Of Archaic Laws & Booby Traps

ANTI-MINE ACTIVISTS and organisation around the world should include India in their list of contaminated countries. Not because the Naxalites are reportedly booby-trapping large swathes of Chhatisgarh with these subterranean explosives. The expertise of anti-mine activists in weeding out live UXOs – or, unexploded ordnances – might come in handy for defusing large chunks of Indian corporate legislation. Many Indian Acts are full of landmines and present potential threats to enterprises and investors.

Look at the Securities (Contracts) Regulations Act. There is a provision in the Act that forbids two parties from entering into a private deal on futures and options. All such contracts have to be transacted on the designated stock exchanges. Therefore, if you have an agreement with your partner to buy back his shares three years hence at a price determined now, which is a kind of an options deal, the courts can rule that the agreement is null and void, ab initio. This absurd rule, otherwise known as Sec 18A, states: “Notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are—(a) traded on a recognised stock exchange; (b) settled on the clearing house of the recognised stock exchange, in accordance with the rules and bye-laws of such stock exchange.” But for the provision to kick in, the courts have to intervene. And for that to happen, somebody (ideally one of the partners) has to go to court.

Ideally, a shareholders’ agreement is like a contract and once two parties sign on it, it becomes binding on both. But, hey, wait a second…here’s an escape route called Sec 18A, provided courtesy GOI and free of cost. And the crucial words are: “Notwithstanding anything contained in any other law for the time being in force…” So, if you signed a deal with your JV partner in a hurry, and want to extract more out of him now, you now know where to look.

Add to this another joker in the pack, Foreign Exchange Management Act, and the Indian corporate landscape resembles a veritable war zone, pocked with undetected landmines. FEMA states that in the case of unlisted shares, the “fair value” has to be worked out as per the erstwhile Controller of Capital Issues. This is strange on two counts: one, the Reserve Bank (which administers FEMA) insists on flogging CCI, which was abolished way back in 1991-92! Also, if it’s an unlisted company, why should anyone bother?

The recent Vodafone purchase of Hutch almost came unstuck because of these rules. Vodafone, after buying out Hutch’s 52% in its Indian operations, wanted to buy out the 12.26% held by Asim Ghosh and Analjit Singh for $430m, according to a pre-determined valuation. Immediately, there was pressure on the government to stop the deal. Reason: its pre-determined prices are essentially null and void. FEMA also kicked in. Fortunately, the Foreign Investment Promotion Board (FIPB) cleared the deal on Friday.

Here’s another interesting case. A few months ago, Narotam Sekhsaria sold off his stake in Gujarat Ambuja to Swiss cement company Holcim. As part of the deal, Mr Sekhsaria also made Ambuja sell off its stake in Ambuja Cement India, an SPV that held Gujarat Ambuja’s stake in another cement major ACC. Under the agreement, Ambuja is to sell off its stake in ACIL in three tranches of 9,53,7500 shares each. The first transaction, completed in the first quarter this year, was struck at Rs 55 per share. Now comes the clincher: the pricing for the next two tranches (to be completed on April 30 this year and April 30 next year) too has been determined (at Rs 56 and Rs 61 per share, respectively). This is like an options contract and can be taken to court by Gujarat Ambuja minority shareholders.

The pact between Holcim and Ambuja for transfer of ACIL shares, at pre-determined prices at a future date, constitute an options contract and can be held to be null and void. The lawyers would have surely wrapped the contract with overseas arbitration clauses and guarantees from various multinational banks. But the minority shareholders might not take to this too kindly. Especially since Gujarat Ambuja had to bear huge interest costs on loans taken to fund the ACIL equity during the ACC acquisition. Now that cement stocks are doing well, they end up with peanuts.

But, guess, who is making the most of all this confusion? It’s a breed called lawyers.

A Case Of Mixed Ethics At Mint Street

IN THE FINANCE ministry or the Reserve Bank of India, rules for banks are decided on the basis of their shareholders. In other words, parentage determines the rules for a particular bank.

True, this is not applicable for all banking operations. Stuff such as the mandatory liquidity ratios, provisioning norms and risk weightages for different asset classes are uniform for all banks. So are a host of other operational details. But the bullet starts biting when it comes to corporate governance norms. One of the areas with the widest divergence is the role and designation of chief executives and the selection of bank directors. Two recent examples highlight the discrepancy in bank governance norms.

First, the government recently asked all listed public sector banks to halve the number of shareholder directors and replace them with government-nominated ones. The second example is the recent public —and rather petulant —exchange between UTI Bank CMD PJ Nayak and RBI. Here’s the spat in short: The bank’s board wanted to re-appoint Mr Nayak as CMD, but RBI put its foot down and said the post had to be split into two — a chairman and a MD. At this point, Mr Nayak told the board that he would continue only as CMD, since “having spent 7.5 years as CMD, it would not be possible for him to function in a different and lesser capacity in the bank and he will, therefore, cease to be associated with the bank after July 31”. This was stated in an announcement to BSE.

The public airing of differences occurred because of the varying rules that exist for different banks. Take public sector banks first. The board composition of these banks is determined by the Banking (Nationalisation and Acquisition) Act, 1970 and 1980 — two archaic pieces of legislation that were drafted for a specific purpose at a particular period in time (mass-scale nationalisation of private banks in two tranches). The Act has undergone several amendments, but one feature remains unaltered: all PSU banks must be headed by a chairman-cum-MD. The only exception is State Bank of India, which is governed by its own Act. For a variety of curious reasons, the government, as the largest shareholder of PSU banks, and RBI (as regulator of banks) have refused to split the posts.

On the other hand, all private banks have to compulsorily appoint a non-executive chairman and an executive CEO or MD. There could be legal reasons for this — these banks are not governed by the antiquated Act mentioned above, but by the Banking Regulation Act. If you look at the boards of most new private sector banks, the chairmen are usually appointed in a non-executive capacity (and are mostly retired senior RBI officers) while the chief executive is the main executive for driving the bank’s growth.

The story is completely different with foreign banks. To start with, foreign banks are regarded as branches of their parent organisations. For example, American banks in India are usually branches of their parent organisations in the US. This peculiar structure is to make the parent liable for any big risk event here. The parent’s capital is then directly committed to the bank’s operations in India, which acts as a safety cushion. This also has a bearing on the board structure. Foreign banks, since they are not incorporated as legal entities, do not have a legal board. They are allowed only an advisory board, which is headed by a non-executive chairman, usually a senior retired bureaucrat.

RBI appointed two committees in recent times to take a look at corporate governance in banks and financial institutions. The first, headed by RH Patil, among other things said: “…any steps to improve corporate governance in the Indian economy would remain incomplete and half-hearted unless public sector units are also covered in this exercise”. The second panel, headed by former HLL chairman AS Ganguly, in fact, went a step further and noted, “It would be desirable to separate the office of chairman and managing director in respect of large-sized public sector banks. This functional separation will bring about more focus on strategy and vision as also the needed thrust in the operational functioning of the top management of the bank”.

However, despite suggestions and the evident infraction of ‘desirable’ governance norms, the government and RBI soldier on in their belief that the goose and the gander need separate sauces.

In Quest For An Eternal Knot

USUALLY people look skywards when exclaiming Good Heavens! Maybe because people feel heaven is located somewhere in the far reaches of a remote galaxy. In any case, it must be somewhere up there in space. Logically, therefore, marriages made in heaven should usually denote unions solemnised in mid-air. No wonder, the owners of a Mumbai jewellery chain got their son married in an aircraft some years ago. They hired an aircraft, yanked out all the seats to accommodate guests, got the aircraft to circle over Mumbai for two hours while the priest tied the groom and his bride into an ‘eternal’ knot.

Sure, people do crazy things to get married. Another Mumbai-based couple first got engaged in mid-air, suspended by ropes 50ft above ground level, and then got married underwater in a local swimming pool. The ceremony, which lasted over 36 minutes, was sanctified by a priest, the bride's father and sundry relatives. The dress code: scuba gear!

The Jet-Sahara now-on, now-off wedding — though redolent of a mid-air fender-bender — leaves behind the acrid smell of burnt gunpowder on the ground. So, was it a shotgun wedding where the suitor doesn't have much of a choice? In the classical sense, the bride's father forced a ‘shotgun wedding’ upon the groom, to protect the family and the girl's reputation. But over time, the term has come to signify any condition under which the groom is forced to walk down the aisle. It could even be external forces, such as competition or to pre-empt impending industry consolidation. Alliances, mergers, sell-outs are all prompted by a variety of reasons, some forced upon companies, some strategic in nature.

When Ramesh Chauhan sold India's leading soft drink brand Thums Up to Coke in the early nineties, there was quite a to-do in Indian industry about Chauhan selling out, capitulating to western forces, not having the stomach to stay in the field and slug it out, and so on. The fact is Chauhan saw the writing on the wall and sold off his brand from a position of strength. That is not always the case. Hindustan Lever sold off Dalda, the iconic vanaspati brand, to foods company Bunge, because it had ceased to deliver high margins in a market that had evolved in tastes and transformed intrinsically. In fact, Levers also sold its fertiliser business — a low-margin business strategy devised to keep the government happy in the notorious anti-MNC days — to Tata Chemicals when it had outlived its utility.

Look at some of the other forced alliances in India Inc. The Tatas had to sell Tomco to Hindustan Lever, when they realised they had a losing business on their hands. All the brands were steadily losing market share, margins were headed south and the company lacked the expertise to rejuvenate the brand portfolio. Even Balsara had to be sold to Dabur for similar reasons.

But alliances can also happen because of strategic reasons. Citigroup tied up with Travellers Group, because the insomniac bank wanted a lucrative piece of the retail banking, such as broking, insurance business. Even if that subsequently resulted in the exit of Citi CEO John Reed. Speaking of which, Jamie Dixon, who moved to Citi with his fellow Traveller boss, quit in a huff, joined Bank One, convinced JP Morgan for a merger and became boss of the combined entity.

Interestingly, current day JP Morgan (before it merged with Bank One) had gathered bulk through a series of historic mergers. On one side was Chemical Bank, which in 1991 joined forces with Manufacturers Hanover (lovingly called Manny Hanny by bond and currency dealers) and merged with Chase Manhattan in 1996. Finally, in 2000, this post-merger giant merged with JP Morgan. Look at the outcome — four of New York's oldest and largest financial institutions (Chemical, Manny Hanny, Chase and JP Morgan) were all now under the same roof. In 2004, Bank One (another product of serial mergers) merged with JP Morgan Chase to create one of the world's largest banks.

Mergers, alliances, or even outright takeovers — unlike marriages — are made mostly in boardrooms or on the floor of stockmarkets, but rarely in mid-air.

India Inc Wakes Up To Pre-nups, But Can They Salvage JVs?

TILL her recent death, Anna Nicole Smith (she of the fabled physical virtues) was constantly reminded how she should have signed a pre-nup before marrying billionaire oil tycoon J Howard Marshall. On his death, the former Playmate felt she was done out of her rightful share of Marshall's estate by his son from an earlier marriage. Marshall, 63 years her senior, had not left Smith anything behind and this resulted in a lengthy suit, which is still continuing.

This seems strange in a land where pre-nups have become synonymous with celebrity marriages. Pop singer Britney Spears has been complimented for having presciently signed a pre-nup before marrying Kevin Federline. So, when they split, the guy got only $300,000 of her $100m assets. Michael Douglas and Katherine Zeta Jones brought respectability to pre-nups during their high profile wedding. Ditto for the Tom-Kat nuptials.

Legally, though, there's a debate whether pre-nups can actually be enforced. While pre-nups may be a legal contrivance to avoid the messy, post-split sharing of assets, they may not still represent the final word in a court of law. And, yet, most wealthy couples tying the knot stateside prefer to incur huge legal expenses to hammer out the tiniest details about who is to get what, including pets, in the event of a divorce. Clearly, getting hitched has become an expensive affair.

Actually, so has the cost of entering into a joint venture in India. Pre-nups of a different nature are being signed by prospective JV partners every day, thereby increasing the cost of doing business in India manifold. JVs forged before 2005 had one uncomfortable thorn in their side, a strange beast called Press Note 18. The note, a policy document, essentially required a foreign partner wanting out of a JV, so that he could set up his own 100% venture, to first get the JV's board to provide him with a no-objection certificate. Many Indian promoters sensed excellent business opportunity and sighted future revenue flows in this arrangement.

Increasingly, as the foreign partner realised that it was time to strike out on his own — whether it was because the foreign investment rules had been relaxed, or the Indian partner could no longer provide any capital or useful entrepreneurial input, or because he had outlived his utility — the NOC became a stumbling block. Worse, it acquired a price tag. Strange as it may sound, the government had provided Indian promoters a monetary protection, or an insurance policy. Predictably, many Indian promoters reaped rich dividends from this.

After substantial lobbying, the government realised this did not fit in with its pro-reforms, pro-FDI image with global investors. Say hello to Press Note 1 (2005 Series). This has two parts. The first says that if a foreign partner wants to set up an independent unit in the "same" field as the JV, then it would need prior government approval. But proof would have to be furnished to the government by both parties — again a form of insurance policy — that the new venture "would not in any way jeopardise the interests of the existing joint venture".

The second part is even more interesting. The note suggests that JV agreements "may embody a 'conflict of interest' clause to safeguard the interests of joint venture partners in the event of one of the partners desiring to set up another joint venture of a wholly owned subsidiary in the 'same' field of economic activity." Hence the hectic signing of pre-nups before JVs are set up.

The only guys who seem to be gaining from all this are lawyers. Scores of them are employed by both sides to draw up an appropriate pre-nup, which minimises the risk, since it cannot be totally eliminated. "Conflict of interest" could mean anything and prenups have to be very specific. For example, a pharma pre-nup has to specifically mention what's a potential conflict — bulk drugs, generics, branded OTC products or life saving drugs. And yet, as lawyers and JV partners point out, the courts can still have the last word. All this adds to the cost of doing business in India.

Pre-nups alone are inadequate for salvaging either joint ventures or marriages.

Words worth in modern times

I won’t make promises that I can’t keep
I won’t make promises that I don't mean
I'll even mean the things I tell you in my sleep,yeah
I won’t make promises babe,that I can’t keepPromises, DEF LEPPARD

INDIA INC HAS AN UNPLEASANT AND UNWANTED GUEST this summer — broken oral agreements. In the history of business alliances, marriage pacts and international negotiations, oral contracts and promises have always had a place of pride and importance. A gentleman's word, once given, was always expected to be honoured. And, usually it was. People gave their lives but would rarely go back on their word. Indian mythology, especially the Mahabharat, is replete with examples of how broken promises — intentionally or otherwise — have resulted in grief and a life led largely in misery.

It is said that, in medieval England, if a man promised to marry a woman and then reneged on his promise, he was liable to pay a penalty. Wikipedia states: "A man's promise of engagement to marry a woman was considered, in many jurisdictions, a legally binding contract. If the man were to subsequently change his mind, he would be said to be in ‘breach’ of this promise and subject to litigation for damages." In fact, the world has seen courts honouring oral contracts on numerous occasions.

For instance, in early 1984, Gordon Getty agreed to sell his substantial holding in Getty Oil to Pennzoil. The hands were shaken and the deal was almost done, save the signing on the dotted line. In came Texaco and offered Gordon Getty a better deal. Like a good businessman, Mr Getty succumbed to the higher bid and sold his stake in Getty Oil to Texaco. Spurned and rejected, Pennzoil filed a lawsuit against Texaco and, surprisingly, won the case and was awarded damages of $10.3billion. Likewise, in 2006, actor Marlon Brando's death left the executors of his estate facing an irate housemaid, who claimed that she had been done out of a house the deceased Hollywood star had left behind for her. Her contention was that since the actor had ‘promised’ her the house verbally, it was as good as any contract. Predictably, after the initial bluster and flurry of court cases, the matter was settled privately.

The Indian legal system, like most other legal systems around the world, too finds oral agreements binding, provided they are backed by sufficient and leading evidence. Courts usually require the complainant to provide proof that an oral agreement did indeed exist and that it was breached. If there are witnesses to the oral compact, well and good. Otherwise, the courts rely on circumstantial evidence and other kinds of proof.

It will be interesting to see how the purported oral agreement between the two warring Bajaj factions gets resolved. It is believed that the two brothers — Rahul and Shishir — entered into an oral agreement over the methodology to be adopted while splitting the family business. What complicates matters is that there's not only one agreement; layers of them exist, to sub-serve the layers of companies used to control the family empire. Different newspapers have cited different agreements as the root of the alleged ‘breach of promise’! In fact, there is also no clarity on who has gone back on this shadowy oral agreement. In the flurry of media reports, both parties have alleged that the other has gone back on his word.

But clearly somebody, somewhere, has not honoured an agreement. Both sides are sure to contest this in the courts and a protracted legal battle looks imminent. If there's any moral in the story, it's this: always insist on a written contract. Another Indian industrialist once learned the same lesson. Having trusted, helped and financed an ally to take over the foreign holding of an Indian company, on the express condition that the stake would be later transferred back to him, the guy watched helplessly as his friend usurped the company, bled it dry and denied ever having entered into any agreement.

As the irascible movie mogul Sam Goldwyn once said: “An oral contract isn't worth the paper it's printed on.” In business, trust seems to last only till the next quarterly results.

After the billing & bustle, it’s time to retire... Indian style

THE concept of a corporate organisation, as a sociological construct, has its origins in the West. India Inc imported this notion from the early mercantilists and has changed it over the years to suit local cultures and customs. Even when the compelling forces of globalisation, in the form of scrupulous foreign portfolio investors, have forced Indian companies to adopt western, cookie-cutter systems and processes, Corporate India managed to retain some indigenous streaks. One of the manifestations is probably the age-old practice of 'Vanaprastha'!

Essentially this meant retreating from active work, family life and worldly trappings into a life of frugality and meditation, preferably deep in the forests, far from prying eyes. Call it the Indian idea of retirement, if you will. In fact, the concept of retirement varies from culture to culture. Sometimes it also depends on the loose change in the pocket to the snug cash balance with the bank. ET wrote about this inimitable itch ('Vanaprastha at 50') in its Cosmic Uplink columns about a week ago. Whatever the circumstances, 'Vanaprastha' has been a long-followed tradition in Indian society and is now becoming acceptable even to India Inc. Infosys co-founder NR Narayana Murthy wrote his own unique Vanaprastha software. Likewise, Bajaj Auto chief Rahul Bajaj decided to park himself in Parliament.

Sunil Bharti Mittal had announced in this newspaper a couple of years ago that he wanted to give it all up and do something completely new. In fact, as the first step towards achieving that goal, he has already decided to give up the grind of running the company on a daily basis and decided to instead focus on "mentoring, strategy and governance." So, here's some unsolicited advice to Mr Mittal on doing some nifty retirement planning.

And, a large part of that depends on the recently signed Vodafone-Essar deal. Here we go. The Ruia family threw a party on Thursday evening, on the lawns of their sea-hugging bungalow in South Bombay, to celebrate the completion of the Vodafone-Essar deal. Some old rivals, some old telecom competitors, some new players, bankers, consultants, promoters... they were all there. In the middle of the party came the time to make the formal announcements. Vodafone's Arun Sarin made a telling statement: "This deal is not for us, not for Shashi (Ruia) or Ravi (Ruia); this deal is for the future generation. It's for Smriti (Ruia, Ravi's daughter), Rehan (Ravi's son), Prashant and Anshuman (Shashi's sons)!" What was he saying?

Reading between the lines, Arun Sarin could be requesting the Ruia family to hang in there, and not get into a hurry to sell their 33% stake Hutch Essar. One reason could be the stretched finances. After having paid top dollar for a 67% stake in the Indian telecom service provider, Vodafone might need some time to breathe before it can cough up another $5bn-odd for the Ruia stake.

And, maybe in the meantime improve the valuation of the company.

So, where does Sunil Mittal fit into all this? Well, at some point in the future, it is inevitable that Vodafone-Essar (V-E, as Hutch is now called) will have to look at the consolidation game. So, will Bharti. With Vodafone being the common thread between the two companies (Vodafone also owns around 4.5% in Bharti), and with both Bharti and VE agreeing to set up a common company to share the infrastructure, it will make eminent sense for all the parties concerned to agree to a merger. The merger will also be driven by the need for large, and continuous, dosages of capital infusion.

The merger, as things stand today, is bound to happen. Not today, not tomorrow, not even the day after. It's going to take at least 2-3 years before the pot starts boiling. And, when it does, the valuations are bound to be higher than today. Under the exit agreement, Essar has the option to sell its 33% V-E stake for $5bn between the third and fourth year from today, or even a part of the stake at a price to be valued independently.

Given that the valuation would have soared by then, and with the Ruia family not actually running the company, it is quite likely that the Essar stake will be sold. That would clear the way for the merger to go ahead, Sunil Mittal's stake in the merged company will be immensely valuable. Post the merger, V-EBharti will easily become the Number One telecom company in the country. As the pecking order stands today, Bharti tops the league tables, with V-E coming in at No 4.

The interesting question is: if he does opt for "Vanaprastha", what will Sunil Mittal do with his stake? The mind boggles at the vast opportunities at his disposal. Mr Sunil Mittal, in effect, will be able to fashion his own Vanaprastha, with doses of entrepreneurship, stewardship and CSR. That's corporate retirement, Indian style, for you.

Pre-empt Regulatory Arbitrage

The Reserve Bank of India’s reputation as a regulator is rock-solid in the global financial system. It now has to ensure that its regulation on NBFCs has the life span of a turtle

SOMEONE once gave regulation one-fifth the life span of a chimpanzee. India has seen numerous examples where the regulator tries to erect walls around a particular sector, only to find that business has found a way around. Some of these sidesteps can be labelled as criminal, but most of these instances can be clubbed into what is now known as “regulatory arbitrage”, which means utilising gaps in the existing regulatory framework without violating the law of the land. There is a regulatory arbitrage occurring right now, which has the Reserve Bank scrambling to plug the loopholes. This involves nonbanking finance companies (NBFCs), especially those promoted by foreign banks or even those sired by international financial giants. The central bank is now planning to come out with regulation that endeavours to eliminate the NBFC-spawned arbitrage.  

Foreign banks are keen to expand their footprint, and given India’s growth rate, they want it all done now! India is currently the hot new thing on the global investment block and everybody desperately wants in. Even foreign banks that once found business in India only marginally engaging now suddenly want to hitch their wagons to this emerging economic powerhouse. For example, certain European banks, which, in an exemplary display of foresight, had deliberately shrunk their Indian businesses in the ’90s, are today jostling to catch a piece of the action. And, this requires branch expansion of an unprecedented scale. 

But then the RBI thinks otherwise. The central bank has been deliberately going slow in granting new branch licences, driven by larger apprehensions of systemic risk. As an alternative, some foreign banks have been expanding their presence through finance companies, or NBFCs. These NBFCs don’t need to approach the RBI for opening branches. Most of them don’t even accept deposits in order to escape the RBI’s gimlet gaze. As a result, foreign banks have been opening NBFC branches furiously. These branches are, for all practical purposes, like bank branches with only one crucial difference — these can grant loans for buying houses, cars or two-wheelers, but cannot issue cheque books. According to a report of an RBI internal group on ‘Level playing field, regulatory convergence and regulatory arbitrage in the financial sector’, banks are likely to set up NBFCs to benefit from regulatory arbitrage: “A bank’s NBFC subsidiary which grants retail loans such as consumer loans, vehicle loans, housing loans, etc., coupled with a bank ATM can circumvent the branch authorisation restrictions imposed on the bank by extending its outreach substantially. The customer can deposit or withdraw cash at the bank ATM, obtain a loan from the NBFC and make repayments into the loan account by using the bank ATM. Thus, the bank together with its NBFC subsidiary can perform more or less all the functions which a bank branch undertakes.”

The trend has now taken a curious twist. The RBI has now stopped a few banks from opening or operating NBFCs, without doing anything about the existing ones. Barclays, Deutsche Bank and HSBC find their applications for NBFCs lost in a black hole. Interestingly, NBFCs launched by non-banks have sailed through — in addition to GE Money, US insurance giant AIG recently got the nod to launch and operate an NBFC. So did Singapore’s Temasek, which bought over an existing NBFC (something reportedly done by Goldman Sachs). In the midyear review of its 2006-07 credit and monetary policy, the RBI has even allowed these NBFCs to issue co-branded credit cards and sell MF products. This puts them somewhat on par with banks.

The RBI’s concern with bank-run NBFCs is not totally out of place. Many of these NBFCs extend risky loans, including loans to speculate in the capital markets. This is risky on two counts — first, any default can lead to an impairment of the parent bank’s capital. But the riskier proposition is the contagion effect it may have on the system as a whole. Most of these NBFCs are heavily leveraged, which means they borrow in multiples of their capital (can be 10-15 times) from the market to finance their lending operations. So, any slight slippage might affect even the lenders, who in turn might knock over another chain of financial agents in the system. 

In all likelihood, the RBI might opt for stricter regulation of the banks that have promoted NBFCs. For instance, it might choose to treat a bank and its family of NBFCs as a conglomerate, inviting consolidated supervision, including imposition of ceilings on the conglomerate’s lending to industrial groups. There might even be stricter norms introduced for bank financing of NBFCs against shares, debentures and PSU bonds, in addition to finding ways that staunch the flow of bank funds to the capital market through NBFCs. Another alternative would be closer coordination with Sebi for regulating finance companies that are engaged exclusively in the stock markets. The overall purport of the new NBFC policy will be to make a distinction between bank-sponsored NBFCs and independent ones, against the current difference of deposit-accepting and nondeposit accepting NBFCs.

All that’s fair enough. But there’s another problem here: if the RBI shuts the door now, it presents a new kind of hazard. It provides the existing foreign banks with an unfair advantage over the others, which might then induce the excluded lot to indulge in an extreme form of regulatory arbitrage. The top five foreign banks already account for 82% of the total profit reported by all the 30 MNC banks in the country. Any form of prospective selection through regulatory fiat might only enhance this discrimination. The Institute of Chartered Accountants of India shut the door on foreign accounting firms some years ago, but only after it had allowed in a couple of the foreign firms. However, the ones left standing outside the gates still managed to sneak in through cracks in the wall. MNC banks, deprived of either branches or NBFCs, might be also tempted to attempt something extreme, thereby putting the entire system to even a greater risk. The RBI’s reputation as a regulator is rock-solid in the global financial system; it now has to ensure that its regulation on NBFCs has the life span of a turtle.

Published as an Op-Ed in The Economic Times (November 1, 2006)

The Business Of Politics

For lasting success, political families should imbibe some of the best practices that business families have implemented to survive and grow

DYNASTY ought to become a four-letter word for politicians, as most family-run businesses have realised to their peril. There’s further evidence of that now from far away lands. In a recent survey of over 700 mid-size manufacturers spread across France, Germany, the UK and US — conducted jointly by McKinsey and London School of Economics — it was found that, on average, family-owned companies with outsiders as the chief executive seemed to be better run than those managed by family members. But, even if the number of successful family-run businesses constitutes a small percentage of the total sample, they seem to hold a message for the political families — for lasting success, they should imbibe some of the best practices that business families have implemented to survive and grow. 

Pioneering US businessman Andrew Carnegie had conveniently provided today’s business families and politicians with a peg to hang their learnings: “From shirtsleeves to shirtsleeves in three generations”. Translated, that means the first generation works hard to accumulate wealth (and so is dressed in shirtsleeves), the second generation consolidates the wealth and the third generation blows it all up, ending up in shirtsleeves as well. Plus, there is the inherent conflict — family, as the only natural and oldest sociological grouping, is intrinsically socialist in nature while managing a business is essentially capitalist. As evidence, the courtyard of post-Independence, postindustrial India is littered with the ruins of many family-run businesses, which have perished in the dynastic death-trap.

At the same time, there are numerous other family-run businesses that have managed to sidestep the grim reaper of bankruptcy. They have managed to do so after a lot of hard work, outside consultation, internal discussions and a clear vision. Businesses run by families have long been the subject of intense study by management experts. B-schools hold special courses for scions of business families, which teach them the nuances of managing and growing their businesses. Many families have even engaged external consultants from famous B-schools to tutor them in the art of resolving family-based conflicts to grow their businesses.

A large number of successful businesses worldwide — such as, Wal-Mart, Ford, Motorola, Cargill, and Hewlett-Packard — are family-owned and many of them are managed by hired professionals. In these cases, the family prefers to oversee and safeguard their investments from the vantage point of a board position. They even lay down a set of values — unique for that family or bequeathed by the founder and followed by subsequent generations — for executives to follow. Even where a family member is part of the management team, he needs to have a separate set of guidelines to steer him through the minefield of familial squabbles and differing expectations. A large number of Indian family-run groups have managed to defuse the in-built, shirtsleeves-time-bomb in their businesses by following a set of structured processes. As a result, they have also reaped the benefits — higher m-cap rewarded by the market, zero day appearance on B-school campuses, easier and cheaper financing options, ability to hire top-of-the-line professionals and respect from JV partners.

So, what kind of lessons do these companies hold for politicians whose kids are also keen on joining politics and nurturing their dad’s constituencies? The first trick is to separate issues of ownership and business control, roles that are essentially conflicting in nature but often end up overlapping with each other. In the politician’s case, ownership is the dedicated vote bank and party workers that dad hands over to the son. But business control is what junior chooses to do with the constituency — by improving governance, infrastructure and the general well-being of the voters. This provides a lasting business model for the son and has beneficial impact on ownership issues as well by earning him higher recognition in the party. According to a 2003 article in the McKinsey Quarterly (Keeping The Family In Business: Heinz-Peter Elstrodt), “at the core of a durable family enterprise is the philosophy that ownership implies, not necessarily the right to sell, but rather the responsibility of handing a stronger company over to the next generation.” TV show host Jay Leno is believed to have remarked: “If God wanted us to vote, he would have given us candidates!” Politics 101: over time, the son should aim to become a candidate, and not something foisted on an unsuspecting public.

There’s another important learning: how to resolve conflicts. Indian politics has seen many sons estranged from their mothers, sons from their fathers, sons-in-law from their fathers-in law, and so on. This brings about a break in succession planning and often ruins the politico-business model. Business families with many members typically spend a lot of time in conflict resolution, before arriving at a consensus. Once that’s done, everybody falls in line. Splits in family-owned groups often happen because of conflicting ambitions among family members and the desire by multiple members to have a say in the working of the business. It is often argued that the rate of survival for a consolidated business is much higher than allowing the business to split into numerous parts with separate investments.

The final bit of knowledge lies in the history of the Rothschild family. In the mid-18th century, Mayer Amschel Rothschild entrusted his five sons with expanding the family’s banking business in the five major European financial capitals of that time — Frankfurt, Vienna, Paris, London and Naples. Each of them was lent money under the stipulation that once the original loan was repaid, they could retain the profits in the individual centres. Over time, only the London and Paris branches survived the ravages of time and modern history. But, the story has a moral: Rothschild Sr could insulate the original business from the shirtsleeves syndrome by diversifying through his sons. Political families with more than one heir should use the Rothschild example to resolve the aspiration issue — one son gets into politics while the others join a completely different profession.

Published as an Op-Ed in The Economic Times (October 12, 2006)