What do Indian telecom companies have to do with Indonesian coal? The short answer is everything, at least for investors in emerging markets
Every country has numerous types of property. The interests in property are governed by the peculiar laws of any country. Many investors believe that the law will determine the value of the property, but as the Nobel Laureate Ronald Coase pointed out in his famous theorem, the law itself probably does not make much difference because if there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. But in emerging markets there are transaction costs. The most glaring is poorly defined property rights. In India the property right was a license to use parts of the radio spectrum for second generation (2G) mobile telephones. In Indonesia the property right was a license to dig for coal.
In 2008 the corrupt telecom minister, Andimuthu Raja, helped by some well-connected tycoons was able to engineer a rigged auction of licenses to use the 2G spectrum that may have cost the Indian treasury as much as $39 billion. In February 2012, the Indian Supreme Court revoked 122 licenses declaring the sale “arbitrary and unconstitutional”. The court ordered the telecom regulator to reallocate the licenses by an auction to be held in four months.
The court was on solid legal grounds. The common law rule is that fraud cannot convey good title. This is quite logical, because it provides a disincentive to crooks, who may not profit from their acts and an incentive to buyers to investigate ownership before they buy. It is also a very important limit to the pervasive corruption that infects not only India, but all emerging markets.
Despite the validity of the ruling, it will have some far-reaching consequences. Three foreign telecom companies including Norway’s Telenor, Russia’s Sistema and Etisalat of United Arab Emirates made a mistake common for foreign investors in emerging markets. They trusted their sellers or just assumed that it was part of the business culture. Nigerian Internet scammers make a good living on the presumption that corruption is so prevalent that deals, no matter how nefarious, will be respected. Whatever their logic, these three companies stand to lose the billions they invested in networks based on the assumption that their licenses were valid.
The press on the ruling has also been mixed. The Indian muck-raking news magazine Tehelka called the court’s action “judicial over-reach” that resulted from “the abject capitulation of the executive”. One commentator stated that “India has become a banana republic in which the banana is peeled by the Supreme Court. Never has ‘brand India’ been so damaged.” Incredible India has become Undependable India”.
The truth is just the opposite. The Supreme Court’s actions go to the heart of any investment. All investing is a bet on the future. The future is filled with risk. The more investors can limit risk, the more likely they are to invest. Strict adherence to rules and well-defined property rights are the most important criteria for attracting foreign investment.
Contrast India’s license revocation with Indonesia. Gossips lament that the ‘I’ in BRICs now stands for Indonesia and not India. The shareholders of Churchill Mining would disagree.
The Nusantara Group is an Indonesian mining company controlled by Prabowo Subianto, a retired general, once the son-in-law to former president Suharto and future presidential candidate. Nusantara held licenses to mine coal in East Kalimantan on the Indonesian part of the Island of Borneo. These expired in 2006 and 2007. A small British company called Churchill Mining bought interests in the licenses after the local government declared them available.
In 2008 Churchill discovered a giant coal deposit, estimated to be in 2.73 billion tonnes. It is the second-largest reserve in Indonesia and the seventh-largest in the world. Based on the authority of its license, Churchill invested more than $40 million in the project.
Within months of announcing its discovery, Churchill found that their property rights in the discovery were in question. The same local government that had declared that Nusantara’s license expired backtracked. They extended them which, if upheld, would nullify Churchill’s claims.
Churchill sued in the local courts but predictably lost. A final appeal to the Indonesian Supreme court could take years and a representative of Indonesia’s president Yudhoyono said that the issue was a local matter and denied any knowledge of the case.
It would be easy to dismiss these incidents as isolated cases, but they are not. They are part of the risk of any investment either direct or indirect. Before any emerging market can live up to the BRIC hype, it has to enforce property rights. India has proved that it is the ‘I’. The real problem has to with the C and the R.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected])
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The fight for bringing exchanges under the ambit of the RTI Act is not over yet. But MCX’s willingness to be brought under the Act would certainly put pressure on other exchanges
Multi-Commodity Exchange (MCX), which received a thumping response for its initial public offering (IPO) in a lacklustre market, said that it is in favour of bringing exchanges under the ambit of the Right to Information Act, 2005 (RTI Act) and willing to work with policy makers to develop a framework for it. This is a path-breaking initiative from MCX, which is the first exchange in India to be listed.
As of 5pm on 24th February, the MCX IPO was oversubscribed by 54 times. The issue size of MCX IPO at the upper band is about Rs663.30 crore and with 54 times over-subscription, the total money mobilised comes to about Rs36,000 crore.
In a statement, the commodity exchange said, “MCX is in favour of bringing exchanges under the ‘Right to Information’ (RTI). The exchange will work with policymakers to develop a framework for exchanges’ RTI policy.” This is in stark contrast with other exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), which so far have resisted any attempt to bring them under ambit of the RTI Act.
Surprisingly the Securities and Exchange Board of India (SEBI), which has been accused of a strong pro-NSE bias by the MCX group, has done nothing to ‘persuade’ the bourse that as a first-line regulator, it falls under the definition of ‘state’ for application of the RTI Act, even if it insists it is just a private company. The regulator’s benign attitude to the NSE would have been unexceptional, but for the fact that both SEBI and the Reserve Bank of India (RBI) use every opportunity to emphasise and underline the fact that bourses are ‘public utilities’ (both regulators made this point in September 2010 at the launch of the United Stock Exchange).
Just two weeks ago, Central Information Commissioner (CIC) Shailesh Gandhi ruled that citizens have a right to know about public-private partnerships (PPPs), which directly or indirectly envisage a partnership with public funds. He also said that any entity which has received finance or grant of over Rs1 crore from the government would constitute “substantial financing” rendering such entity a public authority under the RTI Act.
Earlier in 2007, the CIC had held that stock exchanges are quasi-governmental bodies which are bound to disclose information to the public under the RTI Act. The RTI Act defines a public authority as one that is created by a notification issued by the government or a law passed by Parliament. Stock exchanges are owned by private investors or brokers and have independent managements. NSE is an exception as the majority equity of some of its large shareholders, such as the State Bank of India (SBI), is owned by the government.
SEBI has said that despite their independence in operations, exchanges ought to be classified as public authorities as they can start business only if they are notified by the government. However, so far the exchanges have been adamant about their stance on the Right to Information Act and have resisted the attempts by activists to procure information.
In fact, the NSE even tried to maintain that since it is an autonomous body and not controlled by the government, it cannot be forced to disclose information under the RTI Act. However, SEBI, in an affidavit before the Delhi High Court, said that Government of India or government companies own more than 50% of the shares of NSE. The exchange then tried to dispute the counter affidavit as “contention and not factual statement”. Although the single bench of the high court ruled that NSE is bound to reveal information under the RTI Act, the exchange was successful in getting a stay order from a division bench of the Delhi High Court on the matter.
Last year, the public information officer (PIO) of SEBI directed BSE to allow an RTI applicant to inspect files, documents relevant to the exchange’s market making activities. Earlier in 2009, SEBI slapped BSE with a show-cause notice for engaging in market making without acquiring approvals from the regulator. Market making is artificially creating volumes in the derivatives segment, which infuses liquidity. Market makers quote both ‘buy’ and ‘sell’ for a financial instrument or commodity, hoping to make a profit on the trade.
The fight for bringing exchanges under the ambit of the RTI Act is not over yet. But MCX’s willingness to be brought under the Act would certainly put pressure on other exchanges, which so far have been adamant and reluctant on the RTI Act.