Atul Kumar Thakur
Jan 2012

 Amidst the ongoing financial crisis, it is essential to consider the scale of losses. What we have actually lost in the recent months, which have been in our possession for long. Lot of debates and articles have discussed the potential causes of financial sectors' failure and diminishing market sentiments in past few months.

There could be many reasons behind the present financial chaos; among them, inflated treatment of stock markets can best be attributed for the mess. Because of the unprecedented growth till the financial crisis of 2007 that was finally disturbed by the unrestricted financial routes which were in perfect shadow of regulation. So, no one could exactly trace the investors as their business dealt through intermediaries, even those middlemen's were never required to follow the Know Your Customers (KYC) norms. These myopic investment routes may be considered the progenitor and nurturer of speculative finances. Two most prolific among them are: -






Sovereign Wealth Funds (SWF)

Some SWF are owned by the government with the aim of handling its idle assets for value maximization. SWF is not a fresh concept, its genesis can be traced back to 1950's, and then its worldwide size was $ 300billion. Currently, it's touching the size of $ 4.7 trillion (total Asset under Management by 53 SWFs, Source-SWF Institute); earlier speculations were rife about its size that it may cross $ 11trillion by 2011 which has hardly materialised.

At present, more than twenty countries have set up these funds. A dozen more have expressed willingness in establishing them. More than half of these assets are being possessed and processed by oil exporting countries. Economies from Norway to Trinidad, including Australia, China and Singapore are equally tempting for this exotic SWF. The major holdings are mostly concentrated with the top five funds, accounting for more than 70% of total assets under management of SWF.

Like hedge funds, SWF are also not governed by any single authority except in Singapore. SWF also operates through hedge funds, Private Equity for high returns. That necessitates for great care in fund management. SWF have a positive tendency to go long on securities that means to say, they buy and hold it invested for longer periods. This creates some establishing influence on stock markets.  But this establishing factor of SWF is highly disproportionate with its downside, since it creates more places for irresponsible transaction. In conclusion, SWF are badly surrounded with the chances of unethical risk and failures, so neither it's a meticulous route of investment nor it is good as just and equitable business proposition.

Participatory Notes (PN)

PN is an investment option for Foreign Institutional Investor (FII), it routes through Offshore Derivatives Instruments (ODI); such as Equity Linked Notes and Participatory Return Notes. In the global financial market, these structured financial products have been causing the storm and keep mimicking the tall talks of innovation in awkward humour. In comparison to financial sector's other arms, capital market stands as most blatant loser by these not so plain financial instruments.

Basically, FII issues PN to funds for companies whose identities are generally not known to the authorities. In this way, the PN is discriminatory as it promotes unethical investments besides further creating harmful effects on domestic companies. PN has very firm presence in India, as its proportion moves around 15-20% of the top thousand company's stocks. PN outstanding by middle of 2007 were Rs. 3,53,484 crores (51.6% of asset under custody of all FII Sub Accounts). The value of outstanding ODI with underlying derivatives currently stands at Rs. 1,17,071 crores, which is approx to 30% of total PN outstanding.

Users of PN Route

I. Regular funds whose twin objectives are returns and more returns

II. Entities aiming prodigal money returning

III. Foreign Governments/ Entities who would like to acquire and control Indian entities by tracking over them

PN investor channelises their investment through the FII, but despite playing the role of intermediary, FII are not required to reveal their face. This situation further becomes more mysterious when regulators like SEBI simply let PN to escape from registration, which set them free from any regulation. Such concessions promote these financiers to enter in Indian Financial Market. Unfortunately, their presence violates the very basic rules and ethos of financial regulation by consistent non-compliance to statutory regulations. The cases where participants of PN transaction violate know Your Customers Norms are rampant. Slowly now, finance ministry is looking sincere on these bad parts of governance, after the National Security Advisor cautioned against terror financing through stock market channels. Rising concerns of Indian authorities are very genuine, because chances of unprecedented rises as well as fall of financial markets are misleading for Indian growth story.

Two major constraints, which can lessen the impacts, are

1. A Special Purpose Vehicle (SPV), can be created which would be dollar dominated to hold these funds at attractive rates and which are countered over a period of time to minimise the impacts.

2. Generally, there are two types of PN - Spot based and derivatives/ future based (ODI). The latter source accounts for around 32-33 percent of all PN transaction. FII and their sub accounts shall not issue/ renew ODI with underlying as derivatives with immediate effect. It should also mean that the hedge funds, which have been fairly responsible for the steep rise in the markets, might exit the market because SEBI will never let them register as FII.

On such proposals, consideration was given by SEBI to cope with the threats of PN. Ultimately SEBI allowed eighteen months to wind up outstanding PN by the end of 2007. Now the proposed ceiling has already ended, which means end of the unauthorized PN. Decision taken by the SEBI was timely and decisive on this issue. Since then, its timely implementation optimised and lessened immense potential losses. More such measures are imperative for checking the persistent irregularities in financial markets, but that's not happening and taking the good spirits earned from past in oblivion. Authorities have to play catalyst role in such initiatives. Investors should also rationalise their unrealistic expectations from financial markets and must start to keep faith in realistic rewards and its attainment.

Concerns withstand SMEs on SWF & PN

In the past decade, SWF outpaced hedge funds with its swift rise and secured a prominent place for itself in global financial circle. Recession of 2007, gave SWF major recognition as credit tool for the dwindling western banks. As the manipulation was designed for the betterment of vested interests, SWF suffered huge losses and trend continued for next two years. Now SWF and PN are making money through same suspicious mechanism but it's not stopping emerging economies including India from contemplating its own foray in this infamous league.

Deputy Chairman of Planning Commission, Montek Singh Ahulwalia has his own unsustainable argument on which he seems quite serious that a chunk of India's forex reserve should be used for SWF. His economics is certainly impractical and untenable as he ignoring the India's liabilities which accounts for more than two third of total forex reserve. Second, he is ignoring the interest of SMEs which is already passing through very tough phase in the absence of support it deserves from government and regulatory agencies. Not even in wild dreams, government as moral agent should allow the defamed SWF and PN for overplay and making the Indian financial market a puppet and hub of illegal trade.

In India, Victor Hugo has more followers in financial rather in literary fraternity but lately now, they should realise that the reliance on SWF & PN is something “whose time shall never come”. India's home grown SMEs needs prioritization in policy framing, as they are the backbone of Indian economy. India has adequate saving and their proper utilization in financing SMEs business would improve the socio economic conditions. Sustainability of business will be depending upon how much industrial policies are labour intensive and following the optimization of resource and skill sets. Supporting these noble SME businesses should be considered as “an idea whose time has indeed come”.