A defining phase

We are at the crossroads of either a move towards ‘normalisation’ or towards a super-bubble

The market started the week shedding 80 points from the previous week’s close. The downfall continued throughout the week with the Sensex shedding almost 2% on a weekly basis and ending lower after a straight nine-week rally. While the sentiment was subdued due to the row over the unit-linked insurance plan (ULIP) issue between the Securities and Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority (IRDA) at the beginning of the week, concerns over a possible interest rate hike by the central bank made investors stay away from the market, dragging down indices.

US wholesale inventories rose more than expected in February and sales at wholesalers reached their highest level in 16 months, brightening prospects for better first-quarter financial and earnings growth. European finance ministers have been meeting to work out a solution for the Greek debt crisis. However, the Greek prime minister has said that the nation is going through austerity measures and any proposal for external help will be evaluated on the basis of the nation’s interest. World Trade Organisation chief Pascal Lamy said that the recovery in the global job market will be delayed. China’s economy grew at a faster pace than expected, raising the need for its central bank to tighten its monetary policy. The economy grew at 11.9% in the March quarter, the fastest since 2007.

Closer home, industrial output in February grew at a slower rate than expected. Output rose 15.1% in February from a year earlier, less than a rise of 16.7% in January, and a 16% rise expected by analysts. The Reserve Bank of India (RBI) has allowed foreign institutional investors to use their government bond holdings and foreign sovereign securities with ‘AAA’ ratings as collateral for stock market transactions. The meteorological department has said that a second consecutive dry season is unlikely. The monsoon season last year was the worst in the past 37 years, creating a shortage in sugarcane and oilseed production. Data from the weather office shows that out of about 20 droughts since 1901, 17 were followed by near-normal rainfall. The weather office will issue its formal monsoon forecast in the second half of April. The wholesale price index (WPI) rose an annual 9.9% in March, the fastest pace in 17 months, driven by higher food and fuel prices. The food articles’ index rose an annual 16.65% in March and the fuel price index rose 12.71%. In the 12 months to 3rd April, the food price index rose 17.22% and the fuel index was up 12.43%. The chief economic adviser to the finance ministry has said that the economy has probably grown 8.5% in the March quarter. The finance minister and the RBI governor met ahead of the monetary policy review.

The government hinted that a rate hike may be on the cards—ahead of RBI’s next week’s monetary policy meet—as growth is surging and inflation remains high. Analysts expect interest rates to be hiked by 25 bps or even 50 bps. The RBI raised the cash reserve ratio (CRR) for banks by a more-than-expected 75 bps in January and followed it with a between-meeting surprise 25 bps point increase in the key repo and reverse repo rates in March.

The government expects private companies to invest half of the projected $1-trillion investment in infrastructure between 2012 and 2017. Difficulties in acquisition of land, and underdeveloped bond markets, have been coming in the way of long-term infrastructure projects. A new regulation from SEBI has tightened disclosure norms for foreign institutional investors. Foreign investors now have to disclose to the regulator whether investments are in the form of multi-class vehicles (MCVs), segregated portfolio companies (SPCs) or protected cell companies (PCCs). Gem and jewellery exports rose 16% in 2009-10, compared to the same period a year ago, driven by increased sales of cut and polished diamonds. 


New FII investment norms may separate the good and the bad

SEBI plans to curb potential round-tripping through FIIs and also increase transparency. If successfully implemented, the move will segregate the opportunistic short-term investors from the committed long-term ones

Market regulator Securities and Exchange Board of India (SEBI) has asked all foreign institutional investors (FIIs) not to follow a protected cell company (PCC) or segregated portfolio company (SPC) structure.

A PCC or SPC is an entity with several cells within the same fund vehicle that may represent distinct investment objectives. A cell within the PCC or SPC has its own assets and liabilities as well as capital, dividends and accounts. This helps the fund manager to market a single fund which can have different investment plans for different investors.

"The FII has to declare that it is not a protected cell company (PCC) or segregated portfolio company (SPC) and doesn't have an equivalent structure,” SEBI said in a circular. FIIs have also been directed to declare that they are not a multi-class share vehicle (MCV) by constitution and do not have an equivalent structure. FIIs have to declare that their investment contains only single-class shares instead of MCVs, the market regulator said.

PCCs or SPCs are commonly used in the formation of collective investment schemes as umbrella funds and for the formation of captive insurance companies. They are also sometimes used as asset-holding vehicles, characteristically where each portfolio holds a single ship or aircraft, and they can also potentially be used in capital market debt issuances.

"While we understand the regulators’ concerns about round-tripping and money laundering by Indian residents, we believe that a blindfolded blanket ban on FIIs and genuine investors may not be the correct remedy. We believe that money laundering and round-tripping for tax evasion issues should be rather checked by stronger and robust exchange controls," said law firm Nishith Desai Associates, in a report.

Despite satisfying the broad-based fund criteria at the entity level, the fund vehicle has flexibility to pursue dedicated investment strategies for identified investors. This goes against the essence of a broad-based fund, as the investment does not represent the interest of all the investors, but of specific investors as per their investment strategy.

Though SEBI has provided almost six months for the sunset provisions, it would jeopardise the structures of many existing FIIs and sub-accounts which were structured as MCVs or have a PCC or SPC in their group structure, the law firm added.

Because of the relative ease of forming multiple offshore companies in most jurisdictions where SPCs are available for incorporation, and because it is uncertain how the concept of segregated portfolios and thus no consequential cross-contamination of liabilities would be treated in an onshore bankruptcy or by credit ratings agencies, many promoters still instead opt for the formation of multiple companies under a single holding company.

Similarly, the market regulator had expressed concerns for fund vehicles structured as MCVs, adding new classes of shares or sub-funds after seeking registration as a sub-account. SEBI said that FIIs declaring that they were not MCVs would need to ensure that they had only one category of investors, also referred to as single class of shares.

Typically, MCVs are used in two ways. The first option is to have a common portfolio that has at least 20 investors at the FII level. The second option is to have a segregated portfolio for each class of investors, where each class must have a minimum of 20 investors. SEBI has asked FIIs that were registered before 7th April to comply with the norms by September end.

"In today’s global scenario, apart from the developing economies, India stands to compete with the developed Western markets also for foreign inflow of capital. Therefore, it is imperative that the Indian regulators ensure that genuine foreign investments are not hindered due to an adverse regulatory regime, which may lead to diversion of India-dedicated funds to other economies," added Nishith Desai Associates. However, unless it is clear how much of investment is due to round-tripping, it is impossible to say whether the new rules would be a hindrance. After all, a lot of genuine long-term investors don’t use the PCC or SPC structure.


‘Headwinds galore’ for insurance sector: ICICI Securities

Any ruling that advocates trail commissions or a ban on ULIPs will be significantly negative for the sector, the brokerage has said

ICICI Securities Ltd, a unit of ICICI Bank Ltd, has said that it believes the 'status quo' in the ongoing conflict between the insurance and stock market regulators will be difficult to maintain in light of the finance minister’s comment on the phasing out of the current ‘front load’ structure in the life insurance space.

"Such a structure, if implemented, will be significantly negative for the industry. The implementation would lead to sharp decline in sales and persistency in the short term, pressurise margins and have negative impact on valuations," ICICI Securities said in a research report.

On 10th April, market regulator Securities and Exchange Board of India (SEBI) banned 14 life insurance companies from raising funds through unit-linked insurance plans (ULIPs), without an approval from its side. Later on 14th April, SEBI came out with a second order that exempted the existing ULIP schemes of these 14 players from the ban. Yesterday, the market watchdog had moved the Supreme Court and some High Courts to guard against any ex-parte decision.

ICICI Securities said that valuations of life insurance entities will suffer significantly if either the products become ‘no-load’ or the SEBI stance on regulation of ULIPs is implemented, and it awaits further clarity on the issue and keep its estimates unchanged.

Given the already high capital infusions, dependence of about 30 lakh agents on commissions and high proportion of ULIPs in sales, the brokerage said that it believes it will be difficult to implement a ‘no-load’ structure. Any ruling that advocates trail commissions or a ban on ULIPs will be significantly negative for the sector, ICICI Securities added.

The brokerage said that within its insurance coverage universe, Aditya Birla Nuvo, Reliance Capital and Bajaj FinServ will be most impacted as the life insurance business accounts for a significant proportion of their valuations while the impact on SBI and HDFC will be limited as insurance contributes to a smaller proportion of their valuations.


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