Thursday, March 12, 2009

Myopic Routes of Finance (Sovereign Wealth Funds& Participatory Notes)

Amidst the ongoing crisis; it will be quite interesting to see and visualize the scale of losses…what we have actually lost in recent months, which have been in our possession through a considerable time. A lot of debate and writing has been stuffed about the potential causes of financial 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 best be attributed because the unprecedented growth till the crisis broke out largely caused by the unrestricted financial routes which don’t even canopied under the regulation of SEBI. So, no one can exactly traced the investors as their business dealt through intermediaries, even those middlemen’s never required to follow Know Your Customers (KYC) Norms.
These myopic investment roots may be considered to progenitor and nurturer of speculative finance. Two most prolific among them are: -

Sovereign Wealth Funds (SWF): -
Some SWF own by the State Governments of countries to handle with its idle assets for its maximization of value. SWF is not a fresh concept since its genesis can be traced back to 1950’s, then their size worldwide was $300billion.The current level now reached to $2 trillion to $3 trillion, the size may be cross $10trillion by 2010.
At present more than twenty countries have set up these funds. A dozen more have expressed willingness in establishing them. More than half of assets are possessed by oil exporting countries. Ranging from Norway to Trinidad, including Australia, China and Singapore. Still the holding are mostly concentrated with the top five funds, accounting for more than 70% of total assets under management.

Like hedge funds, SWF are also not governed by any single authority except the Singapore. SWF also operates through hedge funds, Private Equity for high return. So,it requires 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 destablishing factor. Since it creates more place for irresponsible transaction. Overall SWF are immensely surrounded with chances of risk and failures, so neither it’s a meticulous route of investments nor it is good for just and equitable society.

Participatory Notes (PN): -
PN is an investment root by Foreign Institutional Investor (FII), through Offshore Derivatives Instrument (ODI); Such as Equity linked Notes and Participatory Return Notes have created storm in stock markets.
Basically FII issues PN to funds for companies whose identity is not known to the authorities. The PN is discriminatory as it promotes unethical investments; further it creates harmful effects on domestic companies. PN having very firm presence in India, as its proportion lies around 15-20% of stock of the top 1,000 companies. They have almost ruling influence on the market.PN outstanding by middle of 2007 was 3,53,484crores(51.6% of Asset under custody of all FII Sub Accounts). The value of outstanding ODI with underlying derivatives currently stands at Rs.1, 17,071crores, which is approx to 30% of total PN outstanding.

Users Of PN Route: -

1.Regular funds whose twin objectives are returns and more returns
2.Prodigal money returning
3.Foreign Governments/Entities who would like to acquire/control Indian entities by tracking them over.

PN investors channelizes their investment through the FII, but despite playing the role of intermediary, FII are not required to reveal their face. This situation further become more mysterious when regulators like SEBI simply let PN to escape from registration, which set them free from any regulation. Such allowances, promotes Indian financiers to enter in Indian Financials to enter in Indian Financial Markets.
Overall producers of PN transaction violates know Your Customers Norms, lastly, National Security Advisor cautioned against terror financing through stock market channels. Rising concerns of Indian authorities are very genuine, because unprecedented rise as well as fall are misleading the 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 minimize the followed impacts.
2.Generally these are two types of PN- Spot based and Derivatives/Future based (ODI). The latter accounts for around 32-33 percent of all PN. 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 has 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, due consideration was given by SEBI to cope with threats of PN. Ultimately SEBI allowed 18 months to wind up outstanding PN in late 2007, now the proposed ceiling is near end, which means ends of the unauthorized PN.Decision taken by the SEBI was in very right directions. Since its timely implementation optimized and lessen many future losses. Some such more measure are imperative to check irregularities in financial markets.
Authorities have to play catalyst role in such initiatives. Investors should have also rationalize their paramounting expectations from financial markets and now must start to keep faiths in realistic rewards.
Atul Kumar Thakur
New Delhi
March12,2009
atul_mdb@rediffmail.com

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