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Ketan Sheth: The Bond Dealer
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| Ketan Sheth: The behind-the-scenes
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No one had heard of him before his name hit the headlines,
and Ketan Sheth, the 40-something, shadowy figure from the
not-so-known world of bonds, would have liked it that way.
For sometime he was based in Pune, even possessed a card on
Pune Stock Exchange, but he moved to Mumbai in 1992. This
was after the Harshad Mehta scam and he hit the big time by
filling the void in government securities trading created
by the trouble in which several brokerages found themselves.
As it now emerges, Sheth gradually extended his sphere of
influence to Gujarat and established contact with several
co-operative banks. He thrived by selling G-secs to provident
funds and co-op banks; his bids were between 50 and 75 basis
points lower than those offered by rivals; and he preferred
short-term securities that would mature in seven-to-eight
months (their actual delivery wasn't required).
The boom in the gilt and bond markets in 2001, proved Sheth's
undoing. Highly politicised co-op banks with rudimentary risk
management systems were enamoured with gilts; the money they
invested could have, some reckon, found their way into the
stockmarkets that tanked in 2001. Meanwhile, the prices of
gilts kept increasing; and having never purchased the gilts
Sheth couldn't deliver them.
All this apart, he is also rumoured to have called the shots
at Home Trade (he was a director). Indeed, one Maharashtra-based
co-op bank says it extended a loan to the portal only because
it was ''introduced'' by Sheth, ''a valued customer''. As
this article goes to press, Sheth has admitted to siphoning
off Rs 70 crore from the Seaman's Provident Fund, and routing
it to fund some G-sec purchases. He has been charged under
sections 409 (criminal breach of trust), 420 (cheating), and
418 (corruption) of the Indian Penal Code.
-Roshni Jayakar
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Government securities may have been
the instrument of the Home Trade scam, but the unanimous opinion
among trading circles is that it must have taken uncommon chutzpah
and a fair amount of venality (plus a definite eye on the short-term,
but then that's true of all scams) to engineer the heist. In Agarwal,
Sheth, and Kedar, the ingredients came together.
It all started 18 months ago when interest rates started falling.
Now the relationship between interest rates and G-secs (which are
akin to bonds) is inverse-when rates do down, the return on G-secs
increases.
Over the past two years banks of all hues, nationalised, private,
and co-operative, made pots of money on treasury operations, largely
on account of G-secs. "In the last 24 months the yield on G-secs
has fallen 250 basis points, providing attractive trading opportunities
in government securities," explains Dhawal Dalal, Fund Manager
(Fixed Income), DSP Merrill Lynch Investment Managers.
Trading in G-secs is an inter-treasury operation: the treasury
of company A will trade with the treasury of company B. Brokers,
who had access to several treasuries, saw the demand for their services
increase with co-op banks and small provident funds co-opting them
in their search for the right securities (the big guys could do
it on their own).
Nothing wrong with that, only, NDCCB and other cooperative banks
blindly paid money to their broker (Home Trade or one of the other
accused firms) to buy securities for them and didn't bother following
up on the physical delivery. The p d of G-secs (this forms a small
portion of the debt market as the bulk of the transactions are done
in DEMAT form) takes not more than a month; three weeks is more
like it.
The co-op banks now in trouble didn't call for help till several
months after the transaction. Usually, when a broker sends securities
(in physical form) to RBI for transfer, the central bank issues
a receipt (Form 47 A) listing details of the securities, the buyer,
and the seller. Brokers normally hand this over to the buyer and
walk away with their commission.
In this case, the banks didn't have a receipt simply because Home
Trade hadn't applied for a transfer at all. All they had were letters
from Home Trade to the effect that the securities were being transferred.
As allegations against Sunil Kedar, the Chairman of NDCCB show,
the co-op banks had reason not to follow up.
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A G-SEC PRIMER
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What is it?
Government securities or G-secs are certificates
issued by the Government of India through the Reserve Bank of
India confirming money received from an individual or institution
in the form of debt. They bear a fixed interest rate. A G-sec
is known by its interest rate and year of maturity. For instance,
a 12 per cent GoI 2008 would refer to a security bearing a coupon
rate of 12 per cent (payable half-yearly) maturing in 2008.
How is return on a G-sec measured?
The yield-to-maturity (YTM) method is used to calculate
return on G-secs. The price of a G-sec is inversely related
to its yield.
What is the role of brokers in G-sec
trading?
Deals in G-sec trading can be wholesale or retail.
The former are those with a transaction value higher than Rs
5 crore. Most wholesale deals are conducted through brokers
who bring the two parties together. However, the broker isn't
involved in settling transactions. This is done through what
is called a DVP system (delivery-versus-payment), which ensured
simultaneous credit and debit of securities and the amounts
involved in the books of RBI.
Why did co-operative banks get into
G-secs?
RBI advised urban co-op banks to maintain a certain
statutory liquidity ratio. The banks achieved this by investing
in G-secs. That apart, most banks were awash with funds with
few takers. These were diverted to G-secs that held the promise
of high returns.
How does a clean G-sec transaction
work?
One, the co-op bank tells a broker to buy G-secs
from the open market and makes out a cheque in the name of the
seller. Two, the broker buys the required G-secs and sends it
to RBI for transfer. Three, the broker takes his commission
from the buyer. The securities are directly despatched by RBI
in the name of the buyer in three-four weeks. |
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What lies at the root of
the Home Trade fiasco is the fact that the co-op bank involved
failed to follow RBI regulations
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A Sheep Among Instruments
If the scam surprised many in the financial community it was because
of the choice of the instrument. With RBI spelling out settlement
norms for G-secs-between buyers and sellers with the brokers playing
no role in the actual transaction-"there is no scope for murkiness,"
says Arun Kaul, Managing Director, PNB Gilts.
Monish Tahilramani, Head (Interest Rates, Treasury & Capital
Markets), HSBC, agrees.
"The delivery-versus-payment mechanism eliminates all settlement
risks as the transactions are concurrent." In the current instance
they weren't. In hindsight, making it mandatory for all co-op bank
trading in G-secs to be in DEMAT form would have prevented the scam.
What has happened with Home Trade and a clutch of co-op banks,
then, is essentially the result of the failure of the latter to
follow RBI regulations. "If the regulations of RBI are complied
with, the chances of any scam are completely ruled out," explains
Kaul.
Doing away with brokers, as some financial brains have suggested,
may not be such a good idea. At any given point in time, the G-sec
market has about 12-15 actively traded securities, and at least
70 participants; brokers facilitate the trading process.
The co-op banks embroiled in the G-sec controversy bought securities
directly from brokers in contravention of RBI regulations. They
also overlooked the stipulation about banks not buying more than
5 per cent of their G-sec holdings through one broker. NDCCB broke
this rule. Some of the others may have too.
The way out? "RBI has barred co-operative banks from entering
into deals with brokers," says Kaul. Now, they can only trade
with primary dealers or banks. And it has instituted an online trading
system that leaves no rooms for delivery-shenanigans of the kind
Home Trade pulled. "In the new system the buyer, the seller,
and the regulator (RBI) will be linked," says Milind Nandurkar,
Fund Manager (Debt Segment), Sun F&C Mutual Fund.
The immediacy (and transparency) of an online system will help.
As will efforts by RBI to educate smaller banks and provident
funds about the finer aspects of trading in G-secs-it is a rather
technical area and does require some expertise.
The co-operative banking system in the country, though, remains
a black hole. Co-operative banks played a central role in last year's
equities scam.
Now, they are at once victims of and accessories
in an unlikely government securities one. Expect a repeat, in one
form or the other next year-unless the regulator imposes punitive
measures that check greed of the unscrupulous variety. The usual
variety of greed, as Gekko said, is good.
—additional reporting
by Debojyoti Chatterjee in Kolkata, E.K. Sharma in Hyderabad,
Nitya Varadarajan in Chennai, and Ashish Gupta & Subhajit Banerjee
in New Delhi
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