increasingly aware that solutions to our global challenges must purposefully engage youth, at all levels – locally, regionally, nationally and globally. This generation has the passion, dynamism and entrepreneurial spirit to shape the future. The state of the world today has never been more complex, in many ways we are entering uncharted territory – a period of extraordinary opportunities, yet fraught with unprecedented imbalances and tremendous risks. In this context, it is significant that the millennial generation consider themselves as “active agents of change” rather than passive bystanders. In a recent study, 92% agree that the world must change; 84% consider it their duty to drive this change; and almost 82% believe they have the power to make it happen. In large part, this generation is increasingly self-empowered and given access to information and technology, which has catalysed tremendous opportunities for interaction and collaboration. The World Economic Forum has successfully established a history of engaging young leaders to positively and proactively impact the global agenda. In addition to its existing community of Young Global Leaders, who are in their mid to late 30s, the Forum is establishing a special community of young people in their 20s. This new community – the Global Shapers Community – will provide youth with a global platform to shape the future – integrating the personal, community and global dimension. Through the unparalleled convening power of the World Economic Forum, the Global Shapers Community is diverse in demographics, geographical areas and sectors. However, it is united by a common desire to channel the members’ tremendous energy and enthusiasm into building a more peaceful and inclusive world.

Who Are the Global Shapers?

· Young extraordinary individuals with great potential for future leadership roles in society
· Between 20 and 30 years of age at the time of nomination
· Representing all walks of life and sharing a spirit of entrepreneurship in the global public interest
· Highly committed to developing their leadership potential towards serving society
· Adhering to the highest standards of moral and intellectual integrity
· Possessing unique qualities that set them distinctly apart from the mainstream
· Entrepreneurial track record, having already initiated and delivered a major project or founded a company or organization, exceptionally contributing to serving society at large
· Ready to deeply engage in the community, reinforcing its mission and objectives and supporting fellow shapers in their individual and professional development

· Endorsed by an existing shaper or another member of the World Economic Forum Community

Shapers are organized in a network of local hubs based in each major city around the world. They undertake events and activities that generate a positive impact within their local community. The community is vitalized by the manifold interactions generated inside each hub, between hubs and on a global level. Complementing face-to-face meetings, particular emphasis will be placed on the virtual dimension – enabling shapers to collaborate and learn from each other through the community platform. Global Shapers will have an impact by catalysing and enhancing, individually and collectively, fresh ideas and entrepreneurial solutions to the world’s most pressing challenges. Shapers will also get involved in cross-mentoring with other World Economic Forum communities.

Nomination

The Global Shapers’ Community in Mumbai is curated by me for a year. Nominations are solicited for joining this community. Please nominate yourself or a person who meets the above description by sending an email to global.shapers.mumbai@gmail.com or by visiting the Community webpage giving brief particulars of the person, age and why the person is suited for joining this community. The nominee’s willingness to be a part of the activities of the community is necessary to being selected.

For more information about Global Shapers’ Community, please visit http://www.weforum.org/community/global-shapers Please also see the video introducing the community: http://youtu.be/fQ6Vl9xZ4FM

Merchant bankers and investor returns

noreply@blogger.com (Sandeep Parekh) — Mon, 10 Oct 2011 10:34:00 +0000

I have seen many reports trying to crucify merchant bankers about the poor returns from companies (with which they were associated) which have in the recent past gone public. See for instance this post. SEBI also now expects bankers to disclose the performance of the companies they brought to market. The broad trend of the articles is that merchant bankers have helped mis-price the issues given that the market price has falled dramatically since the IPO debut. In fact, the opposite is more true. A banker who leaves as little on the table for potential investors as possible does the most justice to the company and its investors. Keeping the IPO price low is bad for the company and for the economy - and only helps merchant bankers who escape the risk of underwriting as a badly priced issue will not require underwriting commitment. It is therefore in the interest of the banker to mis-price the issue on the lower side - rather than the upper side. A high price in an IPO means (besides less dilution of existing investors) that more money goes from those willing to put their risk capital in the market for capital gains - and into the coffers of a company and productive assets.

Thus assertions like "Sebi should take a more stringent view by not allowing fund raisings it thinks are not justified. The risk factors are telling enough in a company’s prospectus." could not be more wrong. It is not SEBI's job to price an issue or to stop it because it is 'overpriced'. In fact under-pricing it would be wrong and a sure exhibition of conflict of interest. Finally, the entire market, particularly small and mid-caps have fallen dramatically because of the second world-wide crisis and high interest rates charged by banks - this fall has nothing to do with merchant banks.

Alternative investment funds AIF regulations - Finsec comments

noreply@blogger.com (Sandeep Parekh) — Mon, 26 Sep 2011 07:46:00 +0000

Our firm, Finsec Law Advisors submitted the following comments on the concept paper/draft regulations of SEBI on Alternative Investement Fund regulations (AIF), which were proposed last month.We also submitted para by para responses - if you would like our complete response, please send me an email and I will share the comment letter.

"Generally

Regulating alternative investment funds is an important step within SEBI’s remit. Broadly, SEBI regulations must pass a cost benefit analysis and in line with that, SEBI has till now used light touch regulations where the investors are sophisticated and can thus take care of themselves. The concept paper recognises how important the industry is and talks highly of the 'patient source of active capital' which 'plays a very important role in the growth of the corporate sector' and that the capital brings 'a lot of governance and good quality money'. It is therefore important that the regulations sought to be imposed by SEBI should further the object sought to be achieved and such object be achieved keeping in mind a cost benefit analysis which is commonly termed as regulatory impact assessment. This analysis is done by most developed regulators in the world including the International Organization of Securities Commissions (IOSCO) as also by SEBI.

The three goals of the regulations as stated in the concept paper itself are (a) management of systemic risk (paragraphs B.5 and 6), (b) targeting of benefits to certain types of funds and putting investment restrictions (paragraphs B.1 and 2) and (c) addressing conflict of interest (paragraph C.1)

With respect to the first goal, while noting international developments, SEBI has not addressed the issue. In any event, as far as domestic private equity or venture capital is concerned, there is virtually no leverage or debt involved and therefore addressing the issue from a point of view of systemic risk is unnecessary. At the same time foreign investment vehicles may be highly leveraged, and the impact of such leveraged funds needs to be seen from India’s systemic risk perspective. This, SEBI needs to address along with RBI.

With respect to the second goal, the concept paper and the draft regulations seek to create investment silos and imposes restrictions on where each type of fund may invest. This takes away the only free lunch available in the financial markets — of diversification in different types of companies. Thus, a fund which wants exposure in SMEs, early stage companies and listed companies would be prohibited from investing unless they create three different pools. In our view, creating these silos would impose a severe cost not only on the players in terms of lack of flexibility, but such a system would inject higher risk on the investors. Thus to create silos to target benefits is inappropriate. Instead, it would be useful to make such silos optional, so anyone seeking a benefit can be recognised and avail the benefits.

The proposal seeks to mandate the types of companies which are kosher for a particular fund, including whether investment should be in listed or unlisted debt securities. There is a provision for the fund size to be a minimum of Rs. 20 crore, the minimum investment per investor to be 0.1% of the fund size. Then there is a requirement that funds be close ended with a minimum tenure of five years. VC funds cannot hold more than Rs. 250 crore in a single pool and cannot invest in companies promoted by the top 500 listed companies or their promoters. VC funds cannot invest in warrants or convertibles or even in listed debt securities (today a large number of VC funds are invested in convertibles). Private investments in public equity (PIPE) funds cannot invest in companies which are listed on exchanges that form part of any exchange index. PE funds cannot invest in listed shares. Debt funds cannot invest in listed debt securities. Why a regulation should mandate investment in unregulated unlisted debt securities is unclear, when listed debt is a more regulated and secure asset. None of this is useful and serves any regulatory benefit to investors or to the system.

Besides the investment micro management, there are other issues too. With respect to the third goal, the concept paper seeks to mandate minimum investment of 5% by the manager of the pool. This would make many smart managers to go out of business if they cannot shell out so much capital. Clearly, in the industry, what is needed is smart managers who can add value to the economy, rather than rich managers who may or may not be smart. The philosophy behind managers investing in the funds that they manage is to create alignment of interest. This alignment has been elsewhere termed as 'conflict of interest' in the concept note. Thus the 5% minimum investment by the manager ends up mandating a minimum conflict of interest (as per its definition). If at the end of the tenure any investments are un-liquidated, they are required to be taken up by the manager/sponsor. This is also dangerous, if there is a financial crisis and the securities cannot be sold at a reasonable price, both the sponsor/manager and investor would be hit by a regulator mandated fire-sale and by a mandatory underwriting by the manager. There is, therefore, a premium on rich managers and a regulatory exclusion of smart managers — a regulatory self-goal. SEBI needs to seriously relook at these proposals."

C Achuthan - homage

noreply@blogger.com (Sandeep Parekh) — Tue, 20 Sep 2011 05:29:00 +0000

C Achuthan, former head of the Securities Appellate Tribunal (SAT) and an author of much securities market jurisprudence passed away yesterday. Starting from his contribution as a co-author of the SEBI Act to his varied and rich rulings at SAT to his being part of the board of directors who took over Satyam Computers and the author of the proposed takeover report - C Achuthan left an indelible mark on the financial markets and their regulations.

I'm a VC

noreply@blogger.com (Sandeep Parekh) — Wed, 07 Sep 2011 12:08:00 +0000

If you are a Venture Capital or Private Equity investee company, this is tragi-comic. Otherwise this video is a riot. Hat-tip: Paul Kedrosky.

India becomes even more uncompetitive

noreply@blogger.com (Sandeep Parekh) — Wed, 07 Sep 2011 10:14:00 +0000

The World Economic Forum's Global Competitiveness Report is just out and India has done predictably bad 56th out of 142 countries (down from 51st last year and sandwiched between Azerbaijan and Slovenia). Here is the full report and the following commentary about India says it all (jump to page 204 of the pdf file to get a snapshot of India rankings in each area):

India ranks 56th in this year’s assessment. The
country drops five places and demonstrates only minor
changes in its competitiveness performance since last
year.25 Among the BRICS, India continues to rank on
a par with South Africa (50th) and Brazil (53rd) and
ahead of Russia (66th), but its gap with China is widening:
the score difference between the two economies
has increased sixfold between 2006 and today, the gap
expanding from less than 0.1 to 0.6 points.
India continues to be penalized for its mediocre
accomplishments in the areas considered to be the basic
factors underpinning competitiveness. The country’s
supply of transport, ICT, and energy infrastructure
remains largely insufficient and ill-adapted to the needs
business (89th). Indeed, the Indian business community
continues to cite infrastructure as the single biggest
hindrance to doing business in the country. It must
be noted, however, that the situation has been slowly
improving since 2006, although this does not translate
into a higher ranking because other countries have been
improving faster. The picture is similar in the health
and basic education pillar (101st). Despite improvements
across the board over the past few years, public health
and education quality remain a prime cause of concern.
While we observe some encouraging trends in
these two areas, the same cannot be said of the country’s
institutions and macroeconomic environment, the
other two dimensions comprising the basic requirements
component of the GCI. In the past five years,discontent in

the business community about the lack of
reforms and the apparent inability of the government
to provide a more conducive environment for business
has been growing. Corruption (99th) and burdensome
regulation (96th) certainly fuel this discontent. Since
2006, India’s score in the institutions pillar has plunged
from 4.5 to 3.8. Once ranked a satisfactory 37th in this
dimension, India now ranks 69th, having dropped 11
places this year alone. Meanwhile, the macroeconomic
environment (105th) continues to be characterized by
large and repeated public deficits and the highest debtto-
GDP ratio among the BRICS. More recently, the
stability of the country’s macroeconomic environment
is being undermined by high inflation, near or above 10
percent. As a result, India has been hovering around the
100 mark in this pillar for the past five years.
Despite these considerable challenges, India does
possess a number of remarkable strengths in the more
advanced and complex drivers of competitiveness. This
“reversed” pattern of development is characteristic of
India. The country boasts a vast domestic market that
allows for economies of scale and attracts investors. It
can rely on a well-developed and sophisticated financial
market (21st) that can channel financial resourcesto
good use, and it boasts reasonably sophisticated (43rd)
and innovative (38th) businesses.

RBI norms for new bank licenses

noreply@blogger.com (Sandeep Parekh) — Mon, 29 Aug 2011 14:17:00 +0000

The Reserve Bank of India released on its website today, the Draft Guidelines for “Licensing of New Banks in the Private Sector”.

Key features of the draft guidelines are (my comments are given below each para in bold):

(i) Eligible promoters: Entities / groups in the private sector, owned and controlled by residents, with diversified ownership, sound credentials and integrity and having successful track record of at least 10 years will be eligible to promote banks. Entities / groups having significant (10 per cent or more) income or assets or both from real estate construction and / or broking activities individually or taken together in the last three years will not be eligible.

Comment: Why should entities having 10% or more stake in real estate construction or broker activities be excluded from eligibility. SEBI registered brokers are amongst the most regulated entities in the country - in fact being a SEBI registered broker should be an eligibility rather than a ground for ineligibility. Brokers also have a good sense of the economy and the financial world. In any case, the bank is to be created through a separate entity and it is not clear what risk will flow to the bank if over 10% of the holding of the parent, twice removed, does broking business. In fact if the holding company controlling both the banks and the brokerage are regulated by the RBI (see next point), that is a good thing for systemic risk.

(ii) Corporate structure: New banks will be set up only through a wholly owned Non-Operative Holding Company (NOHC) to be registered with the Reserve Bank as a non-banking finance company (NBFC) which will hold the bank as well as all the other financial companies in the promoter group.

Comments: This is a positive development for systemic risk management - as RBI gets a better handle of the financial sector and not just banks and some types of non-banks.

(iii) Minimum capital requirement: Minimum capital requirement will be ` 500 crore. Subject to this, actual capital to be brought in will depend on the business plan of the promoters. NOHC shall hold minimum 40 per cent of the paid-up capital of the bank for a period of five years from the date of licensing of the bank. Shareholding by NOHC in excess of 40 per cent shall be brought down to 20 per cent within 10 years and to 15 per cent within 12 years from the date of licensing of the bank.

Comment: Not clear why RBI want both a minimum shareholding now and a maximum shareholding later. If it wants diffused shareholding - there should be a maximum in both cases. I assume RBI wants a promoter at this stage so it can have someone accountable.

(iv) Foreign shareholding: The aggregate non-resident shareholding in the new bank shall not exceed 49 per cent for the first 5 years after which it will be as per the extant policy.

Comment: The foreign shareholding should be uniform across both existing banks and new banks.

(v) Corporate governance: At least 50 per cent of the directors of the NOHC should be independent directors. The corporate structure should be such that it does not impede effective supervision of the bank and the NOHC on a consolidated basis by the Reserve Bank.

Comment: Having independent directors is only a miniscule part of corporate governance. RBI needs to do a deep qualitative filtering to allow fit and proper persons to enter the systematically important arena of banking. While this may not satisfy some as not based on objective criteria, the RBI should take a call on who is fit and who is not - rather than merely giving licenses based on size, shareholding pattern, number of independent directors etc.

(vi) The bank shall open at least 25 per cent of its branches in unbanked rural centres (population upto 9,999 as per 2001 census)

Whatever is the standard – should be applied to all banks – not just new banks.

SEBI comes out with a proposed regulatory regime for AIF

noreply@blogger.com (Sandeep Parekh) — Fri, 19 Aug 2011 05:59:00 +0000

I have a piece in the Economic Times yesterday on SEBI's proposed set of regulations on alternative investment funds. Here are excerpts:

Sebi recently came out with a proposed regulatory regime for alternative investment funds ( AIF). While the regulator has its heart in the right place, the proposals need to be thought through from the ground up.

...
What Sebi now seeks to do is create an umbrella regulatory regime for all funds. Sebi's stated objective is three-fold. First, create a regulatory framework which registers different types of funds based on investment objective like private equity, real estate, venture capital, debt, infrastructure, SME, social venture and strategy funds. This would enable targeted benefits for a particular sector. Second, to get a handle on systemic risk. As some overseas funds may be highly leveraged they may cause system-wide instability. Third, to improve disclosures, provide for conflict of interest and prohibit fraudulent acts. It is difficult to argue with these goals. Unfortunately, while talking about these, the paper ends up doing something quite different. It seeks to impose investment and other restrictions on these funds, which would hurt the industry without any regulatory benefit.

In Greek mythology, Procrustes, the son of a god, had an iron bed in which he invited every passerby to spend the night, and where he set to work on them with his smith's hammer, to stretch them to fit if they were too short and if the guest proved too tall, Procrustes would amputate the excess length; nobody ever fit the bed exactly because secretly, Procrustes had two beds. Sebi has many investment beds, and its proposals are no less dangerous.

The most damaging aspect of the proposal is that the paper seeks to create investment silos and imposes restrictions on where each type of fund may invest. This takes away the only free lunch available in the financial markets - of diversification in different types of companies. Thus, a fund which wants exposure in SMEs, early stage companies and listed companies would be prohibited from investing unless they create three different pools.

The proposal seeks to mandate the types of companies which are kosher for a particular fund, including whether investment should be in listed or unlisted debt securities. There is a provision for the fund size to be a minimum of Rs 20 crore, the minimum investment per investor to be 0.1% of the fund size.

Then there is a requirement that funds be close ended with a minimum tenure of five years. VC funds cannot hold more than Rs 250 crore in a single pool and cannot invest in companies promoted by the top 500 listed companies or their promoters. VC funds cannot invest in warrants or convertibles or even in listed debt securities (today a large number of VC funds are invested in convertibles). Private investments in public equity (PIPE) funds cannot invest in companies which are listed on exchanges that form part of any exchange index.

PE funds cannot invest in listed shares. Debt funds cannot invest in listed debt securities. Why a regulation should mandate investment in unregulated unlisted debt securities is unclear, when listed debt is a more regulated and secure asset.

None of this is useful and serves any regulatory benefit to investors or to the system. Besides the investment micro management, there are other issues too. The paper seeks to mandate minimum investment of 5% by the manager of the pool. This would make many smart managers to go out of business if they cannot shell out so much capital.

The philosophy behind managers investing in the funds that they manage is to create alignment of interest. This alignment has been elsewhere termed as 'conflict of interest' in the concept note. Thus the 5% minimum investment by the manager ends up mandating a minimum conflict of interest (as per its definition). If at the end of the tenure any investments are un-liquidated, they are required to be taken up by the manager/sponsor.

This is also dangerous, if there is a financial crisis and the securities cannot be sold at a reasonable price, both the manager and investor would be hit by a regulator mandated fire-sale and by a mandatory underwriting by the manger. There is, therefore, a premium on rich managers and a regulatory exclusion of smart managers - a regulatory self-goal. Sebi needs to seriously relook at its proposals rather than make Procrustes smile.

and here is a link to the full piece

Short selling bans

noreply@blogger.com (Sandeep Parekh) — Sat, 13 Aug 2011 15:46:00 +0000

Europe is being not just silly but acting dangerously by banning short selling. I have written about short selling several times in the past and how short selling prevents bubbles and frauds. Suffice it to add that, if someone is holding a hedged position and you ban the short side of the book, that person will also need to unwind the long side. Which can't be good for the markets right?

Alternative investment funds - SEBI's new draft proposal

noreply@blogger.com (Sandeep Parekh) — Tue, 02 Aug 2011 05:44:00 +0000

SEBI has come out with a Concept Paper On Proposed Alternative Investment Funds Regulation For Public Comments

I will come back with more comments, but there are good things about a holistic set of regulations for the investment funds sector but the specifics of the proposed regulations chart into dangerous micro and unnecessary regulations.