Corporates beware ! SDR comes knocking, courtesy RBI

The conventional thinking in corporate lending went that the power of the bank over the borrower was inversely proportional to the size of the loan. Hobbled by laws that made loan recovery a chore, a promoter lobby determined to protect their interests and political masters who prioritized the next election to prudential norms, PSU banks seemed resigned to loan waivers and NPAs. While the 5/25 plan appeared to give banks some leverage, too often the general public has seen the banks fight shy of targeting large corporates (and their nabob promoters).

The current mood in the RBI seems determined to consign this behaviour into the dustbin. First, a tough-talking governor has finally stood up and castigated the “sweep-under-the-carpet” mentality on several occasions. This has been supplemented by a far-sighted government that has been taking bold economic decisions to ease the bureaucratic gridlock and resource constraints, coal and gas being good examples. Equally important, unlike previous administrations the government has largely refrained from second-guessing the RBI’s policy stance. This has helped restore investor confidence and manage the eventual capital flows when the US Fed raises interest rates.

But the significant (and yet largely under-reported) change has been in the RBI’s policy framework for managing bad loans. Through the establishment of the Joint Lender Forum (JLF) and the recent policy directive on Strategic Debt Restructuring (SDR), the RBI has delivered some sophisticated artillery capabilities to banks. The SDR allows lenders with the capability to convert their debt into equity and acquire management control over the firm by wiping out the promoter’s stake. Supported by generous (interim) dispensations on prudential norms and SEBI takeover codes, the SDR mechanism allows lenders to form a united front to force recalcitrant lenders into taking the tough economic decisions necessary for the firm’s survival. This is a massive change as much in the psychology of corporate lending as it is about actual policy. The RBI deserves to be richly commended for taking up such innovative approaches to structural issues, which is fast emerging as a hallmark of Dr. Rajan’s tenure, such as with payment and small finance banks.

It appears that banks are taking tentative steps along this path. On 27^th July, the first SDR “workout” was undertaken on ElectroSteel Steels’s loan of INR 9600 crores. This was followed, on August 10^th, by an INR 500 crores SDR on Lanco Infratech’s project. On 20^th August, the JLF of Jyoti Structures decided to implement the SDR to convert an INR 2,178 crore debt into equity, wiping out the promoter’s stake. So far, the market seems to be pessimistic of the economic prospects for these companies that are trading down 17%, 12%, and 11% from the time of their respective SDR announcement (all data as of 23^rd Aug, 2015).

Exiting the Chakravyuh

Anyone acquainted with Hindu mythology is aware that it was the prospect of exiting the maelstrom that made the hearts of the stoutest warriors tremble. While the SDR exhorts the JLF to keep out the past promoter and work quickly to undertake a sale of the company it is sketchy on the actual details of managing the company in the interim period. This silence extends to communicating the plan and its progress with wider stakeholders. As a consequence, the market has been largely in the dark regarding the improvement in operational parameters.

Corporate Affairs recommends the following tactical inclusions to navigate a smoother exit from the SDR –

a.     

•         Establish a stakeholder engagement plan

A financial restructuring plan spells uncertainty for employees, customers and the authorities such as the sales tax and excise departments of individual states. Often companies also have litigations that are pending at various levels of the judiciary that requires a pro-active outreach.  Employees and customers are in the dark as to the motives of the JLF, which need to be clearly conveyed and fit into the strategic initiatives of the firm. Assuming a “BAU” approach is clearly a recipe for low all-round morale, negatively impacting share prices and negotiating power for the JLF.

•  Strengthen and co-opt the executive management

It seems a naïve to expect that the removal of the promoter could somehow enthuse the firm’s prospects and the contributions of the executive management. Often where the sector itself is in the doldrums, the promoter’s actions might have precipitated the eventual collapse. Several economic sectors continue to remain in oligopolistic cliques, the resolution of which is an element of policy detail. In such a case, the management might require re-skilling and familiarization in the usage of cost management tools to improve [productivity. Management reporting, which might have been given a go-by in the previous dispensation will need to be rigorously implemented to instill operational discipline. This could assist in cost simplification and raising morale as the effect of the “quick-wins” kicks in. 

•       Involve specialist support

It is understandable to see nervousness amongst JLF constituents for incremental funding of their NPAs in SDR. However, there could be strategic investments that might be justified through improvements in capital structure, process, technological and sales effectiveness that could enhance the attractiveness of the account for a potential bidder. Specialist shops, both merchant banking and consulting arms exist within PSU banks themselves. In addition, there are a plethora of outfits that could provide turnkey support to the company which should look to outsource non-core activities. It is not clear whether these are being actively planned for the SDR accounts, but these should be considered too. The incremental expenditure might well be worth it in the asking price and the management time that it saves of the JLF team.

The path less travelled

At the risk of spouting clichés, it is very clear that banks are in uncharted territory with the use of SDR as a tool for tackling NPAs. Notwithstanding the solid support (read ear-wringing) of the RBI, it is up to the banks to embrace bold, innovative solutions. This should also serve as a recurring reminder to the other silent stakeholders – domestic financial institutions and the retail investor community.

The hubris of the promoters is as much a cause of NPAs as is the meekness of their shareholders. Participants need to take a more active interest in the functioning of the companies that they own. Selling out of companies that they don’t like is understandable, but the hero worship of the companies that they like is unpardonable. Investors should understand that today’s heroes could easily turn in to tomorrow’s zeroes. 

Much ado about nothing - Mr. Sathe's appointment to SEBI

The recent appointment of noted jurist Mr. Arun Sathe as a part-time member of SEBI should raise eyebrows, but only due to the partisan reporting that has surrounded its notification.  This episode is yet another indication that in an era of non-stop reportage and TRP pressures the notions of reasoned debate and a respect for process are being given short shrift. The charge against Mr. Sathe is essentially that as a “political man” (whatever this means) of a right-wing persuasion, he is somehow ineligible to hold any responsible office, including the role of a part-time member of SEBI. This kind of assertion is astounding in modern India that aspires to be a superpower in a culture of meritocracy and equality.

Are Mr. Sathe’s critics confident that every official in high office who is in the executive branch of government is completely apolitical? Is it correct to expect that people in public life will not hold an ideological preference in their personal lives? Should the focus not instead be on the individual’s actions prior to an appointment or even after he/she assumes the post under question?

The sad consequence of the brouhaha in this episode is that the facts are being conveniently buried. First, Mr. Sathe is a noted jurist in tax matters. The constitution of the current SEBI board (see here) is without any legal representation and hence it can be argued that he is suited to making valid contributions to SEBI’s board, especially in an era of increasing global regulation of the financial sector. Second, he has been transparent in stating his personal involvement with the RSS and the BJP, neither of which are organizations whose members are debarred from public office.  Third, the government is well within its rights to nominate part-time members to the board. In fact, this prerogative extends even in the appointment of the Chairman of the Board. Fourth, the code of conduct of the SEBI board has explicit provisions that require members to declare conflict of interest. Further, the Board also entertains unsolicited submissions from the public on conflict of interest matters, provided they are backed by material facts. If indeed Mr. Sathe is not “fit and proper” to be on SEBI’s Board, pray where is the smoking gun?

Such protest from within certain quarters is in stark contrast to the situation in countries like the USA. Here, people in high office are often noted members of the industry that is being regulated by the entity. Instances like that of Mr. Robert Rubin (Treasury Secretary and co-head of Goldman Sachs), Mr. Hank Paulson (same as Mr. Rubin), Mr. Robert Khuzami (General Counsel, Deutsche Bank and SEC) are but a few instances of a well-established system. This allows the regulator to implement policy decisions that incorporate the market realities. Closer home, the appointment of Dr. Raghuram Rajan as RBI governor helped to assure global markets and also steer the Indian economy adroitly. This government’s continuing support has helped the RBI to proceed on the path of financial inclusion with confidence.

This government has refrained from over-commenting on this case, beyond stating that due consideration has been exercised in proposing Mr. Sathe to the Board. This is in stark contrast to the unsavoury situation that SEBI found itself a few years back when Mr. C B Bhave, former Chairman and Mr. K M Abraham were “honoured” with a preliminary enquiry (PE) from the CBI for their role in providing a license to MCX-SX. Mr. Abraham had even alleged that there was undue pressure on SEBI from the Finance Ministry (headed then by Mr. Pranab Mukherjee) on this and other cases. In the face of a public backlash, and importantly with no evidence of any wrong-doing, CBI had closed the PE.

Of start-ups, IPO dreams and differential treatment

 Business Standard recently carried an interesting guest column on job creation through start-ups. The gist of the article was - create an " IPO-lite" (my term) environment for start-ups and India can have a job creation machine. The article certainly did not lack authority, what with both authors being distinguished members of the PE fraternity and Mr. Pai having a larger corporate role courtesy his Infosys association.

 My criticisms of the article are primarily the weak logical connections between job creation and start-up IPOs. Further, in coming up with a differentiated exchange for start-ups authorities would need to consider  possible scenarios which could be a slippery slope to letting in retail participation. While I attach the SEBI concept paper here, unfortunately  the responses and SEBI final regulation could not be found on the website. Lastly, the unstated "this-time-it's-different" idea that seems to inspire this article could in fact be the driver of India's second dot-com bubble.

 On a personal note, this is my second unpublished letter to a newspaper - baby days yet !

Link to IPO article by Mohandas Pai & Praveen Chakravarty

Discussion paper on alternate capital raising platforms and other regulatory requirements

----

 “How IPO rules are linked to job creation” (June 3) attempts to embellish the case for an “IPO-lite” mechanism under the helpful suggestion that such proposals can enhance job creation.

Policy makers should re-check their assumptions before signing off on such proposals. While there is no doubt that disruptive business models and VC funding mechanisms are here to stay, it is a well understood that there are other factors which govern VC movements, many of which could run counter to job creation. Portfolio re-balancing (and re-investment) decisions of (mostly foreign) VCs are governed by internal factors such as rate-of-return targets, deal pipelines, and base currency movements, not to mention the relative attractiveness of other markets. No VC is under a mandate to “Make in India”. They are there to provide the best returns possible for their investors.

These returns are derived on the basis of strong management and earnings growth. In the absence of tangible earnings or a management strong enough to deliver it, any proposed exchange will quickly descend into a VCs “musical chairs” with eager participants queuing up for a chunk of shares from the early prospectors/insiders before the next round of fund-raising commences. Setting up an exchange with only institutional investors are participants is also a slippery slope to retail markets. Would MFs and/or pension funds be allowed to invest and if so, are they not deploying retail money? What happens if a start-up (with stratospheric valuations) buys a company on the main board and wishes to pays in stock? Does the exchange not discriminate against brick and mortar firms who might be in the same sector and unable to “IPO-lite”? 

The article is silent on these issues. Ironically the market factors that the article helpfully lists as the cause of poor IPO performance are the same that can stymie the “IPO-lite” policy – lofty (start-up) valuations, poor diligence (institutionalized) by merchant bankers and greedy entrepreneurs (and their VC backers). Is the scene being set for India’s second dot-com bubble?

Impressions – The King of Oil

My earliest brush with Marc Rich might have well been the event that, he believed, would bring closure to the demonization that he was subject to for 17 years of his life. Living in luxurious self-imposed exile in reclusive Zug from US authorities pursuing him on charges of treason and tax fraud, he would find himself up chanting the final prayers in his father's wake over a long-distance call and be reduced to listening over telephone to his daughter die a slow death from leukemia, while being unable attend both funerals in person. He would also complete an acrimonious (and expensive) divorce from his wife of 30 years and go on to marry another (whom too he divorced, 9 years on, in yet another expensive affair).

Somewhere in between all this, in the dying hours of the Clinton era, a Presidential pardon ended and began a new chapter in the media scrutiny in his checkered life. Washed over in the torrent of media horror, I slowly picked together the life of the secretive commodities trader who spawned the colossus that today is GlencoreXstrata.

In this world of self-seekers, both myopic and narrow minded, a shrewd calculating man focused on the long term is indeed rare. Rarer still is to see him as evil. Perhaps this is my bias, but one who thinks long term and puts relationships before profits is in my dictionary termed astute.Marc Rich was an astute man, of this I am confident. But what else was he? An amoral trader, a dutiful son, silent intelligence sentinel, a doting father or a bitter ex-husband? How does one reconcile these contradictions? What can we learn from his failures and his astounding successes – notably, creating the global spot market for oil?

The King of Oil is hence an interesting book, as it pieces together the events in Marc Rich’s life and leaves the reader as the final judge. The absurdities that accompanied his trial and the machinations of Rich’s legal term are laid out in equal measure. Hence the book does not feel like a paid advert. It is in fact a sobering assessment of an infallible truth – even the Supermen and Superwomen that the world has seen will one day fade away in their days of glory or be dragged off their pedestals by Time if they tarry too long.

Reminding us of our mortality through the life of one considered invincible is perhaps the book’s greatest contribution. In parts fascinating, in others saddening, this is a Promethean tale that must be read.

My Name is...

With a mouth like a loose cannon, I am India's latest killjoy.
Spreading trouble with gay abandon, My name is Arundhati Roy !

"Modern Times"

First they came for the women,
and I didn't speak up for I am not a woman.

Then they came for the poor,
and I didn't speak up for I am not poor.

Then they came for my rights,
and I didn't speak up for I don't cherish my rights.

Then they came for Farmville,
and suddenly, all hell broke loose !

(inspired by Pastor Neimoller)

30

The night has passed and dawn has broken,
Another decade now awaits to be written.
With you in my dreams and God in my heart,
Time and I march with nary hesitation.