I hate to say it, but I told you so. For most of 2005, I was going blue in the face telling companies to steer clear of complex derivatives - those that involved leveraged options to get a better forward rate for exports, or those others providing a nice float provided that the yen (or the Swiss franc or whatever) didn't breach a particular level.
"But, Mr Mecklai," they'd plead, "the yen's never strengthened beyond 85." Or, "Jamal, you know the rupee isn't going to weaken with all the international hoo hah about India."
And I'd say, "You're right", "It may" but "No. No, no, no, no."
It had gotten to where clients were complaining that Jamal never gives his assent to anything remotely profitable. (Adventurous, I would say.) I guess, he's getting old.
Well, darlings, old or not, wake up and count the [opportunity] losses. A top-rated manufacturing company, old line, strong in corporate governance and processes, entered into a forward strip - they sold dollars every month from April 06 to March 07 within a range 44.10 to 44.48.
Now, this was done when the spot rupee was 44, and close to the highest level it had been in over six months. The company was nicely able to lock in its next year's margin (on part of its exports) and it was quite happy with the level.
And, perhaps, it still is. Except that it lost an opportunity of 500,000 in April, 20 lakh (2 million) in May, 16 lakh (1.6 million) in June, 22 lakh (2.2 million) in July, and it's still counting.
And then there's this global IT major with an active treasury that just discovered that FAS 133 accounting requires it to write the mark-to-market losses on derivative positions which are not "effective" hedges into its P&L. While they are still jockeying with their auditors, they may have to take a hit of about Rs 5 crore (Rs 50 million) on their bottom line.
Of course, these are just two stories. There are many, many others. And while some derivatives are actually still in the money, the lesson obviously bears repeating at least one more time - don't get into transactions that you can't value and/or exit from simply.
But this is all old hat. The point here is to discover what drives otherwise well-managed companies to get into these dubious practices. In my view, there are three villains of the piece.
First, of course, is the gap in understanding at many boards of the operational implications of certain business targets. "Blinded by quarterly results" push for profits, some boards demand higher other income or reduced interest costs, as a result of which managements set interest cost reduction as appraisal targets, which, in turn, drives the treasury/finance boys to go for it.
Often they deliver. But when the world turns, and, as we always discover once too often, turn it will, there's a huge amount of scrambling at audit time. Quarterly results are delayed - as this quarter - but, since this is India, and business is still excellent, the champagne still flows.
The second villain is my favourite whipping boy - the RBI. Now, you might say, what does the RBI have to do with poor corporate decision-making? There is no argument with the obvious fact that each company's board is responsible for its own decisions.
However, decision-making has to use and make judgments from information that is available. And if rupee volatility is low (2 per cent) and the forward market hasn't moved beyond 44.10 in six months, it's certainly not unreasonable for someone to try and squeeze another 20 or 30 paise out of exports with a structured product.
There is a moral hazard created by any market belief and the regulator needs to recognise that its actions - in this case, intervening to prevent the rupee from strengthening and, coincidentally, pushing volatility down - create these market beliefs, which, in turn, make dangerous positions seem reasonable.
Rather than talking about targeting rupee volatility but actually targeting exchange rates, the RBI should be more transparent and say nothing and do even less.
And, as the final star in our line-up, we have, of course, banks that sell complex and non-transparent products - the more complex and non-transparent, the better - without loudly announcing "BUYER BEWARE".
While (again) I am all for banks making the highest possible profits, the problem arises when internal profit targets are set at levels that compel sales people to push, cajole, coax customers into transactions that are downright dangerous.
I have heard of one bank, for instance, which had given its treasury sales head a KRA, requiring him it to generate $10,000 for every million dollars of business it did with a certain category of clients. That translates into a margin of over 45 paise per dollar!!! (For the record, for spot transactions, companies seldom pay more than 1 or 2 paise per dollar.)
So what is poor Mr Treasury Sales Head to do?
Well, he could come up with an "attractive float", some fancy packaging (to take care of regulatory guidelines), elegant sales pitch, perhaps even a trip to China or Egypt or what have you and - voila!
Our fish is caught. I've made my KRA (key result area). And the client may not even lose money, provided the market doesn't misbehave.
But, of course, as we keep finding out, the market always misbehaves. And, while KRAs and profit targets are met, the bank's reputation gets sullied.
It seems to me that boards need to focus more of their corporate governance efforts on heretofore neglected constituencies - customers (certainly in financial services, the one area where the customer is not yet king) and employees, who sometimes have to labour under targets which can only be achieved by lying (on the sell side) or taking on far more risk than the company would be comfortable with.
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