Shareholders are losing money. Bankers are fuming. Lawyers are smiling. And the auditors—ah well, they are just waking up.
And all this is happening because skeletons are tumbling out of Indian corporate treasurers’ cupboards. As this column mentioned on 26 March, Jamal Mecklai, chief executive officer of Mumbai-based risk management consulting firm Mecklai Financial and Commercial Services Ltd, estimates that Indian firms may have as much as $5 billion (Rs20,000 crore) in mark-to-market losses on their currency derivative positions.
Some of that is now beginning to surface. On 28 March, Amtek Auto Ltd, which makes crankshafts, flywheel ring-gears and other automotive components in factories in the US, the UK, Germany and India, informed the Indian stock exchanges that some of its currency hedges and swaps “could expose” the firm to losses of as much as $18 million over the next two years.
The company, whose shares have declined 40% this year, said it was the victim of the “recent turbulence” in the currency market and vowed that insider shareholders will bring in money, if required, to meet Amtek’s obligations on these contracts through 10-year, zero-interest debt.
Amtek’s strategy to deal with the loss appears to be a responsible one: It’s neither trying to renege on its obligations, nor is it sending the bill to minority investors.
The currency bets of Indian treasurers’ are unravelling—and not just at Amtek. Hexaware Technologies Ltd, a Mumbai-based computer software firm, has set aside $25 million to cover possible losses from what it says were “potentially fraudulent” options trades. Sundaram Multi Pap Ltd, a stationery maker, says the “speculative option deals” offered to it by ICICI Bank Ltd under “the guise of” export-risk hedging are legally void. The courts will see about that.
The problem has arisen because rapid globalization of the Indian economy is taking place without commensurate improvements in either the regulatory framework or the risk management practices of corporate treasuries.
Even the smaller Indian firms have grown at a breathtaking pace in the past few years by acquiring businesses overseas, boosting exports and selling foreign currency convertible debt to finance their growth. With increased openness comes the responsibility for managing the new financial risks associated with greater global integration.
And that’s where managements have been reckless. In the process of hedging the risk of the Indian rupee rising or falling against the currencies in which their exports, imports and loans are denominated, treasurers have gone ahead and taken bets against, for instance, the Japanese yen gaining against the dollar. Since Indian firms were only required to shift to mark-to-market accounting in 2011, they had every reason to seek risks that could remain hidden from shareholders for a long time.
The Institute of Chartered Accountants of India, which sets the rules for the industry, had a meeting last week in which it decided that given the possibility of “heavy losses,” companies should immediately start making provisions for mark-to-market losses on all outstanding derivatives contracts.
So, the accountants are now trying to do, in a rather ad-hoc manner, what they should have done years ago.
Minority shareholders in Indian companies will be grateful if the government creates an independent, professional regulator for the accounting industry, an idea that has been discussed since the 2001 collapse of Enron Corp. and the creation of the Public Company Accounting Oversight Board in the US under the Sarbanes-Oxley Act.
Mecklai Financial did a survey in December 2007 of Indian corporate treasuries and their currency risk management practices. What it found was that two out of five treasuries don’t even bother to measure their currency risk, let alone manage it; more than half didn’t have a risk management policy. Even worse, out of the 18% of companies that said they were using the gamut of derivatives, the majority had sales of less than $60 million a year.
Not only have smaller companies engaged in riskier behaviour, they are also more likely to have hidden it from their shareholders. Most of the respondents in the Mecklai survey who confessed to not regularly marking to market derivative risk also came from this group.
Now that their bets have gone wrong, many of them are looking for loopholes to renege on paying the banks. Lawyers are having a field day. Banks are, naturally, furious.
Since January 2006, Indian publicly traded companies have been required to “lay down procedures to inform the board about the risk assessment and minimization procedures,” and to “ensure that executive management controls risk through a properly defined framework.”
Companies have to be made to take this so-called Clause 49 of their listing agreement seriously. That can only happen if the stock market regulator imposes stiff punishment in a few cases of violation.
Rather than trying to prevent the treasurers from doing anything more in the foreign exchange market than purely hedging risk—something that the Reserve Bank of India rules have failed to do—it may be more effective to stop them speculating without adequate disclosure.
That will create the right incentives for the CEO to cease looking to the treasury for profits. BLOOMBERG
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