Saturday, 19 November, 2011

Rule of law & Dangers of changing laws with retrospective effect

Rule of law & Dangers of changing laws with retrospective effect

Hi folks! This particular post of mine may be of interest only to those who are actually dealing directly with share brokers, and are either actually involved in or contemplating an active involvement in the derivatives market - whether shares, commodities or foreign exchange.

Take a look at this letter written by a futures & options broker to her clients, announcing the closure of her business:

When a broking house goes bust, as MF Global did, the rule of law as we understand things involve a clear and categorical separation of the client accounts and client money from the proprietary account of the broker and his / her funds. Bankruptcy of the broker ought to involve freezing the proprietary account, but certainly the clients ought to be allowed to withdraw their funds.

Apparently, subsequent to the closure of MF Global in US, the clients are stuck in a situation where they can't

  • Withdraw any money owed to them
  • Close any open futures & options contracts

Even worse, there is apparently some talk of "clawback" rules being enforced. This implies that any withdrawal by clients that took place within a certain days before the demise of MF global may in fact be reversed. This is nothing short of crazy and a nightmarish situation.

The relevance to you and me in the Indian context:

  • The respect for the rule of law and ease of enforcement of contracts is even less in India than in US. You just need to ask your friends in legal circles specialising in taxation related matters. They would enlighten you about the number of occasions when the Indian Parliament has actually changed the laws with retrospective effect, so as to enforce their point of view after the courts of the land have passed judgements against the government. In many instances, due to such retrospective change in laws, corporate entities are known to have lost several crores of rupees.
  • Hence, if any of the powerful brokerage houses go bust, you can be rest assured that their promoters would be able to "convince" the powers-that-be to cancel out any number of inconvenient contracts pertaining to their clients. I would not be unduly surprised.
  • In fact, I vaguely recall a few instances (including during the recent Muhurat trading on Diwali 2011 in the BSE) where contracts were reversed because of reasons ranging from "technical reasons" to "wild swings in prices" to "suspicious nature of transactions"

I'm not for a moment suggesting that there should be a free-for-all in the markets. There ought to be rules. But those rules must be framed in advance, and enforced uniformly at all points of time.

As a small investor, you may have, for instance, watch the news item a couple of years back about the Satyam mess and seen the share price coming down crashing from around Rs. 200/= to sub-Rs. 20/= levels.

You might have chosen to take a calculated risk and done the following series of transactions:

  • Sold a couple of lakhs worth of blue chips from your portfolio to generate adequate margins to go short on Satyam in the futures market
  • Gone short on Satyam at Rs. 150/=
  • Covered your shorts at Rs. 30/=
  • Gone long again on Satyam at Rs. 8/= in the cash markets with just your profits as a long-term investment.
  • Used your initial capital to buy back your original blue chip stocks at slightly higher prices than the original price at which you had sold in the morning panic.

You would have been thrilled that you had the presence of mind to react to the situation and be happy about the several thousands gained during the course of a few hours.

  • If SEBI suddenly wakes up and decides that the price movement in Satyam was "abnormal" and all transactions pertaining to Satyam or
  • If your broker had gone bankrupt as it had a huge "long position" on Satyam on the day before, due to which all transactions through that broker during the preceding 24 hours were to be treated as "null and void" and you are not even allowed to withdraw the funds from your broker

Imagine your plight??? Who will compensate for your losses? This is precisely what has happened in the case of MF Global in US. I will not be too surprised if similar reactions are there in Indian markets under similar circumstances.

Some suggested precautions for you to take:

  • Choose your brokers very carefully. Don't go exclusively by "lower brokerage" promises. Ensure that you have a reliable and trustworthy broker, preferably backed by a huge financial institution (like HDFC Securities or ICICI Direct, for instance)
  • Unless your portfolio size is too small, split your business over at least two different brokers. In case of need, you'll be able to shift to your second broker at very short notice.
  • If you must deal in futures and options, ensure that your risk is "manageable". Obviously, your F & O exposure must not be more than the amount that you can financially and psychologically afford to lose.
  • With all the online facilities available, make sure that you don't leave too much of "liquid cash" with your broker. After all, whenever you do need to transact, nothing prevents you from transferring funds online to the broker as and when it is actually needed.

More than anything else, remember: It is your money. If you don't care for it, who will?



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Sunday, 13 November, 2011

Mistake or "Kite-flying"???

Mistake or "Kite-flying"???

I happened to read with keen interest the article about "Downgrading France's credit rating by mistake":

In these tough financial times, a simple typo in an ordinary letter would get a clerk sacked from his organisation. I certainly don't believe for a moment that an organisation supposedly in the business of credit rating can actually reduce the credit rating of an entire nation "by mistake".

So, what gives?

My guess: Certainly, there's more to it than meets the eye. The whole issue looks suspiciously like a case of "Kite flying". Some folks out there must have wanted to evaluate the potential reactions to a change in credit rating from the powers-that-be and the likely impact on the European mess before actually going ahead with an actual downgrade.

But then, ... ... ... ... ... isn't it rather silly?

Forget the ratings for a nation. If an organisation like CIBIL downgrades the credit rating of an indivividual "by mistake", I'm sure that they'll end up facing a demand for compensation in an appropriate consumer court.




Mistake or "Kite-flying"???SocialTwist Tell-a-Friend

Friday, 4 November, 2011

Petrol Price Hike - The Macro Picture

Petrol Price Hike - The Macro Picture

The price petrol of petrol has gone up by a couple of rupees per litre. And as usual, the Tamasha has started.

  • All political parties, including the Congress, are criticising the decision and want a "roll-back".
  • The Finance Minister claims (and so do the the Oil Marketing Companies) that petrol prices have been deregulated and hence the Government can do nothing about it.
  • Will someone care to explain the reasons as to why the price per litre of petrol is virtually identical in all petrol bunks, irrespective of whether you buy from Indian Oil or Bharat Petroleum or Hindustan Petroleum? The same person can also explain the rationale behind the petrol prices changing on precisely the same day, to the same extent.
  • If prices are truly deregulated, will not the consumers complain against cartelisation and won't the Competition Commission take appropriate action?
  • Virtually all the politicians, all newspapers and all TV Channels, "sympathise" with the "Aam Aadmi". According to publicly available statistics, India is a country where 35-40% of the population survive at less than a dollar per person per day (Rs. 50/= per day), with a further 40% (totalling virtually 80% of the overall population) survive at less than two dollars per person per day (Rs. 100/= per day). To the best of my limited knowledge, these people can't possibly be zipping by on a two-wheeler. They're more likely to be depending on public transport like buses and trains, which run don't run on petrol, and are subsidised in any case. My own guess is that these 80% of the Indian population can lay claim to membership of the Aam Aadmi club of India.
  • As per my comprehension of Economics and my knowledge of Pareto Principle, the balance 20% are pretty much likely to enjoy nothing less than 80% of the National Income. My school teacher who taught me Economics had told me that in any group of people those belonging to the top 20% in terms of income and wealth ought to be considered rich in that society. Unless they've changed the basic principles of Economics since my school days, the increase in petrol prices in India impacts the rich people and only the rich people. Certainly, it does not impact the proverbial "Aam Aadmi".
  • If anything, those riding two-wheelers can complain against the richest class belonging to the top 1-2% of the Indian Population - After all, the richest group of people drive around in fancy cars which are powered by diesel, which continues to enjoy a huge subsidy.

Hence, folks, don't be perturbed by all the hullabaloo over the hike in petrol prices. We need to wake up and behave like responsible citizens, and should not eat away the scarce resources which can very well go to give a slightly higher subsidy to people like poor farmers living below the poverty line, who are committing suicides at the rate of around 15000 persons per annum. Think about it!



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Interconnected Nature of the Euro Debt Crisis

Interconnected Nature of the Euro Debt Crisis

Take a look at this pictorial representation:

I'm more concerned about the implications for India.

People, especially politicians, tend to claim that the crisis will be resolved "somehow". I certainly don't believe that's likely.

Let me explain with a simple hypothetical micro example of an indebted individual software engineer from Bangalore with 2-3 credit cards which have maxed out, with "a few months salary" worth of costly personal loans, EMIs due for his home loan and car loan, a home-maker wife and a 12-year old kid. The scenario, while undesirable, is not too uncommon.

Typically, his reactions would be along the following lines:

  • Seek further debt from friends and banks to overcome his financial mess
    • Implies greater debt
    • At a higher cost
    • Getting deeper into the financial trouble that he's created for himself
  • Put on a show of being problem-free or underplay the problem with his immediate family, close relatives and employer till the problem balloons to a size that he considers to be unmanageable.
    • Implies maintaining the same life-style, with the usual round of dining out, weekend movies, occasional parties, etc.
    • Will again result in greater debt and the other consequences mentioned above
  • Hide the problem temporarily from his immediate family & employer, who are perhaps most likely to come up with any meaningful suggestions to come out of the problem
  • Pay up the guys who create the maximum trouble and delay, default and run away from the rest
  • Try to restructure his debts with various organisations

All the above steps will ensure that

  • His performance at his workplace will suffer
  • He will be irritable at home.
  • This will create a situation where the probability of any increments, promotions etc. will reduce and the probability of being "eased out" in case of a recession will increase.
  • Different lenders will talk in different voices and come up with different suggestions, depending on their own self-interest.
  • While he keeps trying to come out of his troubles, the Debt Meter will keep ticking, and the magnitude of the problem will keep multiplying exponentially.

In a nutshell, his financial problems will NOT disappear easily.

Now take a look at the New York Times picture again:

You can guess the magnitude of the European mess by multiplying our typical indebted software engineer's problem by a factor of a few million ordinary individuals in different European countries.

Coming back to the Euro Mess, here is my own basket of predictions:

When the shit hits the roof, as it inevitably must, all hell will break loose. I'm not sure about the timing, but the default of a few European nations and possibly several large banks on both sides of the Atlantic looks increasingly certain.

Some likely consequences would include:

  • Countries and Banks across the world will become very wary about lending to anyone else.
  • Cost of credit FOR ALL will shoot up
  • Global growth rates will tumble, perhaps resulting in a global recession
  • NPAs (Non-performing assets) for banks will increase rapidly
  • Individual consumer confidence will take a mighty beating
  • All individuals across the globe will try to "save more, spend less", resulting in even greater reduction in GDP growth rates, possibly hastening the recession.
  • Many businesses will go bankrupt
  • All business will suffer a reduction in profits
  • Many jobs will be lost across the world, including in India. (However, the impact on India would be less due to the fact that we are far more dependent on the domestic market vis-a-vis many other nations like China, Russia, etc.)
  • There will be utter chaos in the commodity markets, with very wild fluctuations in the prices of key commodities ranging from Crude Oil to Metals to Agri-commodities.
  • The inflation problem will continue to remain a major head-ache.
  • Fund flows will shift away from risky assets towards havens of perceived safety like US treasuries, Gold, Silver, Government Bonds of countries thought to be safe, etc.
  • Share markets will show huge volatility, with a strong and definite downward bias. We'll see very sharp earning downgrades globally, resulting in a significant bear market. However, every promise of any meaningful end to the mess coming from the Political Class will result in sharp intermediate rallies.

Suggestions for Indian Investors:

  • Increase the frequency of reviewing your asset allocation
  • Explore the possibility of increasing your contribution to relatively safe asset classes such as Cash & cash equivalents, Gold, Indian real estate in locations where the prices have not shot up to crazy levels, Public Sector Bank deposits, etc.
  • Review your equity portfolio more frequently. Keep sharper stop loss levels and lower profit targets for the trading portion of your portfolio
  • Use your cash judiciously to accumulate high quality blue chips for your long-term investment portfolio whenever their share prices come down to panic bottom levels due to the violent swings in the market

Most important, be alert, be awake.



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