FINANCIAL TERMS-LATEST-DECODED-VRK100-09102009

Financial Terms

Latest-Decoded

RAMA KRISHNA VADLAMUDI  

October 9th, 2009    MUMBAI, INDIA

  

NEW FINANCIAL TERMS EXPLAINED IN THIS DOCUMENT
1. BSE IPO Index	6. Swiss Banking Secrecy
2. Helicopter Ben	7. Indian Depository Receipts IDRs
3. Defined Pension vs Defined Contribution	8. Cloud Computing
4. New Pension System NPS	9. Carbon Footprint
5. Debt Management Office DMO	10. Clause 49 of the Listing Agreement

BSE IPO INDEX

            Bombay Stock Exchange’s various Indices have been used extensively by several investors, domestic institutional investors, Foreign Institutional Investors, analysts and other market experts. The most famous not only of all the BSE Indices but also in the entire country is Sensex (BSE’s Sensitive Index) consisting of 30 blue chip stocks. Other well-known indices include, BSE-100, BSE-200, BSE-500 and BSE Mid-cap Index. Among the sectoral indices, the heavyweight ones are: BSE Bankex, BSE Oil & Gas, BSE TECk , BSE Capital Goods and BSE Power indices.

            BSE had on August 24, 2009 launched a new index called BSE IPO Index. As the name suggests the new index tracks the value of Indian Public Offers (IPOs). BSE launched this new BSE IPO index that will track the value of companies for two years after listing subsequent to successful completion of their initial public offering (IPO). The index will track stocks that have a free float of more than Rs 100 crore on listing. BSE IPO Index currently has 41 stocks with a free-float market capitalization of Rs 49,500 crore and the list includes Reliance Power (15.58% weight in BSE IPO Index), Power Grid Corp (13.88%), NHPC (12.50%), Oil India (8.31%) and Mundra Port & SEZ (8.25%) (the data are as on October 7, 2009). The base date of the index is May 3, 2004 and on that date the base index value is set to 1,000 points. As on August 21, 2009, the IPO Index was at 1,902. It has since gone up to 1,974 as on October 8, 2009.

“HELICOPTER BEN”

            Mr Ben Bernanke, chairman of the US Federal Reserve, is known for his unconventional views on economy. On a visit to Japan before he became the US Fed chairman, he is said to have told the Japanese to drop bank notes on the public from a helicopter to revive an ailing Japanese economy. Since then he is known as    “Helicopter Ben.”

DEFINED BENEFIT vs DEFINED CONTRIBUTION

            The previous system of pension payments by the Government is called ‘Defined Benefit’ pension in the sense that the amount of pension to be paid by the Government at the time of retirement will be fixed (or defined) as per Pension Rules. Since January 1, 2004, the Government has switched over to a new system of pension payment called “Defined Contribution” pension method. Under the new concept, only the amount of monthly contribution to be paid by the employees will be decided/fixed as a percentage of his basic pay. And the Government will also make a matching contribution to the respective pension fund. The existing provisions of ‘Defined Benefit’ pension are not applicable to the new recruits who have joined on or after January 1, 2004. Under the new method “Defined Contribution” will not guarantee the amount of pension that will have to be paid after retirement.

            Both the contributions-employee’s and employer’s-will be given to a recognized pension fund and the pension fund will generate returns during the period of employment. At the time of retirement, the pension will be paid according to the corpus that will be accrued to the Retirement Benefit Account of the respective employee. The returns generated by the pension fund will be determined by the market rates and dynamics. Under this “Defined Contribution,” the amount of pension will not be guaranteed by the Government, but it is determined by the market rates.

            Already, all the new Central Government employees who have joined on or after January 1, 2004 are compulsorily put under the ‘Defined Contribution’ system. The official nomenclature for this new concept is New Pension System (Government Employees). All state government also have been following this new system; except West Bengal, Kerala and Tripura. The NPS is regulated by Pension Fund Regulatory and Development Authority (PFRDA), a body set up by Government of India.

            The rationale behind switching over from ‘Defined Benefit’ system to ‘Defined Contribution’ is that the Governments wants to reduce their massive burden of pension payments to their employees. Even managements of the Public Sector Banks have been trying to move over to this new “Defined Contribution” system for all new employees with a view to reducing their pension liabilities. However, the employees’ trade unions have been resisting these attempts of the Bank managements. It may be recalled that General Motors, till recently the largest carmaker in the world, has suffered heavily due to wage agreements entered into during 1950s with its trade unions. Even now, the company has been suffering from huge pension liabilities. It almost went into bankruptcy very recently.

Defined Pension versus Defined Contribution

Defined Pension	Defined Contribution
(like GPF)	(NPS for Government employees)
This is applicable for Government employees who joined before January 1, 2004	NPS, based on the concept of defined contribution, is mandatory for all Government employees who joined on or after January 1, 2004. (Now, it is widened to include private citizens, with effect from May 1, 2009)
Employees are assured of a certain amount as pension after retirement. The pension amount is defined by the Government. Hence, the name Defined Pension.	Every month, Government contributes a fixed amount, called defined contribution, to the employee pension account. The government does not guarantee any amount to be received as pension.
Higher pension benefit to employees	Pension amount will depend on market-related returns generated by the fund managers
The Government bears high pension liability	Government’s liability is limited to the extent of its 10% monthly contribution in case of government employees
Assured return	Market-related return

(Please also read about New Pension System given below)

NEW PENSION SYSTEM (NPS)

(Before you go with NPS, please read about ‘Defined Contribution’ given above)

NPS for Government employees:

            The Central Government had mandatorily brought its new employees (except the Armed Forces) under the New Pension System (NPS) with effect from January 1, 2004. As part of the pension reforms process, the Government has moved from ‘defined pension’ system to a ‘defined contribution’ system. Under the old ‘defined pension’ system, the Government gives a defined/guaranteed pension to employees (like GPF); whereas, under the new ‘defined contribution’ system, only the amount of monthly contribution to be made by the Government is defined. The NPS, which is based on the ‘defined contribution’ concept, does not assure any fixed amount of pension. Under the NPS, the pension amount will depend on market-related returns. Most of the state governments too have announced a similar scheme for their new employees. The NPS is regulated by Pension Fund Regulatory and Development Authority (PFRDA), a regulatory body set up by Government of India.

            Under NPS for Government employees, every month, 10 per cent of an employee’s salary and DA will be deducted from salary and kept in her pension account with matching contribution from the Government. The savings will be accumulated till her retirement and maturity amount can be used by the employee for her daily needs after retirement. After an employee attains the age of 60 years, she can withdraw her pension. At exit, the individual would, however, be required to invest at least 40 percent of pension wealth to purchase an annuity. The annuity so purchased is expected to be useful as pension to support the needs of the pensioners during their lifetime. The remaining 60 per cent of pension wealth (accumulated during their service till retirement) can be utilized freely by the pensioners in their own way. Individuals will have the option of leaving the pension system before 60 years but with certain additional conditions.

            The Government had transferred the accumulated funds along with its matching share, around Rs 1,177 crore, to the three Fund Managers on April 1, 2008. The three Fund Managers appointed by PFRDA for investment management in July 2007 are LIC of India, State Bank of India and UTI Asset Management Company. In the year 2008-09, the fund managers have managed to earn a decent for the funds kept with them.

NPS was the brainchild of OASIS (2000) report on Old Age Social and Income Security.

NPS for all citizens other than Government employees:

            In August 2008, the Government had advised PFRDA to extend the NPS to all citizens. Accordingly, PFRDA had rolled out the NPS to all citizens other than Government employees effective May 1, 2009. Originally, NPS was meant for central government employees. Now, the scope of the scheme is expanded to several other categories, like, employees in the private sector, small businessmen, self-employed professionals, ordinary people and workers in the unorganized sector.

            The features of NPS for all citizens (other than Government employees) are slightly different from NPS for Government employees. The NPS for all citizens envisages a new set up, that is being established by PFRDA, which enables citizens to start saving for their retirement right from the day of joining employment.

            Maintenance of NPS records and provision of customer service to all NPS subscribers are provided by a Central Record-keeping Agency (CRA). National Securities Depository Limited has been appointed as a CRA by PFRDA. NSDL issues Permanent Retirement Account Number (PRAN) to NPS subscribers and maintains the database of PRANs. The PRAN will remain the same even though the NPS subscribers change their jobs or are transferred to different locations.

DEBT MANAGEMENT OFFICE   (DMO)

            Till a few months back, the country was abuzz with reports that the Government of India wanted to separate the functions of debt management from Reserve Bank of India and keep it under a new authority called Debt Management Office under the Ministry of Finance. As of now, RBI undertakes the issue of Government Securities and Treasury Bills on behalf of Government of India. Simply speaking, RBI is the Government’s fund or money manager. According to a calendar issued by GOI, RBI will arrange for auctions of Government Securities (G-Secs) that will be subscribed by commercial banks, insurance companies, primary dealers, pension funds, individuals and others. While RBI manages the internal debt functions; the external debt and non-marketable debt is looked after by the Ministry of Finance directly.

            Several committees have highlighted the triangular conflicts of interest for the RBI in its role as debt manager, regulator of banking system and as a monetary policy authority. However, veteran central banker, Rakesh Mohan, till recently RBI Deputy Governor, opines that the time is not ripe for complete separation of debt management functions from the RBI. Significantly, more than 50 per cent of the Indian Banking System is owned by the GOI. The debate about this continues unabated. There are proposals for setting up a National Treasury Management Agency which will initially take care of foreign currency and inflation-indexed bonds.

SWISS BANKING SECRECY TOPPLED

            UBS, one of the largest banks in Switzerland, has ended the much-acclaimed or maligned Swiss Banking Secrecy provisions by coming into an agreement with the US authorities for sharing the details of its customers with the latter. In August 2009, the bank had signed an agreement with the USIRS (United States Internal Revenue Service) whereby UBS will hand over details of some 4,450 UBS bank accounts to the US tax investigators. UBS is forced to share these details with the US authorities in order to avoid any prosecution or cancellation of its banking license in the US.

INDIAN DEPOSITORY RECEIPTS (IDRs)

            Indian Depository Receipts allow foreign companies to raise capital in India. These are issued by a local depository against the shares of a foreign company’s publicly-traded securities. The salient features of IDRs are:

Ø      IDRs are derivative instruments similar to GDRs or ADSs (Global Depository Receipts and American Depository Receipts are used by Indian companies to raise capital on foreign shores)

Ø      They are negotiable instruments

Ø      Foreign Institutional Investors and Mutual Funds are allowed to invest in them

            A foreign company will deposit its shares in an Indian depository (NSDL or CDSL). The depository would issue receipts, in the form of IDRs, to investors in India against these shares. The benefits, like dividends or other corporate actions of the underlying shares will accrue to the IDR holders in India.

CLOUD COMPUTING

            Cloud computing refers to shared computing resources, storing data on a virtual platform rather than on an individual hard drive. The term ‘cloud computing’ was introduced in 2006 by Eric Schmidt, Google’s Chief Executive.

            Cloud Computing is a new concept that has taken the IT Services by storm around the world. In a cloud computing scenario, a company can actually move its core data and other programmes that operate on such data from private machines such as desktops, personal computers or corporate servers to machines owned and operated by vendors. Companies, like, Oracle Corporation, IBM, HCL Technologies, Microsoft, Zoho and Google are offering such services to needy companies. Cloud computing helps reduce costs, both capital and operating, through economies of scale. These services are provided over the Internet enabling companies to work from anywhere in the world and get them connected to the virtual networks or servers owned by vendors.

            Companies will not store their data with them and instead use the servers or networks managed by service providers or vendors. As such, companies need to choose the vendors extremely carefully; otherwise the chances of losing valuable and important data are very many. So the reliability of vendors is vital for the success of cloud computing. Overall, cloud computing has its merits and demerits and individual companies need to assess their own needs before going for it.

CARBON FOOTPRINT

            Carbon dioxide (CO2) and other greenhouse gases are the main contributors to climate change, including melting of North and South Poles. The total set of emissions caused directly or indirectly by an individual organization, event or product is commonly their ‘carbon footprint.’ The inference is that the lesser the carbon footprint the better for the Environment. Scientists have been cautioning us for several decades that the ever increasing pollution levels in the Earth’s atmosphere have been damaging the environment resulting in melting of Poles, raising sea levels, disruption in global weather patterns like El Nino and occurrence of natural disasters. Many of the natural disasters that have been causing havoc across the world at present have been blamed on rising pollution levels, destruction of natural forests like the Amazon and greenhouses gases. As such, we need to go green leaving a lesser carbon footprint on Earth.

CLAUSE 49 OF THE LISTING AGREEMENT

            

The Securities and Exchange Board of India (SEBI) is the capital market regulator in India. It regulates listed companies on stock exchanges in India through various acts, regulations and clauses. One of the most important and well-known clauses is CLAUSE 49 of the Listing Agreement. Listing Agreement is a legally binding contract between a listed company and the stock exchange(s) on which it is listed. Clause 49 is extremely vital from a corporate governance point of view. It is mandatory for all listed companies to comply with the provisions of Clause 49 of the Listing Agreement. Let us see some of the important provisions of this clause:

ü         Not less than 50 per cent of the company’s Board of Directors should comprise non-executive directors

ü         Where the chairman of the Board is a non-executive director, at least one-third of the Board should consist of independent directors

ü         Where the chairman is an executive director, at least one-half of the Board should be made up of independent directors (Independent Directors as defined by SEBI)

ü         All listed companies with paid-up capital of more than Rs 3 crore, or a net worth of more than Rs 25 crore at any time, have to comply with the above rules