India’s Regulatory Dodgeball with Bitcoin

Government warnings have hardly restrained one of the world’s most active cryptocurrency markets.

This article was first published in the Global Association of Risk Professionals on April 13, 2018. Co-author: Anisha Sircar

http://www.garp.org/#!/risk-intelligence/technology/disruptive-technologies/a1Z1W000003IWo9UAG

One in every 10 bitcoin transactions in the world takes place in India, according to cryptocurrency payment company Pundi X. https://pundix.com/  Indian trading in bitcoin grew substantially in 2017, with over 2,500 people trading daily.
Demonetization of high-denomination Indian currency in November 2016 triggered an explosion of interest in alternative currencies. According to some estimates, the volume of rupee-denominated bitcoin trades is third in the world, behind only U.S. dollars and Japanese yen.

However, on February 1, Finance Minister Arun Jaitley announced – after similar warning statements by the central bank in 2013 and twice in 2017 – that the state does not consider cryptocurrencies legal tender. The already-slumping value of bitcoin plummeted further, by an estimated 6.5%.

Still, cryptocurrency operators remain positive about the future of virtual currency, and some economists are convinced that this evolving technology will determine the future of the global economy.

Not Explicitly Illegal

The Reserve Bank of India has taken a stance against licensing any entity to operate with bitcoin and other virtual currencies, and frequently communicates warnings to users, holders, and traders about the risks that they are exposing themselves to.

On December 29, 2017, the Ministry of Finance issued a statement http://pib.nic.in/newsite/PrintRelease.aspx?relid=174985 emphasizing that virtual currencies had no legal tender in India, equating them to Ponzi schemes, and saying that transactions, because they are encrypted, are “likely being used to carry out illegal/subversive activities, such as terror-funding, smuggling, drug trafficking and other money-laundering acts.”

By not declaring virtual currencies legal, and by choosing not to regulate them without actually declaring them illegal, the government placed bitcoin in a troublingly grey area. (This is in contrast to Japan, Canada, Australia, Estonia and Chile, which have legalized it; and Bolivia, Iceland, Vietnam, Venezuela and others that have either banned it or imposed punitive measures.)

Moreover, at the beginning of 2018, Indian cryptocurrency exchanges and payment gateways received notifications from banks to make immediate changes to the way money flowed into their platforms, and warning them of account closure if they didn’t comply.

Koinex, India’s largest cryptocurrency exchange, posted a statement https://medium.com/koinex-crunch/inr-withdrawals-update-january-7-2018-6279bbe42bd2  on January 7: “A tussle between our payment service partner and their bank has caused an indefinite delay in the settlement of a large portion of deposits to Koinex in the past 2 weeks . .

While we have taken firm action, we are also in constant touch with the payment service provider and are providing our complete cooperation to help resolve the matter at the earliest.”

Vague Authority

The rationale behind Indian banks’ moves to suspend virtual currencies in India remains unclear, but hint at a directive from the central bank, which, as noted earlier, has shared an uneasy relationship with the traction of bitcoin in India. 

This directive would fall in line with the general pattern of task forces, nationwide surveys, and notices to traders and financial intermediaries to rein in what governments and banks believe to be a dangerous emerging phenomenon.

However, despite statements and actions discouraging people from trading and investing in bitcoin, several Indian investors began doubling down on the cryptocurrency market, driving bitcoin prices in the country even higher than global market trends.

The number of registrations across exchanges in India surged; bitcoin prices jumped nearly 14-fold in 2017, hitting an all-time high of $19,500 by mid-December (before plummeting to $12,000 and then recovering to $17,000 early in 2018). Trading volumes began doubling in the first weeks of 2018 (see figure 1).

Figure 1

Source: Coin Dance

This general rise in Indian bitcoin trading volume occurred despite the backdrop of a tumultuous global cryptocurrency market. Its popularity in India, particularly among celebrities and entertainers, is due to its appeal primarily as a financial asset, according to Zebpay, India’s first bitcoin exchange, as well as a market for remittances.

The drop in bitcoin trading volumes, from INR 83,214,245 to INR 11,637,525 between January 27 and February 10, seems to owe itself to the budget announcement. on February 1, in which Finance Minister Jaitley stated, “The Government does not consider cryptocurrencies legal tender or coin, and will take all measures to eliminate use of these crypto assets in financing illegitimate activities or as part of the payment system.”

Citi India, the only multinational bank among primary card issuers in India, on February 14 banned its customers from using the bank’s cards in purchasing cryptocurrencies:
 “Given concerns, both globally and locally including from the Reserve Bank of India, cautioning members of the public regarding the potential economic, financial, operational, legal, customer protection and security related risks associated in dealing with bitcoins, cryptocurrencies and virtual currencies, Citi India has decided to not permit usage of its credit and debit cards towards purchase or trading of such bitcoins, cryptocurrencies and virtual currencies.”

At the same time, it was reported https://news.bitcoin.com/more-crypto-jobs-in-india-despite-delhis-stance-on-bitcoin/   that jobs and applicants for employment in the country’s cryptocurrency sector have increased.

Allure Despite Volatility

During one period in 2013, bitcoin’s price increased 85-fold; the following year, it crashed. By the end of 2017, the big U.S. bitcoin exchange Coinbase said that it had signed 12 million customers, surpassing the accounts of several established financial institutions and brokerages, and became the most downloaded iPhone app. https://www.recode.net/2017/12/7/16749536/coinbase-bitcoin-most-downloaded-app-iphone  In early February, talk of government and bank bans caused bitcoin market capitalization to fall 14% in a week. http://fortune.com/2018/02/05/bitcoin-price-crash/ as major international banks stated their plans or actions of banning customers from using their cards to purchase it.

A bitcoin user should invariably tread carefully given the wild price swings.

Source: CoinGecko

Nonetheless, strong interest stoked by geopolitical unease and distrust in traditional financial institutions will perhaps continue to add to the allure of a decentralized, volatile currency outside the control of banks and governments. This has been happening in India amidst flailing international prices, representing an increasing demand in India that supply, particularly with institutional forces working against it, may not be able to handle.

With platforms such as WhatsApp and Telegram making it even easier to connect sellers and buyers of virtual currencies (through the means of the platforms themselves, or through cryptocurrency wallets), the government could be at a loss for ways to stop the spread of cryptocurrency – because if they prohibit exchanges on platforms, the transactions will find a way to migrate elsewhere.

Perhaps the overarching lack of clarity from India’s leadership regarding the legality and mechanics of virtual currencies in India remains a determinant of their survival in the country. 

The larger question for the global economy, however, perhaps extends beyond the regulation of bitcoin – and seems to stem from that of decentralized technology itself, with its power to replace financial transactions, systems of power and meaning, and the very nature of our tomorrow.

ETFs and Liquidity Shocks

Professor Vikas Agarwal on the effects of commonality of stocks under varying market conditions

This interview was first published by the Global Association of Risk Professionals on April 13, 2018

http://www.garp.org/#!/risk-intelligence/market/liquidity/a1Z1W000003fORtUAM

Assets under management in exchange-traded funds have grown from $151 billion in 2003 to more than $3.4 trillion in 2017, according to the Investment Company Institute. 

Like stocks, ETFs trade on exchanges and, like mutual funds, represent portfolios rather than individual companies. But unlike mutual funds, they trade continuously and can track the performance of various indices.

Amid the trend toward passive investing, ETFs offer the advantages of low expense ratios and transaction costs, a high degree of diversification, simplicity and transparency, and tax efficiency.

 Due to the burgeoning size of the market, the impact of ETFs on the underlying stocks is significant. Academic research finds that ETFs increase volatility and reduce liquidity of the underlying securities. In addition, it finds that ETFs increase the co-movement in returns and liquidity of the component securities.

Vikas Agarwal, H. Talmage Dobbs Jr. Chair and Professor of Finance, J. Mack Robinson College of Business, Georgia State University, has been studying commonality in liquidity of underlying stocks owned by ETFs. 

A London Business School (University of London) PhD in finance who has served as a distinguished visiting scholar in the Securities and Exchange Commission’s Division of Economic and Risk Analysis (DERA), Agarwal has published extensively on hedge fund and mutual fund subjects. 

In this interview with Dr. Nupur Pavan Bang of the Indian School of Business, Hyderabad, Agarwal discusses the workings of the ETF market and the findings of his research with Paul Hanouna and Rabih Moussawi of Villanova University and Christof Stahel of the Securities and Exchange Commission (SEC). Agarwal says that the commonality in liquidity affects investors’ ability to diversify liquidity risk, and that it comes at a price.

If ETFs are basically derivatives on underlying securities, when and why does an investor prefer to invest in ETFs rather than index futures?

ETFs provide long and short exposure to many more asset classes, styles, and segments that are not all tracked by futures. Additionally, a typical U.S. large cap long exposure through ETFs can be more efficient than the same exposure by index futures.

For example, ETFs, unlike futures, do not involve a rollover of the expiring contract, which can erode performance for investors with holding horizons spanning beyond the maturity of a futures contract.

According to BlackRock, the annualized rollover cost of a long futures position in large-cap stocks (S&P 500, Euro Stoxx 50, FTSE 100) ranges from 0.9% to 1.4%. The total expense ratio for an ETF on the same indexes can be as low as 0.05% (e.g., the Vanguard S&P 500 ETF). Hence, ETFs provide a more cost-efficient way to track an index, especially for investors with longer or uncertain trading horizons.

Additionally, ETFs provide various exposures to styles (e.g. value/growth, industries), asset classes, and geographies that are not tracked by futures or do not have existing liquid future contracts.

How are ETFs managed, and what are their structural features?

Most ETFs are structured as open-end investment companies and are governed by the same regulations as a mutual fund. Similar to index mutual funds, ETFs have fund managers. 

However, ETFs are fundamentally different from other passive or active funds registered under the Investment Company Act of 1940 since they are traded on a secondary exchange. Unlike closed-end funds, ETF shares can be created or redeemed by ETF primary market makers, called authorized participants (APs).

For U.S. equity ETFs, shares trade concurrently with the underlying basket of securities they hold, thereby providing intraday liquidity to their investors. Additionally, unlike open-end mutual funds, ETFs can be sold short.

The concurrent trading of ETFs and the securities they hold presents the challenge to uphold the law of one price. Therefore, continuously throughout the trading day, ETF prices are kept in line with the intrinsic value of the underlying securities through a process of arbitrage in which APs, market makers, as well as hedge funds and other institutional investors, participate.

How does the arbitrage mechanism work?

APs can engage in arbitrage activity by taking advantage of their ability to create and redeem ETF shares. If ETFs are trading at a premium relative to the net asset value (NAV) of their underlying securities, APs will buy the underlying securities while shorting the ETF in the secondary market until the two values equate. 

At the end of the trading day, the APs then deliver the underlying securities they accumulate during the day to the ETF sponsor in exchange for newly created ETF shares in the primary market. They then use these new shares to cover their ETF short positions.

However, ETF arbitrage is not limited to AP primary market activities, as it also takes place continuously throughout the day by hedge funds and high-frequency traders. Secondary market arbitrageurs hold long-short positions on the ETFs and the main underlying basket constituents until prices converge.

What is commonality, and why should an investor worry about commonality in liquidity?

Commonality represents the co-movement of a stock’s liquidity with the rest of the market. Higher co-movements with systematic liquidity factors imply lower ability for investors to diversify liquidity shocks, which can be crucial in market downturns.

Commonality is especially important in market downturns due to systematic liquidity dry-ups. The higher the commonality of a stock, the more likely it will exhibit liquidity withdrawals in times of market stress.

If ETFs exacerbate the commonality of stocks in their basket, then this would translate in a reduction of the possibility to diversify liquidity shocks that these stocks are exposed to, especially in stressful market conditions, which would give rise to an “ETF-specific” liquidity risk factor.

What should be the benchmark against which we measure liquidity going up or down?

We benchmark the stock to itself by including stock and date fixed effects, and thus exploiting changes in the stock commonality that are related to correlated trading by ETFs due to arbitrage. We also benchmark to other stocks with similar characteristics. In particular, we use two experiments to properly identify the causal aspect of the relation between the ETF ownership and commonality in liquidity.

How does the commonality behave during various time periods (crisis versus normal)?

Our evidence illustrates that ETF-driven commonality is not a crisis-only phenomenon but is also significant in normal times.

What are the implications of commonality in liquidity for investors and policymakers?

Our paper contributes to the policy debate of widespread implications of ETFs in security markets. Specifically, we show that as ETFs continue to grow and gain bigger ownership of stocks, it can reduce the ability of investors to diversify liquidity shocks due to an increase in the commonality in liquidity of stocks included in ETF portfolios.

'The Inheritors' book review: Family values seen in entrepreneurship tales

The Inheritors: stories of entrepreneurship and success- Sonu Bhasin

This review was first published in Business Standard on April 06, 2018

http://www.business-standard.com/article/beyond-business/the-inheritors-book-review-family-values-seen-in-entrepreneurship-tales-118040501386_1.html

Add caption

Penguin Random House India Pvt. Ltd.

7^th Floor, Infinity Tower C, DLF Cyber City,

Gurgaon 122 002

First edition (2017)

Rs 299/-

It is easy to feel that the protagonists are sharing their fears and their deepest, heartfelt emotions with readers

Family businesses have been the backbone of the Indian economy since Independence and played a significant role in nation-building even before that.
However, in the era of the Mallyas, Modis and Choksis they have received bad press, a few rotten apples impairing public perception about the rest. Positive stories are hard to come by.

Sonu Bhasin’s The Inheritors fills this gap by narrating the stories of grit, gumption and guts of the next generation of some of India’s well-known family businesses. The exception being Motilal Oswal and Raamdeo Agrawal, who are the founders, not inheritors, of the Motilal Oswal group.

The book is an easy read and the narrative is interesting for the most part, and would engage the layperson as well. The interviews are detailed, insightful and reveal many unknown aspects of the family, the business, successes, failures and strategies. It is easy to feel that the protagonists are sharing their fears and deepest, heartfelt emotions with readers.

Consider the following examples:

Replying to then Hindustan Unilever Chairman Kaki Dadiseth’s overture to Marico to buy out the profitable Parachute brand of hair care products, Harsh Mariwala said, “Mr. Dadiseth, you may think I am a nut but you will find out that I am a tough nut to crack. Thanks, but no thanks”.

Then there is the very human insecurities of a daughter-in-law, now a successful lawyer in her own right, marrying into a prominent family of lawyers. “It was not something that I had ever thought that I would do…I used to look at all the lawyers and my in-laws and feel somewhat intimidated”, said Saloni Shroff who married Rishabh Shroff, the fourth-generation scion of the law firm Amarchand Mangaldas (or Cyril Amarchand Mangaldas as it became after the brothers split in 2015).

Many of the groups and the next-generation leaders whom Ms Bhasin has interviewed for this book are well known and widely covered by the media, so some of the stories may be familiar.

It was refreshing to read about the ones that aren’t as well known- such as Agastya Dalmia of Keventers, a hundred-year-old brand that he revived with two partners, or Arjun Sharma of Select group. Both created new ventures to revive and advance the family business.

The weakness of the book lies in the fact that Ms Bhasin has missed several opportunities that would have given it a longer shelf life. One of them would have been to synthesize the learnings from the leaders’ experiences.

This would have been very helpful for the next generation of the thousands of business families in India. Ms Bhasin also missed the opportunity to weave together a roadmap for the next generation for successfully establishing themselves.

For example, succession challenges plague most family businesses at some point in their life cycle. What was done right in the companies that Ms Bhasin chose for the book?

Another big gap is the lack of an explanation for the choice of companies and leaders featured in the book. Was the choice dictated by convenience, availability or was there a pattern or a logic for selecting the people she did?

To be sure, there are plenty of fascinating stories in the book: The account of Dabur and Amit Burman exemplify professionalisation and separation of ownership from the management; how Pooja Jain found the perfect mentor in her father; why the Dhingras believe that harmony amongst family members is key to the success of the business; how Tara Singh Vachani is proving her mettle through her passion for “senior citizen living”. But why has the writer chosen these groups and not some of the others?

The production also left much to be desired. Pulitzer Prize-winning author Jhumpa Lahiri calls the cover of a book its “clothing”. “If the process of writing is a dream, the book cover represents the awakening,” she writes.

I am not sure if enough thought has gone into designing the cover of the book under review. It is not appealing enough to entice anyone into picking it up at a bookstore. Also, the editing is poor and there are typos. It is to be presumed that these can be taken care of in the future editions and in the digital versions of the book. Lastly, the Foreword by Anand Mahindra could have been longer.

To summarize, the book is well worth a read, not least because with a staggering 90 per cent and more businesses in India being family businesses, success stories need to be told. A little more rigour in the production values and framework may have made it a great book.