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Posted on 01-Mar-2019 Comments  0

SEBI Board Meet

SEBI sets the tone for some far-reaching shifts in capital markets

Of late, the SEBI board meetings have been a crucial forum for key decisions. The latest SEBI board meet on March 01st has also made some important decisions for the capital markets. Let us look at the implications of four such critical decisions.

SEBI fee structure

For a long time the equity market investors have complained that the cost of trading was too high when the statutory costs were considered. As a start, SEBI has decided to reduce the SEBI turnover fee for equity and F&O from Rs.15/crore to Rs.10/crore of trade value. For derivatives in agri commodity trading, the SEBI turnover fees have been slashed from Rs.15/crore to just Rs.1/crore. These moves are expected to even out the cost anomalies.

MFs in commodity derivatives

SEBI also permitted mutual funds and portfolio management schemes (PMS) to participate in exchange traded commodity derivatives, subject to the safeguards. This will give MFs and PMS an additional asset class to invest in as well as a means to hedge their underlying exposure to equities. In addition, Category III AIFs (Alternate Investment Funds) have also been permitted to deal with goods received in delivery against physical settlement of contracts. This move would deepen and broaden the commodity market.

Debt valuation for MFs

This was a significant announcement by SEBI considering the recent issues that mutual funds have faced on the debt funds front. As against the existing maturity limit of 60 days for amortized valuation, the new limit will be reduced to 30 days maturity. The MF valuation agency will also provide valuation of money market and debt securities that are rated below investment grade. However, AMCs will have the leeway to deviate from the valuations given by the agencies subject to documenting and recording of reasons for such deviations. SEBI has also maintained that the deviation of valuation price from the reference price cannot be more than 0.025% of the value.

Corporate debt restructuring

There have been persistent demands for giving the NCLT buyers exemption from making an open offer to shareholders. SEBI has decided to exempt such NCLT share allotments from the purview of preferential allotment rules as well as open offer requirements. However, there will be some conditions attached. This exemption will be restricted to scheduled commercial banks and financial institutions only. Also, the exemption will only be given to allotments made and approved under the Insolvency and Bankruptcy Code (IBC). This is likely to reduce the hassles for buyout of shares under IBC!

War Games

Who really wants a war; not the Indian markets for sure!

As India and Pakistan indulged in some saber rattling over the last couple of weeks, one thing was clear. Neither India nor Pakistan was interested in getting into a full-fledged war. That explains why Pakistan was more than willing to release the captured IAF pilot back to India. There are 3 reasons why neither country wants a war.

Theater of war

War is not just about the politics of two nations but also about the theater and the economics. Great armies have lost wars when the theater was not right. The Germans lost to the Russians in the Second World War and the US faced a disaster in Vietnam. They were really formidable military powers but they fought in unsuitable conditions. India had a debacle against China in 1962 but the same Indian Army repelled the Chinese with impunity in 1967. The reasons both India and Pakistan do not want a full-fledged war is twofold. Firstly, India may have an advantage in a prolonged war; both militarily and economically. However, in a very short war, the results can be much harder to predict. Clausewitz had himself observed that in a short war, surprise is more potent than military prowess. Second, both are unsure of the theater of war. Whether the war will be driven by the Army, Navy or the Air Force is not clear. Even with its military and economic edge, India would be worried of fighting the war in the wrong theater.

Economy in doldrums

Both the South Asian economies are likely to take a hit but the situation in Pakistan is already a lot more precarious. Inflation is already ruling close to 10% and the GDP growth has stagnated. The nation is strapped for cash and on the last two occasions the Kingdom of Saudi Arabia has bailed out Pakistan. China has been a long time benefactor of Pakistan but they may be a little more cautious in this case considering that China runs a $60 billion trade surplus with India. Pakistan has already lost the MFN status in trade with India and any war would also squeeze the trade that is currently being routed through Dubai and Singapore. The stakes are just too high for Pakistan.

No war for India too!

With GDP growth faltering to 6.6% in Q3 and likely to dip further to 6.4% in Q4, India already has a problem on hand. It needs to build the growth gap over China and the war will not help. Also, war means a bigger hole in the budget, larger military outlays and a spike in the borrowings. For India, the fiscal deficit has spilled over and the ratio of government borrowings to GDP is getting into worry zone. There is an all-important election coming up and the government needs to focus on creating jobs and growth. The last it wants is the distraction of a war. The sooner wise counsel prevails, the better it will be!

What about IL&FS

There is no choice; IL&FS must go into liquidation under NCLT

Abraham Lincoln liked to play a game with his soldiers! His question was, “How many legs does a cat have, if the tail is also counted as a leg”. The answer was obvious; just because you call the tail a leg, it does not become a leg. The cat still has four legs only. That is exactly the situation that is currently on with IL&FS. Just because the Indian government does not want to declare IL&FS insolvent, it does not become a solvent company.

How IL&FS imploded

The problems at IL&FS did not come about overnight. The deterioration in its books started long back. For years, IL&FS had been borrowing short and lending to infrastructure projects. The situation was absolutely fine as long as the debt downgrade did not happen. The moment the debt got downgraded, mutual funds stopped investing in IL&FS paper and the entire situation suddenly imploded. It became apparent that IL&FS was sitting on infrastructure receivables that would take years to monetize. On the resources side, the short term money flows just dried up after mutual funds and banks stopped lending to the infrastructure lender. Transparency was another issue as most infrastructure projects were funded through a maze of group companies. The result was an atrocious maturity mismatch with little hope of any recourse in the short to medium term. Where does IL&FS go from here on?

IL&FS must go to the NCLT

The National Company Law Appellate Tribunal (NCLAT) recently struck down a proposal by lenders of IL&FS to refer the company to NCLT. While there has definitely been opaque funding at IL&FS, not all the money is lost. In fact, if early estimates are to be believed then up to 60% of the monies can be recovered. All that has to be done is to take IL&FS to the NCLT and ensure that the lenders get an equitable share. Since IL&FS owns a lot of quality assets, albeit with long term cash flows, there should not be a problem getting a secondary market buyer. Of course, the bargaining will boil down to how much of a discount to the present value of cash flows that the buyer is willing to pay, but at least that will help to monetize the assets. There are limited avenues for these long term projects.

Pin down the blame; fast

Even as the former ICICI CEO has been hounded and harassed over one lending deal, the IL&FS former management has gotten away despite destroying IL&FS and creating potential NPAs worth Rs.1 trillion. They must not be allowed to get away scot free if the government wants to arrest corruption in high places. There are billions of dollars in public money involved in the form of shares, deposits and through mutual funds. It is time to send IL&FS to NCLT and chase the elusive ex-bosses!




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