The importance of the Standard Chartered IDR
Financial Express, 26 May 2010
The first Indian Depository Receipt, by Standard Chartered, is a historic milestone in the coming of age of Indian finance. Investment in this IDR makes sense for Indian investors and portfolio managers, and issuing this IDR makes sense for Standard Chartered.
Why is this interesting to an Indian investor?
The Indian investor is used to choosing between major Indian stocks in forming her portfolio. As many newspaper reports have emphasised, Indian investors already have a choice of investing in HDFC Bank or Axis Bank or ICICI Bank. What makes Standard Chartered special? The answer lies in global diversification.
Unlike any Indian bank, shares of Standard Chartered reflect the fortunes of the array of countries where Standard Chartered has operations. This gives the Indian investor a unique and precious form of diversification, beyond what is available within India itself.
As children, we are taught to not put all our eggs in one basket. As Indian investors who are tied down by capital controls: we are forced to put all our investments into the Indian basket. This yields higher risk through poor diversification. Global products, then, become highly appealing: the Indian investor is able to obtain reduced risk while roughly preserving the expected return.
Diversification is the only free lunch which has been discovered in all economics. So far, Indian households and portfolio managers have been largely forced to restrict their investments in India through capital controls. While each individual is technically able to take $200,000 out of the country each year, the procedures have been made cumbersome enough for most people to not go down this route.
What is new, then, about the Standard Chartered IDR (and the other IDRs which will follow) is ease of access. The IDR will trade on NSE and BSE alongside all other shares, looking exactly like an Indian share. The settlement process will be identical to that used on our equity spot market. The dematerialised IDRs will be held in NSDL and CDSL. There will be no form filling as far as RBI's capital controls are concerned.
Shares of Standard Chartered have a correlation of roughly 0.6 against typical Indian portfolios. In comparison, shares of Indian banks have a correlation of 0.8 to 0.9 against typical Indian portfolios. This reduced correlation is the source of risk reduction.
Deeper implications
Once Indian portfolios such as mutual funds place significant fractions of their money into global assets, their performance measurement against Indian indexes will become untenable. As long as their performance is measured against Indian indexes, outward investment is an easy way for them to beat the risk/reward tradeoff of Indian indexes. A mutual fund that is internationally diversified will look good compared with Nifty, simply because Nifty is not internationally diversified.
How much should Indian investors hold outside the country, in order to attain optimal risk/reward tradeoffs? Very large amounts, such as 50% to 75% of the overall portfolio. In good countries, very large capital inflows (such as 10% of GDP) are balanced against very large outflows (such as 10% of GDP). When this is not done, there is a possibility of one-way pressure on the exchange rate.
Why does this makes sense for Standard Chartered?
The first factor is precisely the one described above. Because Indian investors are under-diversified internationally, there might be an unusual pocket of demand for the Standard Chartered IDR in India. Bringing these eager investors into their overall global shareholding would, then, be good for their overall valuation.
The second factor which makes India interesting for Standard Chartered is the stock futures. India is the home of the world's most sophisticated stock futures market, which has features such as cash settlement, electronic trading including algorithmic trading, international investors, hundreds of thousands of screens and Internet-scale trading, well-run and well-governed exchanges who run effective market surveillance, etc. There is a fair chance that futures on Standard Chartered will achieve liquidity in India. If this comes about, then Standard Chartered would have gained something new out of listing in India: they would have gained a liquid stock futures contract.
The third factor is sheer advertising. There are now hundreds of thousands of screens in India and abroad, which are linked to the NSE and BSE trading computers. When a firm lists in India, and particularly if the IDR issue is large and if the stock futures take off, it gains unique visibility in the eyes of millions of the most sophisticated individuals in India's financial system. Particularly for a financial firm, there cannot be a better way to gain heightened visibility in the Indian financial system. This reason may suggest that IDRs might be particularly relevant in the thought process of global financial firms who aspire to do business in India.
There are, of course, uncertainties that have yet to unfold. Will the IDR be liquid? Will the IDR attract global users? Will the stock futures and stock options attain liquidity? At the same time, this is an important start.
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