Monday, December 7, 2015



Know your customer

The faster prices fall, the higher the likelihood of their rising again; the faster they rise, the greater the probability of their falling. As the spectre of the Congress returning to power on leftists’ shoulders reared its head on 17 May 2004 (which we shall, in the spirit of the dear departed Hindu nationalists, call Congress Punaraagaman Divas or CPD), the stock market collapsed. It was a golden opportunity. I bought forward contracts on the index, and made a cool 20 per cent in a week.
It was a risk. For no less than the new Prime Minister had threatened speculators with dire consequences. There could be a repeat of the witch-hunt SEBI launched after the market meltdown triggered by Yashwant Sinha’s budget of 2001.
I was not caught; I was too small a fry. But SEBI did hold an enquiry, in course of which it asked brokers on whose behalf they had sold on CPD. Indian brokers know better than to fight SEBI, they know the bloodhounds in the government’s kennels. Just recall how it closed down Shankar Sharma’s businesses and imprisoned him for having financed Tehelka, which filmed UPA leaders of both genders taking bribes.
But foreign brokers are not always so wise. UBS actually lost Rs 170 million on spot sales on CPD. But it had substantial uncovered short forward sales. When prices fell, UBS could square them off. It made a profit of Rs 590 million on covering. This was a sin according to SEBI. It asked on whose behalf UBS sinned.
UBS told SEBI who its clients were. But then SEBI asked who the clients’ clients were. Twelve clients told SEBI to go and jump in the lake. SEBI was offended, so on 17 May 2005 – precisely a year after the market was rude to the new rulers – it banned UBS from issuing or rolling over Offshore Derivative Instruments – that is, certificates to foreign investors that it held securities on their account – for a year. In other words, it ordered UBS to close down for a year.
On 9 September, the Securities Appellate Tribunal (SAT) overturned SEBI’s punishment of UBS. That has incensed SEBI, which is preparing to appeal to the Supreme Court. SEBI should think seriously before it does so. For the Supreme Court is bound to place restrictions based on its view of equity on the sweeping powers that SEBI claims. SEBI cannot afford to take the risk of an end to its arbitrariness.
But more than SEBI, it is its masters in Delhi, especially those in the finance ministry, who should reflect. There are three basic issues in this contretemps. First, the reason for seeking the ultimate client. Second, the reason for seeking Indians, NRIs, PIOs and OCBs amongst those clients. And finally, the reason for launching these enquiries only when the political masters are embarrassed.
When the capital market was opened to portfolio investment in 1992, the entry was restricted to FIIs because it was expected that they would be regulated in their home countries, and because they would be more “responsible” than individual investors. Both reasons are invalid. By the standards of our interventionist country, regulation is pretty lax in countries with fully convertible currencies. And CPD is convincing evidence against the supposed “responsibility” of FIIs as against individuals. Hence in my view, the concept of an FII has outlived its utility. Portfolio investment should be opened up to everybody abroad.
The second reason relates to suspected round-tripping by Indians. Rather than look for Indian needles in the foreign investors’ haystack, the government should seek and address the reasons for round-tripping. If it is that profits on foreign portfolio investment are tax-free, the solution lies in either abolishing what remains of capital gains tax, or in taxing foreigners’ profits made in Indian markets. If it is that promoters are making benami investments in their companies’ shares, SEBI should rethink its ownership restrictions. It should look for market makers to ensure market liquidity instead of restricting promoters’ stake.

Finally, these witch-hunts when the market panics at the sight of the goings-on in Delhi. Every panic creates an opportunity to make a killing for anyone with moderately strong nerves. Anyone could profit from it – even politicians. The reason they disapprove of short panics is that they do not invest in shares; they prefer to invest in land and real estate which give more scope for concealment of wealth and tax evasion. If they paid taxes like the rest of us, they would not take umbrage at a market collapse; they would look forward to one.