Capital Markets: Challenges and Developments

May, 18, 2019

Masala Bonds

News

Kerala state first to issue Masala bonds

  • The Kerala Infrastructure Investment Fund Board issued Masala Bonds to raise funds from the overseas market.
  • It has become the first Indian state to tap into the market for masala bonds.
  • The proceeds from the bond issue are slated to be used to part-finance the rebuilding of infrastructure in Kerala that was devastated by last year’s floods.

Masala Bonds

  • They are rupee-denominated bonds i.e the funds would be raised from overseas market in Indian rupees.
  • According to RBI, any corporate, body corporate and Indian bank is eligible to issue Rupee denominated bonds overseas.
  • While companies can raise funds through these bonds, there are limitations for the use of such proceeds.
  • RBI mandates that the money raised through such bonds cannot be used for real estate activities other than for development of integrated township or affordable housing projects.
  • It also can’t be used for investing in capital markets, purchase of land and on-lending to other entities for such activities as stated above.

Minimum maturity of masala bonds

  • According to RBI, the minimum maturity period for Masala Bonds raised up to Rupee equivalent of USD 50 million in a financial year should be 3 years.
  • And for bonds raised above USD 50 million equivalents in INR per financial year should be 5 years.
  • The conversion for such bonds will happen at the market rate on the date of settlement of transactions undertaken for issue and servicing of the bonds, including its redemption.

Where can these bonds be issued and who can subscribe?

  • The bonds can only be issued in a country and subscribed by a resident of such country that is a member of FATF and whose securities market regulator is a member of International Organisation of Securities Commission.
  • While residents of such countries can subscribe to the bonds, it can also be subscribed by multilateral and regional financial institutions where India is a member country.
May, 07, 2019

[op-ed snap] Deserved penalty

CONTEXT

The Securities and Exchange Board of India (SEBI) last week ordered the National Stock Exchange of India (NSE) to pay a fine of about ₹1,000 crore within 45 days for its supervisory laxity that led to some of its broker-clients gaining preferential access to certain market data.

Details of order

1.Payback from NSE Chiefs – Two former NSE chiefs have been ordered to pay back a part of their past salaries as punishment for their failure to ensure that the exchange was fully compliant with all provisions of the norms governing securities exchanges.

2.Use of tick by tick protocol is responsible for data breach – In its order, SEBI noted that the NSE’s use of the tick-by-tick server protocol had allowed certain high-frequency trading firms using the exchange’s secondary server to receive important market data before other market participants, who were thus put at a disadvantage.

3.Doubts regarding market fairness – While it has not yet been proven decisively that the firms with preferential access to data from the exchange managed to profit from such data, the episode raised serious questions about market fairness.

4.No fraudulent activity but lack of diligence – SEBI ruled that it did not find sufficient evidence to conclude that the NSE committed a fraudulent act, but was unequivocal in ruling that the Exchange had failed to exercise the necessary due diligence to ensure that it served as a fair marketplace.

5.Switch to new data system worked in favour – The fact that the NSE had opted to switch to a new data transmission system, which relays data to all market participants at the same time, prior to a whistle-blower’s complaint in 2015 may have worked in the NSE’s favour.

The relevance of the verdict

1.Relief to stock exchange –

  • Despite the sizeable fine that it imposes on the NSE, the SEBI verdict must surely come as a relief to the erring stock exchange for at least two reasons.
  • First, the fact that it has not been found to have intentionally favoured certain market players over others should help it retain investor confidence.
  • Also, the exchange, which had been barred from proceeding with its initial public offering during the pendency of the SEBI probe, will now finally be able to tap the capital markets to fund its growth, after a six-month moratorium.

2.Welcome regulatory Action

  • While there is bound to be debate about the magnitude of the fine, overall the financial penalty is a welcome regulatory action.
  • Millions of investors choose to do their trading on market platforms like the NSE every year in the belief that the marketplace offers an equitable environment to carry out their trades.

Conclusion

As the markets regulator, SEBI must deal with breaches of their supervisory brief by exchanges in an exemplary manner to ensure that small investors retain confidence in the fairness and soundness of key institutions that enable a market economy.

Apr, 25, 2019

[pib] Investor Education and Protection Fund (IEPF)

News

  • In a major success, the IEPF Authority has been able to enforce a company to transfer deposits worth about Rs 1514 Cr to IEPF.
  • This depositor’s money was pending with the company for the last 15 years.

Investor Education and Protection Fund (IEPF)

  • IEPF is a fund where unclaimed dividend, refunded application money, matured company deposits and debentures, as well as the interest on them, is used, provided it is not claimed within seven years.
  • It is a fund set up under the Ministry of Corporate Affairs to help promote investor awareness and protection of investor interests.

About IEPF Authority

  • IEPF Authority has been set up under the Ministry of Corporate Affairs, Government of India as a statutory body under Companies Act 2013 to administer the IEPF with the objective of promoting Investor’s Education, Awareness and Protection.
  • The Authority takes various initiatives to fulfil its objectives through Investor Awareness Programmes and various other mediums like Print, Electronic, Social Media, and Community Radio etc.
  • Secretary Ministry of the Corporate Affairs is the Chairperson of the Authority.
  • Joint Secretary Ministry of the Corporate Affairs is the Chief Executive Officer of the Authority.
Apr, 05, 2019

National Investment and Infrastructure Fund (NIIF)

 News

  • Roadis, a private investor and operator of transport infrastructure worldwide and the National Investment and Infrastructure Fund (NIIF) have jointly set up a platform to invest in road projects in India.

Platform for Road projects in India

  • The platform would invest up to $2 billion of equity targeting toll-operate-transfer models, acquisitions of existing road concessions and investment opportunities in the road sector.
  • With 710 km of highways under ownership and management, Roadis is one of the largest European highway concession managers in India.
  • Roadis is a wholly owned subsidiary of the Public Sector Pension Investment Board, one of Canada’s largest pension funds.

About NIIF

  1. National Investment and Infrastructure Fund (NIIF) is a fund created by the Government of India for enhancing infrastructure financing in the country.
  2. This is different from the National Investment Fund.
  3. Objective: to maximize economic impact mainly through infrastructure development in commercially viable projects, both greenfield and brownfield, including stalled projects.
  4. NIIF was proposed to be set up as a Trust, to raise debt to invest in the equity of infrastructure finance companies such as Indian Rail Finance Corporation (IRFC) and National Housing Bank (NHB).
  5. NIIF is envisaged as a fund of funds with the ability to make direct investments as required. As a fund of fund it may invest in other SEBI registered funds.
  6. The functions of NIIF are as follows:
  • Fund raising through suitable instruments including off-shore credit enhanced bonds, and attracting anchor investors to participate as partners in NIIF;
  • Servicing of the investors of NIIF.
  • Considering and approving candidate companies/institutions/ projects (including state entities) for investments and periodic monitoring of investments.
  • Investing in the corpus created by Asset Management Companies (AMCs) for investing in private equity.
  • Preparing a shelf of infrastructure projects and providing advisory service
Apr, 03, 2019

SEBI mulls SRO for investment advisers

News

  • The SEBI has proposed a self regulatory organisation (SRO) for the growing number of investment advisers to address issues related to the quality of advice given to investors by such entities.

What is Self Regulatory Organisation?

  • An SRO is the first-level regulator that performs the crucial task of regulating intermediaries representing a particular segment of securities market on behalf of the regulator.
  • An SRO would be seen as an extension of the regulatory authority of the SEBI and would perform the tasks delegated to it by the SEBI.
  • The role of an SRO is developmental, regulatory, related to grievance redressal and dispute resolution as well as taking disciplinary actions.

Why need SRO?

  • SEBI is in receipt of a large number of complaints alleging charging of exorbitant fees, assurance of returns, misconduct etc. by investment advisers.
  • Incidentally SEBI has said that there was a need for an SRO for mutual fund distributors — that currently register with Association of Mutual Funds in India (AMFI).
  • It was aimed to bring in consistency in industry practices and also to take disciplinary action against alleged malpractices such as mis-selling of products and churning of portfolio.

Expected functions

  • SEBI has proposed the strengthening of the existing regulatory framework for SROs by introducing features such as a governing board with public interest directors and a clear policy for arbitration and dispute resolution.
  • The regulator has proposed a governing board with at least 50% public interest directors along with 25% representation each of shareholder directors and elected representatives.
  • Further, the governing board can appoint a managing director or chief executive officer to manage the daily affairs of the SRO.
Apr, 03, 2019

Systematic Investment Plan (SIP)

News

What is SIP?

  • A SIP is a way to invest in mutual funds wherein a fixed sum of money is put into a mutual fund scheme at a specified date every month.
  • It is considered to be investor-friendly and an efficient manner of investing in the capital markets as one can start investing with small monthly contributions instead of first building a huge investment corpus.
  • It is a hassle-free manner of investment as well since one can issue standing instructions to the bank for a specified amount to be transferred to the fund house/distributor every month at a pre-determined date.

How can one start a SIP?

  • There are two ways of starting an SIP. One can use the direct way of investing though the fund house or go through a distributor.
  • For direct plans, an investor can go to the website of the fund house for the scheme in which the SIP has to be started.
  • All the fund houses have a link on their portals for investors who want to start an SIP.
  • Typically, only the PAN and/or Aadhaar is needed to open an account.
  • Thereafter, one can select the scheme, SIP amount, starting date and duration of SIP.
  • If one opts for a distributor, then the same process can be done online on the distributor’s portal.

Benefits of a SIP

  • Timing the market is the most difficult thing when it comes to equity investment. SIPs, in a way, address this issue.
  • SIPs capture every rise and fall of the market and hence, an investor need not worry about the level of the market.
Mar, 21, 2019

India’s first Real Estate Investment Trust subscribed 2.58 times

Note4students

From the UPSC perspective, the following things are important:

Prelims level: REIT

Mains level: Not Much


News

  • The initial public offering (IPO) of India’s first Real Estate Investment Trust (Embassy REIT) was subscribed 2.5 times, with the share sale generating a demand of over Rs 5,300 crore.

What is REIT?

  • REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership – without actually having to go out and buy commercial real estate.
  • It is a company that owns, and in most cases operates, income-producing real estate.
  • REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, hotels and timberlands.

How does it work

  • Unlike shares, investors in a REIT get units, somewhat similar to units in a mutual fund.
  • A REIT owns a number of rent-yielding commercial and hotel properties, and the unit-holders get a portion of this rental income in the form of dividend and interest income in proportion to their equity contribution.
  • It gives the investor an option to buy partial stake in rent-yielding commercial properties, with the benefit of a professional manager managing these assets.
  • Increase in rentals of underlying assets, improvement in occupancy rate and commencement of under construction properties are the growth drivers that an investor can
  • The net distributable cash flows of the Embassy REIT are based on the cash flows generated from the assets.
  • In terms of the REIT Regulations, at least 90 per cent of the net distributable cash flows are required to be distributed to the Embassy REIT.
  • The trust distributes the cash flow to unit-holders in the form of dividend and interest income, generally, once every quarter.

Associated risks

  • Since this is the first REIT issue, there is no comparable data in terms of pricing and attractiveness of the issue.
  • Real estate properties are always prone to litigation and operational challenges.
  • Even though its assets are in cities offering good rental clients, the rate of occupancy is always a critical factor.
  • Also, with future development of new office spaces in upcoming areas, the old buildings lose their charm and thereby their premium to get higher rental.
  • The management fee and operating expenses can rise, eating into the returns of investors. The biggest concern is the valuation of the units.
  • Since the Net Asset Value of the REIT is based on estimated future cash flows and certain assumptions, it is difficult to gauge the margin of safety for an investor.
Mar, 08, 2019

[op-ed snap]Credit rating firms came under criticism from RBI

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: Credit ratings

Mains level: Problems being faced due to credit rating sector in India & need for revamping the market structure for same.


NEWS

CONTEXT

Credit rating firms came under sharp criticism from the Reserve Bank of India (RBI) for failing to identify financial troubles in various companies, especially in the case of IL&FS.

Concerns over rating agencies
  • Inability to assess credit risk and take timely rating actions.
  • Ratings are supposed to be forward-looking, but they are always a laggard.
  • The central bank is said to have told credit ratings officials that the abrupt ratings downgrades in recent months have hurt investors and banks.
  • Credit Rating agencies have been criticised for being late in identifying the stress in the IL&FS Group, which defaulted on its loans from banks, mutual funds and provident funds.
  • Various debt mutual fund schemes saw erosion in their net asset values, or NAVs, because of the defaults.
  • The crisis soon spread to other non-banking finance companies — mainly housing finance — which have been struggling to sort out their asset-liability mismatches.
  • RBI said one third of the total NPAs (non-performing assets) in the system stemmed from investment grade ratings.
  • Total stressed assets are about Rs 12 lakh crore in the banking system.

Conflict of Interest

  • Globally, rating agencies limit themselves to ratings and research related to credit ratings.
  • All other businesses like market research, training, risk solutions are carried out under separate entities with no common directors, employees and shareholding from the rating entity.
  • In India, the same rating agency rates and provides valuation opinions to the same set of securities to investors like mutual funds and provides advisory services.
  • The central bank governor disapproved of the practice of “rating shopping”— where companies migrate from one rating agency to another for better ratings.
  • RBI was also concerned about issues such as rating agency CEOs being part of rating committees and rating advisors who promise better ratings to an issuer due to their special relationship with rating agencies.

Conclusion

  • RBI is examining the matter and along with Sebi, it will bring out regulations to address this.
  • Though credit rating agencies are registered with the capital market regulator Sebi, they are jointly regulated by both Sebi and RBI as these firms rate bank loans which constitute 70% of their business.
  • On short-term instruments like commercial paper, RBI feels that the ratings do not reflect the pricing these papers command.
Mar, 07, 2019

[op-ed snap] Wiggle space: on SEBI's new rules

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Need for better regulation of CRAs to maintain investor confidence in Indian markets


NEWS

CONTEXT

According to new regulations issued by the Securities and Exchange Board of India (SEBI), liquid mutual funds holding debt securities with a maturity term of more than 30 days will have to value these securities on a mark-to-market basis.

Changes in rules

  • Until now, liquid mutual funds could report the value of debt instruments with a maturity term of up to 60 days using the amortisation-based valuation method.
  • Only debt securities with a maturity term of over 60 days were to be valued on a mark-to-market basis. So the new rule seemingly narrows the scope for amortisation-based valuation.
  • Amortisation-based valuation, which is completely detached from the market price of the securities being valued, allowed mutual funds to avoid the volatility associated with mark-to-market valuation.

Impact

  • By exempting securities with a maturity period of up to 30 days from mark-to-market valuation, however, SEBI may be doing no favour to individual investors.
  • this helps avoid the volatility of mark-to-market accounting and the need to provide a fair account of the value of their investments.
  • What is likely is a decrease in the yields received on securities maturing in 30 days or less and an increase in the yields on debt instruments with a maturity period of 31 to 60 days.
  • It will, however, do nothing to make investors in mutual funds become more informed about the real value of their investments.

Contrast with earlier arrangements

  • The latest SEBI rules are also in direct contrast to the usual accounting practices when it comes to the valuation of securities.
  • Generally accepted accounting principles mandate securities with the least maturity to be reported on a mark-to-market basis while allowing the amortisation-based method to be employed to value other securities with longer maturity periods.
  • This makes sense as the profits and losses associated with securities with shorter terms are closer to being realised by investors when compared to longer-term securities.

Conclusion

  • SEBI would do well to mandate that all investments made by liquid mutual funds should be valued on a mark-to-market basis. Simultaneously, it should work on deepening liquidity in the bond market so that bond market prices can serve as a ready reference to ascertain the value of various debt securities.

 

 

Feb, 08, 2019

Unregulated deposit schemes to be banned

Note4students

Mains Paper 2: Governance | Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

From UPSC perspective, the following things are important:

Prelims level:  Particulars of the Bill, Ponzi Schemes,

Mains level: The new bill seeks to protect investors from rising instances of scams


News

  • The Union Cabinet has approved the official amendments to an Act that classifies any deposit scheme not registered with the government as an offence and bans it.
  • The Banning of Unregulated Deposit Schemes Bill 2018 was introduced in Parliament on July 18, 2018 and was referred to the standing committee.

Banning of Unregulated Deposit Schemes Bill, 2018

  1. The Bill contains a substantive banning clause which bans deposit takers from promoting, operating, issuing advertisements or accepting deposits in any unregulated deposit scheme.
  2. The amendment bill aims to effectively tackle the menace of illicit deposit-taking activities, and prevent such schemes from duping poor and gullible people of their hard-earned savings.
  3. The principle is that the bill would make the activities an offence ex-ante rather than the existing legislative-cum-regulatory framework which only comes into effect ex-post with considerable time lags.
  4. It bans deposit takers from promoting, operating, issuing advertisements or accepting deposits in any unregulated scheme.

Provisions of the Bill

  1. The Bill has adequate provisions for disgorgement or repayment of deposits in cases where such schemes nonetheless manage to raise deposits illegally.
  2. The Bill provides for attachment of properties/assets by the competent authority, and subsequent realization of assets for repayment to depositors.
  3. The Bill provides for “severe punishment and heavy pecuniary fines” to act as a deterrent.
  4. The penalties could involve jail term as well as the sale of the offenders’ assets to pay back the defrauded party within set timelines.

Definition of Deposit Takers

  • Deposit Takers include all possible entities (including individuals) receiving or soliciting deposits, except specific entities such as those incorporated by legislation.

Types of Offences

The Bill creates three different types of offences:

  • Running of unregulated deposit schemes,
  • Fraudulent default in regulated deposit schemes, and
  • Wrongful inducement in relation to unregulated deposit schemes.
Jan, 30, 2019

[op-ed snap] Account aggregators and e-consent for credit markets

Note4students

Mains Paper 3: Economic Development| Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

From UPSC perspective, the following things are important:

Prelims level: Basic knowledge of Public credit registry (PCR).

Mains level: The news-card analyses the issues and challenges in the establishment of a public credit registry (PCR), in a brief manner.


Context

  • There has been demand by experts for the establishment of a public credit registry (PCR) in India.
  • According to them, building a robust and centralized credit information system will be able to bring transparency to the credit market that will allow borrowers to build up their “reputational collateral”, reward good borrowers and encourage credit discipline.

Issue with credit information system in India

  • India has a multiplicity of credit information repositories.
  • As a result, it is very difficult for lenders to form a comprehensive view of the indebtedness of potential borrowers as their credit information is dispersed across multiple entities.
  • Additionally, as the formats in which the data is required to be reported to each of these entities varies widely, there is no assurance about the quality of the data, even if it were to be aggregated.

Public Credit registry would remove these inconsistencies

  • A PCR that operates as the single point of mandatory reporting of credit information, would remove these inconsistencies.
  • And leading to improvements in data quality and offering a mechanism by which borrowers of all levels can establish the reputational collateral that is needed.
  • It would additionally allow lenders to distinguish between different types of borrowers, avoiding the pitfall of adverse selection where lenders overcharge low-risk borrowers and undercharge high-risk borrowers simply because they don’t have accurate data.

Establishing PCR: only one part of the solution

  • A registry of credit gives lenders an accurate snapshot of only the indebtedness of a borrower.
  • It provides no information as to that person’s financial assets.
  • In determining whether or not to grant a loan, lenders need to evaluate both the existing debt burden of the individual as well as the details of her financial asset portfolio to assure themselves that she will be able to service the loan.
  • At present, lenders meet this second requirement by asking for copies of bank statements and other financial assets of the borrower and then physically verifying the copies presented to them against original records.
  • The process is time-consuming and runs the risk of fraud.
  • What is required is a trusted, electronic system through which borrowers can provide lenders with verifiable information about their financial assets in an auditable, electronic format that is both accurate and up to date.

RBI’s Account aggregator infrastructure

  • It is with this in mind that the Reserve Bank of India is establishing the account aggregator infrastructure.
  • It is a digital architecture that offers borrowers a mechanism by which potential lenders can view their financial assets without compromising privacy and confidentiality.
  • Central to this construct is the account aggregator, a regulated third-party entity whose sole function will be to maintain and operate a trusted platform on which registered users can link details of their financial accounts, such as bank accounts, mutual funds and insurance accounts.

How this will work?

  • Whenever potential lenders need evidence of the financial assets of a potential borrower, they will have to issue an electronic request setting out details of the data sought and the purpose for which it will be used.
  • To limit the risk of over-consenting, lenders will only be able to request limited information for specified purposes using templates that have been designed keeping in mind principles of data minimization and purpose limitation.
  • Once this request has been received, the borrower can digitally consent to the specific request, thereby authorizing the account aggregator to extract the relevant information from the financial asset portfolio that has been linked.
  • Based on the authority of the digital consent artefact, the account aggregator will instruct the relevant financial institutions to issue digitally signed copies of the required information to the lender.

Implications

  • Some experts have aversion to an over-reliance on consent as a mechanism to safeguard privacy.
  • However, the electronic consent artefact contemplated in the account aggregator framework is not the same as the over-broad, confusingly worded terms of service that we most frequently encounter.
  • It is, to the contrary, a specific, one-time request for limited information, intended to be used for a clearly defined purpose.
  • As such, consent deployed in this manner is highly unlikely to be misconstrued and, as only a limited amount of data is provided, the risk of misuse is contained
  • As much as this construct achieves the objective of purpose limitation, there is no way to ensure that once financial data has been provided, the recipients will only use it for the purposes for which it was requested.

Conclusion

  • At present, there is no technological construct by which the data that has been provided using the account aggregator framework will automatically expire once its original purpose has been served.
  • Nothing stops lenders from retaining, and using, data long after its purpose is served.
  • It is for this reason that the account aggregator architecture needs to be firmly ensconced within an extended regulatory framework that imposes restrictions over and above that which is contained within the technological framework of the consent artefact.
  • While technology offers new means by which results can be achieved, it is critically important that we remember to ground these solutions in appropriately robust legal frameworks.
Nov, 23, 2018

[op-ed snap] Rethinking the CRA regulatory framework

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Need for better regulation of CRAs to maintain investor confidence in Indian markets


Context

New CRA framework by SEBI

  1. The Securities and Exchange Board of India (SEBI), in its continued effort to improve the functioning of credit rating agencies (CRAs), has come up with a fresh set of guidelines for enhanced disclosures on rating rationales
  2. SEBI has been actively trying to enhance regulations pertaining to CRAs, particularly post-2012
  3. The alleged slippage of India CRAs is a more recent phenomenon despite them having been around since 1990

Issuer pays model is the global norm

  1. The general criticism of ‘issuer pays’ model as the crux of CRA performance may be missing the complexity of the matter
  2. Globally, this model goes back to the 1970s
  3. As such, the evaluated-pays-the-evaluator model is not unique to CRAs
  4. Auditors and universities follow the same model

Need of principle-based approach by SEBI

  1. Sebi’s regulatory approach to CRAs has been more inclined to a rule-based approach as opposed to a principle-based approach
  2. Under a principle-based approach, the regulator states the desired outcome, leaving it to the regulated firms to figure out the steps they need to take to achieve the regulator-mandated end-state
  3. In a rule-based approach, the regulator specifies the action to be taken by the firms to be considered compliant

Firms prefer the rule-based approach

  1. Rule-based regulations, despite their appearance of regulatory micro-management, tend to be preferred by firms relative to principle-based regulations
  2. Firms prefer less ambiguity associated with the rule-based approach
  3. Additionally, they are relieved of the burden of proof of being compliant, as may be required in a principle-based approach

Risks from the rule-based approach

  1. Rule-based regulations assume a high degree of technical sophistication on the part of the regulator
  2. Besides, the regulator needs to have a well-articulated end objective
  3. This is different from having rules in response to a specific crisis since there is always a risk that the end objective becomes unclear if not non-existent
  4. It leaves the system exposed to more risks

Some steps that SEBI can take

  • Quantitative disclosure
  1. Rules should be such that they do not commoditize the CRAs’ offerings since the divergence of views/approaches across CRAs is critical for any well-functioning system
  2. The CRA may be required to publish the median values of the critical ratio of their choice, for a specific industry, across various rating levels and for the last five years
  3. This will allow an investor to compare whether the current rating is more or less stringent, and whether, over the period, the CRA’s standards have been consistent
  4. The objectivity and transparency of this numerical disclosure will go a long way towards building confidence in a rating
  • Enhanced transition matrix
  1. The transition matrix should track default rates over multiple years. Investors need to know the default rate of AAA/AA/A ratings over three to five years from issuance, and not just one year
  2. Withdrawn ratings should also be a category, and defaults occurring within one year of the rating being withdrawn should be included in the default study
  3. SEBI may consider independently calculating the default transition matrix by accessing data from a commercial credit bureau or Reserve Bank of India’s central repository of information on large credits database and not depend on the CRAs at all
  • Cursory disclosure of all ratings
  1. CRAs may be required to also summarily refer in the press release to the outstanding ratings of other CRAs for the same borrower and the previously withdrawn rating of the same borrower from other CRAs and the reason for the rating withdrawal
  2. The palpable reputation risk that errant CRAs will face may go a long way towards preventing rating shopping
  • Legal protection for CRAs
  1. Instances of Indian CRAs being sued by the company it rates, in a bid to prevent the rating downgrade, are not unknown
  2. The regulator should consider framing laws that allow CRAs to express their rating opinion without fear of being sued

Way forward

  1. If SEBI adopts a higher dose of principle-based regulations, it may set specific end-objectives
  2. For CRAs, it may be best to act and function in a way that the market’s faith in the quality of ratings is maintained
  3. This faith, in turn, will facilitate the development of the Indian bond market
  4. While SEBI may not suddenly turn to the principle-based approach, it may still achieve the end objective by fine-tuning its latest, well-intentioned guidelines
Nov, 13, 2018

[op-ed snap] A much-needed revamp for rating agencies

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: Credit ratings

Mains level: Problems being faced by the credit rating sector in India & need for revamping the market structure for same


Context

Flaws in credit ratings

  1. The bonds of Infrastructure Leasing & Financial Services Ltd (IL&FS) were rated investment grade as late as July 2018
  2. The firm started defaulting on its debt in September
  3. IL&FS is not unique and it is found that firms that eventually default on their bank loans have an average rating somewhere between BB- and B+ one month before they default

Why does rating matter?

  1. According to Reserve Bank of India’s (RBI’s) capital norms, banks have to set aside more capital to cover for losses only if a firm’s rating goes below B-
  2. So, above B-, banks can allocate less capital to cover losses

Sources of the problems

  • Conflicts of interest from non-rating business
  1. To be effective, rating agencies have to be impartial judges of credit quality
  2. This is not possible if they have other non-rating businesses that they are marketing to the same corporates who they are rating
  • Issuer-pay model
  1. According to current practice, the borrower picks the rating agency that will rate their debt
  2. Thus, instead of an impartial judge, the rating agency is a seller trying to entice the buyer (the borrower) into buying its rating service
  3. Rating agencies will compete with one another to offer the best possible service
  4. Such rating shopping is formalized in some rating agency websites wherein the process of how a company can dispute its rating and obtain redressal is explained
  • Over-reliance on ratings in regulations
  1. The main source of power for the rating agencies are regulations that are tied to ratings
  2. For example, the Basel capital adequacy norms (which India has adopted) allow banks to decide on their capital allocation based on loan ratings
  3. Following India’s adoption of these norms, there has been a multifold increase in the number of firms with credit ratings
  4. Thus, regulators reward rating agencies with more business

Solutions to these problems

  • Rating agencies should be forced to divest from non-rating business
  1. This is an easy solution
  2. The Securities and Exchange Board of India (SEBI) is already trying to implement this
  • The regulator should pick the rating agency or greater disclosure
  1. The drastic solution is for a regulator (say RBI or SEBI) to pick the rating agency
  2. This can be easily automated with the help of a computer programme
  3. The programme will pick the agency randomly while ensuring a target market share for the different agencies
  4. The target market share, in turn, should depend on the accuracy of the ratings in the past
  5. Evaluating rating accuracy is easily done and the agencies do this on an annual basis already
  6. The target market shares should be decided in such a way that it rewards good performance and penalizes bad performance
  7. The less drastic solution is to encourage unsolicited ratings, and also to ensure that the borrowers disclose all ratings and not just the ratings they end up accepting
  8. This will give greater confidence to the rating agencies to tell the truth and not have to cater to the borrower
  • Provide alternatives to ratings
  1. One should try to reduce the reliance on ratings in regulation
  2. For example, banks should have a minimum amount of capital based on the total assets, and not just on risk-weighted assets
  3. This will reduce the importance of ratings for bank capital
  4. The RBI should also insist that bank borrowers obtain multiple ratings with the regulator picking the agency
  5. Competition combined with a reward for good performance will enhance the quality of ratings

SEBI introduces new norms

  1. SEBI has come out with new guidelines to improve the quality of disclosures made by credit rating agencies
  2. According to the new norms, credit rating agencies will have to inform investors about the liquidity situation of the companies they rate through parameters such as their cash balance, liquidity coverage ratio, access to emergency credit lines, asset-liability mismatch, etc
  3. Further, rating agencies will have to disclose their own historical rating track record by informing clients about how often their rating of an entity has changed over a period of time

Way forward

  1. Credit ratings for bank loans in India are a ticking time bomb
  2. With credit ratings threatening to disrupt markets, the systemic issues with rating agencies must be urgently fixed

With inputs from the editorial: Full disclosure: on the credit rating industry

Nov, 09, 2018

RBI relaxes ECB norms for infra companies

Note4students

Mains Paper 3: Economy | Effects of liberalization on the economy

From UPSC perspective, the following things are important:

Prelims level: ECBs, Hedging

Mains level: Factors affecting India’s BoP


News

  • The RBI has liberalized the norms governing foreign borrowings for infrastructure creation in consultation with the Government.

External Commercial Borrowings

  1. Lack of domestic capital and deficit in the current account compels any government to go after foreign capital.
  2. ECBs are loans in India made by non-resident lenders in foreign currency to Indian borrowers.
  3. They are used widely in India to facilitate access to foreign money by Indian corporations and PSUs.
  4. Most of these loans are provided by foreign commercial banks and other institutions. It is a loan availed of from non-resident lenders with a minimum average maturity of 3 years.
  5. The significance of ECBs their size in India’s balance of payment account. In the post reform period, ECBs have emerged a major form of foreign capital like FDI and FII.
  6. ECBs includes commercial bank loans, buyers’ credit, suppliers’ credit, securitized instruments such as Floating Rate Notes and Fixed Rate Bonds etc., credit from official export credit agencies and commercial borrowings from Multilateral Financial Institutions.

Advantages of ECBs 

  • ECBs provide opportunity to borrow large volume of funds
  • The funds are available for relatively long term
  • Interest rate are also lower compared to domestic funds
  • ECBs are in the form of foreign currencies. Hence, they enable the corporate to have foreign currency to meet the import of machineries etc.
  • Corporate can raise ECBs from internationally recognised sources such as banks, export credit agencies, international capital markets etc.

What’s new in the ECB norms?

  1. The minimum average maturity requirement for ECBs (external commercial borrowings) in the infrastructure space raised by eligible borrowers has been reduced to three years from earlier five years.
  2. Additionally, the average maturity requirement for mandatory hedging (an investment to reduce the risk of adverse price movements in an asset) has been reduced to five years from earlier ten years.

Raising Medium and Long term funds

  1. The move comes amid concerns surrounding the availability of funds following a liquidity squeeze and the difficulties being faced by non-bank lenders.
  2. This is especially for those facing asset liability issues due to heavy reliance on short term funding for long term assets.
  3. This, along with defaults by infra lender IL&FS, has hurt the credit markets.
  4. The relaxations in the ECB norms follow other moves by the RBI, including last week’s permission to banks to use credit enhancement to help NBFCs raise medium to long term funds.
Nov, 03, 2018

Seychelles issues world’s 1st 'Blue Bond’

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: Blue Bonds

Mains level: Viability of such Blue Bonds for India


News

Context

  • Seychelles has raised 15 million dollars by offering the world’s first ‘Blue Bond,’ raised from investors to finance ocean-based projects, to expand its marine protected areas and boost its fisheries sector.

World’s First Blue Bond

  1. The blue bond was officially issued on October 9, ahead of the first-ever global conference on the blue economy, which will be held at the end of November in Kenya.
  2. It is partially guaranteed by a USD 5 million guarantee from the World Bank (IBRD) and is further supported by a USD 5 million concessional loan from the Global Environment Facility (GEF) which will partially cover interest payments for the bond.
  3. Proceeds from the bond will be utilised for the expansion of marine protected areas, improved governance of priority fisheries and the development of the Seychelles’ blue economy.
  4. Grants will be provided through the Blue Grants Fund and will be managed by the Seychelles’ Conservation and Climate Adaptation Trust (SeyCCAT).

Benefits of the Bond

  1. The Blue Bond is a part of an initiative that combines public and private investment to mobilise resources for empowering local communities and businesses.
  2. It is aimed to assist Seychelles in achieving a transition to sustainable fisheries and safeguarding oceans.
Oct, 06, 2018

[op-ed snap] Avoiding the currency basket case

Note4students

Mains Paper 3: Economy | Effects of liberalization on the economy

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Need for internationalisation of the rupee


Context

History of Indian currency

  1. The Indian rupee was once a multilateral currency, its usage prevalent across the Indian Ocean in places as varied as Java, Borneo, Macau, Muscat, Basra and Zanzibar
  2. The historic dhow trade ensured that the Gulf had a familiarity with the rupee for over five centuries
  3. The accession of George V to the throne in 1911, enshrining his rule of the British Raj, led to the issuance of a new rupee coin
  4. The colonial rupee leveraged the Mughal rupee’s popularity, facilitated by trading communities, migration and the Raj’s hegemony
  5. Even after Independence, Dubai and other Gulf states were using RBI-minted Gulf rupees until 1966

Why rupee use was discontinued?

  1. The devaluation of the Indian rupee in 1966, after the 1965 war, led to such nations switching to their own currencies
  2. Now, only Nepal and Bhutan regularly conduct bilateral trade with India in rupees

Change in value of the rupee

  1. This decline was precipitated by a variety of factors
  • wars with Pakistan and China
  • the adoption of Five Year Plans requiring foreign loans
  • political instability
  • the Oil Price Shock of 1973

Current trends influencing the value of the rupee

  1. Of late, the rupee has been declining given higher oil prices and FII outflows from stocks and bonds
  2. The ongoing U.S.-China trade war, Iran sanctions and further upward movement in oil prices will continue to test the rupee’s valuation

Options for stabilisation

  1. Overtly intervening in the forex market
  2. Selling non-resident Indian bonds (as last done in 2013)
  3. Conducting a sovereign bond issuance
  4. The rupee’s dependency on the U.S. dollar must be reduced

What can India do?

  1. India should consider formalising the rupee payment mechanism with friendly countries such as Russia, with a focus on reducing its overall current account deficit
  2. We must continue to guard against fiscal profligacy, with any slippage viewed negatively by the currency markets, further encouraging investors to flee Indian markets
  3. Industrial growth should be a priority as without having goods to sell, rupee swaps (say with Iran) will be difficult to institutionalise
  4. The formalisation of the Indian economy, by deterring black money transactions in the rupee, is also much needed

What should be India’s black money strategy?

  1. It should encourage tax rate rationalisation, reform vulnerable sectors, support a cashless economy and create effective and credible deterrence
  2. Administrative agreements with countries like the U.K. and Switzerland which can offer mutual tax sharing should be encouraged
  3. It is important to create a remittance database detailing company transfers out and NGO transfers into India, all reporting to the Financial Intelligence Unit (FIU)
  4. The Direct Tax Administration’s Directorate of Criminal Investigation should be provided the right IT training, infrastructure and funding to become an effective deterrent
  5. The audit cycles for income tax, service tax and excise tax departments should be aligned, helping the Large Taxpayer Unit (LTU) become more effective, increasing the scope of simultaneous scrutiny and examination

Need for internationalisation of the rupee

  1. The rupee is currently not even in the top 10 traded currencies
  2. While the Chinese yuan is increasingly being positioned for an alternative reserve currency through a variety of multilateral trades, institutions (the Belt and Road Initiative, the Asian Infrastructure Investment Bank) and swaps, the Indian rupee remains woefully behind in internalisation
  3. China campaigned hard for the inclusion of its currency in IMF’s benchmark currency basket in 2015, introducing a range of reforms to ensure that the yuan was considered as “freely usable”
  4. The RBI, meanwhile, has adopted a gradualist approach – allowing companies to raise rupee debt offshore, enabling the creation of “masala bonds” and allowing foreigners to invest in rupee debt onshore
  5. By these measures, the rupee has transformed from a largely non-convertible pegged currency before 1991 to a managed float

Way Forward

  1. Institutional resistance against rupee convertibility should be overturned
  2. To restore the rupee’s multilateral nature, we must unshackle its usage
Oct, 04, 2018

[op-ed snap] Blended finance for meeting the SDGs

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Issues related to public financing and propsects of blended financing


Context

Blended finance model

  1. Blended finance is in fashion in the development finance world
  2. It refers to the merging of public and private funds to maximize development impact
  3. t can be termed as a mechanism to reduce investment risks associated with things such as basic healthcare, energy access and livelihood for the poorest
  4. It is most often called upon in reference to meeting the sustainable development goals (SDGs) that countries valiantly agreed to in 2015

How can blended finance help?

  1. Blended finance can reduce investment risk
  2. It can enhance returns
  3. It can increase financial flows

Issues in the management of public and private capital

  • The way money is managed
  1. Most aid agencies need to spend their commitments in a given calendar/fiscal year as internal accounting systems disallow payables over time
  2. This means that any contract that entails future payments is prohibited
  3. Many agencies are thus unable to enter into forward contracts
  4. In reality, projects get delayed and cost overruns happen—particularly in the typically challenging markets that SDGs are relevant to
  5. By focusing only on spending fast, measuring impact and outcomes become secondary leading to the low development
  • The way money is monitored
  1. Public agencies, aid, in particular, focus on monitoring every dollar spent, whereas private funds monitor outcomes over a pre-agreed period of time and rely on audited financial reports as the benchmark for healthy financial management
  2. This perceived micromanagement distracts from focusing on the real outcomes of the investment and redirects often significant human resources into the production of micro-level financial reporting
  3. Rather than control the process, public agencies should set their ‘public benefits’ criteria upfront, and private entities should make those integral to normal financial reporting
  • The pricing of risk
  1. In commercial finance, the higher the risk, the higher the cost of capital
  2. In an ideally blended structure designed to cater to risky markets or make investments economical, public capital should bear a higher share of the risk—but at lower costs of capital
  3. However, in reality, public capital tends to be risk-averse
  • Handling failures
  1. While every private agency works to minimize failures, some degree of failure is inevitable when investing in new technologies, business models or untested markets
  2. Public monies are intrinsically risk-averse, to the point of zero tolerance when it comes to ‘failure’
  3. Unless some level of failure is permitted, innovative business models of types needed to meet the global goals are unlikely to emerge
  • Ideological difference between governments and businesses
  1. While the landscape is changing, many aid agencies still cannot fathom the idea that public monies will be used to enable private entities to make profits
  2. The longer this ideological difference remains, the harder it will be to develop large-scale solutions where public monies will be needed to mitigate the risk that private entities will not otherwise take

Way Forward

  1. The larger goal of blending is a noble one
  2. It is time that a common understanding was achieved among the blenders of capital so that both sides know what to expect
Sep, 25, 2018

[op-ed snap] Capital market challenges of a high growth economy

Note4students

Mains Paper 3: Economy | Effects of liberalization on the economy

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Need of deepening capital markets to continue India’s fast growth momentum


Context

Role of capital markets in sustaining growth

  1. The year 2022 will mark 75 years of independence from British rule
  2. If current growth rates sustain, it is expected that India will be the fourth-largest economy in the world by then
  3. Our growth rate depends on infrastructure development, which in turn requires deep capital markets as banks may be averse to the risk or to the funding tenures

Direction for capital markets

In the next four to five years, the direction of the markets will primarily depend on:

  • Structural changes, including consolidation, to existing capital markets participants’ business models
  • Non-traditional players challenging the status quo
  • Innovations including extensive use of big data, artificial intelligence (AI) and machine learning. Participants will seek to reduce cost and create competitive advantages
  • Straight through processing and use of distributed ledger and blockchain technology
  • Pools of capital increasingly looking to reach out directly to consumers of capital, thereby lowering costs and increasing overall liquidity.
  • Crowdsourcing and peer to peer opportunities, real estate investment trusts and infrastructure investment trusts gaining momentum
  • Investment management seeing impetus through robo advice, smart contracts and electronic trading
  • Successful resolution of applications filed under the Insolvency and Bankruptcy Code (IBC)

Role of regulators

  1. Regulators will have to respond to these challenges
  2. In their facilitation role, regulators have to be forward-looking and identify potential areas for market development
  3. An inter-regulatory working group set up by the Reserve Bank of India has recommended that an appropriate framework be introduced for “regulatory sandbox/innovation hub” within a well-defined space and duration
  4. Here financial sector regulators will provide the requisite regulatory support, so as to increase efficiency, manage risks and create new opportunities for consumers in the Indian context similar to other regulatory jurisdiction

Development of fixed income markets

  1. The Securities and Exchange Board of India (Sebi) came out with a proposal to make it mandatory for large borrowers to source 25% of their incremental borrowings from the bond market
  2. This could pose regulatory challenges in implementation because of structural issues including a requirement to maintain a debenture redemption reserve and liquid funds

Product suitability and data privacy to affect regulations

  1. Product suitability entails an entire framework that requires grading of products in accordance with their inherent risk and categorizing clients on the basis of their capacity and ability to carry the risk
  2. Every mature market model must have robust suitability procedures and controls, and regulators are focusing on this
  3. Traditional players and fintech entities are heavily dependent on technology
  4. These entities collect various personal and sensitive information and become the owners/custodians of such data

Measures being taken to ensure data protection

  1. Sebi intends to examine aspects related to data privacy needs and facilitate the necessary ecosystem to encourage the use of new technologies in capital markets
  2. Sebi is planning a full cybersecurity review of market infrastructure institutions (MIIs) that include all its cybersecurity advisories and a full list of threat vectors
  3. A cyber-capability index is being developed to assess the cybersecurity preparedness and resilience of MIIs

Use of technology by regulators

  1. Regulators are responding through ramping up their knowledge and with continued focus on investor protection and investor education
  2. Corporate governance and enhanced disclosures will provide a fillip to their efforts
  3. They have in place a comprehensive surveillance process and will build on this by using enhanced surveillance and investigation techniques, aided by AI and developing machine learning tools
  4. Regulators have begun to use technology drivers and new products to reduce the time for fundraising through public issues

Way Forward

  1. As the markets deepen and develop, regulatory oversight and supervision must develop alongside
  2. Integrating risk and regulation at an enterprise level is a significant challenge and the success of the capital markets and its participants will depend on this
Aug, 16, 2018

[op-ed snap] Fear isn’t the key: On regulation of securities markets

Note4students

Mains Paper 3: Economy | Investment model

From UPSC perspective, the following things are important:

Prelims level: SEBI

Mains level: T.K. Vishvanathan panel recommendations and their impact on the functioning of SEBI as well as investors


Context

Regulating stock markets

  1. A panel headed by T.K. Viswanathan, a former Lok Sabha Secretary General, has now submitted recommendations to curb illegal practices in the markets and ensure fair conduct among investors
  2. Front-running, insider trading, shady accounting practices that are tantamount to window-dressing firms’ performance, and other shenanigans to manipulate share prices continue

Panel’s recommendations

  1. A key recommendation is that the stock market watchdog be granted the power to act directly against “perpetrators of financial statements fraud”
  2. This means SEBI can act not only against listed entities under its extant powers but also against those who aid or abet financial fraud — including accountants and auditors
  3. The panel has suggested that SEBI, rather than the Central government, be given the power to grant immunity to whistle-blowers who help uncover illegal activities
  4. It has mooted new ideas to address market manipulation, from a better scrutiny of price-sensitive information to the creation of processes to expedite the investigation into cases
  5. It goes to the extent of recommending that SEBI be given powers to tap phone calls

Pros & Cons of these recommendations

  • Pros
  1. Greater executive powers can help the regulator take swifter action against offenders instead of relying on government bodies such as the Ministry of Corporate Affairs
  2. This could also free SEBI from various manifestations of political influence
  • Cons
  1. Given that SEBI is now considering a cap on trading by retail investors based on their assessed ‘net worth’, the committee’s suggestion that it may consider any trading by players beyond their known ‘financial resources’ as fraud could lead to undue harassment of investors

Way Forward

  1. Granting more teeth to enable the market regulator to fulfil its primary role of protecting investors is fine
  2. A strong regulator serves as a good deterrent to truants in the market, but banking on fear too much could also scare away genuine investors
  3. It is equally critical to empower it with the right tools so that a sledgehammer is not deployed to crack a nut
Aug, 01, 2018

Banning of Unregulated Deposit Schemes Bill, 2018

Note4students

Mains Paper 2: Polity | Parliament & State Legislatures – structure, functioning, conduct of business, powers & privileges & issues arising out of these

From UPSC perspective, the following things are important:

Prelims level: Chit Funds (Amendment) Bill, 2018, Banning of Unregulated Deposit Schemes Bill, 2018

Mains level: Illicit deposit schemes spreading across the country and measures to curb them


News

Bill to regulate illicit deposit schemes

  1. The Union government has come up with two bills to tackle the menace of non-regulated deposit schemes
  2. The Chit Funds (Amendment) Bill, 2018 was introduced in the Lok Sabha during the second leg of the Budget Session
  3. The second Bill is Banning of Unregulated Deposit Schemes Bill, 2018

Provisions of the bill

  1. The proposed Bill aims to provide a comprehensive legislation to tackle illicit deposit schemes by completely prohibiting such activities
  2. Nine regulators including the RBI, SEBI, the Ministry of Corporate Affairs, and the State governments regulate financial activities
  3. According to the Bill, all deposit-taking schemes are required to be registered with the relevant regulator, failing which the “Deposit Takers” will be considered “unregulated” and hence be banned
  4. The Bill creates three different types of offences, namely, running of Unregulated Deposit Schemes, fraudulent default in Regulated Deposit Schemes, and wrongful inducement in relation to Unregulated Deposit Schemes
  5. A ‘Competent Authority’ will be appointed which has the powers similar to a civil court, including powers to attach properties of the deposit takers
  6. It also empowers police to search and seize any property believed to be connected with an offence under the Bill, with or without a warrant
  7. The Bill enables the creation of an online central database, for collection and sharing of information on deposit-taking activities in the country

Definitions

  1. “Deposit Takers” include all possible entities (including individuals) receiving or soliciting deposits, except specific entities such as those incorporated by legislation
  2. “Deposit” is defined in such a manner that deposit takers are restricted from camouflaging public deposits as receipts, and at the same time not to curb or hinder acceptance of money by an establishment in the ordinary course of its business
Jun, 15, 2018

The rising risks to financing India’s current account deficit

Note4students

Mains Paper 3: Economy | Indian Economy

From UPSC perspective, the following things are important:

Prelims level: CAD, BoP

Mains level: Impact of rising crude oil prices on CAD and other vulnerabilities.


News

Higher oil prices are raising India’s CAD

  1. The higher current account deficit will put downward pressure on the rupee and it may also raise the cost of Indian borrowing abroad.
  2. The stress on BoP is already visible in Q1FY19 with the INR depreciating 4%; the RBI had to intervene to stem the depreciation.
  3. NRI flows too have proved to be volatile, especially if the rupee depreciates.

Financing CAD is risky

  1. It’s not just that the current account deficit is widening—the means of financing it also became riskier in 2017-18.
  2. On the one hand, higher oil prices are raising the current account deficit and on the other, foreign direct investment—the most stable source of financing the deficit—has come down.
  3. This has led to greater reliance on foreign portfolio inflows, particularly volatile debt inflows and also on short-term credit.

Why such Problem?

  1. This is a problem because the US Federal Reserve has been raising interest rates and has signalled more rate hikes to come.
  2. As per RBI governor the US programme of shrinking its balance sheet, coupled with increased US T-Bill issuance to fund a larger government deficit, has already led to dollar liquidity shrinking in international markets, particularly in the debt markets.
  3. This is behind the outflows from emerging market debt.

Cost of Protectionism

  1. The rapid deterioration in the trade environment as a result of protectionist policies is also likely to affect export growth, while rising investment demand will result in more imports.
  2. The UNCTAD, had in its recent World Investment report pointed to a slowdown in global foreign direct investment flows.

Dependence on FPI is dangerous

  1. Relying on portfolio flows to finance this deficit will expose the country to the vulnerabilities of uncertain international capital flows, making funding difficult particularly during risk-off episodes.
  2. Within portfolio flows, the increased reliance on debt inflows carries more risks, as unlike equity, debt has to be repaid.
  3. Earlier this month, credit rating agency Moody’s Indian affiliate, ICRA Ltd, said high global crude oil prices are likely to widen India’s CAD and pointed to slowing foreign portfolio investments as an area of concern.
Jun, 13, 2018

SEBI panel to study option of direct overseas listings

Note4students

Mains Paper 2: Polity | Statutory, regulatory & various quasi-judicial bodies

From UPSC perspective, the following things are important:

Prelims level: SEBI, GDR, ADR

Mains level: Market regulators and their powers


News

Companies can list abroad now only via depository receipts

  1. The Securities and Exchange Board of India (SEBI) has constituted an expert committee to examine the possibility of allowing unlisted Indian companies to directly list equity overseas while also allowing foreign companies to list directly on the Indian stock markets.
  2. Considering the evolution and internationalisation of the capital markets, it would be worthwhile to consider facilitating companies incorporated in India to directly list their equity share capital abroad and vice versa, SEBI said in a statement.
  3. Currently, Indian firms can only use the depository receipts route — American Depository Receipt (ADR) or Global Depository Receipt (GDR) — to list on overseas exchanges.
  4. For foreign companies wanting to list on Indian exchanges, the Indian Depository Receipt (IDR) is the only option currently.

Masala bonds, IDRs

  1. Companies incorporated in India can today list their debt securities on international exchanges (Masala bonds) but their equity share capital can be listed abroad only through the ADR/GDR route.
  2. Similarly, companies incorporated outside India can access the Indian capital markets only through the IDR route.

Back2Basics

Global Depository Receipts

  • Indian companies are allowed to raise equity capital in the international markets through the issue of GDR.
  • GDR are designated in USD / Euros or any other foreign currency.
  • The proceeds of GDR can be utilized for various purposes.

American Depository Receipts

  • These are like shares issued to US retail and institutional investors and are listed in NASDAQ/NYSE
  • They are entitled like share to bonus, stock split and dividend.
  • ADR route is taken as non-USA companies are NOT allowed to list on US stock exchanges by issuing shares
Jun, 08, 2018

[op-ed snap] Averting Ponzi schemes

Note4students

Mains Paper 2: Governance | Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

From UPSC perspective, the following things are important:

Prelims level: Ponzi Schemes, Particulars of the Draft

Mains level: The new bill seeks to protect investors from rising instances of scams


News

Context

  1. A Ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to investors.
  2. Instances of people losing their hard-earned money to Ponzi schemes keep coming to light.
  3. The Banning of Unregulated Deposit Schemes Bill, 2018 was approved by the Union Cabinet to provide comprehensive legislation to deal with illicit deposit schemes in the country.

Provisions of the draft Bill

  1. The Bill imposes complete prohibition of unregulated deposit taking activity.
  2. Primarily, the Bill defines the “deposit taker” and “deposit” comprehensively.
  3. Some other provisions include:
  • Stringent punishment for fraudulent default in repayment to depositors.
  • Designation of a competent authority by the State government to ensure repayment of deposits in the event of default by a deposit taking establishment
  • Powers and functions of the competent authority including attachment of assets of a defaulting establishment
  • Designation of courts to oversee repayment of depositors and to try offences under the Act, and
  • Listing of Regulated Deposit Schemes in the Bill with a clause enabling the Central government to expand or prune the list.
  1. The Bill contains a substantive banning clause which bans deposit takers from promoting, operating, issuing advertisements or accepting deposits in any Unregulated Deposit Scheme.
  2. The primary responsibility of implementing the provisions lies with the State governments.

Bill recognises 3 types of Offences

The Bill specifies three different types of offences:

  • Running of Unregulated Deposit Schemes,
  • Fraudulent default in Regulated Deposit Schemes, and
  • Wrongful inducement in relation to Unregulated Deposit Schemes.

Prevention better than Cure

  1. The principle of the bill is that it would ban unregulated deposit taking activities altogether, by making them an offence ex-ante, rather than the existing legislative-cum-regulatory framework which only comes into effect ex-post with considerable delays.
  2. It has adequate provisions for repayment of deposits in cases where such schemes nonetheless manage to raise deposits illegally.
  3. The Bill provides for attachment of properties/ assets by the competent authority and subsequent realisation of assets for repayment to depositors in a stipulated time.
  4. The Bill also enables creation of a central online database, for collection and sharing of information on deposit taking activities in the country.
Apr, 21, 2018

SEBI proposes reducing debt issuance timeline to six days

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: SEBI, debt securities, equity offering, ASBA

Mains level: Initiatives taken to make capital markets more accessible


News

Reducing the timeline

  1. The Securities and Exchange Board of India (SEBI) aims to reduce the time required to make a public issue of debt securities and bring it on par with that of an equity offering
  2. The market regulator wants to reduce the time line from the current 12 days to six days

About the proposal

  1. It is proposed to reduce the time lines for the public issue of debt securities from T+12 to T+6
  2. T refers to the day when the issue closes for subscription

Making ASBA mandatory

  1. In order to reduce the time line, the capital market regulator has proposed making ASBA – Application Supported by Blocked Amount – mandatory for applying in such debt issuances
  2. ASBA refers to an online mechanism wherein the application money is kept blocked in the applicant’s account and is debited only at the time of allotment
  3. This effectively does away with the whole process related to refund of money to investors in instances wherein the issue is oversubscribed
Apr, 18, 2018

Bharat-22 ETF offer may worth Rs 10,000 crore

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: Bharat-22 exchange traded fund (ETF)

Mains level: Various efforts to increase revenue base of government & revive infrastructure spending


News

Special ETF

  1. The Finance Ministry may come out with a ₹10,000-crore follow-on fund offer of the Bharat-22 exchange traded fund (ETF)
  2. The government, in November, introduced Bharat-22 ETF comprising shares of 22 firms, including PSUs, public sector banks, ITC, Axis Bank and L&T

Back2Basics

Exchange traded fund (ETF)

  1. Exchange Traded Funds (ETFs) are mutual funds listed and traded on stock exchanges like shares
  2. The ETF simply copies an index and endeavors to accurately reflect its performance
  3. In an ETF, one can buy and sell units at a prevailing market price on a real-time basis during market hours
  4. There are four types of ETFs already available — Equity ETFs, Debt ETFs, Commodity ETFs and Overseas Equity ETFs
  5. The Bharat 22 ETF to be offered now allows the Government to park its holdings in selected PSUs in an ETF and raise disinvestment money from investors at one go
  6. It tracks the specially made S&P BSE Bharat 22 Index, managed by Asia Index Private Limited
  7. This index is made up of 22 PSU stocks and with a few private sector companies
Apr, 04, 2018

What rising bond yields tell us about the economy

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: Government securities, Primary and secondary market

Mains level: Effect of NPAs on other sectors of economy


News

Bond market performance

  1. The bond market is a strong indicator of investor confidence in the government
  2. Government securities or bonds, may not directly affect one’s personal finances, but the yield curve can be telling on the direction in which a country’s economy is headed

What are bonds?

  1. A bond is a debt instrument which acts as an IOU
  2. It can be traded in financial markets like equities and other commodities
  3. It is commonly used by governments to raise capital in order to fund domestic growth and development projects
  4. Government bonds, also known as G-Sec, are issued by governments with maturity terms ranging from medium to long term

How do bonds work?

  1. Investors take on government debt, and in return, are assured a stream of revenue for the duration of the time it takes the bond to mature
  2. Bonds issue coupons, which are interest payments made in part to the repayment of the capital that was borrowed
  3. The final payment is made when the bond attains maturity

Bond market

  1. Till recently, government bonds used to be bought and sold on the secondary market only by institutional investors like provident funds, mutual funds, insurance companies and banks
  2. In 2017, the RBI changed the rules to allow retail investors to buy government bonds in the primary market
  3. The RBI is the institutional entity that has been mandated with selling sovereign debt securities or government bonds

Effect of more bond issuance on the economy

  1. The fiscal deficit is expected to widen if the government issues new bonds to bankroll the populist schemes announced in the Budget
  2. Inflation or expectations of inflation can drive up bond yields since any gains made by securities will be eroded by an increase in prices
Apr, 02, 2018

FBIL will now do the valuation of G-Secs

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: Government securities, FBIL, FIMMDA

Mains level: Money market instruments & their effects on economy


News

Change of roles

  1. Financial Benchmark India Pvt. Ltd. (FBIL) will now be responsible for administering the valuation of Government securities
  2. Fixed Income Money Market and Derivatives Association of India (FIMMDA), an association of commercial banks, financial institutions and primary dealers, has been responsible for administering the valuation of government securities issued by both the Central and State Governments
  3. FBIL will take over this responsibility from March 31

Change in publication methodology

  1. FBIL will commence publication of the G-Sec and SDL valuation benchmarks based on the extant methodology
  2. This is line with the announcement made as part of the sixth bi-monthly monetary policy statement for 2017-18 dated February 7, 2018
  3. The apex bank had announced then that FBIL would assume the responsibility for administering the valuation of Government securities

Back2Basics

Government securities

  1. A Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State Governments
  2. It acknowledges the Government’s debt obligation
  3. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more)
  4. In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs)
  5. G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments
Mar, 13, 2018

Bill on chit funds sector introduced in Lok Sabha

Note4students

Mains Paper 2: Polity | Parliament & State Legislatures – structure, functioning, conduct of business, powers & privileges & issues arising out of these.

From UPSC perspective, the following things are important:

Prelims level: Chit Funds (Amendment) Bill, 2018, Parliamentary Standing Committee on Finance

Mains level: Chit fund scams and ways to curb them


News

Bill to streamline and strengthen the chit fund sector

  1. A bill to streamline and strengthen the chit fund sector was introduced in the Lok Sabha
  2. It mandates video conferencing while the opening of bids and seeks to hike commission of foremen from 5% to 7%

Background

  1. Concerns have been expressed by various stakeholders regarding challenges being faced by the chit business
  2. The Central government had constituted a key advisory group on chit funds to review the legal, regulatory and institutional framework for the sector and its efficacy and to suggest initiatives required for its orderly growth
  3. The Chit Funds (Amendment) Bill, 2018 is based on the recommendations of the Parliamentary Standing Committee on Finance and the Advisory Groups on Chit Funds set up by the Central government

Proposed amendments

  1. The amendment bill provides for allowing the mandatory presence of two subscribers, as required either in person or through video conferencing duly recorded by the foreman, while the bids are being opened
  2. It also provides for increasing of a ceiling of foreman’s commission from 5% to 7%
Feb, 21, 2018

Cabinet nod to amend Chit Funds Act

Note4students

Mains Paper 2: Polity | Functions & responsibilities of the Union & the States, issues & challenges pertaining to the federal structure

From UPSC perspective, the following things are important:

Prelims level: Chit Funds (Amendment) Bill, 2018, Chit Funds Act, 1982

Mains level: Chit fund scams and ways to eliminate them


News

Chit Funds (Amendment) Bill, 2018

  1. The Cabinet has given the approval to introduce the Chit Funds (Amendment) Bill, 2018 in Parliament
  2. Amendments to the Chit Funds Act are proposed to facilitate the orderly growth of the sector and provide more financial products to investors
  3. For this purpose, amendments would be made to the Chit Funds Act, 1982

Proposed amendments

  1. One of the amendments is the use of the words “Fraternity Fund” for chit business in the Act
  2. This is to distinguish its working from ‘Prize Chits’ which are banned under a separate legislation
  3. The bill also proposes to allow two minimum required subscribers to join through video conferencing duly recorded by the foreman
  4. This is because the physical presence of subscribers towards the final stages of a chit may not be forthcoming easily
  5. State governments are proposed to be allowed to prescribe the ceiling amount of fund and to increase it from time to time

Back2Basics

Chit Funds Act, 1982

  1. This act extends to whole of India except the state of Jammu and Kashmir
  2. Transaction is not called a Chit Fund if
  • Some alone, get the prize money without obligation of paying future installments
  • All subscribers get chit amount by turns with liability to pay future installments

3. Chit fund companies name should include “Chit”, “Chitti” or “Kuri” with their name. No other person have right to use these above-mentioned words as a part of their business names

4. All chit fund companies need to be registered with respective state government wherein they will operate

5. Money so collected cannot be utilized for any other business purpose except carrying on chit business, giving loans to non-prized subscribers on the security of subscriptions paid by them, investing in trustee securities and making deposit in mentioned bank

Feb, 05, 2018

SEBI gets teeth to act against exchanges, new market outfits

Note4students

Mains Paper 2: Polity | Statutory, regulatory & various quasi-judicial bodies

From UPSC perspective, the following things are important:

Prelims level: SEBI, REITs, InvITs, SEBI Act, Securities Contracts (Regulation) Act

Mains level: Market regulators and their powers


News

More power to SEBI

  1. In the proposed amendments in the Finance Bill 2018, the government has given more power to the Securities and Exchange Board of India (SEBI)
  2. This will allow it to impose monetary penalties on important market intermediaries such as stock exchanges and clearing corporations
  3. Also to act against newer categories of participants likes investment advisers, research analysts, real estate investment trusts (REITs) and infrastructure investment trusts (InvITs)

Monetary penalties can be imposed now

  1. Till now, SEBI only had the power to censure or warn against any form of failure
  2. The proposed amendments to the SEBI Act and the Securities Contracts (Regulation) Act now allow the capital markets regulator to impose a monetary penalty of at least ₹5 crore on stock exchanges, clearing corporations and depositories for non-compliance with regulatory norms
  3. The penalty can go up to ₹25 crore or three times the amount of gains made out of such failure or non-compliance
  4. The amendments also allow SEBI to act against entities that furnish false or incomplete information to the regulator
  5. Earlier, it could act only if the entity did not furnish any information

Additional powers

  1. The whole-time members of SEBI have also been given additional powers to act against wrongdoers
  2. The government has also allowed the regulator to pursue cases against the legal representatives of defaulters if in case a defaulter passes away during the course of regulatory proceedings

Back2Basics

Real estate investment trusts (REITs)/Infrastructure investment trusts (InvITs)

  1. Real Estate Investment Trusts or REITs are mutual funds like institutions that enable investments into the real estate sector/infrastructure sector
  2. This is done by pooling small sums of money from multitude of individual investors for directly investing in real estate properties/infrastructure so as to return a portion of the income (after deducting expenditures) to unitholders of REITs, who pooled in the money
  3. A REIT in India is allowed to invest mainly in completed and revenue generating assets and other approved investments
  4. REITs/InvITs will have to distribute majority of its income among the unit holders
  5. REITs/InvITs are regulated by SEBI
Jan, 04, 2018

Sebi planning a ‘riskometer’ for stock market investments

Note4students

Mains Paper 2: Governance | Government policies & interventions for development in various sectors & issues arising out of their design & implementation

From UPSC perspective, the following things are important:

Prelims level: Riskometer, SEBI, Stock markets, Mutual funds

Mains level: Risks associated with Capital markets and government measures for it


News

New system proposed for rating stocks

  1. Stock market regulator SEBI will introduce an early-warning system to caution people about the risks of investing in stocks of overvalued companies, those with unsustainable business models and ones that may go bankrupt
  2. SEBI has proposed a system that would rate a stock on a numeric scale or a color-coded system
  3. Mutual funds have a similar system called a riskometer

How will this help?

  1. Since the equity market is rising steadily, investors are prone to take higher unwarranted risks while attempting to gain from the bull market
  2. It will allow investors to easily identify risks associated with a stock on account of its trading pattern or owing to the condition of the company’s business

International examples

  1. Singapore has a system of automatic “trade with caution” alerts which are generated when trading activity in a stock cannot be explained based on publicly available information

Disclosure of other details by companies

  1. Abnormalities in the business could be assessed from certain balance sheet items
  2. SEBI is considering asking listed firms to disclose certain additional details on a quarterly basis
  3. These may include human resource data, cost-cutting details, changes in remuneration of top management, details of loans availed and their usage, and plans to service debts
  4. The public will be shown a company’s business-related risks by comparing its data with the industry benchmark or the average of its listed peer group
Oct, 30, 2017

[op-ed snap] P2P regulations: A missed opportunity

Image source

Note4students

Mains Paper 3: Economy | Investment model

From UPSC perspective, the following things are important:

Prelims level: peer-to-peer (P2P) lending, market-access barriers, leverage ratio

Mains level: Mandate of RBI and various issues related to it


Context

  1. The Reserve Bank of India (RBI) issued the much anticipated regulatory framework for peer-to-peer (P2P) lending earlier this month
  2. This model emerged in 2005 as technology fused with lending and has been replicated across jurisdictions since

What is the P2P lending?

  1. In its simplest avatar, it involves a platform that leverages technology to match lenders and borrowers, receiving fees in lieu of transactions successfully closed
  2. Unlike banks that act as intermediaries and engage in liquidity transformation between retail lenders and borrowers, these platforms are genuine two-sided markets (similar to say, Uber)
  3. These bring lenders and borrowers together without taking any credit risk on their own balance sheet
  4. An important feature of such platforms is that they leverage technology to filter borrowers, determine interest at which the transactions execute and reduce the risk of lender exposure through diversification (through one-to-many transactions, for example)

Review of the P2P regulations issued by the RBI

  1. The P2P regulations delegate potentially arbitrary discretion to RBI in gatekeeping
  • One of the principal governance issues of a modern state is injecting accountability into regulatory discretion
  • P2P regulations fail on this parameter and underscore the need for Parliament to implement reform through legislation rather than delegate it to regulators
  • Broad discretion without effective oversight is effectively a permission to engage in arbitrary behavior

2. They impose high market-access barriers that would inhibit innovation in a technology-intensive sector

  • The RBI has prescribed a mandate that would require a minimum net-owned fund (NOF) of Rs 2 crore
  • That would exclude innovative, lean start-ups from entering the market, and it is unclear if there would be any benefit net of costs
  • P2P model “disintermediates” credit risk
  • It may be feasible for the RBI to tailor minimum capital based on the value of loans made through the platform

3. These regulations also lack clarity around critical issues like leverage ratio

  • Leverage ratio is defined as “total outside liabilities divided by owned funds, of the non-banking financial corporation in P2P (NBFC-P2P)”
  • This leverage ratio has been capped at 2
  • The revenue sources for a P2P platform company include: processing fees charged to borrowers and lenders, origination fees for loan-specific insurance products and fees charged from lenders for collection
  • From regular market numbers, the sum of these three sources of revenue is in the order of 4-8% of the credit facilitated through the platform
  • The overall costs of a tech-enabled P2P lending platform is in the range of 2-4% of credit facilitated through the platform
  • The leverage cap of 2 will mean this regulation effectively limits return on equity in the 10-12% range
  • No technology business can operate with such paltry returns

Other concerns in the P2P regulations

  1. Ultra-conservative lender exposure limits
  2. Data-sharing mandate with credit information companies and
  3. Disclosure of borrower information to the lenders
May, 01, 2017

What you need to know about Infrastructure Investment Trusts

  • The initial public offering (IPO) for IRB InvIT, India’s first infrastructure investment trust fund will open for subscription on May 3 and close on May 5.
  • What are InvITs? InvITs are similar to mutual funds. While mutual funds provide an opportunity to invest in equity stocks, an InvIT allows one to invest in infrastructure projects such as road and power.
  • How do InvITs work? InvITs raise funds from a large number of investors and directly invest in infrastructure projects or through a special purpose vehicle.
  • Two types of InvITs have been allowed: one, which invests in completed and revenue generation
    infrastructure projects;
  • the other, which has the flexibility to invest in completed or under-construction projects.
  • InvITs which invest in completed projects take the route of public offer of its units, while those investing in under construction projects take the route of private placement of units.
  • What is the structure of InvITs? InvITs are registered as trusts with SEBI and there are four parties — trustee, sponsors, investment manager and project manager.
  • What do InvITs mean for investors? According to SEBI rules, at least 90% of funds collected, after paying for expenses, taxes and repayment of external debt, should be passed on to investors every six months.
  • Are these investments taxable? Dividend income received by unit holders is tax exempt. Short-term capital gain on sale of units is taxed at 15%, while long-term capital gains are tax exempt. Interest distributed to unit holders is taxed.
Sep, 29, 2016

Regulator allows options contracts in commodities

  1. News: SEBI has allowed the introduction of options contracts in the commodity derivatives market
  2. Currently: Only futures contracts are available in the commodity segment
  3. Advantages: It would aid the overall development of the commodity derivatives market, attracting broad-based participation, enhancing liquidity, facilitating hedging and bringing in more depth to the market
  4. The decision is based on the recommendations of the Commodity Derivatives Advisory Committee (CDAC)

Discuss: Differentiate between options and futures contracts

Aug, 26, 2016

Banks to issue Masala bonds, RBI opens currency markets

  1. News: The RBI has announced a raft of measures to boost investor participation and market liquidity in both the corporate bond and currency markets
  2. Masala Bonds: The central bank will allow commercial banks to issue rupee bonds in overseas markets, both for their capital requirement and for financing infrastructure and affordable housing
  3. Corporate Bonds: Many of the recommendations of the Khan Committee to develop the corporate bond market have been accepted
  4. PEC: Enhancing the aggregate limit of partial credit enhancement (PCE) provided by banks from 20% to 50% of bond issue size
  5. LAF: RBI will also seek suitable legal amendments to enable it to accept corporate bonds under the Liquidity adjustment Facility (LAF)
Aug, 20, 2016

SEBI faces complex challenges in regulating commodity markets: Sinha

  1. Reasons: These challenges emanate from underlying markets, which are fragmented, dispersed and not under its regulatory purview
  2. SEBI’s aim is to bring the commodities derivatives market at par with securities market in all aspects
  3. In the years to come, SEBI’s vision is to evolve the commodity market with new products and new categories of participants leading to better liquidity, thus facilitating fair price discovery for the benefit of stakeholders
  4. Background: The commodity derivative market has come under SEBI’s purview since September 2015 after the merger of the erstwhile Forward Markets Commission with SEBI
May, 02, 2016

SEBI’s new initiative to spread investor awareness

  1. Initiative: SEBI plans to explore cinema advertising and digital platforms for its advertising campaigns
  2. About: Ponzi schemes menace and dabba trading etc
  3. Aim: To spread investor awareness and financial education
Apr, 14, 2016

SEBI, brokers to discuss retail participation

  1. News: The Securities and Exchange Board of India will be discussing with brokers ways to increase retail participation
  2. It also wants to boost the penetration level of the equity market across the country
  3. Fact: All individuals need a demat account to trade in the capital market
Mar, 30, 2016

Supreme Court allows SEBI to sell Sahara properties

  1. Context: The court had put stringent conditions for the bail of Sahara chairman
  2. News: The SC asked SEBI to initiate the process of selling properties of Sahara group
  3. The apex court asked Sahara group and SEBI to devise a mechanism to sell properties
  4. Impact: The money thus generated will be paid back to the investors of Sahara
Mar, 30, 2016

70% of P-Notes come via Singapore, Mauritius

  1. Context: More than two-thirds of foreign fund flows through P-Notes have been routed through Singapore and Mauritius
  2. Why? These countries have tax treaties with India that are advantageous for investors in these instruments
  3. P-Note holder does not have to pay any Indian capital gains tax if it is based in Singapore or Mauritius under these treaties
  4. Some 36.5% of the total offshore derivative instruments have been channelled through Singapore and 30% through Mauritius
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