Outsourcing in Indian Life Insurance Market

India’s domestic outsourcing market is gaining momentum. Most outsourcing service providers are turning inwards both to diversify risks and partake of the growing opportunity on home ground. Focus is now shifting from telecommunications and technology outsourcing to financial services outsourcing in the country. Of these, the Insurance BPO services market is expected to grow to USD 1.5 billion in size in the next three years- a substantial increase over its current USD 720 million size.Interesting to note here is that unlike their European & North American peers, Indian carriers are not driven by cost compulsions but rather are challenged by volume and manpower constraints resulting in the built-up of a favorable disposition towards outsourcing (See Image).

Carriers see vendors as partners providing best in breed knowledge and performance to enable them to focus on their growth objectives. Indian vendors and multinational vendors have only recently started catering to the outsourcing needs of the domestic market. With the increasing incidence of outsourcing in insurance sector, critical manpower base and know how specific to the Indian geography are also evolving at the vendor end. More firms are likely to realize profitability once the market acquires sufficient breadth and depth.

Celent recently published ‘Outsourcing Trends in Indian Life Insurance’ which captures the key issues and trends in the domain.

Accepting the need for Electronic Trading

In its recent history,the Asian market has been characterized by the adoption of technology in a much more compressed time-frame as compared to its counterparts in the western world. This has been true of the industrial as well as the services sector, where it is also holds true for electronic equity trading. Asia is well poised for a rise in the share of electronic trading in the next few years. Markets such as Japan, Australia, Singapore, Hong Kong and India are seeing a lot of investment happening that is related to Direct Market Access (DMA), Smart Order Routing (SOR) and High Frequency Trading (HFT). The associated infrastructure such as market data services, co-location and so on are also being paid attention to, as is the requirement for helpful regulation. However, in some markets, the regulators are not very confident about and supportive of the needs of greater electronic trading. This is partly because of the financial crisis and rising requirements for risk management, and also due to the flash crashes that have occurred in the NYSE and OSE markets. We expect the regulatory framework to become more flexible in most markets, but there is still an important element that needs to be addressed across the board in the Asia-Pacific. That is the role of smaller brokerages and the buy-side. Unlike larger brokerages, these are still reluctant to adopt electronic trading and to make the investments required to have the same. While attitudes and capabilities do not change overnight, I believe that market investors in Asia need to be made aware of some harsh realities. To start with, the way HFT and algorithmic trading evolved in the US and European markets, there was very little time for market participants to react to and adopt such trading. The change happened so quickly that a number of brokerages and buy-side firms were unable to cope and had to operate in a more constrained fashion or even shut down. The incentive that HFT provides for those trading larger volumes means that the smaller players are at a relative disadvantage. This increases even more if they are slow to react and do not adopt electronic trading. So it is not just the speed of trading that is important to succeed, it is also the speed of thought. Hence, smaller brokerages and buy-side firms in Asia should be more positive and not be afraid of investing in DMA, SOR or HFT. The gains from these might not be apparent immediately, but if the lessons from the western markets teach us anything, it is that the quick and nimble-footed firms were the most successful during the rise of electronic trading. With the trading infrastructure in Asia changing so rapidly, there is little reason to believe things are going to be different here.

Equities Trading at Indian Exchanges: Competition Can Wait

MCX-SX, which offers trading in currency futures, had requested to the Securities and Exchange Board of India (SEBI), the capital market regulator, for approval to launch trading in equities, equity derivatives, interest rate futures and other instruments. It was thought that this move would add a new dimension to India’s exchange landscape which is dominated by the two main exchanges, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The recently started United Stock Exchange, which commenced its operations in the currency futures segment on 20th September, 2010, recorded on its very first day a turnover more than that of the combined turnover at NSE and MCX, the country’s existing currency trading exchanges. It was anticipated equities trading at MCX, if approved, would also throw up similar competition to the country’s two existing exchanges. In September 2008, MCX-SX was conditionally recognized as stock exchange trading in currency futures by SEBI for a year; recognition was extended in August 2009 for one more year to give MCX more time to comply with requirements. In April, 2010 MCX-SX sought permission seeking approval for trading in segments permitted to BSE and NSE. In July, 2010, MCX-SX filed petition before the Bombay High Court seeking intervention over the delay in approving its application by SEBI; in August 2010, the Bombay High Court asked SEBI to take a final decision on the matter by September 30. On 23rd September, 2010, SEBI rejected the application stating it ‘was not satisfied that it would be in the interest of trade and also in public interest to allow the application’. SEBI’s rejection, as mentioned in its order, was based on a number of issues. Under MIMPS (Manner of Increasing and Maintaining Public Shareholding in Recognized Stock Exchanges Regulations), no person resident in India shall at anytime, directly or indirectly, either individually or together with persons acting in concert, hold more than five per cent of the equity share capital in a recognized stock exchange. A select class of financial institutions, however, can own up to a maximum of 15% each.
  • MCX-SX is promoted by Multi-Commodity Exchange of India Ltd (MCX) and Financial Technologies India Ltd (FTIL). When MCX-SX was formed, its promoters MCX and FTIL owned 51% and 49%, respectively, which, after divestment, came down to 37% and 33.9%. The promoters in April, 2010 undertook a further financial restructuring to comply with regulations, by reducing their respective shares to 5% each. However, it also issued warrants to MCX and FTIL, which allows the promoters to gradually sell the warrants under favorable market conditions. Under this arrangement, according to SEBI, MCX and FTIL have together now a holding of 71.90% in the shares and warrants issued by the company.
SEBI listed ‘excessive concentration of economic interest in the stock exchange in the hands of the two promoters’ and ‘not being fully compliant with shareholding regulations‘ as reasons for rejection.
  • MCX-SX had submitted that the two promoters did not share a common management, but it (SEBI) found the two entities are operating under a common management. According to SEBI, therefore the share holding of FTIL together with that of MCX (5% each) exceeds the permissible limit of 5% limit of ownership in a stock exchange.
  • SEBI stated that ‘the promoters of MCX-SX and their associates had arrangements with three shareholders of MCX-SX where sale of shares between the parties were based on offers to buy back the shares at or within specified time in the future’. It found such arrangements illegal.
  • In its order SEBI said ‘MCX-SX has been dishonest in its disclosures to SEBI on material information and has failed to fulfil its disclosure and fiduciary responsibilities’ and also it ‘has failed to adhere to fair and reasonable standards of honesty that should be expected of a Stock Exchange’.
MCX-SX may appeal to the Securities Appellate Tribunal (SAT) against the decision, or go for a writ petition in the high court.

Financial inclusion in India and micro-insurance, the new buzz word

‘Greater financial inclusion’ figures prominently on the economic development agenda set by the Indian government in recent times. The much-talked-about UID project which aims to provide unique identity numbers to all Indian citizens, and links the number up with a compulsory bank account is indeed a bold step towards realizing that goal. The recent buzz word, however, in discussions on financial inclusion seems to be micro-insurance. The Finance Minister, in his recent address at the Global Insurance Summit, stressed on the need for popularizing micro-insurance in semi-urban and rural areas of the country. The attention on micro-insurance seems to have come at a right time, when the success of several government sponsored welfare schemes for the rural poor in India like the National Rural Employment Guarantee Scheme (NREGS) depends quite a lot on the ability of the financial system to mitigate the risks arising out of unforeseeable natural calamities and other disasters. In this context, the increasing efforts of insurance companies in tapping semi-urban and rural markets are an encouraging sign. Insuring the vast rural population against losses from disasters is indeed a big challenge for the Indian insurance industry, when at the same time it is important to ensure that premiums remain affordable. IRDA, the Indian insurance regulator, has in a recent exposure draft on a standard insurance product suggested that the premiums will be decided by the regulator and insurers might not get any leeway in this regard. The regulator’s goal of promoting financial inclusion is laudable, but greater freedom to insurance companies to design products and price them might be more desirable. The regulator has also proposed that insurers will have to mandatorily offer the standard product. The draft also talks about placing restrictions on selling other products with higher premium and lower benefits. Overall, it could be surmised that the regulator is concerned about insurance agents pushing expensive endowment products to the poor, which is a very valid concern. It would be interesting to monitor developments in this area for the next few months, as IRDA is also considering a proposal to allow cross-selling of micro-insurance products which would essentially provide insurance companies access to the large network of public sector banks for selling their products. The banks would benefit too as it would enable them to enlarge their portfolio of products.

Exchange Trading of Mutual Funds in India

In the last year and a half, the Securities and Exchange Board of India (SEBI) has taken a number of steps to develop the mutual funds industry in India. One significant move in this direction has been allowing trading of mutual funds at the country’s stock exchanges. After studying the feasibility of doing this in 2009, SEBI approved mutual fund transactions through stock exchanges in November last year. This was done to extend the convenience of the secondary market infrastructure to mutual fund investors who could earlier invest in funds only through the existing distributor/agent channel. India’s exchanges with a large number of trading terminals connected through numerous Lease Lines and VSAT terminals can reach investors in over 400 cities. Besides reach, exchange trading offers number of other benefits too: opportunity to invest in multiple asset class through a single (demat) account, aggregation of entire portfolio in a single place enabling easy monitoring and more efficient investment decision making, reduction of paper work and errors etc. Also the exchanges’ existing delivery vs payment process offers de-risking of settlement process and increases transparency. Following SEBI’s approval, the two Indian Exchanges, the National Stock Exchange of India (NSE) and the Bombay Stock Exchange (BSE) started trading in mutual funds in November-December, 2009 (NSE: Mutual Fund Service System, BSE: StAR MF). Under the current arrangements investors would be able to deal in Mutual funds that have signed up with the exchanges and in the schemes which the fund houses have permitted to be traded at the exchanges. Out of 40 Asset Management Companies, around 20-22 have signed up with the two exchanges so far. SEBI is planning to make listing of all schemes mandatory. A look at the figures (see graph below) reveals this new channel for investing in mutual funds has not been very popular among investors yet. It can be noted in this context, average daily transaction value (sales+redemptions) for the overall industry during May-July, 2010, had been around 690 bn Rs, which makes exchange trading around 0.3% of total trading during the same period. The occasional jump (July) in trading value is more because of market fluctuations than investors’ preference for exchange trading: Industry Assets Under Management went down by 10% in July as compared to May, as a result subscription went up. Though it has to be acknowledged that of late, there has been a push from the fund houses to encourage investors to take the exchange route. However, these are still early days for this new system. Moreover, since removal of entry load (distribution fee charged by agents to investors) in August, 2009, the industry has been in a state of flux with agents now focusing more on selling insurance products which have high distribution fees. To overcome this problem the fund houses have been trying a number of new distribution models in last one year for attracting new investors; but a clear pattern is yet to emerge. It can be argued with more investor education and awareness about the new technology channels and SEBI’s continuous push, exchange trading of mutual funds is likely to pick up in the future. Banks are a big player in mutual funds and the regulators’ urging banks to transact through exchanges may be one step towards achieving this. Another recent phenomenon is that many brokerages are placing orders through exchanges in the recent months. These all hold good promise for this new channel, however, its long term impacts are yet to be seen.

Introducing CDS in India

The Reserve Bank of India (RBI) recently put out a draft report on introducing credit default swaps as OTC derivatives product for corporate bonds in India. Two attempts to introduce the product were already made earlier in 2003 and 2007. The timing of the latest proposal indicates that perhaps the central bank was waiting for the financial crisis to subside and also buy that extra time to learn lessons from the crisis. However, RBI has not incorporated some key lessons from the crisis. The following are a few glaring shortcomings in the proposal – 1) At a time when the world is moving towards centralized clearing systems, issues such as opacity and counterparty risk associated with OTC markets seem to have been overlooked, at least for now. What is more worrisome is that the proposal is not even keen on establishing a trade reporting platform. While it envisages the establishment of a trade reporting platform in the future, the proposal gives a green signal to begin CDS trading without setting up a trade repository. 2) The proposal says that the market is essentially a dealers market. Users are only allowed to buy CDS from dealers alone. However, what is very surprising is that it does not allow CDS buyers to unwind the protection by entering into another offsetting contract. If buyers desire to unwind, they have to terminate the position with the original counterparty, thereby allowing excessive and unfair control to the sellers. 3) The trade reporting format provided in the proposal does not include price data, which makes it even more unfriendly to the buyers. Opacity in prices even on post-trade basis, along with transparency issues arising out of the OTC nature of the market loads the dice heavily against CDS buyers. One would just hope now that the CDS market does not suffer in the same manner in which interest rate futures market did, especially given that India certainly needs a mature CDS market to manage systemic risks prudentially.

25% Public Float in India : Is the timing right ?

The Securities Contracts (Regulation) Rules (SCRR), 1957 was recently amended to incorporate a minimum 25% public float for all listed companies – private and public. The amendment also applies to listed statutory corporations. Public float is defined as that part of a listed company’s shares that are not held by the promoter. The proposal to push for a 25% public float had been around for some time now, and it has finally seen the light of the day, with the proposal turning into a law with a strong push from the Finance Ministry. There is little doubt about the objectives of the amended law – greater public float creates deeper public markets, making the markets more efficient, thereby reducing the cost of raising funds. However, the crucial question that is being asked now is about the timing of the amendment, and about the time-frame given to companies to comply with the new law. While equity markets all around the world still appear shaky and offer no compelling signs of recovery from the financial crisis, it appears that the amendment is a tad hasty. It is not very convincing that the next 2-3 years is the best time to dilute shareholding, especially given the volatility and the subdued valuations. The criticism is equally about the short time-frame (2-3 years on average) given to the companies to comply. This compliance is estimated to raise money in excess of Rs. 1.6 trillion. Companies might be unable to put the forcefully raised money to any better use. The premise that ‘greater public float results in greater liquidity’ also appears shaky. Higher public float might discourage many companies which are more comfortable with smaller divestment from listing. Also, listed companies which do not want to divest at the moment, might rather prefer to delist than comply with the new law. This might in fact result in lower liquidity. While the objectives of the amendment are noble, and definitely in the right direction towards creating more mature equity markets, the government should have waited for more convincing signs of global economic recovery before making the law.

RBI, Securitisation and Micro-finance – at loggerheads?

Learning lessons from the far reaching consequences of securitisation of sub-prime debt in the US, the Reserve Bank of India has come out with a bunch of regulations, which clearly indicate that ‘caution’ will be the way forward in future. RBI’s June 2010 guidelines for NBFCs stipulate a Minimum Holding Period (MHP) of 9 months before the loans can be sold off for loans maturing within 24 months and an MHP of 12 months for loans maturing after 24 months. In addition, the NBFC must retain a minimum of 5% (for loans maturing within 24 months) or 10% (for loans maturing within 24 months) of the book value of loans being securitised – and in the equity tranche in case there are tranches. In issuing these regulations, the RBI has addressed the most common criticism of the sub-prime crisis – that NBFCs did not perform due diligence, since they were going to sell off the loans anyway. The minimum holding period and minimum retention requirements have ensured that the NBFCs are a significant stakeholder in the loans they are securitising. Also the RBI has implicitly acknowledged the failure or inability of credit rating agencies to properly rate such instruments. Any rating done after 9 or 12 months is likely to be more accurate than a rating done immediately after disbursement of the loans. The reaction to these guidelines has been muted considering the events of the last 2 years. However, the microfinance sector has seen red in these new guidelines. Since the last few years, securitisation was becoming a preferred method of fundraising by micro-finance institutions. However these new guidelines are likely to act as a deterrent to the growth of securitisation in the micro-finance sector as most micro-finance institutions are registered as NBFCs. Micro-finance loans are of short duration and often get prepaid with 9 – 10 months. The borrower typically pays off the remaining tail and gets a new loan. Hence, the guidelines with a holding period of 9 months largely hamper the securitisation route for MFIs. Micro-finance is growing rapidly in India on the back of good returns but concerns have been raised at the fast pace and whether due diligence is being maintained – similar to the situation of fast paced growth of high return sub-prime lending in the US. Also, micro-finance still being a relatively new phenomenon with not enough historical data, ratings provided by agencies are likely to be less accurate. In such a situation, RBI’s cautious approach to securitisation is the right step forward even if it means a slight slow-down in the rapid pace of growth of micro-finance.

The Need for Legacy Work Culture Transformation?

It has been quite some time since the core banking trend hit the Indian banking industry. Almost all the top banks in India have implemented the core banking makeover in their systems and moved towards “Anytime, Anywhere” banking. But, the obvious question arises. Have the banks really moved, in spite of their marketing campaigns saying so? I recollect an incident where my colleague wanted to apply for the online banking service from the bank in which he was maintaining his salary account. Despite being one of the largest banks in India and one of the first banks in India to start the core banking transformations, he was informed that he can apply only in the branch in which he had opened the account! If the bank was indeed centralized and had implemented the “Anywhere” banking concept as advertised, why would the specific branch matter?

The culprit is not in the IT systems implemented in the bank but among the people using it. IT transformation has been the buzzword in the banking industry in India. But, the transformation of the bank is not brought about by IT alone. Business processes, policies and more importantly the work culture of the bank matters the most. I remember reading an interview of a CEO of one of the banks in India, where he mentions that a major challenge that the bank is facing is in changing the work culture of the bank. The current work culture has been inherited from decades of protectionist regime that the nationalized banks have enjoyed. The systems and processes are indeed very bureaucratic. Performance-based work culture has yet to find its place within the nationalized banks.

Fortunately for the banking industry, the liberalization and the emergence of private and foreign banks have started changing the outlook of the bank employees. With even nationalized banks gearing for major rebranding exercises, maybe it is time for them to look into their internal policies and instill corporate culture as well. The true transformation happens only when the legacy processes and policies are changed along with legacy IT systems.

Front-running needs to be eradicated

‘Front-running’, the practice of traders or brokers benefiting from stock market transactions by leaking information of the trades to some of the other market participants in advance, has long been suspected in the Indian stock markets. I have had discussions with the domestic buy side in which they have taken me through the various stages of an equity transaction and pointed out the pre-trade, trade and post-trade stages in which there can be leakage of information that can be profited from. What is worse, the players who suffer from the practice just shrug their shoulders and describe it as something they can do little about. Similarly, when I have spoken of Indian brokerages that have become more capable technologically being used by foreign buy side firms, the same issue has turned up. The latter is wary of the possibility of insider trading or front-running damaging their profitability. Against this back drop, the ban on a trader of HDFC Mutual Fund by the capital market regulator, SEBI, on the basis of 38 instances of wrong doing over 24 trading days between April and July 2007 when the three investors colluding with the trader bought or sold shares before HDFC AMC’s trades were executed, is a welcome development. While it could be merely an initial move in cleansing the markets of an undesirable practice, it shows the capability and the willingness of the regulator to punish participants that undertake front-running. For the traders or brokerages that engage in such actions, it is crucial to understand the damage they are doing to the reputation of their firms and indeed the market as a whole by engaging in such practices. Firms that are very well capable of competing on an equal footing in the markets are being handicapped by the existence and indeed the mere talk of front-running. Such unfair practices are self-defeating and needed to be weeded out. The regulator is to be complimented on taking such an action and we hope that future transgressions would be similarly caught and punished. Furthermore, both buy side and sell side firms need to ensure that they have sufficient checks and balances in place to help the regulator eradicate the practice. Similarly, whistle-blowing needs to be encouraged, not just by individuals, but also firms that believe that their brokers or traders have let them down.