Sebi chairman warns against leveraged derivatives

Securities and Exchange Board of India (Sebi) chairman C B Bhave on Tuesday criticised market intermediaries that devise innovative products, saying they were nothing but ways to conceal high leverage.

"Because leverage is risky and because regulators tend to control leverage, market intermediaries are continuously trying to devise ways to increase leverage,” Bhave said at a financial seminar organised by the Symbiosis Institute of Business Management.

Bhave's comment come soon after the Reserve Bank of India (RBI) recently expressed concerns about complex structured products like synthetic securitisation and credit derivatives.

The RBI had said such products would be permitted only after studying the experience abroad and the risk management capabilities of the Indian system.

Addressing the student community, Bhave said leveraged derivatives might help mint money when the going is good, but the downside could be tremendous if the bet goes wrong. “If you are big and if you have excessive leverage and if you come down, then you will bring the whole system down,” he added. He highlighted the fact that “major US banks were carrying a leverage of 30 to 40 times” when they succumbed to the global economic downturn.

“The temptation to leverage is tremendous and that is why it is difficult to observe discipline,” he said, adding that “when the day of reckoning comes, only those who do not have excessive leverage are the ones to survive.”

Leveraged derivative products were the downfall of many of the world's largest financial institutions in the US, precipitated a worldwide debt crisis and economic slowdown. Bear Sterns and Lehman Brothers have been wiped off the global financial arena and entities like Merrill Lynch and AIG survived only because of the massive bailout packages from the US government. Several Indian companies also built up exposures to complex forex derivatives products and made heavy losses after the Lehman Brothers crisis.

In India, some popular structured products include Nifty-linked debentures, debt-linked notes, daily range accrual notes, look-backs and Maxof structures. The size of structured products market in India is roughly $2 billion.

Experts said such products, which are growing in popularity, are mainly targeted at high net worth individuals.