Our International Derivatives Seminar

India’s corporate sector had for long been controlled, constrained, repressed and suppressed. This was a fair and square assessment by the end of the 1980s. The early 1990s provided both the opportunity and the necessity to unshackle the immense potential of the private corporate sector. The time had come to unshackle the immense potential of the public corporate sector.

“Potential” and “value” are related. “Economic value” is a direct function of “economic potential” and “organisational performance”. Hence, the unshackling of economic potential leads to the uncorking and unlocking of economic value. The unchaining of human capital does the same.

The epochal 1992 union budget had multiple and composite objectives. Unchaining human capital and unshackling economic potential had become necessary. The route to that was complex. But opening, widening and deepening the channels to the capital market were seen to be some of the prerequisites.

Primary markets and secondary markets together constitute the capital markets. A robust and reliable secondary market is a prerequisite for the flow of investment capital through the prime market.

This is where we – Mr. V. Sankar, member of the Madras Stock Exchange (MSE) and I – saw our opportunity. Equity futures and equity options would serve the Indian secondary market and its constituents (1) with clarity, transparency and fairness and (2) without snuffing out a paisa of the rewards for risk taking.  

The 1992 budget

Dr. Manmohan Singh presented the epochal union budget of 1992 on February 29, 1992. It unshackled India’s corporate private sector. It loosened the controls on the corporate private sector’s capital raising functions and capabilities.

First, the Office of the Controller of Capital Issues was abolished. Second, India’s businesses had the freedom to issue equity at whatever prices they thought were good. They could swim. They could sink. It was their choice.

Third, foreign institutional investors could invest in Indian equities. Fourth, India’s corporate sector – both private and state-owned – could issue financial securities outside the country. Indian companies could issue global depository receipts (GDRs), American depository receipts (ADRs) and euro convertible bonds (ECBs). This listing is indicative.  

Fifth, wealth tax on financial assets was abolished. Sixth, the corporate taxation rate – which was higher for closely-held companies – was levelled for both widely-held companies and closely-held companies.

These policy components were aimed at enabling India’s corporate sector to get closer to (1) the sources of global capital and (2) the flows of global capital. At the same time, these policy components had the bigger objective of unlocking and uncorking the enormous but repressed “economic value” within the companies.

The operational implications were clear. Both components of the capital market – the primary market and the secondary market – had to come to speed to make the most of the abolition of controls and the expansion of the freedoms.

An absurd secondary market

A dominant part of India’s secondary market was strange and absurd. It had a unified and contemporaneous price discovery for (1) the cash market and (2) the system of carry-forward trades and periodic deferred settlement of trades. This system was known as badla. It was an economic absurdity. It was an economic oddity. It had historicity.

Why do I describe this as an absurdity? Imagine these. First, the price of motor spirit (also known as petrol and gasoline) is, say, Rs. 80 per litre for delivery-versus-payment (DVP) on Monday, October 12, 2020.

Second, the price of motor spirit is the same Rs. 80 per litre for DVP on Monday, October 19, 2020 with some adjustments known as badla charges that the brokerage will inform us on October 19, 2020.

Moreover, the price of Rs. 80 is discovered on the open-outcry trading floor. Neither the buyer nor the seller would have to specify if the trade was for DVP on October 12, 2020 or for DVP on October 19, 2020.

For four possible sets of intentions, the contracted price is the same: Rs. 80 per litre. This is a simplified illustration. But the price of Rs. 80 per litre hides and/or obliterates (1) utility from possession, (2) profit from deferring payment, (3) profit from deferring delivery, (4) loss from deferring payment, (5) loss from deferring delivery, (6) storage cost and (7) cost of funding the inventory over a week.

India was in desperate need of a sane secondary market for equities that worked unambiguously on clearly stipulated DVP terms. India was in desperate need of an equity futures and equity options market.

Badla destroyed coterminity

Badla was a badly mixed up system that destroyed the “coterminity” of contracts. Should not a buyer seeking delivery on October 12, 2020 contract with a seller seeking payment on October 12, 2020? Badla brought together prices and contracts that were not necessarily coterminous.

I coined “coterminity” in 1991 as the noun of coterminous, an adjective. Coterminous means having a common boundary or limit in time, range and scope. When a buyer seeking delivery on October 12, 2020 contracts with a seller seeking payment on October 12, 2020, they have a coterminous contract.

Coterminous is a legitimate word. Coterminity is not a legitimate word. It sounded better than coterminousness, another illegitimate word. I chose coterminity. I used it wherever I spoke. I used it in my reports. No one objected. No one knew it was illegitimate.

My scholarly backers

I had an amazing and steadfast set of backers. They found the word coterminity cute and totally acceptable. The late N.J. Yasaswy (NJY) – the principal founder of the ICFAI Business School – was the first to state this.

Moreover, NJY made it possible for me to teach (1) futures and options and (2) treasury management in the institution’s classrooms spread across the country. We were intensely good friends. We would make an eleven-city tour of India in 1994 to present and to explain the economic policies of the Narasimha Rao government and the finance minister, Dr. Manmohan Singh.

I had three other backers. They were Professors P.G. Apte, Prasanna Chandra and R. Vaidyanathan. They were reputed teachers at the Indian Institute of Management Bangalore (IIMB). Professor Apte was a senior and a decorated alumnus of the Indian Institute of Management Calcutta (IIMC), our common alma mater.

Professor Apte and I shared a fondness for discussing currencies, sovereign bonds and the LIBOR market. LIBOR is London Interbank Offered Rate. His jokes based on political behaviour on either side of the Atlantic Ocean would break my ribs. He would fetch some coffee to cement them. He would later become the director of IIMB. 

Professor Prasanna Chandra thought I should return to teaching. We had a whole lot of common scenarios pertinent to corporate finance in India. India in 1991, 1992 and 1993 was the world’s laboratory for corporate finance. 

Professor Vaidyanathan had taught me at IIMC. He taught one of the three compulsory courses in finance. I thought I had done well in his course. He too thought the same. As a consequence, he invited me to his wedding in Madras in the summer of 1979.         

Professor Vaidyanathan left IIMC for IIMB in the early 1980s. We met very frequently in the early 1990s. He understood coterminity in a nanosecond. He knew I had nailed it.

NJY and the three professors at IIMB spent considerable time with me in getting the “story flow” for the badla versus futures and options debate. There was much at stake for India. A dozen-dozen seeds were at work to make the most of the opportunity. Everything was diffuse. Everything was done with that exhortation in mind: “Ask not what your country can do for you – ask what you can do for your country.” In the meanwhile, the futures and options seminar in Vadodara had been completed in early January 1993.

Informing the world

India was ready to inform the world of its earnestness to have a robust and reliable capital market. The Securities and Exchange Board of India (SEBI) entrusted some part of the task to Mr. V. Sankar, Mr. M.K. Khanna – the executive director of the Vadodara Stock Exchange – and me.

What was the task? SEBI had planned the international derivatives seminar in Bombay. The dates were September 16 and 17, 1993. The venue was the magnificent Taj Mahal Hotel. The seminar would take place in the Crystal Room.

Our fifth ally

The world is a big place. You would want to roll on the floor laughing. You know the world is a big place. India wanted its space in this big place. I knew we needed a candid and an unbiased spokesperson who could SPeaK to the world and its discerning decision-makers.

Professor S.P. Kothari (SPK and SP hereon) was then teaching at the University of Rochester. SP and I had been students in the department of accounting in the (Tippie) College of Business, University of Iowa, Iowa City, United States of America. He had reached the University of Iowa in 1982. I had reached the University of Iowa in 1983.

SP had written to me in March 1983 informing me of the good news – the admission – a day before the department sent the admission letter. Those were snail-mail days. Pre-digital, pre-internet, at least to me it was this. I had not known SP until I read his letter. The letter SPoKe for him and of him.

SP had driven along with another graduate student – Mr. Mir Zaman – to receive me at the airport in Cedar Rapids on Sunday, August 7, 1983. Incredible! We had not known each other. And here he was! He took me to an amazing apartment on South Van Buren Avenue in Iowa City. This would be my home. His home.

Our third roommate was Mr. Raju Yavatkar, an alumnus of Indian Institute of Technology Bombay. His major was computer science. Our fourth roommate was Mr. Ayanikat Radhakrishnan, an alumnus of Indian Institute of Technology Madras. His major was chemical technology and later finance.

SP was (1) an alumnus of Birla Institute of Technology and Science Pilani and (2) an alumnus of Indian Institute of Management Ahmedabad (IIMA). My almae matres: College of Engineering Guindy and IIMC. The four of us were very different people. We did different things.

But we shared our housekeeping, grocery-buying, bill-paying and cooking responsibilities. We ate the same meals. For two years! SP was an amazing cook. He made the best sheera and kheer. No one makes it - even today - as well as he did 30 years ago. We watched football, basketball, tennis and the 1984 Olympics together. We could invite our personal friends to this common home for entertainment, food and beverages.

Mr. Sankar and I invited SP and his professorial colleague at the University of Rochester – Professor Clifford Smith – to participate as two of the principal speakers in the international seminar on derivatives. SP agreed! He became our fifth ally. We are in 1993.

We will now move the calendar by 27 years to the present. SP was awarded the Padma Shree – India’s fourth highest civilian award after the Bharat Ratna – in January 2020.

SP is the Gordon Y. Billard Professor of Management at the MIT Sloan School of Management. SP was named the chief economist and director of the Division of Economic and Risk Analysis (DERA) of the United States Securities and Exchange Commission (SEC) in March 2019. In this role, SP oversees economists, data scientists, and other professionals who provide financial economics and data science in support of the SEC’s mission.

The big day

It was a magnificent day at the magnificent Taj Mahal Hotel in that historic part of Bombay – the Gateway of India. The Crystal Room was sparkling and cool. On our part, Mr. Sankar and I had made the participation of SP and Professor Smith possible.

SEBI had arranged the participation of the heads from the European Options Clearing Corporation (EOCC), the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE).

The audience comprised asset managers, brokerages, bankers and investment bankers from around the world. India had many messages.

First, India had to tell the world about its intent to tap the market for GDRs, ADRs and ECBs. Second, India had to tell the world about how foreign institutions could invest in its companies. Third, India had to tell the world its intent to set up the world’s biggest electronic order-matching exchange, the National Stock Exchange. Fourth, India would introduce financial futures and options.

The chairman of SEBI, Mr. G.V. Ramakrishna (GVR), delivered the inaugural address. GVR mentioned two names in his inaugural address: the late Dr. R.H. Patil’s and mine. He said India would continue to look up to us to serve and to move forward. I froze. Delight, gratitude and a certain fulfilment!

SP was seated to my right. He gently put his left palm on my shoulder to wake me up from the freeze. September 16, 1993 was a great day. Every day thereafter has been as great.