Mark2Market_Volume_III

FROM THE EDITOR’S DESK

EDITORS

MOULI GHATAKRAHUL RAVI

SAGAR KAPOORSUMIT PAL SINGH

TEAM MARK2MARKET

DebargharyaDiwakar ShuklaPartha PratimPrashanth P

Rashmi SinghSohini BanerjeeSritha Basupally

Greetings Readers!

The Mark2Market team presents before you the September 2012 issue of the maga-zine.

“Money has never made man happy, nor will it, there is nothing in its nature to produce happi-ness. The more of it one has the more one wants!”

The degree of one’s acceptance or the lack of it, of the above postulation is not the moot point. The consideration here is that a cursory glance at the recent events would stir up in our minds an infamous menace, that goes by the name of “Tax evasions”. The incidents of tax evasions coupled with corruption are so challenging that they are threatening India’s economic integrity as never before. With this backdrop, the cover article for this issue, traces the bigger picture behind the much maligned issue of corruption, and maps out the various modes of corporate conduits exploited, to conceal vicious trails of corruption. Interna-tionally, tax avoidance has been recognized as an area of concern and several countries have expressed concern over tax evasion and avoidance.

The industry section brings in the perspec-tive of experts pertaining to the dynamics of Mutual Funds and some critical insights on the domain of Merger and Acquisition. The former, “Mutual Fund: Prospective View Given the Regulatory Reform”, talks about Mutual Fund’s role as one of the indexes of financial ambiance in any country. It takes Mutual Fund in Indian perspective and talks about the challenges faced and the steps taken by SEBI to strengthen it. The later on M&A stresses upon the challenges in the current M&A Environ-ment, Global Economic Environment and

lucidly explains how uncertain regulatory framework gives rise to unrealistic valuation expectations of Indian promoters.

The recent events at VGSoM section includes FINCON’12 which is a IIT Kharag-pur and Finterest initiative to bring industry stalwarts and management students on a common platform. In this series, the NSE SEBI Seminar received an overwhelming response from all the KGPians. The very popular Brown Bag Sessions, conducted by Finterest, have a special attraction this session. The second year students, who did their Summer Internship projects in the Finance domain, are sharing their experi-ences in these sessions. The same finds a mention in this issue in the section “ Finance Internships At Vgsom: Experi-ences“. The Fin-Cross challenges are again laid out for you all to keep a check on your fin-acumen.

Our Finventory section consists of five students’ article. The top three entries find a special mention and also win some cash prizes. The articles cover a gamut of topics and provide an incisive analysis. “Manufac-turing in India ”, talks about the history of manufacturing in India, comparing Indian economy with the world’s third best econo-mies in the manufacturing sector. “Go Bankrupt, Get Bailout” talks about how some “too big to fail” companies are being given bailout in case of bankruptcy to avoid crumbling down of the world economic order. “Dark Pools_The Yin-Yang of Trad-ing” talks about how companies may be indulging in trading in "dark pools" - secondary stock markets operating beyond the reach of regulators and out of bounds for the average investor.

Happy reading!

MARK2MARKETVOLUME III

02

04 ___ COVER ARTICLE 04 THE TRAILS OF VICE

09 ___ INDUSTRY INTERACTION AT VGSOM 09 CHALLENGES IN THE CURRENT M&A ENVIRON- MENT 12 MUTUAL FUND - PROSPECTIVE VIEW GIVEN THE REGULATORY REFORM

15 ___ FINVENTORY 15 GO BANKRUPT, GET BAILOUT 18 PRIORITY SECTOR LENDING 20 DARK POOLS: THE YIN-YANG OF TRADING 23 MANUFACTURING IN INDIA 27 NEARING THE END OF DOLLAR’S DOMINANCE

30 ___ RECENT FINANCE EVENTS AT VGSOM 30 FINCON’12 31 BROWN BAG SESSIONS 32 GURUKOOL SERIES OF LECTURES

33 ___ FINANCE INTERNSHIPS AT VGSOM: EXPERIENCES

35 ___ FIN-CROSS 35 FIN-CROSS, VOL III 36 FIN-CROSS SOLUTION, VOL II

CONTENTS


03

AUTHOR

PARAMA BARAI

Assistant Professor

Vinod Gupta School of Management

IIT Kharagpur

THE TRAILS OF VICE

COVER STORY

The list has been increasing; so has the bill. From a few hundred crores to thousands, lakhs and now to tens of lakhs of crores – the scams that have rocked India keep shocking Indians by the sheer extent of money siphoned off by those holding public office. The scale of corruption is undoubtedly anarchic, and discreditable in front of the rest of the world. But it begs the question: how exactly does so much money exchange hands?

The Finance Ministry of India, in a White Paper on Black Money published in 2012, defines corruption as “bribery and theft by those holding public office – such as grant of business, leakages from government social spending programmes, speed money to circumvent or fast track proce-dures, black marketing of price controlled services, and others”. A large body of academic work has proven that corruption is the single largest source of black money in any economy.

“A 2010 study by GFI reported that the size of India’s under-ground economy was $640 bn in 2008, nearly 50% of India’s then GDP of $1.25 trillion”.

The latest figure that was officially quoted was by the Director of CBI, Mr. Ambar Pratap Singh. In the Interpol Global Programme on Anti-Corruption and Asset Recovery held in February 2012, Mr. Singh mentioned that nearly Rs. 24.5 Lakh crores ($500 bn) of illegal money is stashed in tax havens of Mauritius, Switzerland, Lichten-stein, British Virgin Islands, etc.

Once corrupt practices has led to a pact of making illegal payments, commences the transfer of huge, unaccounted amounts of money from the beneficiary to the benefac-tor, such that it is finally integrated into the

legal financial system of any part of the world, all below the radar of law. This conversion is known as ‘money laundering’. One of the most common forms of money laundering is expatriating the illegal assets out of the country. The main conduits used for moving capital is by (mis)using corpo-rate structures.

Obviously, there exists a huge market that caters to this requirement of money laun-dering. The demand side of this market is dominated by political and economic elites across the world. The supply side is popu-lated by financial advisors, accounting professionals and lawyers. Finally, the institutional structures that facilitate this market comprises of Offshore Financial Centres and tax havens, and banks. Offshore tax havens are relatively small geographical locations which offer secrecy and confidentiality to international capital, require no financial disclosure or other regulations and claim very low or nil tax. Accountants facilitate corruption by selling tax avoidance schemes, setting up shell companies, arranging complex corporate structures through a web of offshore com-panies and offshore trusts. Top accounting firms are also well entrenched in these activities. In fact, the US Senate Committee and the US Justice Departments have convicted a number of well known compa-nies like Ernst & Young International, Price-waterhouse Coopers, KPMG, Grant Thorn-ton Partners, among others - these firms

were accused of providing money launder-ing services for the bribes and kickbacks paid by their client companies to secure arms contracts, technology contracts, and other high value contracts. Similarly, many high profile banks, especially those that have branches in a number of jurisdictions, actively provide money laundering services to high profile customers.

Modus Operandi of Money Transfer

The basic process of diversion of funds has three predominant stages. First, in the placement phase, the capital is inserted into one or more corporate vehicles, which could be a public limited company whose shares are not traded in the stock market, a private company, a foundation or a trust. This corporate vehicle would further be a part of a web of companies, set up in various countries with complex ownership structures. Even there, the owners would usually be nominees and business partners so that the actual beneficial owner

is completely hidden. In the next layering stage, money is moved through the web companies with bank accounts in different countries. Finally, the capital is integrated into the financial system by investing them for personal gain, in real estate or capital markets.

The corporate vehicles that are usually

used are those that offer maximum anonymity. The most abused form is the shell company. A shell company is a legal entity that has no economic operations, no assets, and usually, no employees. Being legal entities, shell companies can open accounts in banks through which money can be transacted. Typically, shell compa-nies are legally used as special purpose vehicles to facilitate mergers and joint ventures, or to form a consortium in huge infrastructure projects. But, these struc-tures can be misused very easily too. Hawala operators set up shell entities in the form of proprietorship firms, partnership firms, companies, and trusts. The propri-etors, or partners, or shareholders who

shareholder of a company where the bribe was paid; further, the actual shareholder might be just a front man for the actual beneficiary.

There are other modes of exploiting an operational company. It has been found that shell companies in foreign lands invest in shares of a listed firm with their illegal capital, which is later offloaded to genuine shareholders. GDR issued by Indian start-ups in Luxembourg Stock Exchange is one known channel of money laundering . Innovative derivative instruments have been found to be (mis)used. One such instrument is the “Participatory Note”. Through these instruments, foreign investors can invest in Indian markets without disclosing their identity. Obviously, SEBI has no jurisdic-tion over those ghost investors. Although SEBI requires the issuer of PNs to disclose the names and location of the investors on a monthly basis, shadow or shell companies can be put up as front investors, with no link to the actual benefi-ciary. Because of their very property of anonymity, such offshore derivative instruments are regularly exploited, as is evident from the number of cases initiated by SEBI.

Another facility offered by SEBI is deletion of transactions carried out in Stock Exchanges, in case of genuine human errors, which is also misused. For example, in March 2010, NSE was found to have effected 713 deleted transactions, amounting to Rs. 56,000 crores. Since the client codes were completely erased in these transactions, it is impossible to know who effected them. Then, there are benami transactions, wherein an asset, typically land or financial instruments, exchange ownership between two

individuals, but the payment is made by companies completely unrelated to the transaction.

Measures to Curb Corruption

The Enforcement Directorate, Financial Intelligence Unit (FIU), Economic Offences Wing of the State Police, Central Bureau of Investigation (CBI), Serious Frauds Investi-gation Office (SFIO), are agencies in India who are actively involved in the process of supervision and unearthing instances of corruption. We also have the Central Economic Intelligence Bureau (CEIB), National Investigation Agency (NIA), and the High Level Committee (HLC), who oversee the process. Finally, there is the Central Board of Direct Taxes (CBDT) whose brief is to investigate large transfers of money through the domestic financial system, thereby helping in detecting corruption.

In the G20 summit in 2009, some tax havens like Switzerland, Luxembourg, Monaco and Liechtenstein agreed to accept OECD standards of transparency and information exchange. Double Taxa-tion Avoidance Agreements (DTAA), and Tax Information Exchange Agreement (TIEA) are two legislations aimed at obtain-ing financial information on an international scale. Many countries are signing these Agreements, thereby strengthening the hands of law enforcers.

Actions Taken

The Finance Act, 2011 introduced a new section that discouraged transactions with jurisdictions which do not exchange infor-mation with India. Under this section, if a company has a subsidiary/sister concern in a non-cooperative jurisdiction, none of the

own these shell companies could be other trusts or foundations located in different countries altogether, making it extremely difficult to find the actual beneficiary of the shell companies. Sometimes, the shell companies are acquired multiple times, without registering the change in owner-ship, leading to a cold trail.

Besides shell companies, operational com-panies are also often misused. In these cases, illegal money is mixed with legal funds, and transferred under the very

noses of regulators, without raising alarm. One of the activities indulged in are manipulation of sales/receipts with propor-tionate manipulation of expenses – in both cases bogus invoices of shell companies can be used. Companies which have sister concerns in different countries move capital in the guise of license fees or trans-fer prices. Sometimes bribe takers accept consultancy fees from the bribe giver, where the bribe taker may be a nominee of the actual beneficiary. Other times, the recipient of the bribe might be a minority

expenses charged to that subsidiary will be regarded as expenses, and would be fully taxable. The Finance Bill 2012 proposed the General Anti-Avoidance Rule (GAAR) – a tough stance against the practice of creating complex web of holding compa-nies in tax havens and routing transactions through them, so that incomes can escape scrutiny as well as taxation in both India and in their home countries. It has also proposed radical amendments in cash transactions of jewellery and bullion markets, which has been one of the favou-rite non-corporate methods of money laun-dering.

Further, the source of funds booked as share capital or share premium in a closely held company, and donations to charitable institutions would require stringent disclo-sure norms. The Benami Transaction Prohibition Bill 2011 has been proposed wherein benami transactions are prohib-ited. The Lokpal and Lokayukta Bill 2011 aims to set up powerful Lokpals and Loka-yuktas to prevent corruption by public servants, including ministers.

Wishlist of Actions

Some of the sectors that are more vulner-able than others in the movement of corruption money are real estate, jewellery and bullion, and financial markets. While SEBI and RBI has instituted some norms in financial markets in India, there is still a lot to be covered. Dabba trading, proxy invest-ments and FIIs through tax havens need to be restrained substantially through adequate norms. However, the other sectors are largely unregulated, and hence open to all sorts of manipulation. Stricter legislations are needed that demand trans-parency, accountability and stricter report-ing norms of these sectors. As a beginning, TDS could be levied for all transactions on real estate and jewellery. Furthermore, the process of allocation and utilization of natu-ral resources are crying for reforms, delays in which perpetrated the coal scam, spec-trum scam, and other scams in India. Last but not the least, the judicial prosecution process in the country needs a total revamp. In a country where trials take decades, and judgements are rare, corrup-tion becomes merely a calculated risk – the

many former and sitting ministers with graft cases for years are living examples of the failure of the judiciary in India.

Literature says that some of the most potent causes of corruption are greater control of political parties over civil service appointments, close interrelationships between business, politics and state, less transparent procedures of allocation, and unscrupulous politicians and public servants. Obviously, a wishlist of actions would not be complete without suggesting regulations that address each of these causes of corruption. Unfortunately, such rule making is in the hands of the very people who are greatest offenders. If the cat is asked to bell itself, which Team Anna, for example, expect our MPs to do, we will only get a fuming cat.

“What I discussed here are mere symptoms of a decadent state, and possible remedies to purge the symptoms; in order to truly harness corruption we need to find what is it that is fundamen-tally wrong with us? Why are we so corrupt as a nation? Or, are we?”

Note:The article represents the author’s personal views on the subject and does not reflect in any way the views of Mark2Market, Finterest and VGSoM.

References: 1. Shera, A. (2011). Corruption and the impact on the Economic Growth. Journal of Information Technology and Economic Development, Vol 2(1), 39-53.2. Ministry of Finance, Government of India (2012). White Paper on Black Money. Downloaded on September 17, 2012 from http://finmin.nic.in/reports/WhitePaper_BackMoney2012.pdf3. World Bank (2011). The Puppet Masters. Down-loaded on September 17, 2012 from http://documents.worldbank.org/curated/en/2011/01/15444885/puppet-masters-corrupt-use-legal-structures-hide-stolen-assets4. Numerous newspaper reports


04




















Actions Taken







Wishlist of Actions







ABOUT THE AUTHOR

Manager - DesignTATA Steel (1999-2005)

Fellow XLRI Jamshedpur(2005-2011)

PhD,Finance, StrategyXLRI Jamshedpur

MSStructural EngineeringIndian Institute of Science

B.E,Civil EngineeringNIT Durgapur

She won the Best Paper Award for her paper titled "Deterrence Strategy in Takeovers - a Game Theoretic Model" at 12th Annual Convention of the Strategic Management Forum held at IIM Banga-lore on May'09.

Case in pointA Raja, former Telecom Minister, is alleged to have collected Rs. 3000 cr as bribes for his services towards fraudulently allocating spectrum licenses to telecom companies like Swan owned by the Ambanis, UniTtech, Videocon, S-Tel and Aircel. He used bank accounts in his wife’s name to park the amount in places as diverse as Mauritius, Seychelles, Cyprus, Dubai, Moscow, Norway, Isle of Man, Jersey Island, British Virgin Island and Singapore.

Source: http://articles.timesofindia.indiatimes.com/2011-03-02/india/28646452_1_2g-spectrum-scam-bribe-money

Case in pointY S Jaganmohan Reddy, an MP of the YSR Congress Party, has been under scanner for amassing thousands of crores of rupees from different companies, including Aurobindo Pharma, India Cements, PVP Real Estate Group, in lieu of land, mining leases, and water. Enforcement Directorate is investigating inflow of large sums of mysterious funds into his power project – Sandur Power Company Limited. Funds received by SPCL have been further channeled into his listed ventures, like Jagathi Publications, Bharati Cements, Sandur Power and Saraswati Power. The funds in question came from shell companies incorporated in Mauritius, Luxembourg, Singa-pore, Hong Kong, UK and British Virgin Islands. In fact, Mr. Reddy reportedly owns 56 shell companies located around the world.

Source:www.outlookindia.com/article.aspx?281090;indiatoday.intoday.in/story/noose-tightens-on-jaganmohan-reddy-enforecement-directorate-begins-investigating-his-assets/1/188901.html and related newspapers report


05




















Actions Taken







Wishlist of Actions







DID YOU KNOW

A Participatory Note is issued in foreign coun-tries by Foreign Institu-tional Investors or Indian brokers who are regis-tered with SEBI, which has equity shares, debt, derivatives or indices as underlying asset.

Case in pointSuresh Kalmadi, as chief of Indian Olympic Association, brought the Formula One Grand Prix to India. For this, F1’s organizers signed a Rs. 1600 crore contract with JPSK Sports Private Limited. JPSK is a shell company whose shareholders are Jaiprakash Associates (74%), Sulba Realty Private Limited (13%) and Trackwork Inter-national Private Limited (13%). Kalmadi’s son is the Director of SRPL and his daughter and son-in-law are Directors of JPSK. JPSK received 2500 acres in Noida for this project, out of which 1000 acres was delineated for the race circuit while the balance was agreed to be developed for private gains.

Source: www.indianexpress.com/news/for-kalmadi-f1-is-family-1st/505516/0 and related newspapers reports

Case in pointShashi Tharoor, former external affairs minister, helped a Kerala based consortium to bid for one of the two IPL franchisees on offer. In return for this favour, his friend, Ms. Sunanda Pushkar, who was then employed with a Dubai based real estate company, was promised sweat equity in the consortium that was reportedly valued at Rs. 70 crore.

Source:articles.economictimes.indiatimes.com/2010-04-14/news/28475454_1_kochi-franchisee-kochi-team-rendezvous-sports-world and related newspaper report

Case in pointMadhu Koda, ex Chief Minister of Jharkhand was accused of expropriating 3356 cr during his stint as minister. The transfer of money was facilitated by 18 companies he had floated or acquired in India. He also opened 2 companies in Dubai. During 2005-2008, he held charge of the mining ministry. In that capacity, he allotted coal blocks to his own companies. Besides, he also allotted coal blocks to established companies like ElectroSteel Castings, Rungta Mines and Sunflag Iron and Steel. The kickbacks received by him in lieu of the preferential allotments were invested in two ways. First one was to “acquire” defunct firms. Second conduit was to “invest” in private comp-anies for more than 50% shareholding. These investments were made in the names of close aides of Mr. Koda, who were paper owners, while the actual beneficiary was Mr. Koda. The money invested were further transferred to Dubai, Indonesia, Thailand, Liberia and Sweden, where it was invested either in real estate or parked in banks.

Source:http://indiatoday.intoday.in/story/madhu-koda-and-associates-laundered-staggering-rs-3356-crore/1/174473.html and other newspaper reports


06




















Actions Taken


DID YOU KNOW

There are international agencies, too, like Financial Action Task Force, Global Forum on Transparency and Exchange of Information for Tax Purposes and the United Nations Conven-tion against Corruption, who are linking countries for joint combat of corruption, including asset recovery, through international cooperation, technical assistance and information exchange.






Wishlist of Actions







Case in pointThe Adarsh Housing Society Scam has thrown up a number of benami transactions; Former Chief Minister of Maharastra, Mr. Ashok Chavan allegedly received flats in the names of his mother-in-law and brother-in-law, with no trace of the entity that paid the amounts. These flats were purportedly received in return of granting illegal approvals and land allocations to the Society, during his tenure as Revenue Minister.

Source: http://www.businessworld.in/en/storypage/-/bw/ashok-chavan-12-others-chargesheeted-in-adarsh-scam/425340.0/page/0 and related newspaper reports


07




















Actions Taken





DID YOU KNOW

Benami transactions are made by companies as bribes and kickbacks to kin of the actual beneficiary, in return of out of turn allocations of various resources.



Wishlist of Actions








08

CHALLENGES IN THE CURRENT M&A ENVIRONMENT

GAGAN BAKSHI

Director, M&AInterGlobe Enterprises

DID YOU KNOW

“Rip Van Winkle" is the protagonist of a short story by the American author Washing-ton Irving. Rip famously slept for 20 years and on waking up from his deep slumber, finds that American Revolution has taken place and the British Rule in America is over.

INDUSTRY INTERACTION AT VGSOM

Guests from the industry at various events in VGSOM have shared their expertise through the following articles:

1. Challenges In The Current M&A Environment

2. Mutual Fund – Prospective View Given the Regulatory Reform

The inherent risky nature of M&A makes it tough for corporates to close a deal successfully in any economic cycle. The current environment brings its own unique challenges that have made deal-making even more difficult both at globally and in India.

While M&A activity is still being undertaken, the deal volume has moderated and deal values have come down considerably. More and more corporates are focusing on strengthening their core operations to ride out the uncertain and tough economic conditions, rather than looking at inorganic growth

Global Economic Environment

Unless you have woken up from a ‘Rip Van Winkle’ slumber, it’s tough to imagine anyone unaware of the current global economic environment. Some would term the current malaise historic and unprec-edented.

Recessionary conditions are impacting growth for most companies in the devel-oped world with Europe teetering on the edge and US in a low-growth mode. Most developing nations are facing prospects of slow growth in the near to medium term.

Even the fast growing BRIC countries have an asterisk on their growth forecasts.

The Euro currency crisis, coupled with the recent spate of scandals (e.g. LIBOR fixing, Barclays ‘London Whale’ trades, etc.), has shaken the very foundations of the global financial system.

This uncertainty and pessimism is forcing companies to be extremely cautious in their M&A activities. Only truly strategic acquisi-tions are being considered – deals which provide economies of scale and/or scope, allow for market and/or product extension, or enable a company to integrate up or down the value chain.

The Leverage Issue

Availability of ample quantum of cheap acquisition financing fueled the global M&A frenzy in recent years with several compa-nies (including Indian corporate) success-fully bought targets globally with relatively small amounts of equity contribution. While most deals done with the correct rationale have generally been successful, several ‘opportunistic’ deals have floun-dered and buyers are under acute stress from their inability to service the acquisition related debt.

Today, while interest rates quite low glob-ally (unlike India) and funding is generally available for most buyers, lenders have become very selective. Credit providers are acutely focusing on buyer’s credit profile and target’s cash flow generation ability as opposed to a business plan with ‘hockey-stick’ growth scenarios baked in.

Uncertain Regulatory Frame-work

As part of the Union Budget 2012, GAAR (general anti-avoidance rules) provisions were proposed to be implemented by April 1, 2012. However, due to widespread protests from the investor community, their applicability has now been deferred to April 1, 2013.

Conceptually, GAAR is a broad set of provi-sions which aim to tax any transaction, or any of the steps in a transaction, that have been deemed to be undertaken solely for the benefit of obtaining tax benefits. As defined, the provisions have a very wide scope and would likely impact all M&A deals including cross-border (inbound and outbound) investments, PE deals, and domestic M&A deals. The provisions can potentially override double tax avoidance treaties. Further, the onus will lie on the taxpayer to prove the deal was done for “permissible” purposes.

The Vodafone issue has already generated enough negative press. The lingering litiga-tion has created a climate of distrust between investors and tax authorities. The ability of legislators to propose laws that

could go beyond the ruling of Supreme Court is particularly unsettling for foreign investors. The proposal to provide the state the right to retroactively tax cross-border deals in which the underlying asset was located in India, would negatively impact transactions that were consummated some time back “in compliance” with the laws of that time.

Investors are rightfully concerned about the potential for poor implementation and misuse of such sweeping provisions by the tax authorities given inherent ambiguity in interpretation of the guidelines. Evidence from implementation of GAAR in other countries has shown evidence of increase in litigation and the dispute resolution system in India offers no comfort to the investors.

Weakening of Indian Rupee

In the current environment of government policy paralysis, widening fiscal deficit and persistent high inflation, the Indian Rupee has taken a major beating versus major global currencies. Consequently, outbound deals have become pricier as has the debt servicing of foreign currency denominated loans.

Unrealistic valuation expecta-tions of Indian promoters

Capital markets in India have been shut for a while with only a handful of IPOs in 2012. With M&A as the only other avenue for exit, one would have expected the deal flow to pick up. However, unrealistic valuation expectations by sellers and the inability of promoters to exit family business continue to impact deal volumes. Ranbaxy’s sale to Daiichi and Piramal’s acquisition by Abbott are welcome exceptions to the above rule.

Concerns over corporate gov-ernance standards in India

The recent avalanche of corporate scams (e.g. Satyam, Everonn, Lilliput, SKS Micro-finance, etc.) has impacted investor senti-ment and foreign buyers are showing increased concern over lax corporate governance standards. They are conduct-ing more intense due-diligence studies to cover not only the commercial, tax and legal aspects but also corporate gover-nance and ethics related practices.

Management incentives not aligned to promote deal flow

Senior management is increasingly spend-ing more time on consolidating their exist-ing business operations and improving the quality of cash flows via organic growth avenues rather than focusing on transfor-mational deals. A classic example is the cash hoard of ~$4bn at one of the leading Indian IT/BPO majors. Despite increasing calls from investors and analysts for the company to get into a deal-making mode, the company has been cautious and stayed away from making any big moves.

The heady days when senior management was disproportionately rewarded for grow-ing the top-line on the basis of inorganic growth, are clearly over. Several Boards have re-aligned incentives for senior man-agement in-line with the above mentioned thought process

Summary

The global macro-environment is tough and challenges abound in closing M&A deals successfully. The Indian economic environment is beset by its own problems due to a deteriorating economic environ-ment, an uncertain regulatory framework, corruption at the highest levels, and a general wariness amongst corporate regarding M&A deals.

Every dark cloud has a silver lining. The newly appointed Finance Minister has made the right noises to soothe the jarred nerves of the investor community. The recently set up Shome Committee has suggested deferral of GAAR provisions for three years and abolition of capital gains on transfer of securities. We expect our regulatory and tax framework to continue to evolve and become more investor friendly in the future.

Despite the short-term problems, the long-term economic outlook for India continues to look robust. Indian corporate have tasted global success, and given their stated business need to expand to overseas markets, the CXOs are likely to reignite their cross border ambitions and strive to be global leaders in their respective industries.

References:1. “GAAR & M&A”, Anshu Khanna, Partner – Tax & Regulatory Services, Walker, Chandiok & Co, 31 May 2012, M&A, Grant Thornton India LLP2. “Overview of M&A environment in India”, 31 May 2012, Grant Thornton India LLP

Note:The article represents the author’s personal views on the subject and does not reflect in any way the views of InterGlobe Enterprises.

Editor’s Note:As this article went to press, Infosys has announced its purchase of Lodestone for $350mn.


09









The Leverage Issue











DID YOU KNOW

GAAR (General Anti-Avoidance Rules) provisions seek to control tax avoidance.

GAAR provisions are in place in several countries including USA, UK, Australia, Canada, South Africa, China and Netherlands.

DID YOU KNOW

Mergers and Aquisitions in India are regulated under the Competition Act, 2002. The objectives of the Act are sought to be achieved through the Competition Commission of India (CCI), which has been established by the Central Government with effect from 14 October 2003.








Summary







DEAL VOLUME2009 2010 2011 H1 2012

Inbound 74 91 142 77Outbound 82 198 146 48

Cross Border 156 289 288 125Domestic 174 373 356 158

Total M&A 330 662 644 283

DEAL VALUEUS$ bn 2009 2010 2011 H1 2012

Inbound 3.9 9 28.7 4.9Outbound 1.4 22.5 10.8 2.1

Cross Border 5.3 31.5 39.5 7Domestic 6.7 18.3 5 3.1

Total M&A 12 49.8 44.5 10.1

INDIAN M&A DEAL ACTIVITY

Source: Grant Thorton, 2012

INR vs. 2009 2010 2011 2012USD 46.8 45.3 54.3 55.5GBP 74.5 70.1 83.9 87.9EUR 67 60.1 70.3 69.6SGD 33.3 35.1 41.8 44.4

INR Exchange Rates

Source: www.oanda.comNote: All values as of Dec 31 for all years except 2012; Where values as of Aug 31

30

40

50

60

70

80

90

100

2009 2010 2011 2012

USD

GBP

EUR

SGD


10









The Leverage Issue


















Summary







ABOUT THE AUTHOR

The author is the Director of M&A at InterGlobe Enter-prises, a leading conglom-erate spanning aviation (IndiGo airlines), travel, hospitality and technology domains. He is responsible for all M&A activities in existing lines of business.

Over the past four years, Gagan has been an integral member of the Group Leadership team tasked with developing the Group’s growth strategy.

Gagan joined InterGlobe in 2008, prior to which he spent over 7 years with Credit Suisse as an Investment Banker in the New York, London and Mumbai offices. He is credited with providing M&A advisory and capital raising (equity & debt) services to his clients globally.

Gagan holds an MBA in Finance from The University of North Carolina at Chapel Hill, an MS from The University of Georgia, and a B. Tech. from the Indian Institute of Technology - Delhi


11

a very significant but new market while delicately balancing between the demand of financial inclusion and PMLA act. It has technically cleared the way for investment of Rs. 20000 in cash under mutual fund scheme for those classes of investors who necessarily do not have PAN card or have lower income than stipulated for filling Income tax. A significant section of society is expected to be benefited. Similarly, SEBI has earlier cleared the investment of up to Rs. 50000 for similar classes of investors dispensing with the requirement of PAN in mutual fund scheme.

While efforts were made to address the need of AMC revenue, enrichment and enlargement of market and marketing force, and protection of investor interest was of paramount value. SEBI has reduced expense fee by a considerable extent for investors approaching the fund house directly instead of going through broker. The fall out is immense and immediate. More and more of investors would be getting an incentive to be personally involved in taking investment decisions. A matured and informed market is good both for market participants and the fund houses. Gradually the informed lot will utilize a more efficient mode, which is tech-nology. Technology will replace all physical interaction. Given the fact that there are nearly 15 crore internet user in this country, next wave of technology driven support and portal would change the face of entire industry in the days to come.

There has been a prolonged debate on who should bear Exit Load - existing inves-tor, fund houses or use it for market devel-opment. Finally exit load has been brought under NAV. “The bottom line is that industry is poised to take off from here. Now it is up to asset manage-ment companies and market par-ticipants to utilize the opportu-nity.”

The challenge lies ahead in transforming this potential to the doorstep of the inves-tor. Investor education, distributor engage-

ment and installing requisite infrastructure including trained and skilled manpower will pave the road ahead. The ability to promote user friendly technology driven enhancements and portals will significantly reduce the stress and increase the efficiency.

Similar Innovation is desired on the product level in terms of product engineering to tap into the market potential. Risk manage-ment and efficient handling of portfolio popularly known as fund management skills will guide the future course. Some new product like ETF, fund of fund, specialty fund, capital protection fund, treasury fund, and real time liquidity enabling scheme are certainly going to be popular on the line of traditional diversified debt and equity schemes.

The Market is set to open great demand of skilled and accomplished manpower in finance, marketing and IT. In fact scarcity of requisite human resource has been one of the traditional worry of regulator and market forces. NISM, a SEBI promoted institute, along with several fund houses are seriously engaged in fulfilling this capacity. Much depends on the academic institutions, as to how professionally they extend the support.

Needless to say, the present size of asset management industry of roughly 7.5 lakh crores should blissfully be very low given the potential placed before the market.

Note:The article represents the author’s personal views on the subject and does not reflect in any way the views of HDFC AMC.

Translating that into revenue, say for scheme of Rs. 20000 crores asset, the extra revenue would be of the order of Rs. 60 crores, which is huge given the kind of meager profitability AMC business is into. There is absolutely no doubt that signifi-cant and lofty incentive has been awarded by SEBI to all fund houses. The implication will be measured and definite. The focus will shift to tier 2 and tier 3 cities. With focus comes effort on investor education, distributor development program, market development and host of other opportuni-ties. If NBFC and Post Office can thrive and build up a fortune in such catchments, a more vibrant, transparent and attractive proposition will certainly make huge changes.

While aligning the mutual fund house revenue vis-a-vis incentive to accept challenge, a long pending demand of fungi-bilities in expense utilization was also taken care of by SEBI. The fungibles are replace-able.

“In fund house terms, there was restrain and demarcation limit on the utilization of expense with

respect to various expense heads like marketing fee, invest-ment fee, brokerage fee. With fungibility, the limit has been removed to the desecration and uses of fund house. This amend-ment will bring more flexibility in a fund house’s ability to address the issue of pertinence”.

Another far reaching change has taken place in creation of distribution force and distributor education. The distributor with graded ability and qualification to promote various products, with the extended eligibil-ity criterion for becoming distributor, is going to introduce more fresh blood and walking fleet in the street. The contribution of NISM and its program is of immense importance here. The present strength of nearly 70000 odd distributors is grossly inadequate, given the fact that a high percentage of them are inactive. This act of SEBI is a giant leap in the direction of financial inclusion and related efforts.

SEBI has also exhibited its ability to create

The scale and depth of capital market are very often treated as the index of financial ambiance in any country, as a whole. In that context, the role of a Mutual Fund/Asset Management company is no less significant than any other financial institution and financial intermediary.

Indian Mutual Fund started way back through an Parliament act of 1963 with inception of UTI, followed by various bank promoted asset management companies (SBI AMC, PNB AMC, BOI AMC) and private sector held asset management companies (HDFC AMC, ICICI AMC, Franklin Templeton AMC, etc.), adding up to nearly 40 asset management compa-nies. AMFI – Association of Mutual Fund in India is the main advisory body to upkeep the ethics and standard business practices with SEBI as the supreme regulator.

The spectacular growth in the AMC business was never disassociated with hoards of challenges. But the consistent and innovative regulatory supervision has established a very high standard of process, compliance, performance and expectation of all the stake holders. Regu-latory reforms have been the key to this success.

Post 1963, 1993 was the milestone year when the first set of mutual fund regula-tions was introduced which was compre-hensively replaced in 1996 through SEBI Mutual Fund regulation. With the repeal of

UTI-63 Act through 2002 Parliament Act, all companies including UTI became SEBI compliant thereby extending the regulatory role from mutual fund structure to guiding market practices, accounting, valuation, setting business standards, compliance, and investor protection in almost all the areas. Pursuant such changes, the recent SEBI Board decision on 16th Aug 12, which is soon slated to be implemented, is certainly going to change the overall indus-try face again.

“One of the shortcomings of asset management industry is skewed business concentration in tier 1 cities. The statistics account for nearly 80-85% on gross term getting mobilized from tier 1 cities”.

Not only it deprives larger population from taking advantage of a dynamic capital market, but more so, it weakens the basic concept of mutual fund. In order to penetrate in the tier 2 and tier 3 cities, it is necessary to arm AMC house with requi-site incentive and revenue. And the recom-mendation has been revolutionary. The yardstick of minimum 30% mobilization from tier 2 and tier 3 cities compared to overall sales under a particular scheme enables fund house to charge extra 30 paisa of expense.

MUTUAL FUNDPROSPECTIVE VIEW GIVEN THE REGULATORY REFORM

The Indian Mutual Fund industry, which is roughly Rs. 7.5 lakh crores as of date, is one of the biggest contributors in enriching the capital market, introducing variety and dexterity in handling financial instruments and roping in immense faith and trust of millions of small investors across the country.

SANAT BHARADWAJ

Senior ManagerHDFC AMC

DID YOU KNOW

Researcher credits a Dutch merchant with creating the first mutual fund in 1774.

The first mutual fund outside the Netherlands was the Foreign & Colonial Govern-ment Trust, which was established in London in 1868.


12























ABOUT THE AUTHOR

Mr. Sanat Bharadwaj has beem working in HDFC AMC for six years in sales and managerial capacity. Prior to this, he worked for UTI AMC for twelve years in sales and managerial capacity. And before working in UTI AMC, he worked in FERA for two years as an Investigator.

Mr. Sanat is an MBA and has acuired a multitude of professional qualifications.

Mr. Sanat has been proactive in driving industry relations with varoius education institutes such as VGSoM - IIT Kharagpur, XLRI - Jamshedpur. He has also been part of Investor Awareness Programs for Xavier Group, Ranchi and in other cities like Kolkata, Jamshedpur, and Patna.

Mr. Sanat is also a faculty of Commerce & Economics of Kolkata University at Kolkata Stock Exchange.


13










DID YOU KNOW

Mutual funds are classi-fied by their principal investments. The four largest categories of funds are money market funds, bond or fixed income funds, stock or equity funds and hybrid funds. Funds may also be categorized as index or actively-managed.

DID YOU KNOW

Forty percent of their financial institutions expect to invest 2 percent to 10 percent of their overall marketing budget on social media next year.















14

GO BANKRUPT, GET BAILOUTPerspectives on the Subprime Crisis and the rescue measures adopted.

ABOUT THE AUTHOR

TANAY DESHPANDE

Indian Institute of Manage-ment Calcutta

E mail- [email protected]

cal.ac.in

FINVENTORYArticles Contributed By Students From B-schools Across The Country

1. Go Bankrupt, Get Bailout2. Priority Sector Lending3. Dark Pools - The Ying Yang Of Trading4. Manufacturing In India5. Nearing The End Of Dollar’s Dominance

The protesters thread their way through the streets of the world’s busiest cities; Los Angeles, Athens, London, Madrid and of course, the cradle of all financial sins- New York. The Occupy movement has gained worldwide significance and the protesters, personifying the ideology of the movement, are characterized by their famous “We are the 99%” slogan. Amidst the thronging streets, flashing their banners and demon-strating their dissatisfaction against skies as grey and stormy as the economic scenario unfolding in front of them, they have vociferously declaimed the status quo of financial affairs in their respective coun-tries. At the spearhead of their argument is the issue of government bailouts.

The term “Too big to fail” was first innocu-ously used by U.S. Congressman Stewart McKinney in the 1984 seizure of Continen-tal Illinois by the FDIC. Today, the term has experienced a complete renaissance of its impact since the 2008 financial meltdown. TBTF implies any organization which relies on taxpayers’ money to survive insolvency. The chief motivation behind why certain firms are not allowed to go bankrupt is that their failure would create systemic prob-lems that would be inimical to the entire economy. For instance, if the automotive giants of Detroit, Chrysler and GM, had

been allowed to sink by the government, the U.S. would have faced massive unem-ployment, shutdown of complementary businesses and an overall manufacturing slowdown. Such a thorough wipeout of the U.S. economy would have been much more detrimental than pouring the taxpayers’ money into failed business models. On the other hand, the bankruptcy of Lehman Brothers in September 2008 caused a cata-clysmic implosion of the global financial system, causing the Dow to fall by around 10% (the largest decline ever recorded in a month) and an erosion of $10t in equity markets worldwide. Lehman’s case in particular, epitomizes the idea of TBTF.

“The main source of opposition to bailouts stems from the concept of moral hazard. With the com-forting knowledge of the financial safety net offered by the govern-ment, large corporations can afford to be recklessly misman-aged without any fear of the con-sequences. In fact, firms will now try to get as large as they can so as to avail of this facility. In a par-ticularly disgusting episode of the

2nd PRIZE

2008 crisis, Wells Fargo and Citi-group actually fought to buy out the subprime assets of the insol-vent North Carolina firm Wacho-via so that they could strengthen their status of being considered too large for bankruptcy.”

The most pragmatic solution to the problem of TBTF goes back to the Glass-Steagall Act of 1933. By this piece of legislature, there would be a clear divide between investment banks and commercial banks and these two separate entities could not be permitted to lay claim on the same assets or operate from under the same roof. However, in 1999, Bill Clinton repealed the Glass-Steagall Act with the Gramm-Leach-Billey Act to permit the mergers of Citigroup & Travelers as well as Citigroup & Salomon Smith Barney. No sooner than 8 years later, the world faced its worst recession ever. Loans and mort-gages serviced by commercial banks now became the assets of the investment banks through the Asset Securitization pipeline. Via ABS’s and MBS’s (Mortgage backed securities), the I-banks would now pool several thousands of mortgages (subprime or not), and then slice them into tranches of

varying risk and return to be sold as com-plex derivative products back to the clients of the commercial banks. Effectively, the bankers were issuing unsustainable subprime loans to the general public and then letting the general public take on the risk with the bankers simply acting as middlemen to the transaction, pocketing a hefty commission in the midst. Clearly then, as Paul Krugman had noted, there exist positive economies of scale in the banking sector. More the number of people the I-banks could involve in their specula-tive game of risk transfer, the heftier the profits they could earn. But are these economies of scale even remotely benefi-cial or even justifiable to the general citizens at large?

Further, the reckless risks taken by the I-bank traders while investing in a whole universe of asset classes originating from various emerging economies on the globe cannot benefit even the shareholders of the same investment bank. Most of the returns are absorbed by the highest echelons of the banks’ management, including the heavy bonus pay and com-pensations offered to the traders and the I-banking sales teams. However surpris-ingly, when the same bank runs into losses, they are borne indirectly by the sharehold-ers through the taxes they pay to the govt.

And hence, we are brought to the situation of lemon socialism, where gains are priva-tized and losses socialized.

Worse still, although the banks repaid their debts incurred in the Troubled Asset Relief Program (TARP), their characteristic lack of acknowledgement of the burden they had laid on the shoulders of the general public is flagrantly shocking. While AIG CEO Edward Liddy had deemed the 2008 Fed takeover of 80% stake in AIG in return for borrowing $85b as the best alternative for the company to return to profitability, Ex AIG Chief Hank Greenberg later sued the U.S. Treasury for “deliberately disparate and discriminatory treatment” for a “tempo-rary liquidity problem”.

The negative externality created by the coexistence of I-banks and commercial banks is widespread moral hazard- the larger the size of the institution, the less likely it will be allowed to die insolvent. What’s scarier is that the contagion origi-nating in the financial services industry can spread to other interconnected sectors of the economy. A liquidity crunch in financial services, which are at the heart of any business, and the subsequent simultane-ous bank runs, can destroy entire national economies. Thus, the only rational way to curtail the expectations of a govt. safety net in the form of facilities such as Deposit Insurance & TALF (Term ABS Loan Facil-ity) is to bring in the Glass-Steagall Act and break down today’s major financial institu-tions into more manageable segments whose core operations are clearly defined.

In other industries though, sometimes a bailout may be a necessary evil. The cycles of expansion and contraction in any capitalist economy would occasionally lead to a scenario where the operations of a large corporation are grossly misman-aged over a period of time. In cases like these, if the collapse of that particular corporation can seriously hinder the economic well-being of a country, the govt. should, by all means, lend sufficient oper-ating capital for a window of time for the stakeholders to decide whether to change the management or formulate a plan to get the operations back in control through partial liquidation, spin-offs or downsizing.

However, the regulatory authorities must then also very carefully monitor the func-tioning of any such organization whose failure would be catastrophic to the economy.

Finally, as per the status quo, bailouts are an essential part of the world’s business system and the corporations who have received them have probably emerged stronger and larger in size than ever before.

“The financial system is even more in their control than it was before 2008, and the world can only hope for better leadership and better legislature to solve the insolvency problems of large, mismanaged organizations. It is indeed a long way to go to ‘Go bankrupt, forget bailout’.”


15





DID YOU KNOW

Banks worldwide earned an estimated $13 billion by taking advantage of below-market rates on emergency U.S. Federal Reserve loans from August 2007 through April 2010.

DID YOU KNOW

The six -- JP Morgan, Bank of America, Citigroup Inc. (C), Wells Fargo & Co. (WFC), Goldman Sachs Group Inc. (GS) and Morgan Stanley -- accounted for 63 percent of the average daily debt to the Fed by all publicly traded U.S. banks, money managers and invest-ment- services firms, the data show.













16





DID YOU KNOW

ObamaCare is shaping up as a de facto bailout for states. To make its envisioned, monumental expansion of Medicaid palatable for the states, the act offers them a 100 percent reimbursement rate for newly-covered Medicaid populations

DID YOU KNOW

The Dodd-Frank Act by declaring that every banking organization larger than $50 billion is “systemically important.” signals that these banks — simply because of their size — are more likely than others to be rescued if they are in danger of failing.













17

ments in rural as well as urban India comes at a huge cost. Lending to individual and self-help groups certainly comes at a risk. No bank would like to get their money involved in something which gives no guarantee of getting the invest-ment back. It is a fact that these invest-ments are for the economic development of the state and generally have very low returns. While banks all over the world are focusing on cutting costs, banks in India are being asked to invest 40% of their advances into priority sectors. The very purpose of opening branches in India is being done away with, that is higher return on investments.

Even before the new guidelines were issued, it was difficult for the banks to meet the target of 32% priority lending. Raising the target level to 40% will only add to the woes. Micro credit requires a maximum of Rs. 50000 per borrower in rural, semi urban and urban areas. The problem again comes at the local presence of these banks in rural India.

“Every year RBI issues only 15 branch licenses to foreign banks, which makes it difficult for them to expand their presence. Earlier the banks could invest or distrib-ute loans to any priority sector based on their core competen-

cies, now with the new rule of sub–targets they are hooked with a nail and their diameters are defined.”

The bank’s net credit of 40% is to be distributed amongst agricultural sector, small scale industries, small business/enterprises, micro credit, educa-tional loans and housing loans. These banks are only left 60% of their net profits to invest in other sectors.

The new regulation also makes the foreign banks which do not fall under the category (foreign banks having less than 20 branches), reluctant to open new branches and expand their businesses. Opening an extra branch (from 20 to 21), makes them face the cost of priority sector lending.

References:1. Latest guidelines by the RBI2 . http://rbidocs.rbi.org.in/rdocs/Content/pdfs/71207.pdf

DID YOU KNOW

Reserve Bank of India (RBI) had slashed the statutory liquidity ratio (SLR) by one per cent. This had released an additional Rs 55,000 crore into the banking system for providing loans.

In 1980, lending to priority sectors under-went a major shift after the meeting of Union Finance Minister and Chief Finan-cial Officers of various public banks. It was decided to raise the priority sector lending bench mark from 33.33% to 40% within a span of 5 years. The foreign banks still enjoyed at the mark at 32%. Since then there have been many changes to the targets and sub-targets applicable to different banking groups.

Come July 2012, RBI ,with its various guidelines on priority lending, also said that the foreign banks with more than 20 branches in the country will have to abide by the rule of 40% lending of their total advances. The banks have a maximum of 5 years to reach the mandatory level, which they can do in a phased manner.

As expected, the foreign banks resisted the move on the grounds that it will eat into their profits to a large extent. Prior to the announcement, the foreign banks had enjoyed a target of 32%, which was inclu-sive of export credit.

This regulatory guideline of RBI can be analysed from different viewpoints, firstly from the perspective of the foreign banks, and secondly from the perspective of the priority sectors. The priority sectors i.e. the agricultural sector and small scale enter-prises have nothing to lose from the new policies. Higher the percentage of lending better it is for the farmers and SME’s to take up loans and invest wisely. It is the literacy level and financial understanding of the borrowers that might result in a prob-lem. The wiser the borrower, higher are the chances of early repayment and hence

recovery of loan. Keeping in mind the huge 40% of advances, in case the borrower is unable to pay, who knows, a cycle of default payments might lead to another world crisis.

“Foreign Banks: Am I gaining or losing from the latest chaos?”

As per the RBI’s April 2012 report, we have around 46 foreign banks from 24 countries around the world that have branches in India. Out of these banks RBS Netherlands, Citibank USA, HSBC Hong Kong, and Standard Chartered UK have more than 30 branches each, in the coun-try. Standard Chartered Bank has almost one third the total number of foreign bank branches in country.

The new rule changes the 32% net credit to 40% and also includes sub- targets for the foreign banks. Moreover, the RBI has removed the 12% export credit that the foreign banks were enjoying till now. Failure to meet these obligations will need the banks to deposit the equivalent credit in Nabard (National Bank for Agriculture and Rural Development). In such a case the earnings will be lesser than had they fulfilled the obligations.

Foreign banks were earlier focussed on high end services catering to corporate and high net worth individuals (HNI). These services don’t require huge work-force and moreover the staff is well versed and equipped to deal in such transactions. The latest priority lending regulations ask banks to plunge into a new area, where the officials have little or no expertise. Training the new workforce on the require-

PRIORITY SECTOR LENDING

A situation called Priority Sector Lending:Gains for one becomes pain for some

ABOUT THE AUTHOR

SAURABH CHADHA

International Business

Symbiosis Institute of International Business, Pune

E mail:[email protected]


18

DID YOU KNOW

Agriculture lending by banks is categorised under the priority sector lending (PSL). According to the RBI guidelines, every year banks have to lend 18 per cent of their adjusted net bank credit as on March-end of the previous year to the farm sector.

DID YOU KNOW

Islamic banking (or participant banking) is banking activity that is consistent with the principles of sharia law. Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees for loans of money. Investing in businesses that provide goods or services considered contrary to Islamic principles is also haraam ("sinful and prohibited")

ments in rural as well as urban India comes at a huge cost. Lending to individual and self-help groups certainly comes at a risk. No bank would like to get their money involved in something which gives no guarantee of getting the invest-ment back. It is a fact that these invest-ments are for the economic development of the state and generally have very low returns. While banks all over the world are focusing on cutting costs, banks in India are being asked to invest 40% of their advances into priority sectors. The very purpose of opening branches in India is being done away with, that is higher return on investments.

Even before the new guidelines were issued, it was difficult for the banks to meet the target of 32% priority lending. Raising the target level to 40% will only add to the woes. Micro credit requires a maximum of Rs. 50000 per borrower in rural, semi urban and urban areas. The problem again comes at the local presence of these banks in rural India.

“Every year RBI issues only 15 branch licenses to foreign banks, which makes it difficult for them to expand their presence. Earlier the banks could invest or distrib-ute loans to any priority sector based on their core competen-

cies, now with the new rule of sub–targets they are hooked with a nail and their diameters are defined.”

The bank’s net credit of 40% is to be distributed amongst agricultural sector, small scale industries, small business/enterprises, micro credit, educa-tional loans and housing loans. These banks are only left 60% of their net profits to invest in other sectors.

The new regulation also makes the foreign banks which do not fall under the category (foreign banks having less than 20 branches), reluctant to open new branches and expand their businesses. Opening an extra branch (from 20 to 21), makes them face the cost of priority sector lending.

References:1. Latest guidelines by the RBI2 . http://rbidocs.rbi.org.in/rdocs/Content/pdfs/71207.pdf

In 1980, lending to priority sectors under-went a major shift after the meeting of Union Finance Minister and Chief Finan-cial Officers of various public banks. It was decided to raise the priority sector lending bench mark from 33.33% to 40% within a span of 5 years. The foreign banks still enjoyed at the mark at 32%. Since then there have been many changes to the targets and sub-targets applicable to different banking groups.

Come July 2012, RBI ,with its various guidelines on priority lending, also said that the foreign banks with more than 20 branches in the country will have to abide by the rule of 40% lending of their total advances. The banks have a maximum of 5 years to reach the mandatory level, which they can do in a phased manner.

As expected, the foreign banks resisted the move on the grounds that it will eat into their profits to a large extent. Prior to the announcement, the foreign banks had enjoyed a target of 32%, which was inclu-sive of export credit.

This regulatory guideline of RBI can be analysed from different viewpoints, firstly from the perspective of the foreign banks, and secondly from the perspective of the priority sectors. The priority sectors i.e. the agricultural sector and small scale enter-prises have nothing to lose from the new policies. Higher the percentage of lending better it is for the farmers and SME’s to take up loans and invest wisely. It is the literacy level and financial understanding of the borrowers that might result in a prob-lem. The wiser the borrower, higher are the chances of early repayment and hence

recovery of loan. Keeping in mind the huge 40% of advances, in case the borrower is unable to pay, who knows, a cycle of default payments might lead to another world crisis.

“Foreign Banks: Am I gaining or losing from the latest chaos?”

As per the RBI’s April 2012 report, we have around 46 foreign banks from 24 countries around the world that have branches in India. Out of these banks RBS Netherlands, Citibank USA, HSBC Hong Kong, and Standard Chartered UK have more than 30 branches each, in the coun-try. Standard Chartered Bank has almost one third the total number of foreign bank branches in country.

The new rule changes the 32% net credit to 40% and also includes sub- targets for the foreign banks. Moreover, the RBI has removed the 12% export credit that the foreign banks were enjoying till now. Failure to meet these obligations will need the banks to deposit the equivalent credit in Nabard (National Bank for Agriculture and Rural Development). In such a case the earnings will be lesser than had they fulfilled the obligations.

Foreign banks were earlier focussed on high end services catering to corporate and high net worth individuals (HNI). These services don’t require huge work-force and moreover the staff is well versed and equipped to deal in such transactions. The latest priority lending regulations ask banks to plunge into a new area, where the officials have little or no expertise. Training the new workforce on the require-


19

The benefits of a dark pool may be summa-rized as:1. Anonymous trading with very low market impact. 2. Price improvement and opacity 3. Reduced transaction costs 4. Less “leakage” of information5. Technology enabling access to as much liquidity as possible

The Odds Against Dark Pools

Today we are swiftly approaching a two-tiered market structure in the equity markets. One tier represents open public exchanges providing full price transparency to all investors and traders. These exchanges have to file extensive data on the trading activities with regulators overseeing the markets and bear regulatory costs as well. And the other tier represents the dark pools and other venues of non-exchange matching anonymous buyers and sellers. These markets also have the ability to discriminate between certain traders (for example, giving a trader a first insight at order flow before the other market participants get to see it).

Thereby, more high-frequency and institu-tional traders are migrating to these venues, which offer trading with less regu-latory scrutiny. This situation puts retail

investors on a sticky wicket as more infor-mation is now outside the public view. The price discovery process deteriorates further as liquidity providers gradually become less willing to display quotes in public. Figure 3 shows dark pool and broker crossing activity by venue in July 2012.

The Indian Challenge

SEBI (Securities and Exchange Board of India) does not favor introducing such anonymous platforms in India yet since these transactions are executed outside the purview of the main exchange platforms and thus, out of bounds for the majority of ordinary investors. It is not an ideal proposition for India considering the mystery and secrecy shrouding these “hidden type of liquidity”. No one knows the buyers, the sellers or the prices that others quote.

Himadri Das, Dean of Academic Program at International Management Institute, New Delhi adds, “In our markets, we don’t have sufficient liquidity. Dark pools will take away a huge block of liquidity provided by institutional investors, who may find these off-market platforms cheaper in transaction costs. Dark pools are exclusive clubs for the big institutional investors with no trans-parency. India is not ready for such

platforms,” he said.

Available Alternatives

Securities and Exchange Commission (SEC) in the U.S. approved a new trading program, the Retail Liquidity Program (RLP), at the NYSE, that will allow bids to be placed before trading in the stocks actu-ally begin on the exchange floor. The RLP is subject to SEC rules that govern exchange participation. It is more open than traditional dark pools since it will advertise when better bids are being offered on a stock, ultimately leading to better stock prices for the investor and helping in the overall process of price discovery.

Also, big deals may go through the block deal mechanism approved by SEBI where the two parties agree on a certain price and then settle the trade themselves, before letting the transaction pass through the public markets. The argument in favor of block deals is that the transaction is carried out between two parties where prices are negotiated and the identities are known.

Conclusion

Evolution of a two-tiered system signifi-cantly undermines confidence in markets for investors as well as equity issuers. This

erosion of faith in the capital markets’ efficiency and effectiveness will ultimately affect capital formation, thus damping job creation. Transparency need not be sacri-ficed for promoting competition in financial markets. Fairly implemented regulation, if properly designed and equitably applied for all participants, is a critical constituent of an open and transparent marketplace.

References:1.http://www.advancedtrading.com/managingthedesk/231600191

2.http://thomsonreuters.com/products_services/financial/financial_products/a-z/market_share_reports/#tab1

3. http://wrd.mydigitalfc.com/news/dark-pool-trading-may-not-see-light-day-india-864

4.http://www.investopedia.com/terms/d/dark_pool_liquidity.asp#axzz23fHuEw00

5. http://modernir.com/what-are-dark-pools.aspx

6. http://www.pwc.com/us/en/alternative-investment/assets/NY-10-0105-PwC-alt-Caplan.pdf

7.http://www.economist.com/blogs/schumpeter/2011/08/exchange-share-trading

8.http://www.ft.com/intl/cms/s/0/f96b0022-c110-11e1-8179-00144feabdc0.html#axzz23fHwNvNE

9.http://www.huffingtonpost.com/2012/07/06/sec-trading-platform-dark-pools_n_1655265.html

The Marketplace

Displayed pools are public stock exchanges, which are regulated (e.g. Nasdaq) and anyone wanting to buy or sell shares has an equal view of the activities pertaining to the company, including the volume of shares being traded. In financial jargon, the opposite of displayed is "dark". Thus, “dark pool” refers to where trading liquidity exists, which is not available for everyone to witness. These may be thought of as members-only platforms for the trading participants who wish to execute larger trades, but without advertis-ing interest through a displayed position.

Private operators include Liquidnet and Pipeline, and also broker-run operations like Sigma X (Goldman Sachs) and Cross-Finder (Credit Suisse). According to Finan-cial Times, in the U.S., there are more than 50 dark pools operating and almost 40% of equity trading volume now occurs in these dark pools outside the traditional stock markets. By the end of 2010, a total of 52 dark pools accounted for 12.5% of all trading volume in America, and 36 dark pools accounted for 10% of all European share-trading (Figure 1).

Why Dark Pools?

An institutional investor trying to move a large chunk of a company's shares on a public exchange would likely discover that

the large volume altered the market, resulting in a price distortion. However, by trading in dark pools, that investor can trade at the huge volumes without auto-matically being at a disadvantage. The anonymity offered to investors and trades through dark pools not only protects the parties’ identities, but also decreases the sensitivity of share price movements when any significant demand surfaces.

They help large institutional participants to mobilize sizeable amounts of liquidity without encountering the trading interme-diation which distorts stock prices. For instance, if Life Insurance Corporation of India (LIC) wants to offload a huge chunk of shares (say, 20 million) in Reliance Industries Limited (RIL) through the stock exchange, it will witness a big variation in the share prices and the market since on bellwether indices RIL has the biggest weight. Also, the high frequency of trading in the open market pushes up the cost of buy orders, thus decreasing sale prices. A dark pool trade would have avoided such a situation.

Dark pools are thus a response to regula-tory efforts which are aimed at creating a single market for all participants. These are contrary to human nature and at odds with the time horizons and diverse purposes typifying the trading transac-tions. Figure 2 shows dark pool and broker crossing activity for all European Equities from July 2011 to July 2012.

DARK POOLSTHE YIN-YANG OF TRADING

After the ringing of the closing bell at the New York Stock Exchange (NYSE) or the Nasdaq, one may believe that trading activity is over for the day and shares of the companies are sitting quietly till the markets open again the next day. How-ever, behind the scenes, the same compa-nies may be indulging in trading in "dark pools" - secondary stock markets operat-ing beyond the reach of regulators and out of bounds for the average investor.

ABOUT THE AUTHORS

SRINJOY SAHA

MBAVGSOM, IIT Kharagpur


ARNAB MOITRA

MBAInternational Management

Institute


Figure 1: Plumbing the depths

3rd PRIZE


20

DID YOU KNOW

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 following the financial collapse of 2008 rewrote many of the rules governing investment firms, including hedge funds. It compelled many of anonymous firms which worked away from the bright lights of regulators in the past to register with the SEC and reveal the names of their managers and advisers.

DID YOU KNOW

Traders at the Chicago Mercantile Exchange staged a mini walk-out in April when they found themselves frozen out of trading by a similar program as Dark Pools at the CME.













Conclusion












The Marketplace



Why Dark Pools?




Dark pools are thus a response to regula-tory efforts which are aimed at creating a single market for all participants. These are contrary to human nature and at odds with the time horizons and diverse purposes typifying the trading transac-tions. Figure 2 shows dark pool and broker crossing activity for all European Equities from July 2011 to July 2012. Figure 2: Dark Pool & Broker Crossing Activity for All European Equities - July 2011 to July 2012


21













Conclusion












DID YOU KNOW

In the US, where high frequency trade accounted for up to 70 per cent of daily move-ment, with 'dark execu-tion' making up 25 per cent to 40 per cent of the market each day, flash crashes which wiped $400 million from Knight Capital remain problem-atic.

DID YOU KNOW

Liquidnet, the US dark pool trading systems operator, expanded its block trading system to its ninth market in Asia with the launch of trading in Philippines stocks on September 5th, 2012.

The Marketplace



Why Dark Pools?




Dark pools are thus a response to regula-tory efforts which are aimed at creating a single market for all participants. These are contrary to human nature and at odds with the time horizons and diverse purposes typifying the trading transac-tions. Figure 2 shows dark pool and broker crossing activity for all European Equities from July 2011 to July 2012.

Figure 3: Dark Pool & Broker Crossing Activity by Venue July 2012


22

Rostow's Stages of Growth model (1960) is one of the major historical models of economic growth. Though it would be difficult to apply this old model in current socio-economic scenario but we can roughly fit India as shown below (the circled region).

Finland is an example of a late but successful industrialization story led by the government through a judicious mix of heavy-handed governmental intervention and private incentives. The Government aimed at a fast build-up of industrial capital in order to ensure a solid manufacturing base and also respected the basic property rights of capitalism.

It is high time India lessened its focus on supplying the developed and other devel-oping countries with raw material and services and built a strong manufacturing base. Over the last few years the growth of manufacturing and its share of GDP has been declining in most of the western advanced economies (e.g. from 26% of US GDP in 1970 to 13% in 2005) and this is the time to grab the opportunity before India loses out to Brazil, Indonesia, Thailand, Taiwan or S. Korea. A few measures recommended are:

1. Investment as a share of GDP has to increase by more than 10 percentage points (India’s investment lies in the range

ABOUT THE AUTHOR

PRITOM GOGOI

MBA core

NMIMS, Mumnai


The biggest blunder any developing coun-try like India can commit is to bask in glory of a few numbers like GDP growth of 9%, $1.7 trillion economy, sensex crossing 20,000 mark, 69 billionaires and so on. Though these numbers may lighten up the eyes of an average person, India fails dismally when it comes to numbers like HDI (ranked 134), per capita nominal GDP (ranked 137 as per World bank, 2010), per capita GDP PPP (ranked 124 as per World Bank, 2010), corruption perception index (ranked 95), Gini coeffi-cient (0.368) and so on.

The Indian economy is the world's 10th largest by nominal GDP and 3rd largest by purchasing power parity (PPP). But this is no precursor to fast growth as we see in the case of Argentina. In the late 1920s, Argentina was among the top ten richest economies in the world; almost at par with the US. In the 1950s they were almost 3 times richer than the Japanese. But then, America decided to industrialize, skilled its people, adapted to changes and learnt from experience and today it is the richest country in the world. On the other hand, Argentina backed landlords and the self-centred elite, relied on small-scale handicraft workshops and unskilled workforce, spent lavishly and today it is still stuck as a developing economy (ranked 21st in GDP PPP). Let’s take the case of India and Japan. In the 1950s, both India and China had similar levels of economic growth and half the population were mired in poverty. In 1990, India and China had almost the same GDP per capita. But as of 2012 the difference of any economic

indicator between these countries is humungous. Though many argue that the 190 year long colonial rule in India had drained most of its resources and dragged it backward economically, but even the Japanese economy was ravaged by WWII and still it is the 3rd largest economy. The common trend of growth in almost all the developed economies is that it starts with the agriculture sector, which is slowly replaced by the manufacturing sector and then the service sector but the disturbing trend seen in India is that even in 2012 around 55% of the population are dependent on agriculture for their livelihood (67% in 1950, 69% in 1990 and 58% in 2010). Around 37% of the Indian population are living below the poverty line. Unlike China which grows by around 10% every year on the back of a booming manufacturing sector, India decided to leapfrog straight from a predominantly agricultural economy to a knowledge-based service economy.

No country has been able to reach the developed level without depending on manufacturing at one point or the other, whether it is the USA, UK, France, Germany, Belgium or Japan. India has never been able to increase the manufacturing sector’s share in total GDP more than 18% (growing at avg. 6-8% annually) while the service sector accounts for around 55% of GDP (37% in China, 3-4% in Germany, S. Korea and Japan). It’s no sin to depend on services (considering the huge manpower we have), but services don’t provide the other direct and indirect benefits than only

MANUFACTURING IN INDIATHE MISSING LINK

Late Russian economist Simon Kuznets once said, “There are four kinds of countries: developed, developing, Japan and Argentina.” Needless to say, India has been in the developing category for more than 2 decades now and many economists foresee India as a developed nation by 2020. But this is not something predestined and the choice is ours whether we want to remain a developing nation for a couple of decades more or we want to fast-track our growth to become an advanced economy, let alone a super-power. It will take more than just achieving an annual GDP growth of 7-9%.

manufacturing can give. Manufacturing brings economies of scale that is not so in the case of the service sector. Unlike the service sector, manufacturing provides employment for all (unskilled, semi-skilled and high-skilled). Though the IT/ITES sector boom in India has given a boost to its GDP growth, it has employed mostly the skilled and semi-skilled people, leaving a huge chunk of the Indian population untouched. Manufacturing promotes growth at the bottom of the pyramid and also in non-urban areas. Manufacturing has multiplier effect, creating 2-3 jobs in the service sector. When China moved from primary to manufacturing sector, it doubled its share of workforce and tripled its share of output.

The choice to promote the manufacturing sector which is well-established as the chief wealth creating sector in any economy has to be a strategic decision. India has currently many issues at hand like rural-urban divide, inequality, rising fiscal deficit, rampant corruption, poor education system, inflation, stashing of black money, complex tax policy and so on. Development of the manufacturing sector will indirectly address many of these issues

as shown in the diagram above. What India desperately needs is dynamic structural transformation. Instead of tackling issues like policy paralysis, age-old laws and rules, corruption, red tapism, high income inequality through various tools and means and in a piecemeal manner, India can do better by addressing something that can have a domino effect on most of these socio-economic issues. The answer lies in the manufacturing sector.

The disturbing trend, as seen in the figure above, is that, though both the service and industrial sector have grown hand in hand in all the economies, the growth of the industrial sector in India is hardly signifi-cant. Unlike in other three nations, the industrial sector in India has grown almost at par with GDP growth rate but lower than the services sector growth rate. Apart from these examples, there are many theories which emphasize the importance of the manufacturing sector for growth. As per Kaldor’s laws, the growth of the GDP is positively related to the growth of the manufacturing sector. Verdoorn’s law states that the productivity of the manufac-turing sector is positively related to the growth of the manufacturing sector. The

of 20-25% as compared to china’s invest-ment rate of around 40%).

2. Infrastructure is the foundation on which industries are built. So Infrastructure investment has to increase many-fold. (China spends around 11% of GDP on infrastructure while India spends just 4%).The rapid development of Chennai City over the last decade is an example of how good infrastructure can propel industrial, economic and social development. It has the highest level of urbanisation (47%) in the country today with companies like BMW, Dell, Ford, Hyundai, Nokia, Sam-sung etc. having set up their operations there. An example to follow.

3. The New Manufacturing Policy (NMP) announced in 2011 to increase share of manufacturing to 25% of GDP by 2025 and create 100mn jobs is a welcome move. India needs more such policies.

4. Education lays down the foundation for skill development, knowledge growth and productivity. India needs more schools, more vocational training institutes, more IIScs, more labs, more R&D centres etc. Land acquisitions need to be streamlined and made smoother. India should ensure the ‘license Raj’ is not replaced by “Inspec-tor Raj”.

5. India cannot just manufacture and be happy. Manufacturing has to be based on modern technology and innovation; the manufactured goods have to meet all stan-dards required for exporting. Just domestic consumption will not be able to sustain India’s growth for long.

6. India has to increase trade with its neigh-

bors like Pakistan, Bangladesh, China, Myanmar etc. This will give a thrust to Indian goods before they are sold in Germany and Japan.

7. Prudent and credible fiscal and mon-etary policies are the need of the hour to sustain the FDI/FII inflows and enjoy the trust of foreign investors/NRIs.

8. Electronic goods are on the rise and India has the opportunity to take lead in semiconductor and LED industries. Korean brands, Nokia etc. have already made India their regional manufacturing hub for exports to South Asia and the Middle East.

9. Lastly, India has to stop taxing the private industry with higher excise, service tax etc. to increase its revenue; as seen in the 2012 budget.

References:1. The Growth Record of the Indian Economy, 1950-2008: A Story of Sustained Savings and Investment. (by Rakesh Mohan2. India economic update: June 20103. Is manufacturing still an engine of growth in developing countries: St. Galle, Switzerland, 20104. www.cii.in5. India still laggard in per capita manufacturing: article in Economic Times6. India: Country growth analysis: Subir Gokarn & Gunjan Gulati7.http://www.eastasiaforum.org/india-s-economy-growing-rapidly-and-unequally

1st PRIZE


23

DID YOU KNOW

PPP states that exchange rates between currencies are in equillibrium when their purchasing power is the same in each of the two countries.Two versions of PPP are there---absolute & relative PPP.Relative PPP is for example -if India has an inflation rate of 5% and US has an inflation rate of say 3% ,then Indian ruppee will depreciate against the US dollar by 2% per year.

DID YOU KNOW

The Indian IT services industry which is only about two decades old has already notched up exports in excess of US $15 billion. This is in comparison to the age old industries of textile and auto components which are today at US $13.4 billion and US$ 1.4 respectively.

























24
























Source: Development path of China and India and the challenges for their sustainable growth (Li and Zang)


25

DID YOU KNOW

Pakistan’s decision to grant most favoured nation status to India, moving away from a highly restrictive positive list, containing items that could be imported from India, to a negative list. Out of 8,000 tradable items only 15 per cent are now on the negative list, and this will be phased out by December 2012.

DID YOU KNOW

The productivity of China's manufacturing industry was 35.30% of the gross domestic product and approxi-mately 78.68% pertaining to all other industries in the year 2003. Chinese manufacturing industry paid taxes accounting for 90% by industries and the contribution of employees accounted for 90.7%. exports regis-tered 91.2%. Trade value registered USD$1150 billion in the year 2004.
























Country

Great BritainRussiaUnited States

GermanyCanada

ChinaIndia 1952

1952

1896-19141850-1873

1843-1860

1890-19141783-1802Take-off Period Country

Great BritainRussiaUnited States

GermanyCanada 1950

1910

1900

19501850Maturity Year


26

DID YOU KNOW

As per 2009 data, Manufacturing together with the media and rating agencies had to settle for a mere 6 per cent of the future cream of Indian managerial talent.

DID YOU KNOW

Capgemini Consulting Services undertook a survey of 340 from among the Fortune 5000 global manufacturing companies and, in its report, observed that India could well overtake China as a global manufacturing hub. Most of the respondents stressed that India was large on their radar screen for outsourcing manufacturing over the next three to four years.

The Setting Sun

"On her dominions the sun never sets" -The famous phrase from “The British Empire”, by Caledonian Mercury expressed the robustness of the British Empire that spanned over the major part of the world for around a century before it finally collapsed. The World War II ended, the United Nations came into force, bring-ing an end to colonialism and giving rise to an era of,what came to be known as, “neo-colonialism”.In the world of globaliza-tion and consumerism, US Dollar became the chief monetary instrument used across the world to facilitate international trading of commodities such as petroleum, manu-factured products, and gold. This had tremendous benefits for the financial system and consumers of the United States, and it gave the U.S. government tremendous power and influence around the globe.Then onwards the introductory phrase could be easily attributed to the American sphere of influence.

Today, greater than three-fifth of all foreign currency reserves in the world are in U.S. dollars. However, with some of the biggest economies on earth making agreements with each other to move away from using the U.S. dollar in international trade, foremost international institutions such as the UN and the IMF issuing official reports

about the need to move away from the U.S. dollar and toward a new global reserve currency and many other events around the globe strongly indicates the huge changes in the horizon that is about to take place. Let us have a look at these major factors behind the current entropy in the “one-man show” of US-dollar that might eventually make the Sun of US dollar set.

The Fading Petrodollar System

Petrodollar or the “oil for dollars” system came into existence since 1975, when all OPEC nations agreed to trade exclusively in US dollars and to invest excess profits, if any, in US Treasury bonds, and bills, in exchange of military protection from the Soviet Union. This created “artificial demand” for US dollars across the globe. Since then, Iraq was the first nation to defy the system when Saddam Hussein decided to sell oil to France for food in Euros, in 2000. Renowned American economist Alan Greenspan says: “I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil.”

The growing popularity of China and other BRICS countries in trade with OPEC

NEARING THE END OF THE DOLLAR’S DOMINANCE

The history of the PetroDollar could be described as a syndicate contract between the United States and Saudi Arabia to subsi-dize the US Dollar, to prop up the Western banking system, to enable the Arab royals (sheiks & emirs) to continue to claim their national treasures as their private property.

system, and its inefficiency in dealing with its critical problems. All this has eroded the faith of people from the dollar system. The United Nations has stated that “the current system of currencies and capital rules which binds the world economy is not work-ing properly and was largely responsible for the financial and economic crises” and that “the dollar should be replaced with a global currency.”The International Mon-etary Fund issued a statement about replacing the dollar as the world’s reserve currency with a “basket of national curren-cies” backed by the recognition of the member countries’ governments.

The Final Demise Considering all the factors discussed above, it is quite conclusive that the value dollar is coming down, and is close to losing its status as the World’s reserve currency very soon. With the US running into a current federal deficit of almost 75% of its GDP, chances of its rebound, currently looks bleak. The effects of this disruption in the market will be dramatic as Michael Payne points out:

“When this economic tsunami hits America, it will make the 2008 recession and its aftermath look like no more than a slight bump in the road."

All I can say is, let’s prepare for the economic revolution of the century and the drastic changes it is about to bring.

References:1. www.bbc.co.uk2. www.economist.com3. The Beginning of the End for the U.S. Dollar as the World Reserve Currency- article by Max Payne published in www.OpEDNews.com4. Scrap dollar as sole reserve currency: U.N. report –By Louis Charbonneau published on www.reuters.com5. Preparing for the collapse of the petrodollar system – By Jerry Robinson

nations are threatening this system, which has been the lifeline of American economy for four decades. This would be further illustrated in instances stated in the follow-ing part of the article. Though petrodollar system still prevails, with some middle-east nations having started to sell oil in curren-cies other than the U.S. dollar, chances of other OPEC nations following suit and forsaking the system is very strong. Once the petrodollar system is crashed, the demise of the US dollar, according to most economists, would just be a matter of time.

Rise of the Eastern Dragon

China, widely acknowledged as the leading economic power of the future, is actively working to bring spectacular changes to the way international trade is conducted. Following are instances of the same that made headlines in the economic news reports worldwide:

1. Towards the end of the year 2011, China and Japan, the 2nd and the 5th largest economies of the world in terms of GDP, agreed upon direct exchange of the curren-cies, thus eliminating the role of USD in the large volume of trade conducted between the two.

2. Russia and China, in November 2010, decided to discard the dollar in their bilateral trade. 'So far we have been paying each other in foreign currencies, first of all in dollars. Now, and this is only the first step, trade in the Rouble has started in China. In December the Yuan will be traded in Moscow', said the prime-minister Vladi-mir Putin.

3. In 2009, China unseated US as Africa’s biggest trading partner and has maintained its position since then, seeking to expand the use of Yuan in the continent.

4. China and UAE has also agreed to abandon the US dollar in their bilateral trade. If more such oil-supplying nations follow the same route, the petrodollar system would soon fade into oblivion.

5. Saudi Arabia and China have teamed up to construct a massive new oil refinery in

Saudi Arabia, and leaders from both nations have been working to aggressively expand trade between the two nations. In fact, China has replaced US as the largest importer of oil from Saudi Arabia. Hence, will it be a surprise if Saudi Arabia follows the UAE, in forsaking the petrodollar system?

BRICS: The Rising Economic Powerhouse

The BRICS nations namely, Brazil, Russia, India, China and South Africa recently agreed at their summit meeting in Sanya, China, to trade in local currencies. This is of great significance since this group of nations represents a very powerful economic bloc in days to come. Besides, Russia, India and China, still continues to maintain healthy relationship with Iran and other Middle –East nations, once again posing a serious threat to the life-line of US currency, the petrodollar. Here again, China has been instrumental in trying to find new avenues for its currency in the BRICS states. Not to forget, as per reports, India will be using gold to buy oil from Iran.

The Eroding Faith in USA

While the petrodollar system gave an apparent boost to the American currency, the imported goods available at cheaper rates in the nation led to the downfall of America’s manufacturing industry. Despite repeated warnings by economists, US refuses to downscale its military empire that literally eats away major chunk of its budget every year, making the country run into fiscal deficit. The recession of 2008 exposed the flaws in American banking

ABOUT THE AUTHOR

SINJANA GHOSH

MBA Ist YEAR

VGSOMIit Kharagpur


DID YOU KNOW

Intra-BRICS trade is growing at an average of 28 percent annually and currently stands at about $230 billion


27

DID YOU KNOW

BRICS accounts for 26 per cent of the world's landmass and 42 per cent of the global population, including India and China, two of the world's most popu-lous countries.

DID YOU KNOW

Larger bills ($50, $100) can last in circulation up to 8 years.The average life of a dollar bill is just 18 months.97% of all paper money contains traces of cocaine.

The Setting Sun


























28

DID YOU KNOW

In 1989, the Renminbi (yuan) had an exchange rate of 13.5 RMB to 1 US dollar on the black market. The current rate as of October 2010, 6.69RMB to 1 US dollar.

DID YOU KNOW

Martha Washington is the only woman whose portrait has appeared on a U.S. currency note. It appeared on the face of the $1 Silver Certificate of 1886 and 1891, along with the back of the $1 Silver Certificate issued in 1896.

The Setting Sun


























29

RECENT FINANCE EVENTS AT VGSOM

FINCON’12

April 7th, 2012

FinCon’12 was an effort to bring together the industry stalwarts and management students on a common platform to under-stand the challenges and opportunities these turbulent times provide.

The event was a great success and acheived its objective, it also gave a platform to VGSoM students to showcase their ability and also understand industrial perspective towards real life challenges and roadblocks.

The efforts of Finterest coordinators and members to hold such a conference was highly appreciated by the guests and the faculty at VGSOM alike.

Guests at the conference:

Mr. Amit Khurana – Director (Research) at Dolat Capital Markets

Mr. Kaushik Saha – Associate Vice President at United Stock Exchange

Mr. Sanat Bharadwaj – Senior Manager at HDFC AMC

NSE SEBI Seminar

March 30th, 2012

In March 2012, Vinod Gupta School of Management, IIT kharagpur became one of the few B-schools in the country to host stalwarts from SEBI, NSE and HDFC AMC as a part of the SEBI-NSE regional Investor Seminar.

The NSE-SEBI regional seminar received amazing response not only from manage-ment students but also from the students at IIT Kharagpur where more than 200 students participated in the seminar. The seminar enlighted the students about the need and feasibility of investing in the capital markets and discussed its advan-tages over more traditional methods of savings in our country. VGSoM students received accolades for organizing the event with professional efficiency.

Guests at the conference:

Mr. Amar Navlani - Deputy General Manager at SEBI

Mr. Anirban Kundu - Manager at NSE

Mr. Sanat Bharadwaj – Senior Manager at HDFC AMC

FINCON’12, SEBI-NSE REGIONAL SEMINAR, BROWN BAG SESSIONS and GURUKOOL SERIES OF LECTURES

The Finance Club of VGSOM, IIT Kharagpur has been involved heavily in knowledge sharing among the finance enthusiasts at IIT Kharagpur. Through initiatives like “FINCON’12”, “SEBI Regional Conference”, “Brown Bag Sessions” and “Gurukool Series of Lectures” it is encouraging the finance fraternity at VGSOM and in the industry to learn and share simulta-neously.


30

DID YOU KNOW

As per budget estimate, Gross Tax Receipts is estimated at 10,77,612 crore

DID YOU KNOW

In Union budget 2012-13, Government under National Manufacturing Policy announced the objective of raising, within a decade, the share of manufacturing in GDP to 25 per cent and creating of 10 crore jobs.

In conituation with the trend of brown bag sessions, Finterest organised three more sessions.The first one on “Rating Agencies Demystified”. This session was held in the wake of downgrading of sovereign debts of multiple countries by the biggest credit rating agencies of the world. The students discussed about the various parameteres rating any agency uses to rate an individual or a country as a whole. Also, the discussion panned out towards the revenue stream of these rating agen-cies which pointed out a contentitious issue in the system of getting rated by an agency.

Another session on the “Union budget 2012-13” catered to the most significant announcements made in the budget and their potential implications on the nation and the industry as whole. The students discussed in detail the taxation policy changes with respect to certain industries and the intention of the govenment to ramp up the manufacturing sector through a multitude of appropriate announcements.

"On Monday, 13th Aug, 2012, Finterest hosted its first Brown Bag session for the academic year 2012-13. The enthusiasm to become a part of the knowledge sharing finance community at VGSOM was evident as students from both the batches turned up in big numbers even at 9:30 pm after a day full of classes.

The session was the first one in a series of

sessions on summer intern-ship experience in the field of finance of second year students. For this session, Sumit Pal Singh shared his experience at the Competi-tion Commission of India, where he worked on assess-ing the state of competition in the cement industry in India. The topic was especially lucra-tive given the orders (in June and July) of the Competition Commission against 12

cement manufacturers in India in the case of cartelization.

The session embarked with discussion with the audience about the Competition Law and a couple of its intricacies. Then a video explaining the formation of cartels enriched the audience and the discussion embarked in the form of questions and conditions relevant for cartel formation.

Sumit presented his economic analysis of the industry with the key indicators of cartel formation in cement industry and related his work to the simple example given in the initial video shown. The session continued for 45 minutes or so, with the discussion being majorly driven by the inquisitive minds of the first year students.

Finterest is extremely pleased at the response and will surely continue to provide a platform for such healthy knowl-edge sharing.

Brown Bag Sessions


31

DID YOU KNOW

There are a range of different styles of fund management that the institution can implement. For example, growth, value, growth at a reasonable price (GARP), market neutral, small capitalisation, and indexed.

DID YOU KNOW

Baillie Gifford’s structure – it is owned and operated by 36 partners– allows it to be progres-sive, and encourages genuine long-term strategic thinking. In 2012, assets under management passed the £75 billion level and staff numbers exceeded 700.

Third in the series of Gurukool sessions was:

"A Day in the life of an Invest-ment Manager" By Praveen Kumar, Investment Manager - Baillie Gifford

Baillie Gifford is a leading investment man-agement firm in UK and as of 31st March 2012 it had over 78 billion pounds of fund under management.It invests in multiple regions like Australia, Japan, UK, USA etc. Each region is managed by an investment manager, the current speaker Mr Praveen Kumar is an investment manager for Japa-nese equities.

Mr Kumar gave a brief introduction about Baillie Gifford and he continued and explained that Baillie Gifford follows bottom-upapproach to invest in a stock. This approach focuses on individual attributes of a company (financial stability, P/E ratios, peer competitors, management policiesetc.) unlike Top-down approach which focuses on an industry and then selecting a company from the chosen industry.It helps in deciding Investment and Exit Strategy.

According to Praveen lot of research has to be done by the investment manager. To

determine the value of an asset he can either use DCF(Discounted cash flow) or FCF(Free cash flow). In DCF assumptions are extremely important.After this insight-ful and knowledgeable session we had Q&A session with him. Some of the points discussed are as below.

When asked about impact of currency in investments in different countries, his response was “There will not be a major effect in the mar-gins of the investments”.

Another interesting discussion was about the Indian market for which his response was a mixture of both hope and despair as the majority of the market is handled by the household names like Tata’s, Birla’s and Ambani’s. As India is still an emerging economy there is still a lot of room for improvement, Baillie Gifford itself has a prominent share in HDFC.

A few questions asked by Praveen as food for our thought like “Why India isn’t coming up with a centralized Oil company?” and a book advised by him to study is “Checklist by Atul Gawande”.

Gurukool Series Of LecturesFinterest conducts online Knowledge Sharing Sessions with the stalwarts of the Finance Industry and special sessions by the faculty on wide range of topics like "Electricity Derivatives" along with talks pertaining to real life situations such as "Building careers in Private Equity" "Life of an Investment Manager", it provided good exposure and opportunity to explore trending and niche areas in finance industry.


32

FINANCE INTERNSHIPS AT VGSOM: EXPERIENCES

Abhijith Vangipuram, ING Vysya

The treasury department of ING Vysya bank houses many key functions of their wholesale banking segment namely, the interest rate products’ trading desk, the Forex products’ trading desk, the asset liability management desk (ALM Desk) and the economist’s desk. As a part of my internship I had the privilege to work on different projects with all these desks.

During the first two weeks of my internship I was asked to work on the “Determinants of Forward rates in the Indian Forex Market”. I had to explore the multiple factors that distort the covered interest rate parity and come up with regression analysis to prove my assumptions.

Consequent to that, I was asked by the economist to work on a preparing a model to “Quantify the opening trend of NIFTY & USDINR based on the global cues”. This model has tremendous application potential as it gives valuable cues to the traders in assuming positions for the day. This model downloads data from Bloomberg© and automatically computes the predictions for NIFTY & USDINR before the markets open.

Later I have worked on identifying and documenting the processes involved in the maintenance of CRR & SLR regulations. The CRR & SLR balances are required to

be monitored daily as any discrepancies could cost the bank its commercial license. The process flow document identifies the roles of all the involved parties comprehen-sively and can be used as a reference or a learning tool for the employees in the future.

I have also worked on modeling a few arbitrage trading strategies in both the fixed income and equity investment segments.

Dinesh Kumar , TVS Capital

I started my internship with top down approach. I first did sector analysis, followed by the analysis of few major players in that sector. This activity helped me understand their business/revenue model and how does a firm sustain itself as a major player in a given group of compa-nies.

Subsequently, I did financial valuations of the listed firmsand deduced inferences based on the financial statements, reports and valuation multiples from databases like Bloomberg , capitaline. After four weeks of my secondary research, I started with my primary analysis. I did make some telephone calls for the firms that are not listed and captured substantial information to understand their model. I did zero-in an emerging firm with outstanding business model in my sector for investment purpose.

This section throws light on some of the internship experiences of the many students who did their internships in the field of finance. These students have worked in diversified roles focussing on various verticals in the field of finance and economics. Mark2Market has included a section exclusive for sharing these experiences to promote peer learning and better understanding of the plethora of roles students are offered to work in.

CFA LEVEL I

The following six students from the batch of 2011-13 in VGSOM cleared the CFA Level 1 exam:

Abhinav MinnalaAnkur BangaAshaf Faraz KhanDinesh KumarSohini BannerjeeSumit Pal Singh

Mark2Market congratu-lates them and wishes them all the very best for their future endeavors.

Finally, after understanding the nitty-gritty of the entire process and sector, I gave my opinion for the investment activities in that sector.

Sohini Banerjee, RBI

During the 2 month long summer internship project at Reserve Bank of India (RBI), I was assigned to the Department of Bank-ing Supervision (DBS) in RBI and had worked under the guidance of Mr. Arnab Kumar Chowdhury, GM, DBS. My entire project was divided into four different parts and a brief description about each of these is provided below:

Understanding the key concepts and meth-odologies associated with Interest Rate Risk (IRR). This includes the primary forms of interest rate risk experienced by banks, the effects of IRR in terms of earnings and economic perspectives and the various measurement techniques associated with IRR.

Measurement of IRR in the trading portfolio using the Standardized Duration Method as per Basel II Norms: This activity was carried out for a Kolkata based bank and the interest rate risk assessment was done as of 31st March, 2011. As an integral part of the Standardized Duration Method, emphasis was laid on understanding the requirement for disallowances and the process of calculation of both vertical and horizontal disallowances. This part concluded with the computation of the total value of risk-weighted assets under inter-est rate risk faced by the bank.

Measurement of IRR in the Banking Book: In this part, the 1-Day potential loss or reduction in equity value in the banking book was calculated using the Value-at-Risk (VaR) approach. This section also provides a thorough description of Principal Component Analysis (PCA), which has been used at an intermediate stage in the VaR approach in order to model the term structure of interest rates

Comparison between the VaR measure and the traditional IRR measurement

approach:The project concluded with the calculation of the 1-Day potential loss using the Dura-tion Gap Analysis(DGA), that is, the tradi-tional approach used by the banks and a comparison between the estimated VaR measure and the DGA measure.

Manish Gupta, Punjab National Bank

I worked on ‘Credit Analysis of Small and Medium Enterprises’ during my internship. The aim of credit risk management is to establish a framework that defines corpo-rate priorities, loan approval process, credit risk rating system, loan-review mechanism and comprehensive reporting system. Objectives of my project were to study the existing credit appraisal process of Small and Medium Enterprises (SME), to under-stand the methods used to assess the credit risk of SMEs for various types of loans and to develop a model to assess the credit risk of SMEs.

I studied the prevalent methods used for assessing the risks pertaining to the credits extended to SMEs. Credit risk is assessed through different parameters including Financial Parameters, Business and Indus-try Parameters and Effectiveness of Man-agement. I had gone through various stan-dardized risk assessing methods/ models as well as the models used by PNB for credit risk assessment. Later, on the basis of the outcomes of the studies, I had devel-oped an MS Excel based credit risk analy-sis model for SMEs.

Ashaf Faraz Khan, Indian Angel Network

Indian Angel Network (IAN) is the largest network of angels in Asia. My Internship was to understand the process of deal sourcing, business plans analysis, valua-tion of startups and exit strategy of angels at IAN. Deal sourcing is the process by which the network identifies potential deals. As part of my internship I was fortu-nate to assist and close a deal in integrated cloud-based platform space.


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Abhijith Vangipuram, ING Vysya

The treasury department of ING Vysya bank houses many key functions of their wholesale banking segment namely, the interest rate products’ trading desk, the Forex products’ trading desk, the asset liability management desk (ALM Desk) and the economist’s desk. As a part of my internship I had the privilege to work on different projects with all these desks.

During the first two weeks of my internship I was asked to work on the “Determinants of Forward rates in the Indian Forex Market”. I had to explore the multiple factors that distort the covered interest rate parity and come up with regression analysis to prove my assumptions.

Consequent to that, I was asked by the economist to work on a preparing a model to “Quantify the opening trend of NIFTY & USDINR based on the global cues”. This model has tremendous application potential as it gives valuable cues to the traders in assuming positions for the day. This model downloads data from Bloomberg© and automatically computes the predictions for NIFTY & USDINR before the markets open.

Later I have worked on identifying and documenting the processes involved in the maintenance of CRR & SLR regulations. The CRR & SLR balances are required to

be monitored daily as any discrepancies could cost the bank its commercial license. The process flow document identifies the roles of all the involved parties comprehen-sively and can be used as a reference or a learning tool for the employees in the future.

I have also worked on modeling a few arbitrage trading strategies in both the fixed income and equity investment segments.

Dinesh Kumar , TVS Capital

I started my internship with top down approach. I first did sector analysis, followed by the analysis of few major players in that sector. This activity helped me understand their business/revenue model and how does a firm sustain itself as a major player in a given group of compa-nies.

Subsequently, I did financial valuations of the listed firmsand deduced inferences based on the financial statements, reports and valuation multiples from databases like Bloomberg , capitaline. After four weeks of my secondary research, I started with my primary analysis. I did make some telephone calls for the firms that are not listed and captured substantial information to understand their model. I did zero-in an emerging firm with outstanding business model in my sector for investment purpose.

Finally, after understanding the nitty-gritty of the entire process and sector, I gave my opinion for the investment activities in that sector.

Sohini Banerjee, RBI

During the 2 month long summer internship project at Reserve Bank of India (RBI), I was assigned to the Department of Bank-ing Supervision (DBS) in RBI and had worked under the guidance of Mr. Arnab Kumar Chowdhury, GM, DBS. My entire project was divided into four different parts and a brief description about each of these is provided below:

Understanding the key concepts and meth-odologies associated with Interest Rate Risk (IRR). This includes the primary forms of interest rate risk experienced by banks, the effects of IRR in terms of earnings and economic perspectives and the various measurement techniques associated with IRR.

Measurement of IRR in the trading portfolio using the Standardized Duration Method as per Basel II Norms: This activity was carried out for a Kolkata based bank and the interest rate risk assessment was done as of 31st March, 2011. As an integral part of the Standardized Duration Method, emphasis was laid on understanding the requirement for disallowances and the process of calculation of both vertical and horizontal disallowances. This part concluded with the computation of the total value of risk-weighted assets under inter-est rate risk faced by the bank.

Measurement of IRR in the Banking Book: In this part, the 1-Day potential loss or reduction in equity value in the banking book was calculated using the Value-at-Risk (VaR) approach. This section also provides a thorough description of Principal Component Analysis (PCA), which has been used at an intermediate stage in the VaR approach in order to model the term structure of interest rates

Comparison between the VaR measure and the traditional IRR measurement

approach:The project concluded with the calculation of the 1-Day potential loss using the Dura-tion Gap Analysis(DGA), that is, the tradi-tional approach used by the banks and a comparison between the estimated VaR measure and the DGA measure.

Manish Gupta, Punjab National Bank

I worked on ‘Credit Analysis of Small and Medium Enterprises’ during my internship. The aim of credit risk management is to establish a framework that defines corpo-rate priorities, loan approval process, credit risk rating system, loan-review mechanism and comprehensive reporting system. Objectives of my project were to study the existing credit appraisal process of Small and Medium Enterprises (SME), to under-stand the methods used to assess the credit risk of SMEs for various types of loans and to develop a model to assess the credit risk of SMEs.

I studied the prevalent methods used for assessing the risks pertaining to the credits extended to SMEs. Credit risk is assessed through different parameters including Financial Parameters, Business and Indus-try Parameters and Effectiveness of Man-agement. I had gone through various stan-dardized risk assessing methods/ models as well as the models used by PNB for credit risk assessment. Later, on the basis of the outcomes of the studies, I had devel-oped an MS Excel based credit risk analy-sis model for SMEs.

Ashaf Faraz Khan, Indian Angel Network

Indian Angel Network (IAN) is the largest network of angels in Asia. My Internship was to understand the process of deal sourcing, business plans analysis, valua-tion of startups and exit strategy of angels at IAN. Deal sourcing is the process by which the network identifies potential deals. As part of my internship I was fortu-nate to assist and close a deal in integrated cloud-based platform space.

Other roles offered for internships

Anaswara at Bank of Baroda, worked on comparative analysis of investments in mutual funds and life insurance products.

Harpeet Kaur and Eshita Jha at CitiBank.

Neelesh Khattar at Fidelity, worked on financial management information

Priyanka at Axis Bank, worked on analysis of SME products.

Sumit Pal Singh at Competition Commis-sion of India, working on the Indian Cement Industry by competi-tively analysing the industry.


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FIN-CROSS

5

6 7

8 9

2 3

4

1

13

17

1918

14

16

15

10

11

12

Across

2. Below the best4. NASDAQ: MSFT6. Legal instru-ments to transfer property8. Authentic11. The bank insur-ance model12. Home of NYSE15. Provisions16. Permyriad symbol is the clue 18. Monetary valua-tion19. Right to redeem

Down

1. Accumulating3. Dalal bull - made of?5. Firm in the middle7. Period toss (anag)8. Dusk in tale of two cities9. Non-payment10. Equalize13. To provide a report14. Principles of accounting17. Forming a new corporation


35

Check out the answers in the next issue.

FIN-CROSSSolution, Vol II

Across

1. Burden2. A transportation medium5. Kind of cow6. Secure8. Get on9. Free trading11. Business maga-zine 12. 24-karat15. Obligation16. Euro forerunner17. Redemption (10 letters comprising of 2 words attached)

Down

1. Hint2. Bargain-basement 3. Declared but not paid4. In Jeopardy7. Injured10. Reply to acaptain 12. A thump13. Deposits14. Component of an asset


36

T A X C Y C L E

I C A S H U U

P L C E M

U B O A R D

E F T A P I N C Y V

P U R E P R O F I T

O A W D

U S U R Y E E C U

N I N

D R A W N B O N D S

FI

NTE EST

VG

SO

M

I I T K H A R AG

PU

RVINOD GUPTA SCHOOL OF MANAGEMENT established in 1993, was the first school of management to be setup within the IIT system. It was initiated by a distinguished alumnus & a Life Time Fellow of the Institute, Mr. Vinod Gupta, whose generous endowment was matched by liberal support from the Government of India.Today, VGSOM is one of the best and leading B-Schools in India.

FINTEREST, the Finance club of VGSoM, is dedicated to nurturing and enhancing the fin-quotient of students and also to increase industry interaction with our college. The club keeps its members updated on the latest trends and developments in corporate finance, capital mar-kets, investment banking and other related areas.

Contact InformationVinod Gupta School Of Management

IIT Kharagpur, KharagpurWest Bengal - 721302

Mark2Market: [email protected]: [email protected]

Mark2Market_Volume_III

Documents

industry section

vgsom section

tax avoidance

maligned issue of corruption

finventory section

students article

section finance internships

dynamics of mutual funds