Monday, June 20, 2016

Algorithmic Trading: Balancing Pros and Cons

This article was first published by the Global Association for Risk Professionals on June 19, 2016

Six years since allowing algo trading, India wrestles with questions familiar across financial markets  

Since first being allowed in 2008, algorithmic trading has grown to account for 40% to 50% of the turnover on the National Stock Exchange (NSE) of India.
Widely regarded as a disruptive technology, and creator of advantages for some that harness it, algo trading was defined by the Securities Exchange Board of India (SEBI) as “any order that is generated using automated execution logic.”
The late Gangadhar Darbha, who was executive director and head of algorithmic trading strategies at Nomura Securities, said, “Algorithmic trade per se is nothing but a reflection of what happens in our brains. Algo trading is the use of electronic platforms for entering trading orders with an algorithm which executes pre-programmed trading instructions whose variables may include timing, price, or quantity of the order, or in many cases initiating the order without human intervention.”
Institutional investors, insurance companies and mutual funds use algorithmic techniques for portfolio rebalancing and risk control amid large order flows on either side. Anonymity and mathematical logic to break large orders into small pieces can counter adverse price moves and manipulation.
Financial firms apply the cutting-edge technology to product development and innovation in such areas as liquidity-seeking, cross-asset and multiple-exchange trading.
While it is difficult to know the strategy or logic being applied by looking at the trade data, it seems unlikely that the algorithms act on fundamental information about companies or the economy. Algo trading takes into account quantitative information regarding trends, reversion to mean, arbitrage, etc.
It is argued that computer-assisted trading improves liquidity in the markets by breaking down large trades into smaller trades, reduces bid-ask spread and lowers risks of adverse selection and trade related price discovery. Terrence Hendershott, Charles M. Jones and Albert J. Menkveld, in “Does Algorithmic Trading Improve Liquidity?” (Journal of Finance, Vol. LXVI, No. 1, February 2011), argue that algo traders are more likely to be providers of liquidity. They also increase the speed and efficiency of trades and reduce costs of trading.
Flash Crashes
There are also purported disadvantages.
There have been many instances of flash crashes on exchanges around the world, in which automated trading has been implicated, whether due to erroneous coding, a systems failure or cascading effects of certain trades. Algo is also often blamed for causing large fluctuations or volatility in the markets.
On October 5, 2012, the CNX Nifty Index of top 50 companies traded on India’s NSE fell nearly 16% within seconds (before rebounding), causing panic amid traders and institutional players, as stop losses were triggered. Similarly, the Bombay Stock Exchange (BSE) had to annul all trades on “muhurat day” in 2011 due to extraordinary volumes. (Muhurat day is a special trading session on Indian bourses to mark to beginning of the new financial year on the Hindu calendar. It coincides with the popular festival of Diwali.)
Algo trading’s effect of improving liquidity has been scrutinized. It is alleged that algo trades focus on a few large stocks, resulting in short-term liquidity improvement only for those stocks. If this also means that trading gets concentrated in fewer stocks, then this is not good for an exchange. And if algo trading magnifies panic, it can have an avalanche effect on prices.
Technology is reducing the cost of trading and attracting large volumes. But that requires exchanges to improve the efficiency and capacity of their data servers, matching engines and bandwidth, which in turn increases infrastructure cost and has to be added back to the brokers transaction cost.
Haves and Have Nots?
Does algorithmic trading "discriminate between rich and influential brokers and common investors/retail investors and create inequality” among constituencies on the BSE and NSE, as has been alleged by the Intermediaries and Investor Welfare Association? Algo traders have a technological advantage over the regular market participants, who are not able to afford such high fixed costs.
The Technical Advisory Committee of the SEBI, it was reported in April, noted that a certain broker benefited from loopholes in the systems architecture of NSE, which were not prevented by the exchange. Larger questions regarding the role of the regulator in coming out with policies on co-location and algorithmic trading are being raised as well. The surveillance systems of the exchanges and regulatory actions against manipulative activities have not kept pace with the improvements in technology and the complexity of algorithms.
Interestingly, rampant accusations that flash orders favor insiders led some lawmakers in the U.S. to urge in 2009 that the practice be banned by the Securities and Exchange Commission. It remains legal. The Indian counterpart, the SEBI, has set an agenda for itself to come out with a discussion paper on high-frequency trading, or algo trading, in the coming three months, which could lead to regulations of those activities.

Perhaps the right way to look at it is as Darbha once said in an interview: “Algorithmic trading is not just a facility, but an aid. While algorithmic trading gives you freedom to trade, it does not replace fundamental research. It only enhances trading efficiency.”

Monday, June 13, 2016

The Indian Economy under Rajan

This article was first published by the Global Association for Risk Professionals on June 09, 2016; was updated on June 20, 2016; Co-author: Anisha Sircar, Flame University, Pune

Results of the central banker’s first term made a strong case for reappointment to a second

Subramanian Swamy, a Harvard University PhD in economics and a member of the Upper House of the Parliament of India, recently wrote a letter to Prime Minister Narendra Modi. It criticized Dr. Raghuram Rajan, the 23rd governor of the Reserve Bank of India, on many different counts, and urged immediate termination of Rajan’s services, on grounds that the central banker, whose three-year term expires in September, is deliberately trying to “wreck the economy.”

After saying he was open to serving a second term and leaving the decision to the Modi government, Rajan issued a statement June 18 saying he will step down.

Rajan has been generally recognized as one of the most influential and proficient governors of the RBI. He was previously chief economist at the International Monetary Fund, chief economic adviser of India’s Ministry of Finance, and the Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago’s Booth School of Business. He is credited with predicting, early in 2005, the global financial crisis that hit in 2008. He was regarded as someone with international exposure who could anticipate problems and find distinct solutions.

When Rajan assumed office at the RBI in 2013, the economic climate was characterized by a free-falling rupee, touching nearly 70 against the U.S. dollar, alongside rising deficits, high inflation and overall sluggish growth.

Early on, Rajan announced his “Five Pillars of Reform,” inspired by the three “arrows” of the Japanese Prime Minister, Shinzo Abe. The pillars were an effective monetary policy framework that was transparent, credible, clear, and that could be “understood by the broader public”; banking sector reforms to give anybody the liberty to apply and set up a bank at any time; deepening the Indian markets; providing financial services to rural areas; and the creation of a “simpler, cleaner and less value-reducing” mechanism to address financial distress so that lending was rendered easier, faster and more efficient.

Besides delivering on the promises made at the start of his term, Rajan, along with other key decision makers and other factors, helped in ensuring that India has been the emerging-markets nation to withstand a general economic downturn. Other BRICS countries were considerably weakened in the aftermath of the Chinese slowdown.

Furthermore, facing anticipated Federal Reserve tightening, the rupee remained relatively strong. Last year, when the rupee plummeted to a two-year low, passing the 66/$ mark, and Sensex tumbled after the yuan shock, Rajan assured the world that India was in a far better position to weather the volatility.

Downward Inflation
Monetary policy under Rajan has been regarded as far more clear and systematic than its antecedents. According to the new framework, the challenge was to achieve an inflation target of 6% by 2016 and 4% by 2017; that is on target, with inflation now around 5.4%.

Declining inflation has made India a favorable investment destination and paved the way for continual interest rate cuts. However, containing inflation through interest rates has not gone down well with critics such as Swamy, who has called it “disastrous” to the industry, causing unemployment.

In his May 16 letter to Modi, Swamy voiced objections to the shifting of the inflation target from the wholesale price index (WPI) to consumer price Index (CPI). That the move was recommended by an Expert Committee set up to “Revise and Strengthen the Monetary Policy Framework,” and that the committee was comprised of eminent economists and statisticians from such institutions as the Indian Statistical Institute (New Delhi), Williams College (USA), JPMorgan, Bank of Baroda and Nomura Securities, apart from being represented by the RBI, does not seem to matter to Dr. Swamy.

As explained in the committee report, “CPI inflation excluding food and fuel has remained sticky at an elevated level, averaging above 8% and playing a growing role in determining wage and price behavior in India.”

The report also stated: “Shocks to WPI inflation have no statistically significant impact on inflation expectations, indicating that targeting the WPI would do little to anchor inflation expectations”.

It is also contended that private-sector corporate investing has flatlined after peaking in 2011, that the stressed assets may lead to a decline in investment, and that this is a bottleneck that needs to be dealt with by the RBI. “In the last two years,” Swamy wrote, estimated NPA [non-performing assets] in public-sector banks has doubled.”

Bank Provisions
It needs to be acknowledged that the NPAs have accumulated over several years. But, at least under Rajan, the banks have started to recognize these stressed assets and begun provisioning for them. The first step towards solving a problem is to recognize that there is a problem – and that step seems to have been taken.

It is also argued that despite the success so far with inflation, and interest rates coming down, real borrowing costs remain high. And although it has remained relatively resilient, it is not on a strengthening trajectory, which is a cause for worry as it may engender higher inflation in months to come. The cost of borrowing/lending is determined by the banks, and Rajan has been appealing to the banks to pass on the decrease in interest rates to the customers.

Equity strategist Christopher Wood of CLSA, in one of his “Greed & fear” reports, argued that the biggest risk to India’s bond and currency markets would be to let Rajan’s term expire.

Doyens of Indian industry have come out in support of Rajan, urging a second term at the RBI. These are the same industrialists who have kept up pressure on Rajan to reduce interest rates further. So why would they be so supportive of him? The answer is simple. Rajan has “performed.”

Rajan said on CNBC Awaaz as reported June 8, “The announcement over my tenure will be made between now and September 4 when my term ends.” He acknowledged that his “long-term plan is to get back into academics, to teach and to go for research.

Rajan has now ended the suspense, stating the following in an open letter to RBI colleagues that, in large part, defended his record: “While I was open to seeing these developments through, on due reflection, and after consultation with the government, I want to share with you that I will be returning to academia when my term as governor ends on September 4, 2016. I will, of course, always be available to serve my country when needed.”

Tuesday, June 7, 2016

The role of TPAs in the Health Insurance Eco System

This interview was first published in IIB Bulletin, Vol. 2, Iss. 4, 2016, pp.11-12

Malti Jaswal, has close to 30 years of experience in the General Insurance industry in India in different capacities; marketing, operations, claims management etc. She has worked with both public sector and multinational insurers. Since 2008, she is working in health insurance field and is an active member of multi‐stakeholder working groups on health insurance in India. She is a regular speaker at health insurance forums and she has published papers relating to Universal Health Care, Third Party Administrators (TPAs) best practices, claims management, and fraud control.  


She has also been a member of sub-committees of Ministry of Health on Categorisation of Hospitals and Costing of Care. As a Consultant, she worked on varied projects relating to health insurance training and education, Information Technology (IT), payer-provider exchange platforms, cost control, and fraud control.


She has developed a Certification Course on Health insurance for Insurance Institute of India. She is currently working as the Chief Operating Officer of the Health Insurance TPA of India Ltd (HI TPA), a joint venture of the four public sector general insurance companies in India, namely, National Insurance Company Ltd., New India Assurance Company Ltd., Oriental Insurance Company Ltd. and United India Insurance Company Ltd, along with GIC of India.


In a conversation with Dr. Nupur Pavan Bang of the Indian School of Business, Hyderabad, Jaswal talks about the need for HITPA, the important role played by TPAs and fraud in Health Insurance claims.

You have worked extensively in the field of Health Insurance. Can you tell us about the role of TPAs in the Health Insurance Industry in India?

The concept of TPAs came to India around the years 2001-2002. That was the time the Insurance sector was opened up to the private players. The private players, when they started, didn't have in- house capability of running 24*7 claims support functions and wished to focus on core areas to build business. Public sector companies also did not have such capabilities though Mediclaim (generic term for health insurance product of PSUs) is being sold since 1986. Thus outsourcing seemed a natural choice. This gave birth to the concept of TPA in India. The TPAs were licensed by the Insurance Regulatory and Development Authority of India (IRDAI) to ensure that certain minimum requirements were met to set up a TPA. 

There are 30 licensed TPAs in India. So what is the purpose of setting up another TPA- Health Insurance TPA of India (HI TPA), promoted by four public sector general insurance companies?

The growth of business in health insurance has been exponential in India in the last decade with a year-on-year growth of 25%-30%.  To handle the growing business, robust processes, latest systems and technology and trained people are needed. However, the required investment did not happen across the spectrum of TPAs and the TPA industry remains under capitalized even today.   

Most of the large private sector insurance companies, including standalone health insurers, gradually started setting up in-house TPA/claims management facilities to have better control and do not use TPAs in big way anymore. Public sector insurance companies however continue to use the TPAs because of certain peculiarities of 24*7 operations. The terms and conditions of employment contracts of public sector general insurance companies are not generally geared for engaging manpower for round the clock services nor is rest of infrastructure.  In my view perhaps, it is also realized that the demanding nature of 24*7 TPA services required by customers, could be delivered more efficiently and effectively through a non-public sector entity.

Thus it seems to be a considered decision for the four public sector companies to come together, pool capital and create such an entity. This way, adequate capital investment could be made in HI TPA from an IT perspective because robust IT infrastructure and trained manpower are the key requirements for the TPAs to handle complexities of current health insurance products and high volumes. The four companies already enjoy the benefit of scale when bargaining with the hospitals together under Preferred Provider Network (PPN) arrangements.

Would HITPA also provide services to private insurance companies? And would the PSU companies use only HI TPA’s services in the future?

As of now the TPA license given by IRDAI to HI TPA is only for the four public sector companies. We have represented to IRDAI to make the license open to service business of private insurers.

There is absolutely no doubt that PSU companies will continue to use multiple TPAs. There is no intention of moving business completely to HI TPA as voluminous business is being serviced by various TPAs and retaining competition in essential to ensure that all parties deliver value to the customer.  At the same time if there is an entity with adequate capital, trained and skilled resources, robust processes and IT infrastructure, which can in a way, set the benchmarks for the entire TPA industry in India; it will surely bring better practices and impact the market in a positive way.  HI TPA aims to be that entity.  

You mentioned that the concept of TPAs came to India around 2001-2002. Prior to that, the public sector companies were managing the claims in-house. Since many of the private companies are now setting up in-house TPAs and claims processing teams, why can’t even the public sector companies continue the earlier practise of settling the claims in-house?

Claims management is an integral part of any insurance operation world over.  Since inception public sector insurance companies have had high quality technical manpower to do so for all lines of their business. The companies were also managing health insurance claims in-house prior to 2002.

In 1986, retail Mediclaim was launched for the first time in India by the public sector companies. The practice from 1986 to 2000 was that the customer would pay the hospital from her pocket and get the expenses reimbursed later from the insurance company which could take many days/weeks. With the entry of private sector companies in joint venture with large and experienced international insurers, cashless facility was introduced, as one of most customer friendly service.

For cashless facility to work, TPAs were inducted to organize and facilitate the same 24*7*365. TPAs facilitate networking with the hospitals on one hand and cashless/claims processing for the customers on the other.   

So the TPAs only process cashless claims?

A claim is a claim whether on cashless basis or on reimbursement basis.  Cashless is a customer friendly process wherein customer need not pay for treatment and then file claim later.  However customer has every right to seek treatment in any non-network hospital (so long as it meets the criteria) and file for reimbursement claim.  A claim is admissible and payable depending on terms and conditions of the policy, on what risks are covered, to what extent etc. The TPAs process both types of claims, however traditionally (and even today), role of TPA is primarily considered to facilitate cashless and all other services around the same e.g. 24*7 call center, issuance of member id cards, hospital network etc.   

Does the TPA pay the claims?

As per IRDAI guidelines, claims are required to be paid and repudiated by insurers directly to customer/provider.  TPA’s role is to process the claims as per guidelines of the specific insurance company and subject to terms and conditions of the policy.   The TPAs do not carry the risk, nor are involved in selling or underwriting. 

Some accounts put Health Insurance frauds to the tune of 15% of all health insurance claims in India. That is huge and puts a lot of burden on the customers in the form of increased policy premiums. Would HI TPA be instrumental, to some extent, in controlling fraud in health insurance?

As the health insurance industry has grown in India, so has the number of fraud cases and also modus operandi of fraudsters is getting sophisticated.  High growth tends to loosen controls and here in India we do not have Health Regulator. HI TPA aims to fulfil the twin objectives of its creation - enhancing customer experience and bringing in greater efficiency in Health Insurance claims processing.  Efficiency in claims processing would also incorporate better handle on controlling and managing fraud.

Can you elaborate on the ways in which fraud may be controlled?

The main job of TPA is claims processing and managing the hospitals network. TPAs handle the claims process right from the point of intimation to the settlement of the claim. TPAs have good IT systems. Policy data is integrated with their systems. Policyholder and members’ (people covered in the policy in the case of family and group policies) profiles are available with the TPAs as also the details about network hospital. All this information, coupled with the knowledge about medical practices and hospital tariff should make it easy to detect any outlier behaviour or pattern.

For example, let’s say a customer reports a non-emergency claim 1000 kilometres away from home.  It should ring a bell. If it's a non-emergency claim, why would a patient go to a hospital which is so far away from home unless it’s a specialty treatment like cancer.  Another example, if there is a very large reimbursement claim of say Rs400,000 or more, it should raise an alert. Why a customer would chose to pay such a large sum out-of-pocket and not avail the cashless facility made available in so many good tertiary care hospitals in normal circumstances.

During the entire chain of events, from intimation to payment, there are at least 5 or 6 trigger points, which a smart system and skilled manpower should be able to detect. Next step is data analytics in retrospect. Sometimes small value claims can slip through. But if analysed appropriately, those leakages would also become apparent over a period of time and amenable to control.

In India, there is no proper definition of what is a financial/insurance fraud. In the absence of a clear definition, even if a fraud is detected, the companies may choose to not pursue it if the amount is small. Even when a company decides to take legal recourse, the battle is often very long drawn and not worth the effort. As an industry, are there any steps being taken to tackle this lacunae?

It's indeed a big lacunae – there is no definition of insurance fraud under Indian laws nor provisos to deal with the same. There are three angles to fraud management; one is detection, second is recovery, and third is prevention/deterrence and punitive action.  Right now the insurance industry in India is primarily focused on detection and to some extent on recovery.  Not losing the money is the first and foremost priority. Unfortunately, prevention through punitive deterrent action is missing because our legal system and penal codes have not yet caught up with the changes in the financial and insurance domain. The Insurance Act of 1938, in spite of the recent amendments to it, doesn’t carry any active provisions to handle fraud. Punitive action is necessary for effective deterrence.

There have been industry level discussions at the Federation of Indian Chamber of Commerce and Industries and the Confederation of Indian Industries about what can be done to tackle fraud in the absence of legal provisions and health regulator. There have been suggestions to involve the Indian Medical Council to prevent doctors from conniving with the customers and hospitals to exaggerate claims or be a party to the fraud in any way. A few companies have started issuing letters to hospitals and doctors to seek explanation when a certain course of treatment seems unreasonable.   ‘Name & shame’ guidelines have been discussed.  

IRDAI has taken cognizance of growing menace and ways to control the same. IIB is also now directing lot of action to health data collection and analysis, hospital registry has been set up for the first time. Though a small step, data sharing of fraudulent customers and fraudulent hospitals has now started. Hopefully in times to come, we shall see more action on this front.