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There is a constant debate between financial services firms and government regulators over financial market regulations – over regulate them or let them run wild and free. If there are no financial regulations in place, you end up with what we have today – a highly unregulated derivatives market. The unregulated derivatives market led to the financial collapse of 2008 and the massive destruction of wealth, yet as of today there are still no guidelines in place to regulate this highly toxic market. On the other end of the spectrum is completing choking the market with financial regulations and deterring business.

In between is that fine line that needs to be in place for markets to be efficient, transparent and trustworthy. In an emerging market like India, the regulators should be first and foremost focused on protecting the consumer. Secondly, in order to attract first time consumers the regulators should be promoting a culture of openness, simplicity and easy to understand language for financial products.

However, over the past 3 months the Indian regulators seem to be going in reverse and making it more difficult for first time consumers to make decisions. They appear to be adding more financial jargon to the process and potentially scaring off first time consumers. For most consumers in India, there are 3 government regulators that have oversight over the bulk of their money:

- IRDA (Insurance Regulatory and Development Authority) – insurance sector
- RBI (Reserve Bank of India) – banking industry
- SEBI (Securities and Exchange Board of India) – oversight of the equity/debt markets

About 3 months back the IRDA essentially shot itself in the foot when it announced new guidelines for websites that aggregate insurance information. Overnight the guidelines killed the business models for insurance aggregators. Personally, if I’m shopping online for insurance I want to be able to compare the various products and understand the pros/cons of the various offerings. However, with the latest IRDA ruling it has banned these websites from providing “opinions” on products or ratings. For first time consumers a rating is such a quick way to decide which product is better. Instead you force the consumer to read through jargon filled insurance material and in the end they will probably not buy anything because its difficult to decipher.

Likewise, SEBI recently introduced new guidelines for the type of information that mutual fund companies can provide in their marketing materials across all mediums – print, TV and web. Specifically, mutual funds companies can no longer provide a rating from someone such as Morningstar, Value Research or S&P. In addition, rankings or testimonials are also off limits. Once again this is moving in the wrong direction, a star rating is easy for someone to understand like a hotel rating – 1 star vs 5 star. Of course, consumers could just goto the websites of Value Research or Morningstar and get the star ratings and rankings themselves.  But, that assumes a first time consumer would know about Value Research or Morningstar which I doubt.

The flip side is that these rankings and ratings were leading some consumers to skip researching these new products altogether. My feeling is if consumers are that stupid to part with their money that easily, then no amount of change in regulations will curb that kind of behavior.

The term innovator’s dilemma is applied when talking about how a company handles disruptive technologies that could cannibalize their existing revenue streams. Innovator’s Dilemma is also the name of a book written by Clayton Christensen where the term originally came from.

Kodak is a company that couldn’t handle the innovator’s dilemma and recently filed for Chapter 11 bankruptcy. As crazy as it sounds but Kodak actually invented the digital camera. However, it didn’t commercialize the technology because it couldn’t look past the highly lucrative camera roll and printing business. Those revenue streams would have been killed but it potentially could have made a killing with it’s latest innovation – the digital camera.

Another recent example is Cisco. Since the early 2000′s Cisco has been selling internet telephony products which were complex and required a lot of expensive equipment. In the meantime, Skype was building a consumer product that was easy to use and cheap. Ideally, Cisco should have bought Skype but it couldn’t look past its enterprise customers that were buying expensive equipment. And remember, back then Cisco was looking to be a consumer focused company by acquiring brands such as Linksys and Pure Digital, the makers of the Flip camera. Instead, Microsoft saw an opening and eventually acquired Skype. Now Cisco is challenging the Skype/Microsoft merger because it fears its own video conferencing solution may be blocked and enterprise customers would opt for a Skype/Microsoft solution.

This brings me to India, which I believe is stuck in it’s own version of innovator’s dilemma. Inefficiency, middlemen and leakage are all words for the same thing – corruption. When technology is pitched as a solution to curb corruption people come out of the woodwork and say how the proposed system is too expensive or too difficult to use or politically motivated. The reason for the bad press is because no one really wants to change the way they work.

One example is the government’s plan to move to an electronic system of government subsidies and social welfare payments using Aadhaar linked accounts. Initially it would appear that the middlemen would be completely cut out from the process, however by having money go directly to bank accounts many other industries/services might benefit from it. Services such as micro insurance, micro payments, micro financial services, etc… The dilemma is that the middlemen will have to do more work to benefit from these new opportunities and usually that is not taken very well. Hence, all the trash talking about how bad Aadhaar is for the country and people’s privacy will be at risk. This is a classic case of innovator’s dilemma – the middlemen are happy with status quo because they can’t think beyond their current revenue stream.

The above example is par for the course all over India. People don’t like technology because it speeds up everything, makes people accountable and introduces transparency. People are afraid of technology because they feel they will become irrelevant, but you become irrelevant if you ignore technology.

The dust has settled between SKS Microfinance and Vikram Akula and the verdict is in…a complete disaster for investors in the public markets. Rewind back to 2009 when Akula was the poster boy for microfinance institutions (MFI) and was on the cover of Forbes India. A year later SKS went public on August 10, 2010 at Rs. 935 a share and closed at Rs. 1171 for a gain on the first day.  Today, SKS is trading at under Rs. 100 a share, down over 90% from its peak of Rs. 1407. Akula has since resigned from SKS and investors are resigned to the fact that they lost a lot of money during the IPO. So what happened?

The press has had a couple theories of that went wrong, one of them states there was a power struggle between Akula and the duo of CEO (Rao) and CFO (Raj). The SKS model is similar to other MFI’s in that they loan small amounts largely to village women and then the village women ensure they all pay off the loan with interest. It’s a great way to push the risk management down to the village level. This has been done successfully for many years and continues to do well. What hurt SKS more then anything else was being a publicly traded company.

When you have shareholders, their goals are pretty simple – grow the top line revenue, grow the bottom line profits which will lead to a higher stock price. In order to do that at SKS you have to find more people and give out more loans, which is very similar to what caused the economic crisis of 2008. If the investment banks wanted to sell more mortgaged backed securities (MBS) they needed more loans which meant the lending standards were relaxed – if you had a pulse you got a loan. With SKS something similar happened, they were giving loans to anybody and everybody in the state of Andhra Pradesh. Some people had 4-5 loans outstanding and those people couldn’t manage to pay them back. This led to SKS reporting less than impressive quarterly numbers which led to a downward spiral of their stock price. In addition, once the government realized people had multiple loans and SKS was charging as high as 36% in interest they hit the pause button on the SKS business model. This again led to the stock price getting pushed down even further.

I believe SKS would have been fine if they remained a for-profit but privately held company. I can understand the founding team of SKS wanting an IPO as it provides an excellent liquidity event for them to cash out, however the short term goals of the investors are completely out of sync with the long term mission of what SKS was trying to achieve.

The Indian government finally got its shit act together and approved the rules enhancing foreign direct investment (FDI) into the Indian retail segment. The bill had been hotly debated for the past 2-3 years since it has the potentially to affect many people.

The new rules allow major big box retailers that sell many brands like Walmart, Carrefour and Tesco to own 51% of the business. Whereas single store brands such as Reebok, Apple and Prada can own 100%. The timing might not be great but India is the last big market that has not been tapped yet and many brands might try their luck at the Indian consumer to grow their sales.

Locally, the retail industry is divided into two categories: organized and unorganized (aka kirana stores). Many reports have shown that 90% of all sales flow through the unorganized retail segment.  With the new guidelines, many are hoping that the organized retail sector can grab a larger share of the pie and in the process bring about a better experience for the consumer. Once of the reasons the bill was stalled for so long was the concern about how the “kirana guy” would cope if Walmart setup shop next to his store. That’s a valid point, however I think it forces the kirana shop owner to provide a much better customer experience since he can’t compete on price. Unfortunately, the concept of customer experienece is so alien to them that many will end up closing shop since they won’t be able to adjust.  On the flipside, I see many kirana shops converted into an extension of a major retailer who would service the local area and deliver the goods.

The bigger question for me is how the e-commerce space is going to play out with the new rules in place. If Amazon.com sets up shop in India will it partner with FlipKart.com or Pantaloons? Will the kirana store replace companies trying to build out the last mile mechanism for delivery (Chhotu) and payment collection (GharPay)?

It’s very early days in the retail sector and I would imagine whatever worked for these big box retailers in other countries will be very different from what ends up working in India. That’s where the local retail partner comes in and adds value since they know the local demographs, environment, buying patterns, etc… Most of the retail stocks are up today since the future looks very bright for retail and the companies that are already executing in the retail space.

In 2005, my colleague and I partnered with Refco which at the time was the largest commodities brokers in the world to launch a new product in India…what could go wrong? I landed into India on October 1, 2005 and on October 10 a press release was issued that the CEO was resigning because of “accounting irregularities”. Whenever you hear “accounting irregularities” you can safely assume the worst possible outcome, a week later Refco filed chapter 11 bankrupty. Listening to the reports over the past two weeks about the impending collapse of MF Global was like déjà vu for me, this is actually their second collapse.

The latest collapse is even more sinister then the first one. At least during the Refco collapse Phil Bennett took a loan to cover his proprietary trading (aka prop trading). However, it appears MF Global took customer segregated funds to shore up their losing prop trades on bonds which is hugh no-no. The reports are still filtering in as to what exactly happened and who knew what. However, this quote from a lawyer really ticked me off “To the best knowledge of management, there is no shortfall”. A very carefully worded statement which essentially says “don’t hold the management team accountable”.

When working with Refco during the transition to Man Financial (which eventually became MF Global) it was surreal. I just landed into India with plans to stay for 6 months while we got everything up and running. And within 10 days my dreams turned to despair. I had a great vantage point as I was sitting next to Vineet Bhatnagar, MD of Refco-Sify India, as everything was collapsing around the world for Refco. We would hear reports of what was happening via the newswire or rumors from the “New York guys” but during all this craziness Vineet was calm and cool throughout the entire ordeal. He gave interview after interview saying how the India operations were “ring-fenced” and things would be back to normal. Certain parts of the business came back to normalcy faster then others, it was a trust thing. I think the institutional guys understood their money was safe but many retail clients didn’t care what was being said.

In any event, our new fund was completely crushed…100% wanted their money back NOW. All the investors got their money back and said they would re-invest once the dust had settled. Sadly, some of India’s most prolific investors who were in the first fund did not return for the second fund which we started in March 2006 under the Man Financial banner.

Right now there are two types of people that exist at MF Global-Sify India, people that witnessed the first collapse and the “new guys.” Anyone who was there during the first collapse is a little concerned but have seen this movie before. The “new guy” is probably shitting in his pants. Having worked with the Indian management team there is no doubt they are top notch and everything continues to be above the board. There was a report in DNA Money newspaper that Vineet “had put in his papers”, I almost choked on my morning coffee when I read that. Not because “oh my god he is leaving” but rather “oh my god he would NEVER leave India”. Of course, people love sensational headlines and the MF Global collapse definately provides it.