Moneycontrol » News » Management

Zia Mody & Cyril Shroff: 2008 In Review

Published on Sat, Jan 03, 2009 at 16:46 | Source : CNBC-TV18

Updated at Tue, Jan 13, 2009 at 13:16

Like this story, share it with millions of investors on M3

Share on Tumblr

Nifty

BSE | NSE 25/05/12

Are Mutual Funds betting on Nifty?

Thomas Friedman was right. The world has been flattened out by an unprecedented financial crisis. As the global economy struggles to revive itself the spotlight is on regulatory responses, new international investment laws, and rules that help business to stay in business.

In India, that has meant a review of foreign investment in both FDI and FII and the ability of Reserve Bank of India as well as Securities Exchange Board of India to respond to the changing economic environment and more dynamic rule making that allows markets and companies to stay relevant.

So, what has 2008 delivered and what does 2009 hold? Zia Mody, Managing Partner, AZB & Partners, and Cyril Shroff, Managing Partner, Amarchand Mangaldas, delve deeper.

Here is a verbatim transcript of their exclusive interview on CNBC-TV18's show The Firm anchored by Menaka Doshi. Also see the accompanying video.

Q: How do you look at 2008, take us through how you characterize the year?

Mody: I think the beginning of the calendar year was fanatic activity probably for both of us. More work than probably we could handle, desperate deals being put together at excessive valuations in too little time which is always good for lawyers but not very good for sustaining that sort of growth. Then from a country and a regulatory point of view of course, we have seen a lot of flip-flops, sea changes with the entire policy on the participatory notes (P-Notes) being changed, and brought back virtually to what it was earlier. There were no quantitative restrictions anymore apart from the qualitative ones which we can address later.

We then saw the regulator coming out with measures, which were meant to bolster the capital market, but many of them seem to come little later than when they should have. We saw then after the Black Swan of course, where there was lot of work in restructuring, litigations, people wanting to put their hands up, trying to put their hands up, needing to put their hands up, and the practice morphed to some extent to that sort of advisory work.

The private-equity deals now became more of an opportunity for people who just went back to the promoters saying less price and the promoters were not walking away. Cap markets - everyone knows hardly anything ‑ and there the regulator needs to probably have a couple of measures, which could boost it up. I think one of the most interesting things that I saw recently was shareholder activism. The Vedanta response, the Satyam response are things that maybe ten years ago we would not have expected to happen in the public place, so that has been extremely interesting.

Q: How would you characterize the year?

Shroff: I would say the best word for it is 'bitter sweet'. As I look back and look at the year gone by, some clear themes emerge. The three themes I see emerge are the decline of governance. We have seen sharp decline of governance. Second is the emergence of activism and the demand for accountability. Third is the sheer unpredictability and the impossibility of planning because the world is changing so fast.

A lot of what we as corporate lawyers, business people and others do, flows from these three events. I am sure there are more but these are things which affected me, that's how I look at it.

We can talk about governance at a couple of levels, first at the corporate level and then in terms of public administration, the regulatory and law making process, and even about the media as well.

There are still large parts of corporate India which only pay lip service to good corporate governance. It has become more a matter of form rather than of substance. When you look back, you look back with a little sadness that after all the effort that has been spent, there are still important companies which trivialize this.

The second part which I would comment on is ‑ this is more a global rather than a local comment - governance in financial institution, because if you look at the financial crisis, it is nothing but a failure of governance. That is what it really is.

Q: Fortunately, we have been spared by - in India at least - from a large impact of that?

Shroff: We have been spared not so much by the governance at the individual level. We have been spared by good regulation or by conservative regulation.

There are two dimensions to the failure of governance in public administration. One which is on top of my mind and embedded in my heart at this moment is this whole terror thing. It has affected the psyche of not only businessmen and civil society here but it has affected the psyche of foreign investors and friends abroad. They are scared and you cannot really prosper as a nation with this kind of fear overhanging over you. There is no point of talking business when you are not even sure that you are safe.

It is a good thing that it has been dealt with, but that is again a part of failure in public administration. The good old theme of our infrastructure is collapsing. You just have to look around you and you can see how that is all falling apart.

Then on the regulatory and law making sphere, I think we have seen a clear and sharp fall in the quality of law making. I don't want to get into the sort of nitty-gritties of which regulation is good or which regulation is bad.

Q: Can you illustrate that point with a couple of examples?

Shroff: I think it emanates more from conceptual difficulties because I don't think the government of the day ‑ I don't mean just this government, any of the past few governments ‑ have finally figured out in their heart whether they want to help a hinder growth. I think the political bosses - most of them seem to be right of center, the bureaucracy is left of center and never the twin shall meet, which is why you have these bizarre problems like the operating-cum-holding company which is almost a surreal kind of a situation that is taking place. People outside India who talk to us cannot believe that this is an economy that wants to modernize itself or grow. So, this is one clear example.

Q: That has probably been the most dismal thing this year. The inability to get to grips with the situation and respond to it is one aspect of dealing with this crisis. But generally speaking, life has not been able to go on. The competition commission, the company's bill, we finally managed to pass the limited liability partnership (LLP), but this is so much undealt with. For years, we have been talking about cleaning up the buyback process, and delisting process, it just never gets done?

Mody: Sometimes they say if you wait long enough, the problem goes away. Maybe that is what people are thinking. But on the competition bill, I am not that upset because I think once it comes into force, it will create more problems than we can handle. So, the longer that gets delayed from my perspective, the better.

On the company's bill, I think that if there is not enough debate that still goes into that bill for the present, we will still end up with a new bill which will give us many of the problems we didn't want to have.

Again as Shroff says, it is the mindset. For example, why takeaway differential voting rights that existed for a private limited company since 1956.

Q: That finally when implemented just months before this bill comes into the parliament?

Mody: Right. I think that when things reach crisis mode, there is a knee-jerk reaction to regulation. Otherwise, if it has to be structured like the company's bill, sometimes it takes so long to go through, that some of the provisions that were appropriate at that time have just outlived that purpose now.

I think things like the draft delisting guidelines won't come to pass because I don't think the reverse book bill will go away. Things like the short swing profits draft guidelines at Sebi, is again sometimes populist measures, sometimes it is just reacting to a situation. Now, you have the warrants exception that has gone away from the promoters, you have a complete divergence of 18- month convertibility on a regular warrant, but a five month convertibility under the QIP issue makes no sense, so why can't you rationalize those two. This will continue to happen simply because there will not be enough law makers in any regulatory body to just quietly have the time and look at the macro landscape.

Q: You are damning us forever that means?

Mody: I think the solution is to have an open mind as a regulator for private consultation and debate - not private behind closed doors but with the private participants coming in and giving. Very often, consultation is seen as an insult to something that has already drafted. I think that mindset is already changing.

Shroff: I have a slightly different perspective on this because I think this is just deterioration in methodology of law making that has been taking place for a long time. What we have done is law making or regulation making has been committeeized. It is the sort of wisdom of the many by aggregation of opinions rather than the wisdom of the few experts. So, what you have in a company's act is one example where you consult a whole lot of people and then just total their agendas together that is not how you draft legislation.

I still go back to legislation drafted in last century by Lord Macaulay whether it is the Penal Code or the Contract Act, it has survived a 150 years with very few changes. So, what was different between how laws were made then and the law that is made now. The difference I see is this process which is followed. I think we need to as a nation think about this and go to the heart of governance as well, because if governance has to be related to law making, and how is the process that you are going to follow, sure by all means consult people but in the process of evolving new policy, this is the real flow in my view.

It is just different agendas that get total together.

Q: From what both of you are telling me though Zia believes that the mindset maybe is changing, it seems like none of this is really going to see any revolutionary change over the next two-three years, it might be evolutionary maybe 10-15 years from now we will be drafting our bills in a different fashion but doesn't look like 2009 can fix any of these problems, right?

Shroff: I think we have to start somewhere.

Q: The next point you were talking about is emergence of activism?

Shroff: Tata recently said he is going to deal with his own security and I am going to fix my own anti-terror processes, what does that mean when a leading corporate citizen says that, it simply means that he has lost confident in the state and they are not going to be able to protect him and its something which I have to figure out for myself and that demonstrates and its an indication the fact that cynicism has set in very deep in society out of sheer frustration of the failure of governance and we are seeing that now finds its activation in expression. The Satyam company or the manner in which civil society has reacted to 26/11 and we haven't seen something like this and its not just fear but its anger, cynicism and frustration and you are seeing people like me having to take steps that I would have never done before and a lot of people like that who are now willing to come out and say governance is just too important to be left on the government if something which civil society has to take in and I am saying that and I hope the trend continues for a lot more accountability.

Q: What does that mean for a corporate law prospective?

Mody: We get a lot of enquiries of who can be stopped of doing what than we saw in the last 2-3 years which is not a good thing and share holders are willing to examine their options pretty seriously to see what they can or cant do unfortunately the law doesn't give them too many options. It's the reputation ultimately that takes somebody to task and I think you don't have to go to court.

Q: Do you think the laws in 2009 might be amended to address some of the needs of share holders being able to take the direct action against managements or boards?

Mody: The may amend the company's bill, civil rights but if you look hard between the listing agreement, the company's and the Sebi's general requirements and there is enough masala there if you really want to dig up and start making somebody miserable. I always say ultimately the guy has his front name flashed on the front page of the news papers and most people aren't. So, if there is something which is touching their conscience or if there is enough of a furore coming from the other side, most sensible people will re-examine their actions.

Shroff: Clients always come to us and tell us to find a solution to work around such regulations and innovation has normally been the mantra we distinguish ourselves by innovation but as we are seeing this governance theme become more its going to force people like us to innovate and force us to become a little more cautious and a little more conservative and ask our selves the question as we advice because we get involved in putting together a lot of the structures of is this just right in law or is it also nice in substance.

Q: This is an honest admission I must say

Shroff: The entire advisory committee finds on works for solutions and which doesn't mean to evading the law but you try to work around it and what's happening in the broader sense and people like us will become a bit more cautious in many terms

Mody: That as always been and what has been characterized and it has always been and if I hear that Cyril has given some aggressive opinion and I don't believe and if I call him up and check that he has not given it and people don't know we have this conversation offline. But at the end of the day as a lawyer you have to be able to have your advice withstand and if it doesn't withstand the smell test then you haven't done justice to your client, you can tell him that these are the structures and you can say but these wont withstand, the clients really come to you is for the touch and feel on where and which gap does it fall and that's where they really value.

Q: Perceptions becoming bigger issues with most companies lately, you just don't want to be in the front page of any newspaper?

Shroff: Yes and particularly in a country where there is so much unpredictability and so much of grey, its basically a legal system with large patches of grey and very little black and white, so that's the environment for which we work,.

Q: Your third point was unpredictability and that has really played every business executive for the last one year?

Shroff: That's the stunning part of this year we have seen financial institutions which we thought would survive for ever disappear in a blink of an eye, you have seen oil prices of USD 140 per barrel in June and USD 35 per barrel now, interest rates change so dramatically and confidence change in a matter of few months, how do you plan for and whether you are corporate, or government or you are a private citizen, you are living of that society that is moving and changing every minute and in order to deal with that just a kind of reflex that corporate will have to develop and so regulators that have to develop have been remarkable, just to take to perspective the FII Regulations, you had the problem of plenty last year and you had regulations which tried to restrict the flows, this year you have a draught and the regulators are trying to find ways of turning it upside down, you had this phenomenon of this take over code limit being increased from 55% at 8 pm at night. So the kind of flexibility and fleet footed ness that has had to be shown by the regulators, whether its enough or not is a different matter but that is a direct out come of unpredictability.

Q: How do you legislate to be able to factor in unpredictability? How can regulators re-look at laws and say the world has changed and how do we allow for these laws to be more adaptive?

Mody: They are looking at them and the problem is that its not being done fast enough for example in the external commercial borrowings, they have amended that but its still not good enough because the basis points about the six month LIBOR that they have allowing you to go for and nobody is lending to you at that price, so its nice to look liberal but it doesn't achieve anything and then you are saying go and buy back at a discount they have got so many conditions wrapped around, so they need to really look at is to cut the knot some where and let go of some legacy issues, the whole NRI legacy issue and NRI's are just bad and the money is just tainted and you have to come separately and you cant come as an FII etc, the assumptions of the 70s are not the assumptions of this century and there the regulator just has to trust the world again a little more than he is doing and one regulator if is being fleet footed, the holding or operating policy is unacceptable, you can cry but basically, you are basically telling the foreign investor there is no longer an automatic route into India almost every company that a person invests in will have a subsidiary downstream and even if both are under the automatic route you are telling that company that if you take foreign money then I will send you to the RBI to pay a lot of money to which is called compounding, there are 800 applications which are pending for the government and it is completely unacceptable that the government is just not moving and doing anything about it despite knowing that it has to.

Shroff: They haven't made up their mind whether they want to help or hinder. Is this a problem because the regulations are much more law based other than principal based and is that the source of the problem or is it just the cloudy thinking or both?

Mody: if you look at this just particular example, no one was taking this interpretation both of us never thought we needed to go back to the FIPB, this is basically been a regulatory re-look at a rule that says the same thing but its just being perceived so differently.

Q: Everything that both of you have spoken to me about doesn't paint a pretty picture of 2009, here is what I asked you what you expect from 2009 maybe changes the some of the specific things that we have mentioned already maybe completely new regulatory adoptions, what do you expect from next year?

Mody: I think there will be more lawmaking and judicial pronouncements on insolvencies, bankruptcies, restructuring. That has been an area of law that many of us don't practice too deeply that we have had to re-look and give opinions and advise and get into much more.

We will have to go back to the regulator and discuss innovative instruments for capital raising because that need is not going to go away. One of the things that I was discussing with one of my partners was why not give infrastructure the status of priority lending to the financial institutions. That will give a boost to the whole system because the banks will then get the benefit of priority lending; infrastructure is what the government wants.

I think that there has to be good progress because we are committed to a growth rate whether it is 9% or 5%, it is better than most of the world. If legislation and government actually hinders that growth rate, then they have a lot to answer for and they don't have to do much to help it.

Q: When you speak of new products any ideas of what we can expect in 2009?

Mody: Not that I can talk on the show.

Q: There must be some sense you can give us of maybe what currently does appeal to the regulators?

Mody: I think the products that we think will become more innovative and capital raising will involve some changes in the Foreign Exchange Management Act because things like optionally convertible preference shares today are treated as debt. But at the end of the day preference shares are not treated as debt. So why put that label?

So FII investment if it can be allowed should be allowed. The QIP route which has the non-convertibles with the warrants, query where the RBI will allow the FIIs to participate as QIPs in that and if not then should some special exceptions be made.

So I think it is a function of trying to find products which have a little regulatory change required to them because as it stands today, we know what the problems are. So if we have to speak to the regulator and make a few mix and changes, I think it will involve a little bit of tweaking.

Shroff: My instinct on instruments is that you are going to see big changes on the debt side. We have equated capital markets de facto with equity capital markets. The big change that we are going to see from next year onwards is the emergence of the debt capital markets as an extremely important part.

Q: We have been talking about this for two-three years; you think 2009 will finally deliver on the promise?

Shroff: I think it will now happen partly because the manner in which risk is perceived and secondly it is just overdue. It is probably the right thing to emerge when the market is passing through this kind of phase.

Mody: There is a buy-in from the government I think in perception. And the philosophy is that yes it has to be a good thing and is the right thing and committee after committee has talked about it.

Shroff: Continuing with what Zia Mody said a lot of the change, innovation will be around debt. In the new product space that we are talking about and it have a number of implications in terms of bank capitalisation, or the manner in which infrastructure is financed or just how do companies finance themselves when the equity markets are completely dead? So there will be many variations of that.

Q: Do you want to share with us some illustrations?

Shroff: Different varieties of preference shares being evolved, varieties are hopefully the Company's Bill comes too fast. I think differential vote shares also will continue to play a role.

Q: You spoke of insolvencies being one new area, new products, infrastructure and how to boost that, anything else that you expect next year?

Mody: Out of litigation or arising out of, I think that the best sort of shareholder activism doesn't go to litigation. I think it stops short of that because that is when you've succeeded. But in terms of pure litigation, it is going to be just on foiled contracts, pulling out every comma to get out of an obligation, people who want to recover making aggressive cases and creating aggressive strategies to force a company to come.

Q: Derived from the way the economic environment is going to be, if you want to rethink strategy?

Mody: And in terms of positive reconstruction I think that when everybody comes to terms with the fact that their values have been knocked off, private equity will come back and start looking at opportunities.

Shroff: On a slightly more cheeky note, I think one good thing for both of us and maybe some other firms as well that there will be a flight to quality because when contracts - just to continue on what Mody was saying - where every thought in terms of how to break a contract, how do I get out of this, how do I deal with that that sort of thinking is going on, people are going to think about how am I going to use the best advisors, the move from price to quality I think will happen.

So, I think it will be good news for quality in the markets. I am not saying necessarily that all the quality sort of sits over here. But as a broader theme it is a flight to quality.

Q: So you are done with 2009 expectations?

Shroff: I want to see the current mood and this insecurity being dealt with what I expect to see as a part of the business world, I would like to see clarity on rules and specific things and more clarity in terms of whether the policy is to help or hinder, so we know where we stand.

Q: This is never going to happen right?

Shroff: Whether its market things like buyback regulations relisting or whatever it is, half the problems are just because of confused regulation but its not just the words which are poor but its also the thought behind it which is sometimes not clear, so I am just giving you my wish list and this is one thing which I would like to see and then let me come down a little bit to the micro level I would like to see some of those irritants of 2008 and some of them which are hanging there for so long be put behind us, clarify this debate on FDI versus FII and get rid of this silly delisting problem, make up your mind and just tell us once and for all and we must have simpler, clearer and more principal based regulations rather than the kind of complete mosaic of self contradictory laws that we have.

Q: Do you believe the transition to the principal based regulations and not rule based regulations, is this ever going to happen?

Mody: It will but slowly and many people are convinced that principal based regulations are good but having said that even the UK which is the model of principal based regulations especially after what's happened to them now, and has just tripled their rules, so again it's a combination of what you need to have at that relevant time, the principals are always good in more stable environments where you can just say behave your selves people and in that times you better behave yourself and do 20,000 things, so right now we don't get rid of the rules so quickly and maybe while life settles down the debate will come back more but the debate has stopped now and no body is talking about principles.

Q: How do you think global regulations and some of the practices across the world follow are going to maybe evolve in 2009?

Shroff: It is continue to going to be evolved and the deeper issue is that we are going to see a completely new financial architecture globally that's on the cards and there will be a lot of change.

Q: In specific areas you can point out?

Shroff: The whole financial sector I see having starting with a lot of change and its not going to be as if we are going to be lagging behind, we are at the same table now and we are going to play a role in how the financial regulation shapes up.

Q: So you mean scrutiny of banking and non banking firms and investment banking firms if there are?

Shroff: The arbitrage between the banking and the non banking finance sector and we know what that is and we might see some of those gaps cover up, so you might see a new model for the mutual funds across the world because its probably and here as well and its doing bank type things without the bank type safeguards, so that's one area where we are going to see a lot of conceptual change and all these institutions will have to adapt to the new framework, the world is getting firstly used to a fundamentally and we never been used to it and we have seen things go this way, and in the last six years that's where a lot of growth took place, so that's going to be an interesting thing to be seen.

Q: 2009 might also be the year that foreign law firms might be allowed in the country, what do you think it is going to be?

Mody: I don't think in 2009 they will be allowed into the country and I think and I am not as opposed as Shroff is.

Shroff: It is not the question of being opposed but it's a question of having a framework where independent firms survive and see and we have clarified this many times and it's not a question of opposition for the sake of opposition. For this thing to happen, it's going to take longer.