Trading on Japan

If you are in India, and hear news about the earthquake, tsunami and nuclear reactors in Japan, you might want to trade on this. Either because you are hedging Japan exposure that's embedded in your Indian equity holdings, or because you think you are an informed speculator who has a better and faster judgment about what these events mean for Japan.



Sadly, the Indian capital controls don't let you trade on the Nikkei 225, which is the Nifty of Japan. But there is something you can do: Trade on the JPY/INR futures trading on NSE.



Quite a few people seem to have thought like this. Here's a graph of the turnover:

Now let's pause to think about the story playing out on this market. On one hand, it's the purely domestic speculators or hedgers, who are buying and selling from each other. This is fine, but where are the linkages to the global financial system?



The most important arbitrage which should be at work is in the currency triplet INR/USD, USD/JPY and JPY/INR. But unfortunately, currency futures trading in India does not include the USD/JPY contract, so one crucial leg of the arbitrage is not readily available. With turnover like $100 million in a day, I'm sure some people are doing such arbitrage in some painful ways.

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Rule of law: A pair of stories

by Shubho Roy.



One essential feature of the rule of law is transparency. When a government says something, it must say why it said so. This is important from three points of view:

1. A government that does not need to explain itself is one that has arbitrary power. When a policeman can tell you that you're prohibited from driving because he does not like your face, it is rule of men and not rule of law.


2. The fundamental idea of common law is that the laws enshrine principles that are unvarying for decades or centuries. But institutional and technological details of the economy change rapidly. Well reasoned orders tell the households and firms of the economy how timeless principles are to be interpreted in the present milieu.


3. The aggrieved party can appeal against the order, on the grounds that there are factual errors or errors of reasoning in the order.

A success story: A recent SEBI order

I picked up a recent SEBI order banning a brokerage services agency from operating for two weeks. The punishment is not all that bad: the firm is out of business for two weeks. Yet, before inflicting such a penalty, SEBI had to do the following hard work in the order:

1. Point out when the investigation was ordered.


2. Clearly state which rules were violated. A vague reference to a governing Act does not suffice.


3. Informs the reader about when the affected company was asked to respond. It also mentions that the copy of the investigation report was given to the company.


4. The order then mentions the advocates who appeared for the accused.


5. The findings of the enquiry officer are summarised.


6. The observations of the enquiry officer are recorded.


7. The arguments that the broker made in defense of its actions are presented.


8. The exact transactions which were found to be illegal are described.


9. The reasoning of the officer making the order is clearly laid out.


10. The amount of penalty (suspension of certificate to trade for two weeks) is clearly mentioned.

This is a nice example of legal process in operation. It is a reasoned legal order. Anyone can read and understand it. The order adds to the body of law of securities in the country. It gives an example of the transactions which are considered illegal by SEBI: everyone can learn from the order and not make the same mistake. An appellate court can read the order and decide whether the action of SEBI was fair or not. More generally, SEBI is accountable to the public at large and Parliament in particular, to behave in such controlled fashion.



The right to operate is a very valuable thing. Interfering with the life and liberty of an individual or firm must not be taken lightly. By providing a detailed order, SEBI clearly shows why this right was withdrawn from a person.

A failure story: A recent RBI order

A recent update from the Reserve Bank is a study in contrast. The order prohibits a company from providing money transfer services to India. The text just states that the company is barred from operating in India under the Payments and Settlement Systems Act, 2007. It seems that the company had applied for a licence for operating in India and that application has been rejected.



The order is not reasoned. It does not inform the reader as to why the company was banned. Did the company not comply with rules? If so, which rules did it not comply with? Were there any other reasons, such as inadequate capital, or lax oversight, or failure to enforce KYC rules, which led to RBI denying them the permission? Was there any other required disclosure that the company did not make? Was any hearing given to the affected party? The order/press release also does not state the procedure that RBI used to come to its conclusion.



This is not how common law should function. The order does not add to the body of law in the country. Prospective businesses do not learn what led to the rejection of the application and may continue to make the same mistake when they apply.

Conclusion

The agenda for legal reform in India consists of (a) writing laws rooted in the common law framework, (b) of building agencies such as SEBI which are fully imbued in this ethos, and then (c) of building top quality courts like SAT which exert checks and balances upon regulatory agencies.

Related reading

1. Rule of law and foreign venture capital
   
   


2. C B Bhave's 3 years at SEBI
   
   


3. Corporations and OTC derivatives
   
   


4. Chapter 4 of the Report of the Working Group on Foreign Investment discusses the importance of rule of law in financial regulation in detail.

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Buying respectability

The Economist has an article titled Glitzkrieg, where the blurb reads: "Respectability is for sale. Here is a buyer's guide."



As I read it, I thought: A lot of these tricks are used within India by some businessmen rocketing up to respectability! But there are a few unique dimensions of this racket in India. E.g. big hoardings on the street in Bombay; Gaddafi doesn't do that in London.



But it's interesting to think of three shades of gray:

1. Goods with objective attributes: An ogre can make a commodity like steel, and the customer does not care. The quality of the steel is objectively visible in the steel.


2. Goods where reputation helps: A second tier of products & services are those where there are some intangible attributes.


3. Goods where reputation is essential: In finance, regulators require producers of certain products & services to be fit and proper. Here, it's a matter of life and death. A wannabe has to buy the reputation, to be considered fit and proper, else he will be thrown out of that business. It is similar with ponzi schemes: The emergence and survival of ponzi schemes requires constructing a reputation. There is also an intersection: of ponzi schemes which require fit and proper approvals.

So an ogre who makes steel can choose to spend money on buying a private jet or he can choose to spend money on buying a reputation: that's just a matter of taste. But as you go into the 2nd and 3rd categories, the purchase of reputation increasingly becomes a cost of business.

On these issues, you might like to see: Section 8.1, The intrinsic value of regulation for IFS production, in the Percy Mistry report; and Ethics and entry barriers.

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8th conference of NIPFP-DEA Research Program

The Program
is up on the website. The full set of papers and slideshows will
trickle in within a day or three.

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Education research opening at Centre for Civil Society

The Centre for Civil Society (CCS) is an independent public policy think tank based in New Delhi working on research, advocacy and outreach on critical public policy issues that affect India. CCS is currently looking for researchers, advocacy specialists, and program coordinators to help take the Centre to a higher level. We are recruiting for a Research Coordinator to manage our research agenda, focusing on our ‘Education Reforms Initiative’ and the ‘Law, Liberty and Livelihoods' campaign. The Research team at CCS is responsible to help develop, capacitate, and deliver high-quality research focusing on education reforms and livelihoods in line with the goals of the Centre. For more information on this and other open positions, please look us up on the web.

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A big step forward on interest rate derivatives

For the backdrop, here are two key facts. First, the failures of policy in the field of interest rate derivatives have led to a peculiar situation where substantial trading on the INR yield curve now takes place outside India. Second, while RBI has permitted one exchange traded interest rate derivative product, there are a host of problems with this contract. The process of policy reform in this field has been a disappointing experience. RBI seems to have quaint notions that cash settlement is harmful, that derivatives trading on short-dated bonds could interfere with monetary policy, etc.



In this setting, here's a big move today: cash-settled futures on the 91-day treasury bill. In a nutshell, it will cash-settle to the price of the 91-day treasury bills (details yet to be announced).

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Two unconventional ideas in breaking with bad governance

Jumpstart a city

Cities are the heart of civilisation and growth. A well functioning
city is a great opportunity to obtain economic growth and social
change. The best thing that we can hope for, in thinking about the
lives of poor people or those facing discrimination in rural India, is
for them to escape to a city. We in India don't have a single well
functioning city. As an
example, governance
in Bombay is deeply broken.

How could a poor country kick start the emergence of one or more
good cities? Paul Romer has an idea : To walk down the Hong Kong
route, to create `charter
cities'. See href="http://ajayshahblog.blogspot.com/2010/01/two-paths-to-good-cities.html">Two
paths to good cities. Writing on CFR.org, href="http://www.cfr.org/economics/future-cities-need-hand-over-keys/p24014">Sebastian
Mallaby reports some big events. Last year, Madagascar came close
to signing onto a charter city, but it did not work out. And last
month, Honduras approved a Constitutional Amendment which will make
this possible. So Paul Romer's three-year crusade appears to be going
from a wild idea to the zone of possibility. If it works, it'll score
bigger impact than Romer, 1986, which is in Nobel Prize range.

I personally think it would be a much better use for aid money, to
go down this route, instead of the conventional development economics
that aid agencies emphasise. I feel these existing strategies range
from useless to counterproductive. In contrast, it seems that under
the right conditions, a charter city could work, and if it works, the
upside is phenomenal. So even if 10 charter cities are attempted and
one works, it'd be a huge contribution.

On a related theme, you might like to see: href="http://ajayshahblog.blogspot.com/2009/05/what-if-india-had-hong-kong.html">What
if India had a Hong Kong?

Elect a foreigner

Raghuram Rajan has been talking about another line of attack. He
has a recent paper titled href="http://www.cgdev.org/content/publications/detail/1424879">Failed
States, Vicious Cycles and a Proposal. The blurb reads:

...examines the problems of failed states, including
the repeated return to power of former warlords, which he argues
causes institutions to become weaker and people to get poorer. He
notes that economic power through property holdings or human capital
gives people the means to hold their leaders accountable. In the
absence of such distributed power, dictators reign.

Rajan argues that in failed states, economic growth leading to
empowered citizenry is more likely if a neutral party presides. He
proposes a unique solution to allow the electorate to choose a
foreigner, who would govern for a fixed term. Candidates could be
proposed by the UN or retired leaders from other countries; they would
campaign on a platform to build the basic foundations of government
and create a sustainable distribution of power.

Rajan emphasizes that this is not a return to the colonial mode:
the external candidate (like all the others) would be on a ballot and
the electorate would choose whether he or she was their best chance to
escape fragility.

Each country is unique and we have to ask ourselves what might work
where. In India? Bangladesh? Sri Lanka? Pakistan? Afghanistan?
Libya?

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