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GDR Robbery

Feb 20, 1998

We all know about the robbery of 10 million Indian investors by the primary market offerings madeby fly-by-night operators in 1994 and 1995. And we all know how many Indian corporates, eggedon by naive research analysts (like myself) and greedy foreign investment bankers (yes, that is whatmany of them are despite the fact that they wear suits and colourful ties!) tapped the internationalmarkets with overpriced GDR issues and used that money to buy real estate and bought-out deals.

But no one in the Indian press or the Indian government talks about the biggest rip-off still beingcommitted by the foreign broking community in the way GDRs are being priced and traded eventoday. Let's step back a bit in history. It is 1993 and the foreign brokers have begun to enter India.They scream for a seat on the Indian stock exchanges and they continuously flood their foreigninvestors with horror stories of how crooked the Indian brokers are and how there is notransparency in trading in the Indian stock market. Alarmed at these allegations of fraud (most ofwhich was true), the foreign investors make sure that they make the right noises when they meet thegovernment officials and the regulators: Sir, we are keen to invest in India but will only do so whenthere is transparency in the Indian markets which we believe will happen when the foreign brokinghouses are allowed to be members of the Indian stock exchanges.

So, between 1994 and 1997 the Indian stock exchanges are placed on what must have been one ofthe most revolutionary changes anywhere in the world. In 3 years flat (a really short time given thescandals in the GDR market) the Indian market goes from complete opaqueness to outrighttransparency; from yelling and screaming in trading pits to silent electronic blips in air-conditionedrooms. Now, with dematerialised trading the market will move to paperless form in less than 12months. Whatever the historic perception of the Indian broking community, they must becongratulated for where they stand today. The average spreads on the liquid Indian shares is nowless than 0.1% and their brokerage charges to institutions is 0.5%, of which probably 0.3%is due tothe finance cost of delivery mechanisms.

But what of the GDR market? Despite the fact that it is run by foreign broking houses, it is the mostilliquid and opaque market in which investors are being taken for a ride! The more liquid GDRs havebid-offer spreads of 10% and some, like Tata Electric have spreads of 25%. Imagine, Tata Powerbeing quoted at Rs 100-125. And when that foreign broking house quotes a price it is usually forsmall volumes. There are no screens to show what investors are doing or the volumes that have beentraded. As one GDR issuer correctly pointed out, the broking house's market maker will first try andensure that his employer is making money and worry about the investor last! Think about it, theforeign brokers came in and told us to change: we did. But now they run a racket in GDR trading -five years after the first Indian GDRs hit the foreign markets! And the shocking part is that foreignbroking houses still highlight the risks of the Indian domestic market and prod investors to trade inGDRs - where they can make a lot of money.

There are many lessons to the GDR story - and opportunities, too. There is the issue of power: theforeigners imposed discipline on us, can we not now impose their own yardsticks of discipline onthem? Or are we happy to be ruled by double-standards? Can we not use this lack of liquidity in theGDR market as an opportunity to allow Indian brokers a chance to market-make in GDRs? Sure,FERA rules will need to be changed but these have been done anyway to allow the issuance ofGDRs. Assuming trading in GDRs is US$ 10 million each day and that the foreign brokers make10% profit on that, that is US$ 1 million profits per trading day is what can be opened up for theIndian broking community. All that the RBI needs to do is to set aside 1%of its fx reserves - US$270 million - to be made available to Indian broking houses to trade in GDRs and settle in GDRs forforeign clients. This US$ 270 million - or some such number - can be kept with a custodian bank thesame way local shares are given to a custodian bank against GDRs issued. The market capitalisationof all Indian GDRs today is about US$ 3.5 billion so a US$ 270 million pool of money will amountto about 8% of the issued GDRs outstanding - sufficient to cover any inflow-outlfow of US$ onaccount of GDR trading by foreign investors. If the RBI is worried about losing fx, they need not be:knowing the Indian brokers, they will capture a large chunk ofmarket share and earn fx in spreadsand commissions. Foreign investors will welcome this change to enhanced liquidity and transparencyand they will finally have an alternative to the GDR market in its present form. The Indian brokingcommunity has done a fantastic job in re-orientating their business. They deserve a chance to beatthe foreign broking houses at their own game.

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