current affairs on commerce

Updates on FINANCIAL INSTITUTIONS

Metropolitan Stock Exchange of India Limited

  • Metropolitan Stock Exchange of India Limited (MSEI) is recognised by Securities and Exchange Board of India.
  • The Exchange was notified a “recognised stock exchange” by Ministry of Corporate Affairs, Govt. of India, on December 21, 2012.
  • Shareholders of the Exchange include India’s top public sector banks, private sector banks and domestic financial institutions who, together hold over 88% stake in the Exchange.
  • MSEI offers an electronic, transparent and hi-tech platform for trading in Capital Market, Futures & Options, Currency Derivatives and Debt Market segments.
  • MSEI commenced operations in the Currency Derivatives (CD) Segment on October 7, 2008, under the regulatory framework of SEBI and Reserve Bank of India (RBI). MSEI launched Capital Market Segment, Futures and Options Segment and flagship index ‘SX40’ on February 9, 2013 and commenced trading from February 11, 2013.
  • ‘Information, Innovation, Education and Research’ are the four cornerstones of the unique market development philosophy adopted by MSEI and supports its mission of Financial-literacy-for-Financial InclusionTM, as is envisaged by the Government of India.

Recently  London-based GMEX Group signed an agreement with MSEI to acquire a 5% stake in the exchange and its clearing corporation. The two entities plan to work in areas of product development, technological innovation and market infrastructure development for new products and project finance.

          
Debt Funds:
While equity funds invest mostly in shares of listed companies.
 
Debt fund is one that invests in instruments like government bonds, commercial papers (CPs), certificate of deposits (CDs) and non-convertible debentures (NCDs). Debt funds invest in such securities and earn interest income that is shared among the investors after deducting the fund-management charges. By investing in such debt schemes, investors can indirectly invest in instruments like government bonds as well where direct retail investment is not possible.
 
What are the different types of debt funds?
Debt funds can be classified on the basis of the tenure of the bonds or instruments in which they invest. Various types are:
·       Liquid funds invest in instruments that have a tenure of less than 90 days. 
·       Short-Term funds that invest in instruments that typically have a tenure of three to six months. 
·       Corporate Debt funds too that could have a tenure of up to three years. 
·       Long-Term funds would invest in bonds that have a tenure of three to five years or even more like in the case of government bonds (G-Secs).
 
Do retail investors invest in debt funds?
·       The share of real retail money in debt funds is still minuscule though the share is rising as more and more investors take to financial planning wherein a certain portion of the investment fund is allocated to debt products. 
·       Most fund houses now offer systematic investment plan (SIP) facility for debt funds as well. 
·       Interestingly, debt funds are popular among high net worth individuals (HNIs) to park their money temporarily before moving to other asset classes, mostly equity. 
·       Debt funds are generally used by banks and corporates for their treasury operations.
 
Are they better than bank deposits?
·       Debt funds offer more return than bank fixed deposits and that is one reason why many HNIs and institutions use such schemes for their treasury operations. 
·       While debt schemes offer comparatively higher returns, the risk is also higher compared to the safe FDs that offer assured returns. 
 
What about tax liability?
·       The gains made on the investment in debt schemes are taxable. If the securities are sold within three years, it is considered short-term wherein the gains are added to the income of the investor and taxed as per the applicable tax bracket. 
·       If the securities are held for more than three years before selling, there are long-term capital gains tax. 

 

Manipulations in Capital Market in India

  • Manipulation probes by SEBI hit a new high. SEBI probed 174 cases between April and December 2016, the highest in any fiscal so far SEBI has come a long way in its surveillance systems. 
  • In 2017 SEBI barred Reliance Industries and 12 other entities from the equity derivatives segment for one year and directing them to disgorge almost ₹1,000 crore featured the word ‘manipulation’ 15 times.
  • This was the highest in the last seven financial years since data had been made available. Incidentally, this was also the first time that the number of such cases had exceeded 100 in a fiscal. The previous high was 86 in 2012-13.
  • SEBI’s increased monitoring perhaps in the matters relating to collective investment schemes, misuse of long term capital gains (LTCG) and intentional self-trades through algorithmic trading seems to have led to the increase in numbers. Usually operators tend to do some of these activities assuming SEBI might not be able to capture it in their alerts or systems. 
  • But SEBI has come a long way in its surveillance systems and risk containment measures. In 2015-16, SEBI had initiated investigation into as many as 84 case for market manipulation and price rigging.
  • Manipulation and price rigging as a category had historically accounted for the largest share among all forms of investigations.
  • Price rigging: Between April and December 2016, SEBI completed investigations in 70 matters of which 57 were related to market manipulation and price rigging. Apart from market manipulation and price rigging, the market regulator had categorised investigations under insider trading, takeovers and issue related manipulation segments.

‘Increased bandwidth OF SEBI’

  • The emphasis clearly seems to be on reducing market manipulation activities and with the increased bandwidth, the regulator seems to be taking up more alerts,” said Tejesh Chitlangi, partner, IC Legal.
  • “Stock exchanges provide information to SEBI that generates internal alerts as well. SEBI has been hiring professionals from top institutions, that has increased its capacity to better handle such cases. Market integrity is of paramount importance and SEBI has started looking at more cases of market manipulation,” added Mr. Chitlangi.

 

Capital market Reforms by SEBI:

The market regulator approved:

  • Options in commodity derivatives,
  • unified licence for brokers,
  • mutual fund investments through digital wallets,
  • Stricter public offer norms and
  • Eenhanced safeguards to curb illicit fund flows.

 

Self  Trades

  • A self-trade refers to the same entity placing a buy and a sell order in the same stock through the same broker. A self-trade is a form of circular trading, over which the regulator has expressed concerns as such trades could be used to drive up stock prices.
  • A trade where the buyer and seller are the same and not resulting in a change of ownership are termed self-trades. Typically, these occur when multiple dealers from the same broking house carry out trades using the same client code. As many as 270,000 of an average of 12.2 million orders executed every day in the derivatives market are self trades, stock exchange data shows.
  • Self-trades generally happen inadvertently as dealers doing algorithmic trading place buy and sell orders for the same stock to gain advantage of intra-day price movement. Similarly, domestic and foreign institutional investors use the secondary market to transfer their holdings from one scheme to another, which can lead to self trades.
    • Sebi defines circular trading or self-trade as an action by a single entity or a group of entities that enter buy and sell orders with an intention to manipulate the price of a share or create artificial or false market demand. Most times, entities use trading accounts across various brokerages to carry out such trades.

 

  • As per SEBI there is an increase in such trades, with the aim of creating artificial volumes and to manipulate prices.

 

  • SEBI has decided not to penalize self trades, reversing its earlier stand of penalizing such trades. SEBI has also formulated a legal policy to dispose of the adjudication proceedings related to 100 showcause notices issued to market entities on self trades. As part of the legal policy, such orders and proceedings would be allowed to be settled through the so-called ‘consent’ mechanism against a nominal fee of Rs2-5 lakh. Allowing consent to these entities would help resolve these cases as there were diverse positions taken by adjudicating officers.
  • As per the latest policy Sebi will proceed with orders only in cases where there is an intention to manipulate. Mere occurrence of self trades would not be considered illegal per se in the absence of additional evidence to prove intent to manipulate or commit fraud
  • Stock exchanges, both NSE and BSE  have already taken measures to prevent self trades and that no further action was envisaged in the matter. NSE and BSE had laid down the mechanism for preventing self trades in 2015. 
  • Really, penalizing in cases of self-trades without going into the merit of each case would be detrimental to genuine market transactions. Market players argue that foreign portfolio investors and mutual funds often use the secondary market route to transfer holdings from one scheme to another. In these cases, the custodian on both the sell and buy side would be same, resulting in self-trades. Similarly, a dealer can place the buy and sell order for the same stock in one day to get the advantage of intra-day price movement but without knowing that the orders might get matched.
  • “It is not possible for brokers to prevent self-trade from occurring altogether. Trades are executed in an exchange’s order matching systems. Once an order is accepted by the trading system, it is not possible for the broker to have control over who the counter-party is at the time of matching of that trade, as the trading engine finds and matches orders based on price time priority,” the letter said.

    Market participants have asked the regulator to increase its checks and balances to curb self-trades that are fictitious in nature. To prevent a potential self-trade, a Personal Account Number (PAN) check is needed at the pre-trade level. This would entail technical challenges that need to be sorted at the exchange level.

 

What is 'Front Running?'      

  • Front running is the unethical practice of a broker trading an equity in his personal account based on advanced knowledge of pending orders from the brokerage firm or from clients, allowing him to profit from the knowledge.
  • It can also occur when a broker buys shares in his personal account ahead of a strong buy recommendation that the brokerage firm is going to make to its clients.
  • In the context of stock trading, front running is the practice of stepping in front of orders placed or about to be placed by others to gain a price advantage.
  • For example, a broker receives an order from a client to buy 500,000 shares of XYZ Company. He holds it until he executes the purchase of a smaller order of the same stock in his own account. He then executes the client’s larger order, which drives up the share price. The broker can then sell his share, making a profit at the direct expense of the client.
  • That form of front running is not only unethical, it is illegal. 

 

Challenges before capital market in India (as per PM Modi)

Lauding the success of Dalal Street in the past 150 years, Modi said for him to "consider the financial markets to be fully successful, they have to meet the following three challenges. 

  1. The primary aim of the market should be to help in raising capital for productive purposes. Derivatives have a use in managing risks but many feel derivatives are dominating the markets and the tail is wagging the dog. Means investments in derivatives is not productive. 
  2. Most infra projects are financed by the government or through banks. Capital markets are rarely used for infra financing and opined that for infra projects to be viable, it is very important that the borrowing should be of long duration. Bond markets must become a source of long term infra finance". 
  3. Even now we do not have a municipal bond market. Sebi and the finance ministry to ensure that at least 10 cities issue municipal bonds within one year.

                Noting that ultimate success of market is in providing benefits to the millions of farmers, Modi said, "The true measure of success is the impact in villages, not the impact in Dalal Street or Lutyens' Delhi." 

  • Our stock markets need to raise capital in innovative ways for projects in agriculture.
  • Our commodity markets must become useful to our farmers, not just avenues for speculation. People say that derivatives can be used by farmers for reducing their risks. But in practice, hardly any of our farmers uses derivatives. Unless we make the commodity markets directly useful to farmers, they are just a costly ornament in our economy, not a useful tool," the Prime Minister said. 
  • In this context, he asked the Sebi to work for closer linkage between spot markets like e-NAM (the electronic National Agricultural Market) and derivatives markets to benefit farmers. 

 

Twin Balance Sheet Problem (TBS)

TBS deals with two balance sheet problems. One with Indian companies and the other with Indian Banks. Thus, TBS is two two-fold problem for Indian economy which deals with:

  1. Overleveraged companies – Debt accumulation on companies is very high and thus they are unable to pay interest payments on loans. Note: 40% of corporate debt is owed by companies who are not earning enough to pay back their interest payments. In technical terms, this means that they have an interest coverage ratio less than 1.
  2.  Bad-loan-encumbered-banks – Non Performing Assets (NPA) of the banks is 9% for the total banking system of India. It is as high as 12.1% for Public Sector Banks. As companies fail to pay back principal or interest, banks are also in trouble.
  • Origin of TBS problem can be traced to the 2000s when the economy was on an upward trajectory. During that time, the investment-GDP ratio had soared by 11% reaching over 38% in 2007-08. Thus non-food bank credit doubled and capital inflows in 2007-08 reached 9% of GDP. Due to such a boom in the economy, firms started taking risks and abandoned their conservative debt/equity ratios and leveraged themselves up to take advantage of the upcoming opportunities.
  • But Global Financial Crisis (2007-08) reduced growth rates and thus revenues from the investment. Projects that had been built around the assumption that growth would continue at double digit levels were suddenly confronted with growth rates half that level.
  • Firms that borrowed domestically suffered when RBI increased interest rates to avoid inflation increasing financial costs.
  • Environment and land clearances in infrastructure sector delayed the projects.
  • Thus higher cost, lower revenues, greater financial costs-all squeezed corporate cash flow leading to NPAs in the banking sector.

Steps taken to address the problem of TBS : See separate topic on steps taken to address problem of NPAs in India.

Why the India did did not solve the TBS problem?

  • Loss recognition: Banks do not recognise stressed assets and continue giving loans. They are reluctant to conduct the asset quality review for their assets.
  • Coordination problems: Difficulty in deciding compensation by different banks on Joint Lenders Forums which has not achieved much success.
  • Court cases: Public Sector Banks are reluctant to write down loans as bank managers are afraid of accusation of favouritism.
  • Lack of Capital: Indradhanush Scheme promised to infuse Rs 70,000 crore into Public Sector Banks by 2018-19. But this amount is not enough and banks need atleast Rs 1.8 lakh crore more.

What is the solution to the Twin Balance Sheet Problem?

India has till now pursued a decentralised approach where individual banks have taken decisions on its own to resolve NPAs. This approach has not resolved the problem and time have now come to create a centralised agency called Public Sector Asset Rehabilitation Agency (PARA).

Why does India need a Public Sector Asset Rehabilitation Agency (PARA)?

  • The argument for PARA is made on the grounds that companies have been grappling with deteriorating cash flows, which makes loan repayment tougher at a time when their interest obligation is already mounting. While companies have sold assets, it was to "buy time" as they continue to "haemorrhage".
  • It will be able to resolve not only NPA problems but also bad debts of the companies, thus resolving TBS Problem.
  • The centralised agency would help in fixing the problem faster and the decision will be taken swiftly.
  • It could solve the coordination problem since debts would be centralised in one agency.
  • The stressed debt is heavily concentrated in large companies and such bigger cases can be resolved by an independent agency.
  • Failure of Banks and private ARCs in resolving NPA problem till now.
  • An international experience like of East Asian countries has shown that centralised agency can resolve Twin Bet Problem.

Working of PARA

  • PARA would purchase loans from banks and then work them by different ways like converting debt to equity and selling the stakes in the auction.
  • After taking off the loans from Public Sector Banks, the government would recapitalize them. Similarly, once the financial viability of the over-indebted enterprises is restored, they will be able to focus on their operations, rather than their finances and will be able to consider new investments.

Funding of PARA

  • RBI may transfer some of the government securities to PARA.
  • Government funding in the form of securities.
  • Rest of the money may come from capital markets.

Conclusion

Twin Balance Sheet Problem (TBS) is a major problem that Indian economy is facing today. The past mechanisms of resolving this problem in the form of decentralised approach have failed. There is no point of delaying this problem because the delay is very costly for the economy as impaired banks are scaling back their credit while the stressed companies are cutting their investments. The time has come to adopt the strategy that East Asia adopted during their crises period. The centralised agency in the form of PARA would allow debt problems to be worked out quickly. The time has come for India to consider the same approach.

As per economic survey the key elements needed for resolution are still not in place despite several measures being announced by the RBI and the government. "The road to resolution remains littered with obstacles, even for the most ordinary of bad debt."

 

Cabinet clears new Bill (Financial Resolution and Deposit Insurance Bill, 2017) to deal with bankruptcy in financial sector

  • In June 2017 Union Cabinet cleared a proposal to introduce a Bill in Parliament for setting up the Resolution Corporation to deal with bankruptcy in banks, insurance companies and financial entities. It will also result in the repealing of the Deposit Insurance and Credit Guarantee Corporation Act, 1961, to transfer the deposit insurance powers and responsibilities to the Resolution Corporation.
  • The Financial Resolution and Deposit Insurance Bill, 2017 aims to instill discipline in financial service providers in the event of a financial crisis by limiting the use of public money to bail out distressed entities.
  • The Resolution Corporation would ensure the stability and resilience of the financial system, protecting the consumers of covered obligations up to a reasonable limit and public funds to the extent possible.
  • The government has recently enacted the Insolvency and Bankruptcy Code, 2016, for the insolvency resolution of non- financial entities.
  • The proposed Bill complements the Code by providing a resolution framework for the financial sector. Once implemented, this Bill together with the Code will provide a comprehensive resolution framework for the economy.
  • The Bill aims to strengthen and streamline the current framework of deposit insurance for the benefit of a number of retail depositors. Further, this Bill seeks to cut down the time and costs involved in resolving the problem of the distressed entities.

 

Bankruptcy proceedings against 12 Borrowers by RBI

  • In June 2017 Reserve Bank of India had identified 12 accounts, which account for 25% of non-performing assets of the Indian banking system for immediate resolution under the Insolvency and Bankruptcy Code (IBC).
  •  gross bad debt in the banking system as on March was Rs 7.11 lakh crore, which means the 12 accounts contribute to about Rs 1.78 lakh crore.
  • What does bankruptcy mean: A company is bankrupt if it is unable to repay debts to its creditors (banks, suppliers etc). The inability to repay debts by some of the Indian firms has resulted in a huge pile of non-performing assets for the banking system. A mechanism to free up the money stuck as bad loans is one of the key for the banking system. IBC is seen as one such. 
  • The government had recently amended the RBI Act, which gave powers to the central bank to direct banks to take punitive action against individual accounts under IBC.
  • Banks can start bankruptcy proceedings against defaulters by filing a petition with the National Company Law Tribunal.

 

Prompt Corrective Action (PCA) by RBI

RBI has issued a policy action guideline (first in May 2014 and revised effective from April 1, 2017) in the form of Prompt Corrective Action (PCA) Framework if a commercial bank’s financial condition worsens below a mark. 

         The PCA framework specifies the trigger points or the level in which the RBI will intervene with corrective action. This trigger points are expressed in terms of parameters for the banks. The parameters that invite corrective action from the central bank are:

  1. Capital to Risk weighted Asset Ratio (CRAR)
  2. Net Non-Performing Assets (NPA) and
  3. Return on Assets (RoA)
  4. Leverage ratio

When these parameters reach the set trigger points for a bank (like CRAR of 9%, 6%, 3%), the RBI will initiate certain structured and discretionary actions for the bank. As per the revised framework by the RBI, in April 2017, capital, asset quality and profitability continue to be the key areas for monitoring. Along with this, leverage of banks also will be monitored.

The some of the structured and discretionary actions that could be taken by the Reserve Bank are:

  • recapitalization,
  • restrictions on borrowing from inter-bank market
  • merge/amalgamate/liquidate the bank
  • impose moratorium on the bank ETC

The  major trigger points in the original format were:

CRAR

(i) CRAR less than 9%, but equal or more than 6%

(ii) CRAR less than 6%, but equal or more than 3%

(iii) CRAR less than 3%

NPAs

(i) Net NPAs over 10% but less than 15%

(ii) Net NPAs 15% and above

ROA below 0.25%

 

The PCA framework is applicable only to commercial banks and not extended to co-operative banks, non-banking financial companies (NBFCs) and FMIs.

 

The rising clout of mutual funds:

The influence of MFs has made the market more resilient to pullouts by foreign portfolio investors

·  The total assets managed by Indian MFs, at Rs 19.5 lakh crore is at a record and has more than trebled in the last five years. Interestingly, this expansion has been driven as much by retail investors, as the conventional corporate treasuries.
·  As of end-March 2017, retail investors had parked a whopping Rs 8.7 lakh crore with domestic mutual funds. This is up from Rs 3.2 lakh crore just five years ago, a study by the industry body AMFI jointly with CRISIL shows. Indian mutual funds now feature more than 5.2 crore retail investor accounts.
·  Clearly, MFs are breaking free from the crisis of confidence five years ago, to emerge as a popular investing vehicle for retail investors. This has structural implications for the market itself. 
·  This has rendered the Indian stock market more resilient to FPI pull-outs. To cite an instance, between October 2016 and January 2017, foreign investors withdrew a net Rs 39,979 crore (roughly $5.8 billion) from Indian equities. But on this occasion, the BSE Sensex saw a barely-felt 1% dip over the four-month period. This is because as FPIs sold, domestic institutions stepped in with almost matching net purchases of Rs.39,823 crore. 
·  In fact, MFs gaining muscle is a trend that isn’t restricted to the stock markets alone. With better tax treatment of returns, debt funds have been gaining ground as an alternative to bank deposits with retail investors. Mutual funds today corner 10.4% of the outstanding debt issuances in India too.
·  It is the runaway popularity of SIPs, or systematic investment plans, that should take credit for the stability of MF flows.
·  The popularity of the SIP route has wrought a sea change in retail investor behaviour, because it takes away the temptation to closely watch the markets and alter one’s investments based on its ups and downs. SIPs, by allowing investors to set up standing instructions with the bank to invest a fixed instalment each month, essentially put one’s investments on autopilot.
·  Despite the recent surge in retail interest though, MFs are nowhere close to displacing bank deposits or the provident fund/insurance policies as the favourite investment channel for Indian households. MFs accounted for just a 2% share of gross financial savings in FY16, while bank deposits hogged 44% and provident funds/insurance took up 36%.

 

Electronics Development Fund (EDF)

  • The Centre is targeting an investment of about ₹ 2,200 crore by 2019 in start-ups working on new technologies in the electronic sector under the Electronics Development Fund (EDF).
  • The EDF is a ‘fund of funds’ that works with venture capitalists to create funds, known as ‘daughter funds,’ which provide risk capital to companies developing new technologies in the area of electronics, nano-electronics and IT.
  • The EDF would put in 10% of the capital in ‘daughter funds’ and the rest would be invested by venture capitalists. Hence, a targeted investment of ₹ 2,200 crore by the government will help mobilise ₹ 22,000 crore for the ‘daughter funds,’ which will then invest primarily in start-ups.
  • The results had been very encouraging as, in one year, the government had been able to mobilise ₹ 6,870 crore, of which the government’s share has been ₹687 crore.

 

Infrastructure Investment Trusts

InvITs are similar to mutual funds. While mutual funds provide an opportunity to invest in equity stocks, an InvIT allows one to invest in infrastructure projects such as road and power.

 

How do InvITs work?

InvITs raise funds from a large number of investors and directly invest in infrastructure projects or through a special purpose vehicle. Two types of InvITs have been allowed:

  • One, which invests in completed and revenue generation infrastructure projects;
  • the other, which has the flexibility to invest in completed or under-construction projects.

InvITs which invest in completed projects take the route of public offer of its units, while those investing in under construction projects take the route of private placement of units. Both forms are required to be listed on stock exchanges.

 

How do InvITs help the developer?

  • InvITs allow developers of infrastructure assets to monetise their assets by pooling multiple projects under a single entity (trust structure).
  • For instance, IRB InvIT constitutes six special purpose vehicles consisting of toll-road assets aggregating to 3,645 lane kilometres of highways located across the states of Maharashtra, Gujarat, Rajasthan, Karnataka and Tamil Nadu.
  • InvITs are designed to attract low-cost, long term capital and the underlying focus is to reduce the funding pressure on the banking system as well as generating fresh equity capital for infrastructure projects.

           Infrastructure projects suffer from lack of availability of long-term capital and have depended on bank finance which typically has a short tenure.

 

What is the structure of InvITs?

InvITs are registered as trusts with SEBI and there are four parties — trustee, sponsors, investment manager and project manager.

  • Sponsors are the firms which set up the InvITs.
  • Investment managers manage assets and investments of InvITs and undertake activities of the InvIT.
  • The project manager is responsible for executing the projects.
  • The trustee oversees the role of InvIT, investment managers and project manager and ensures that all rules are complied with.

 

For which class of investors are InvITs suitable?

  • As per present regulations, InvIT investments are not open for small and retail investors.
  • The minimum application size for InvIT units is ₹10 lakh.
  • The main investors could be foreign institutional investors, insurance and pension funds and domestic institutional investors (like mutual funds, banks) and also super-rich individuals.

 

What do InvITs mean to investors?

According to SEBI rules, at least 90% of  funds collected, after paying for  expenses, taxes and repayment of external debt, should be passed on to investors every six months. IRB InvIT is expected to pay about 12% as returns to investors. Dividend income received by unit holders is tax exempt. Short-term capital gain on sale of units is taxed at 15%, while long-term capital gains are tax exempt. Interest distributed to unit holders is taxed.


What are the potential investment risks?

InvITs are listed on and are subjected to the vagaries of the stock exchanges, resulting in negative or lower returns than expected. An economic downturn or project delays may hit infrastructure projects and result in lower returns. As in mutual funds, investors in InvITs have no control over investments and exits being made by the trust.

Recently IRB InvIT, India’s first infrastructure investment trust fund has come for IPO. The trust aims to raise up to ₹4,035 crore. Reliance Infrastructure, Sterlite Power Grid Ventures and other infrastructure firms are also gearing up to unveil InvITs.

 


Venture Capital investment scenario in India

(Students are advised to read the following free flow writing to have information and ideas on recent venture capital situation in India. Question is probable on this topic)

  • Since 2007, when venture capital as an asset class returned in earnest to the Indian market, venture capital firms have invested more than $10 billion in local start-ups, mostly in the technology and Internet sectors. So far, such investors have struck exit deals worth $8.5 billion.
  • For the past several months, more than a few venture capital portfolios in India have been up for sale en masse and at steep discounts.
  • The problem is that there aren’t many buyers out there for those portfolios. Most of the portfolios on sale represent the so-called copycat investing that has marked the greater part of the past decade of early-stage investing in India and aren’t worth much today in the midst of what is now clearly a prolonged downturn.
  • People are trying to get rid of the lemons through these secondary portfolio sales.
  • All of that is just the early-stage capital that’s been sunk into the market. Add to that the later-stage or growth capital that has followed the early-stage money, and the overall investment would easily ride up to at least $20 billion.
  • Much of the later-stage money, which has come mostly from global hedge funds and strategic investors, also remains unrealized, further compounding problems for the early-stage market.
  • For the past 18 months, since the venture capital market slipped into a downturn, early-stage investors have been more focused on conserving cash and less eager to back new start-ups.
  • Early stage investments will remain on pause till investors are able to consolidate existing portfolios. Right now, nearly every venture capital firm out there is trying to get rid of assets that aren’t going anywhere in the hope that they will get at least the principal (investment) back.


Copycat investing in India

  • The current crisis that the venture capital industry finds itself in today can, to a great extent, be attributed to investors backing too many so-called copycat businesses, especially in the consumer Internet sector.
  • A substantial portion of the money that has been invested over the past 10 years has gone into businesses that one way or the other tried to clone successful versions from elsewhere in the world.
  • In the consumer Internet sector, these manifested themselves across a variety of segments such as e-commerce, cab-hailing services, food ordering and delivery services or the so-called food-tech segment, online classifieds and property search.
  • Now, there’s absolutely nothing wrong with borrowing business models from overseas markets. Except, it cannot be done without paying heed to ground realities.
  • “Even if business models are borrowed from the West or East, they will need to have some strong India-centric localization to make the business both differentiated and better suited for Indian consumers.
  • In rushing after copycat businesses, investors may have forgotten to diversify their bets enough to cushion themselves against a downturn in select segments.
  • By nature, venture capitalists tend to invest in a herd. As the so-called copycat businesses gained popularity, investment portfolios became heavily skewed in favour of such businesses.
  • Further encouragement came from unlikely quarters such as hedge funds and strategic investors who jumped onto the bandwagon.
  • The entry of such non-traditional investors in the start-up market would lead to a ballooning of valuations that would eventually crash.
  • The consumer Internet sector alone is estimated to have been the recipient of nearly 80% of all the money that has been invested in start-ups, early- and late-stage, over the past decade.


Eroding valuations

  • The downturn that is currently in session is largely on account of consumer Internet start-ups losing their bearings in the deluge of capital that flooded the market, especially in the later part of the decade.
  • Indian entrepreneurs need to change their mindset. The goal should be to build viable and profitable companies with great business models as quickly as possible.
  • Even the celebrated unicorns, start-ups privately valued at $1 billion or more, haven’t been able to withstand the downturn.
  • Delhi-based e-commerce company Snapdeal, once India’s second most valuable technology start-up, is on the block after running out of cash. Its valuation has crashed from a peak of $6.5 billion to about $1 billion in a matter of months.
  • Flipkart, the Bengaluru-based e-commerce company in talks to buy Snapdeal, has also seen its valuation erode from a peak of more than $15 billion to about $11 billion over the past 18-odd months.
  • Though it has recently been able to raise $1.4 billion in a fresh funding round, the jury is still out on whether that will be enough for the company to square off against Seattle-based Amazon.com Inc.
  • It doesn’t help that the company’s founders, Sachin Bansal and Binny Bansal, have taken a back-seat and its affairs are largely in the hands of its largest investor Tiger Global Management.
  • But just blaming copycat businesses for the current crisis is a bit harsh. 
  • The deluge of capital, the need for speed and scale and, funds that were initially disproportionate to the size of the opportunity has created relatively sub-optimal returns. Without an infrastructure for scaling or pools of trained skills or exit routes such as small IPOs (initial public offerings) and M&As (mergers and acquisitions), the first 10-year cycle was destined to be a mild disappointment.
  • In some ways, the ongoing downturn in the venture capital market offers early-stage investors a window of opportunity to rebuild some of what they may have lost from the past decade.
  • There’s certainly more than enough money still available to back the next generation of start-up businesses.
  • The early-stage market in India is still relatively nascent and competition between similar start-ups remains intense. Hence, it is important to keep the bar high and look to fund those teams and models which are likely grow despite competition and create enough positive unit economics and scale to be able to exit through an IPO.

 

 
 
Should you join a techies union to save your job?
After reports of large-scale layoffs in the information technology (IT) industry, affected employees are coming together to form unions which can help them fight unfair practices and forced removals at IT companies.

There is a variety of views on the relevance of unions in the IT sector. 
·    Industry veteran Mohandas Pai recently accused people trying to forge unions in IT industry of trying to "create a hype, fear-mongering". He said, "Nobody is supporting them. People who go with them will never get jobs." 
·    No one can deny that forming or joining a union is everyone's right. 
·    Unions help employees fight discriminatory practices of employers as most individuals don't feel empowered to raise their voice against discrimination by organisation. Unions are mechanisms to settle employee-employer disputes which an individual employee does not have the means to.
·    The decision to join the union should depend on whether you face discrimination in your company or fear you would be removed without a valid reason.
·    The current layoffs, however, might be driven by situations that cannot be mended by unions. New visa policies in the US, increasing automation and emerging technology are the main factors behind the layoffs, and not arbitrary policies of the industry.
·    A private IT company cannot be forced to retain employees if that does not make business sense. It will impact its overall profitability and long-term prospects.
·    Unions are not a cure of the current problem which is not created by the employer's style of functioning. However, if you face discrimination at work, a union might help you fight for justice when you are laid off in an unfair manner. If you are already laid off and you feel it was not merely due to the changed business environment, you can become part of a union and even move court.