Derivatives losses keep adding up

Derivatives losses keep adding up
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First Published: Tue, Apr 29 2008. 01 44 AM IST

Updated: Tue, Apr 29 2008. 01 44 AM IST
Mumbai: The derivatives effect refuses to go away with two more Indian firms announcing significant mark-to-market, or MTM, losses on account of their exposure to these exotic instruments as part of financial results for the March quarter.
Taking a significant hit from its exposure to foreign exchange derivatives, India’s sixth-largest drug maker by revenue, Wockhardt Ltd, posted a 30.25% decline in net profit in the March quarter, its first of fiscal 2008, while software services firm KPIT Cummins Infosystems Ltd said its MTM loss on foreign exchange derivative contracts stood at Rs89.27 crore at the end of March. The loss was on account of the strengthening of the euro against the dollar, it said in a statement.
WRITING ON THE WALL (Graphic)
The derivatives involved are complex cross-currency options and structured products, bought by Indian companies to protect themselves from foreign exchange risks. However, many firms have discovered that these instruments are double-edged and come with increased risks. Several firms that bought derivatives allege that their bankers oversold these to them without explaining the downside, and several spats between companies and banks have ended up in courts.
Mark to market is an accounting practice of assigning a value to a position held in a financial instrument, based on the current market price for that instrument.
Wockhardt’s net profit at the end of the March quarter stood at Rs50.9 crore compared with Rs66.3 crore a year ago, despite a 50.3% surge in sales. A provision worth Rs27.9 crore to take care of MTM losses has shaved off about one-third of the company’s net profit.
Like Wockhardt, several Indian firms have been providing for such losses in their earnings for the March quarter. For instance, Bharti Airtel Ltd, the country’s biggest mobile phone services by sales as well as subscribers, recorded a MTM loss of Rs204.5 crore for the entire year, including Rs123 crore towards “embedded derivatives”.
Big MTM losses: Wockhardt chairman Habil F. Khorakiwala. (Madhu Kapparath / Mint)
Auto maker Maruti Suzuki India Ltd’s MTM loss on account of its exposure to derivatives was Rs50.5 crore in the quarter.
Among banks, Axis Bank Ltd has provided for Rs71.97 crore. Even though the bank itself has not incurred any MTM loss, it has made the provision for two firms that have made the loss and filed court cases against it.
ICICI Bank Ltd, too, has made provisions worth Rs400 crore in the quarter ending 31 March. This is, however, on account of MTM losses for the bank’s exposure in credit derivatives obligation and credit linked notes. Under the law, Indian banks cannot have a naked or uncovered exposure to cross-currency derivatives. This means, all cross-currency options and swaps of their customers are hedged back-to-back with the same tenure and amount with foreign banks. So, if a company defaults, banks will have to pay to settle the contracts with counter-parties.
About 98% of KPIT Cummins’ revenues are in foreign currencies. Last year, the company entered into forex derivative transactions worth $42.6 million (Rs171.2 crore) covering a period of five years. Apart from the rupee-dollar conversion rate, the contracts also had a component of “contingent premium payment with reference to the euro-US dollar rates” beyond the benchmark rates, the company said. This means that the company’s exposure was driven by the way the euro moved against the dollar. The contracts had not yet been cancelled and the loss was notional, KPIT Cummins said in a statement.
KPIT Cummins is in the process of ascertaining the accounting treatment for these transactions but Wockhardt has gone ahead and provided for its MTM losses.
“Pursuant to the announcement on accounting for derivatives issued by the Institute of Chartered Accountants of India in March, the company has accounted negative mark-to-market losses aggregating Rs27.9 crore during the current quarter,” Wockhardt said.
In March, the company had issued a statement, saying it would “neither incur any losses arising out of the derivatives-hit scenario in the current quarter, nor will there be a situation of such losses to occur subsequently.” The statement came in response to a Page 1 story in Mint on 20 March.
Mint’s report in March said that Wockhardt had taken a “significant” hit from such hedging options, and the drug maker’s paper losses, because of the dollar’s continued weakness against global currencies, were “substantial” and could result in it registering a loss when it reported its results for the March quarter.
Wockhardt had also said that there had been considerable currency fluctuation in the preceding year and that “in such situations, it is normal practice to protect the company from such currency fluctuations.” The company also said then that it “has a highly professional and expert team that undertakes normal business related to hedging.”
On Monday, Wockhardt said that according to its internal risk management policy, it hedges the interest for 50% of the long-term loans, and does not hold or issue derivative financial instruments for trading or speculative purposes. It did not explain statements it issued after the Mint story.
Accounting Standard (AS) 30, which deals with a firm’s MTM losses from the derivatives business, will come into effect from 2011, but the Institute of Chartered Accountants of India (Icai) has suggested that Indian firms should start recognising their MTM losses on derivatives trade from the year ending March 2008.
The derivatives issue first came to light in November when software firm Hexaware Technologies Ltd announced that it had made provisions of Rs98.25 crore to cover exposure from unauthorized deals entered into by an employee that involved derivatives. The company later reported a net loss of Rs81 crore for the quarter ended December after the actual damage on account of these transactions ended up being Rs103 crore.
For the quarter to March, Hexaware reported on Monday a net profit of Rs20.86crore, dented by a MTM loss of Rs5.6 crore, which it booked on account of foreign exchange derivative transactions.
Meanwhile, more firms are moving court against banks over the legality of sophisticated foreign exchange derivatives. At last count, at least eight cases had been filed by firms against banks.
The last two firms to join the legal battle are Garg Acrylite Ltd and Nahar Industrial Enterprises Ltd. While Garg Acrylite has filed a case against India’s largest private sector lender, ICICI Bank, Ludhiana-based textiles firm Nahar Industrial has moved court against Axis Bank.
ICICI Bank has at least four court cases against it at Karur, Hyderabad, Haryana and Mumbai. The list of firms that have moved court against the bank includes Garg Acrylite, NCS Sugars Ltd, Sabare International Ltd and Sundaram Multi Pap Ltd. ICICI Bank has filed a criminal case against Sundaram Multi Pap after a cheque issued by the firm bounced.
The bank has also moved the debt recovery tribunal in Mumbai against the company to recover dues.
Risk management consultants and audit firms say Icai’s insistence that all companies should disclose and provide for losses on derivative contracts from the current financial year is acting as a trigger for more court cases.
If a firm moves court and manages to get a stay order, it can convince its auditor that it has a “good case” and escape the provisioning requirement to take care of the MTM losses in derivative transactions, say these consultants and audit firms. Those firms which do not want to move court are announcing MTM losses.
(Ashwin Ramarathinam of Mint and Reuters’ Janaki Krishnan contributed to this story.)
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First Published: Tue, Apr 29 2008. 01 44 AM IST