India?s disinvestment mandate is running a big moral risk. The risk stems from the almost zero fees the disinvestment-led managers have begun charging the government for handling the issues. The trend began several years ago but after the UPA government settled down to a sizeable disinvestment plan for every fiscal, it has become almost institutionalised.
When a company appoints a merchant banker to guide its issue, it pays a fee to the latter. The fees and related incomes are what drive the attractive investment banking business across leading financial centres.
It began similarly in India, when the government began its disinvestment programme. Early disinvestment managers used their contacts with industry to attract significant players to bid for the business.
The picture has changed now, as the number of companies offering such services have shot up. For each of them, a stab at being the lead managers to a government disinvestment issue is the best feather in their cap. The heavy duty competition means the companies are now willing to work for free to bag the mandate. As a result, for all the recent mandates, there are no single winners; instead there is more than one lead manager and several more names in the syndicate.
For a penny wise country, this has translated into an excellent bit of news. The government does not pay out anything, rather it earns everything from the programme. So long as the markets were on an upswing, this logic worked fine.
As the downturn in 2010-11 in the primary markets has shown, this is a dangerous logic. How much motivation would a merchant banker have to make an issue a success in a market that is tanking, when there is no income for its services? The merchant banker has already made its reputation when it got the mandate from the department. Subsequent to that, the fate of the issue does not really matter.
More, a zero-fee regime means that instead of the government holding the reins, it is the investment advisor who is effectively in charge. As we shall see later, it means when something goes wrong, the words of the contract are, for all practical purpose, useless.
In 2011-12, the government plans to raise R40,000 crore from the primary market through disinvestment in a clutch of big league companies, including Sail, IOC and ONGC. As it is, this is made difficult by a hugely sinking market buffeted by global and domestic bad news. In such a market, a disinterested group of investment managers is about the last thing one would expect the government will need both to market the issue and police the environment.
In its defence, the government managers have often said they are not responsible for having driven down the fees the advisors charge. This is true. But it is possibly time for the government to ponder if a minimum level of bid fees should not be built in, despite what the CAG or even the CVC might have to say. Incidentally, the absolute amount the government would pay out would not be substantial from the budget point of view. In most cases, it would be less than a couple of crore of rupees per issue.
There is, however, a more serious risk in continuing with the current zero-fee regime. Disinvestment is quite a complicated process, where there are several regulatory procedures to maintain. In addition, since it entails the prospect of making profits by a large number of investors?big or small?the chances of cutting corners by some of them are quite high. The IPO scam around the IDFC issue had nothing to do with the company but a lot to do with how easy it was to duck the procedure of applying.
Of all the crimes that could take place surrounding a public issue, insider trading will, of course, be the most severe but there can be several other less heinous crimes. A merchant banker carries a lot of responsibility to ensure none of this happens. The primary means to ensure compliance against any slip up is the contract signed between the banker and the department, with the monetary penalty etc pencilled in. In the absence of any financial inducements, the means available with the government will, therefore, have to be harsher.
This makes the resolution of any dispute more difficult. Right from the beginning, the government has to wield heavy duty weapons when a light rap on the knuckles, like withholding payments, would suffice in many cases. For the merchant banker, too, the incentive to mobilise support to avoid unpleasantness would be far higher.
Notice, this threat would not help the advisor develop an incentive to sell the issue better as the government would find it extremely difficult to pin charges of malafide on that score.
Since the Indian financial markets do not rank very high on the global league of markets, the government in any case will find it difficult to make the charges stick on the transnational ones. Instead, thanks to the publicity, the image of an Indian market hit by a misdeed, again, would be the more over-riding picture globally.
Of much more salience will be the impact of any unsavoury developments on the disinvestment programme. In the current state of mutual accusations that the nation finds itself, this is something to be carefully avoided. Yet the moral hazard, which the programme has opened itself up to, is something that needs to be switched off fast. The cost of doing so is pretty cheap and it will be an unwise state that does not address it.
subhomoy.bhattarcharjee@expressindia.com
