Large investors too need protection

WITHOUT CONTEMPT

Last fortnight, this column spoke about some of the lessons that the international sub-prime debt crisis holds for India from a policy perspective. There is another element to unlisted structured debt products which has only recently begun to attract public debate.

The unlikely initiator of this debate is the Insurance Regulatory Authority of India (IRDA). In a statement issued last month, the IRDA signalled that it had asked the insurance companies to phase out unit-linked insurance products (ULIPs) and re-calibrate the manner in which these products are sold by insurance companies. The IRDA's grouse was that the consumer of these products was quite clueless about the nature of the risks run by him, the costs borne by him, and how to compare one product with another.

For instance, some ULIP products entail charges to the investor to the tune of 60-70 per cent of the initial premiums contributed. Yet, others claim that the investors would be charged only 20-30 per cent. Most ULIPs are sold not as insurance products, or for the value of insurance perceived by the investor, but as investment avenues akin to mutual funds. In short, a conversation with most salespersons marketing a ULIP would entail the investor being told about insurance being a by-product of a spectacular investment avenue.

The IRDA's move is a very important development. Investor protection in India has so far been very socialistic in nature. Indeed, some Left party-leaning politicians have rendered yeoman service in furthering the cause of investor protection. However, a sub-text of derision for anyone who is not perceived to be a "small investor" is a universal feature in India. Getting fingers burnt, being short-changed and having incurred wrongful loss do not evoke sympathy for the high net-worth investor across the law-making, law-enforcing and law-adjudication system.

One just has to scratch the surface to realise the plight of the large investor. Typically, this would be a customer of portfolio managers registered with the Securities and Exchange Board of India (Sebi), or an investor in insurance companies' ULIP products, or an investor in unlisted structured products. A standardised sign-on-the-dotted line documentation would greet him at every turn. If the regulators were to conduct a study on the quality of drafting the product documentation and disclosures to the investor, the results could be startling.

For instance, a leading ULIP provider has product documentation that does not even have an alphabetical arrangement of definitions. Capitalised terms are merrily used across the document, without even being defined. Terms and conditions governing other products offered by the same service provider would be found in the same agreement, left in, only for purposes of a plethora of cross references and adoption of definitions. An investor who chooses to read his contract would be quite lost to know his precise rights and obligations under his contract.

Documentation governing structured products offered by portfolio managers could be even more revealing. Some of these so-called "sophisticated" products are available only to investors who are able to invest Rs 10-25 lakh in every product, but the documentation of terms and risk disclosures can prove to be shoddy. Similarly, the Reserve Bank of India (RBI) would do well to examine the documentation governing securitised paper arranged by, or invested in, by various commercial banks.

Should some of such contracts go into a dispute over enforcement, leave alone the investor, even the courts and arbitrators could be hard-pressed to appreciate the commercial contract between the parties. Not just for want of sophistication among judges and arbitrators, but also because the much-touted sophistication does not permeate the quality of legal documentation and effective disclosure to investors.

On its part, Sebi, the capital market regulator, has published a consultative paper for securitised paper. However, the scope of Sebi's proposed law would cover only listed instruments and not unlisted instruments and the risk disclosures in them. That leaves a large segment of the market uncovered.

The IRDA, Sebi and the RBI would do well to exchange notes and co-ordinate their coverage of risk disclosures to investors and quality of effective documentation. They would do well to review a consultative paper issued by the Australian Securities & Investment Commission (ASIC) last month after the sub-prime debt crisis, proposing an "if-not-why-not" approach to regulate investment in unlisted and unrated financial instruments.

The ASIC has proposed a simple approach of providing benchmarks to help investors assess the risk, continual disclosures against such benchmarks, bearing such benchmarks in mind while carrying out functions around the instruments, and educating investors about the benchmarks themselves. The if-not-why-not approach entails keeping the investor informed about what his investment avenue is about, how it has performed, and if it has failed to meet a benchmark, explaining why the target could not be met.

The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own

somasekhar@jsalaw.com