Quantitative Easing Simplified
.jpg)
I have, in my endeavour, tried to explain the meaning of “Quantitative Easing” in a complete layman’s language so that the nuances of “Quantitative Easing” can be crystal clear to all the readers.
“Quantitative Easing” is a tool deployed by the US Federal Bank (also called as ‘The Fed’) to counter the Global Economic Meltdown which the entire world witnessed in 2008. In the wake of low unemployment rates and a complete dysfunctional economy, ‘The Fed’ used this unconventional tool whereby it would create money and purchase bonds and other financial assets from the commercial banks of their country to set short term interest rates.
Now you might be thinking of what would happen when the central bank of USA (‘The Fed’) start buying bonds and other financial assets from the commercial banks(Like Bank of America, JP Morgan . Right? Most certainly this was something that I also thought of.
Here is our answer...
1. Since ‘The Fed’ will start purchasing bonds and other financial assets, the commercial banks will have more cash available to loan. As a result the loan-giving capacity of the banks will improve and this would, in turn, make it easier to finance projects- for example, the construction of new offices, new buildings, new bridges. These projects will then require both skilled and unskilled labour to be worked upon and therefore the unemployment rates will be reduced, leading to the increase in National Income and thereby leading to growth of Economy.
2. Moreover, ‘The Fed’ purchases help to drive up the demand for the bonds and given the supply of bonds, the price of bonds will rise which causes their yield to fall. Lower yields provide the fuel for economic expansion by lowering borrowers’ cost and hence it would lure them to invest in new avenues and earn more.
My learned readers would be surprised to know that “Quantitative Easing” is bifurcated into three phases namely QE1, QE2 and QE3
QE1, with the objective to stimulate the economy, was laid down from the period between November 25, 2008 to March, 2010 comprising purchases of $600 billion worth of bonds and other financial assets. But the move had little impact and therefore the bar was raised to $1.25 billion on 18 March, 2010.
But when this unconventional move was wrapped up, new form of trouble emerged in the form of slower growth due to European Debt Crisis which caused renewed instability in the financial markets.
This made the then Chairman of US Fed Bank*, Ben Bernanke to further announce the QE2 policy which was spread over the period from November, 2010 to June, 2011 to achieve a sustainable economy (an economy which can grow without a stimulus). But this move did little to stimulate growth.
On September 10, 2012 another round of “Quantitative Easing”, QE3 was launched and this time the easing was not period-specific but dependant on economic data and unemployment rates. Observing the move, a singular thing that comes out from this is ‘The Fed’ view that the economy has not reached a point of self sustaining growth.
QE3 is also known as “QE Infinity” under which ‘The Fed’ purchased the following:
ü $85 billion of Fixed Income Securities per month
ü $40 billion of Mortgaged-backed Securities per month
ü $45 billion of US Treasuries per month
US economy unemployment rate in 2013 was at a five year low of 7% of the labour force. It is expected to be around 6.3% in 2014 and 5.8% in 2015.
Now both the unemployment rates becoming low and the economy growing well ‘The Fed’ started to taper (lessen, reduce) their data driven approach of QE3. They first hinted to taper on 22 May, 2013 but surprised all by going the other way and decided to reduce the quantum of purchases only at the end of 2013.
Former Chairman of ‘The Fed’ announced the first tapering to begin on December 18, 2013 reducing the quantum of purchases as follows:
ü $75 billion of Fixed Income Securities per month
ü $35 billion of Mortgaged-backed Securities per month
ü $40 billion of US Treasuries per month
‘The Fed’ Chairman Ben Bernanke on his second last of his 8 year tenure that is on 29 January, 2014 gave another shock to the emerging markets across the globe by announcing a further round of tapering which was as follows:
ü $65 billion of Fixed Income Securities per month
ü $35 billion of Mortgaged-backed Securities per month
ü $40 billion of US Treasuries per month
Now you might be thinking why this tapering will affect the emerging financial markets? Right... but before going into this let me explain why ‘The Fed’ continued with its tapering.
The only reason for this move was that the economy had become strong enough that the quantum of injection can be reduced and it is expected that ‘The Fed’ will continue with its tapering and finally phase out the entire stimulus by the end of 2015 depending on the economic data.
Coming to the effect of tapering on emerging financial markets, although the policy of “Quantitative Easing” was meant for the developed economies yet it had an immense affect on the developing economies. During 2008, the US economy and other developed was faced with near-zero returns and therefore investors started seeking new and alternative avenues of investment for higher returns.
Emerging economies had higher returns and had witnessed a steady growth rate which lured the investors to invest in these new avenues as they appeared to be a better alternative to invest.
Therefore, they started to borrow from US economy in near-zero rates and started to invest in developing economies like India, China, Argentina and the like. But now since the US economy has started to perform better (due to ““Quantitative Easing””), the rational investors have started to withdraw their money from the emerging and developing economies and started to invest their money in developed economies.
The detailed effect on TAPERING will be explained in my next article.
Hope that this article has enlightened you on “Quantitative Easing”.
The author Akhilesh Poddar can be contacted at
*The current Chairman of US Federal Bank is Janet Yellen. She was appointed by the President of USA on February 1, 2014.
Outsourcing the Audit Function-Key Considerations (Published in Corporate Professionals Today)
Executive Summary
Historically auditors have faced unique considerations when the clients outsource their business processes to a foreign captive unit / a third party. In recent times, we have also witnessed the emergence of a trend where non-judgmental auditing procedures are being outsourced by large accounting firms in the developed world to their Captive Off-shore Entities (COEs) located in developing economies. While this move is driven primarily by the cost efficiency gains that would accrue by operating in relatively lower cost economy, there might be a host of other considerations that might emerge out of the process. This article explores the intricacies involves in the process.
Outsourcing the Audit Function-Key Considerations
Introduction
Offshoring of business processes has gained wide currency in recent times. From its simple beginning in the 1970’s with the movement of payroll and repetitive transaction processing, off-shoring has grown to a $65 billion market. As per the Global Financial Services Offshoring Report 2007 by Deloitte, over 75% of major financial institutions report off-shoring a portion of their operations. It is estimated by some economists that up to one-third of total U.S. employment in services may ultimately be off-shored.
Audit Quality Inspections; Annual Report 2011/12 published by the Audit Inspection Unit of Financial Reporting Council, UK had this to state about off-shoring
“A number of firms are continuing to pursue “off-shoring” strategies where certain audit procedures are performed in off-shore locations, in order to reduce costs. While the extent of offshoring remains small, generally less than 5% of core audit hours, it continues to increase at a significant rate. Firms will need to ensure that their policies and procedures evolve in order to manage effectively any risks to audit quality associated with off-shoring.”
Concept
In an audit, offshoring is when certain auditing procedures for the audit of a US based company are performed by audit firm personnel located in another country, where the US based company may or may not have operations.
Large accounting firms are increasingly performing audit work for their global clients in off-shore locations such as India, China, Pakistan, Philippines etc. This is highly advantageous as the latter provides a skilled labor pool at significantly lower costs than the global counterparts. A partner of KPMG commented at a 2007 faculty symposium that the ‘all-in’ cost of a chartered accountant at the firm’s Indian COE is approximately 25 percent that of the employee’s U.S. equivalent.
Further the Indian off-shore team of say a UK practice, typically called a captive offshore entity (COE) would offer the flexibility in work timings in order to bridge the five and a half hour time-gap between the two countries. An increasing amount of audit related number checking and tabulation is being performed remotely. Improved technology for scanning and transmitting documents to far off locations is facilitating this development
Legal Structure & Impact on Audit Responsibility
In the year 2011, James Doty- the Chairman of the Public Committee for Accounting Oversight Board (PCAOB) has stated the question marks that are being raised about off-shoring of audit function from a USA standpoint. “I am concerned about investor awareness. I have been surprised to encounter many savvy business people and senior policy makers who are unaware of the fact that an audit report that is signed by a large U.S. firm may be based, in large part, on the work of affiliated firms. Such firms are generally completely separate legal entities in other countries.” In his book No One Would Listen, Bernie Madoff whistleblower Harry Markopolos (2010) writes “What many people don’t realize is that PricewaterhouseCoopers is actually a different corporation in different countries. The corporations have the same brand name, but basically they’re franchises.”
In many instances, a significant portion of the audit may be conducted abroad—even half or more of the total audit hours. The core question here is whether the audit firm in the parent country would be completely responsible for the part of the work that has been off-shored to global networks of member firms.
Let us consider the example of Deloitte Touche Tohmatsu Limited (DTTL), that employs 193,000 people across 150+ countries and posted FY 12 revenues of $. 31.3 bn from its practice of audit, consulting, financial advisory, risk management, and tax services.
This relationship is described on Deloitte’s website as follows:
“DTTL does not itself provide services to clients. DTTL and each DTTL member firm are separate and distinct legal entities, which cannot obligate each other. DTTL and each DTTL member firm are liable only for their own acts or omissions and not those of each other”
Through this legal structure, governing organization (such as DTTL) is apparently exonerated from liability for audit failures of other member firms, as well as member firms from liability for audit failures of other member firms. This risk is mitigated in the US where audit form which issues the report is responsible for the entire audit, including audit work done by foreign affiliates. But it is not very clear how it operates elsewhere.
Investor Perception over Quality of Audit
The off-shoring practice is also causing eyebrows to be raised in the off-shoring countries as the audit function has traditionally required the firm’s audit staff to spend a significant quantum of time on the premises of the company being audited, allowing for direct observation of its operations and documents. Critics argue that offshoring of audit by large firms is in fact a form of self-inflicted tick-box mentality, breaking down the audit into a series of mundane tasks devoid of client interaction. However, supporters maintained that in every audit there will be routine tasks requiring no judgment, and these boxes can be ticked just as well from India as the UK
As per the current regulatory framework, “If the principal auditor is able to satisfy himself as to the independence and professional reputation of the other auditor and takes steps he considered appropriate to satisfy himself as to the audit performed by the other auditor, he may be able to express an opinion on the financial statements taken as a whole without making reference in his reports to the audit of the other auditor”. It is then added with emphasis that “if the principal auditor decides to take this position, he should not state in his report that part of the audit was made by another auditor because to do so may cause a reader to misinterpret the degrees of responsibility being assumed.”
Meanwhile in a keynote address in 2012, James Doty- the Chairman of the Public Committee for Accounting Oversight Board (PCAOB) stated that Board is developing a standard to require audit firms to disclose in their audit reports the names of other public accounting firms, including a firm's own affiliates (COEs), as well as individual accountants not employed by the principal audit firm, who contributed to the audit.
It could so happen that if there is an audit failure due to inadequacy of off-shoring unit’s personnel, juries may attribute a disproportionate share of the blame to outsourcing. The principal audit form might to able to comply fully with the standards on Audit Documentation if they do not maintain work-papers on procedures performed at AOEs
Thus it becomes onerous on part of the principal auditor to exercise control over the work executed by foreign affiliates. The risk of quality should be addressed in a strategic manner by the audit partner deciding on the optimum mix between off-shoring of judgemental and non-judgmental areas. Also the credentials of the personnel employed in the COE need to be checked via interviews before initiating them on a project. A host of measures can be taken to ensure seamlessness in the quality of work done globally on the project.
Confidentiality
A member in practice shall not disclose any confidential client information without the specific consent of the clients. They may not be uncomfortable with the idea that their confidential information is being passed onto an individual in a foreign COE that they have never met or established a working relationship with, in-spite of the fact that the professionals are the firm’s employees. In fact legislation had been proposed in the US - Personal Data Offshoring Protection Act of 2004 to mitigate such concerns. In the UK, The EU’s Data Protection Act served as the basis for a lawsuit against Lloyds TSB, which transferred certain customer information to its Indian processing center.
Audit firms will have to reinforce their assurances to clients that procedures are in place to appropriately safeguard the confidentiality of off-shored client information during and after completion of the audit
Cultural Diversity
Again there are major challenges inherent in the off-shoring process as the engagement team would comprise of individuals from diverse cultural backgrounds who mostly communicate over phone and rarely get to see each other face to face. Audit requires an auditor to be able to demonstrate control of their working papers and supervision and control of the audit work used in arriving at their conclusions. This limitation is overcome if there staff exchanges with the offices providing the offshore services.
Future increase in costs
Even though the offshore provider’s location may presently offer pay and tax advantages over time, these costs might rise and may well start to match local costs. Historically, locations such as Singapore and Taiwan provided cheap labour but that is no longer the case. With currency appreciation and rapid growth in their economies, the story might be repeated for India, China, Philippines etc. This underscores the imperative that corporations that make global location decisions ought to focus less on short-term cost considerations, and more on long-term projections of talent supply and operating effectiveness. Off-shoring would need to be cost competitive even after factoring in costs for maintenance, monitoring, and quality control processes
Conclusion
The offshoring of audit procedures presents auditing firms with unique opportunities and challenges. While off-shoring allows firms to reap benefits from economies of scale and the cost arbitrage, the management of such practices would also need to have adequate mitigation strategies for the real risks and hidden costs. However provided that audit quality is maintained, and appropriate levels of supervision and review are employed to ensure compliance with local regulations of the parent audit firm/expectations of stakeholders; there lie tremendous opportunities where off-shoring could expand into areas requiring judgment as well.
References
About Deloitte; Retrieved from http://www.deloitte.com/view/en_GX/global/about/index.htm
Audit Quality Inspections, Annual Report 2011/12; Retrieved from http://www.frc.org.uk/getattachment/98e3e7dd-cdbe-4e45-9078-14e07bf0d7d8/Audit-Quality-Inspections-Annual-Report-2011-12.aspx
Doty, J. 2011. “Statement on Proposed Amendments to Improve Transparency through Disclosure of Engagement Partner and Certain Other Participants in Audits.” Speech, PCAOB Open Board Meeting, October 11. Washington DC.
U.S. House of Representatives, Subcommittee on Commerce, Trade and Consumer Protection, 2004; H.R. 4366: Personal Data Offshoring Protection Act of 2004.
Soft Copy of Published Article
This article titled 'CRM strategy for the CA firm' will be worth a read for SME practicing firms that are yet to harness the potential of Customer Relationship Mgt to their advantage
Customer Relationship Management (CRM) Strategy for the CA firm
Executive Summary
The world around us is witnessing a spate of changes. The forces of globalisation, internationalization of business, outsourcing and competition from alternate service providers/offerings have led firms to dispense with the age-old belief that clients should accept whatever product quality and service level that they provide. With a wide range of service providers to choose from, customers would seek to forge long term relationships with only those vendors who can customize their product/service offerings to meet their requirements. Customer Relationship Management (CRM) then emerges as a tool that becomes relevant for firms in such a scenario. Effective usage of this would enable the firm to provide excellent client service and also possibly develop new business. This article explores the intricacies involves in the process.
Introduction
Nurturing relationship with existing as well as prospective clients is one of the most critical constituents of a firm’s success strategy today. Customer Relationship Management (CRM) as a concept has been in vogue for quite some time. As per the latest enterprise software forecast from Gartner, the CRM industry globally is a $ 20.6 billion industry today and is likely to grow @ 15% to $ 36.5 billion by the year 2017. The leading players are Microsoft CRM, SAP AG, Salesforce.com Inc, Oracle etc
CRM perse is designed to maximize sales and increase customer satisfaction. It allows companies to track all the previous interactions with a customer and deliver the integrated information to the staff handling the client. This ensures that the customer’s core expectations are fully met in course of the interaction and also the firm gets a chance to potentially drive revenue by getting the client to buy complementary services and products.
However, CRM has not been implemented in a structured manner across most accounting and auditing firms in India. In other words, audit practitioners are in the business of relationships but have not taken CRM seriously. Since the business essentially hovers around ‘people profitability’, it is imperative that firms concentrate on this crucial dimension. This also assumes importance in wake of the new regulatory framework in India where the concept of ‘firm rotation’ will make acquisition of new clients a strategic compulsion for accounting and auditing firms.
CRM essentially would hinge on three concepts that are applicable to a firm as it is to every other business owner:
b) The Pareto Rule: 80% of a firm’s business comes from 20 % of its customer base.
c) The most effective way to grow the firm’s revenues is through the referral route.
Through Customer Relationship Management (CRM), firms can nurture ‘smarter’ relationships with customers, learn about their preferences and develop trust. With every interaction with the customer, the firm can record information and learn. In other words, CRM revolves around the concept that the lifetime value of a customer is much greater than the single transaction. If the firm can learn from each transaction and interaction with its customer, it would be in a position to render superior service. Thus the form gets an opportunity to differentiate itself from competitors, secures a unique competitive advantage and thus is in a position to proactively manage, track, and leverage client and prospect communications.
How to get started
CRM can be defined as the firm’s digital nervous system. If the CRM system is properly designed, it can be integrated with the other components of the firm’s software systems such as time recording and billing, document management, and email management.
The firm’s managing partners can take advantage of CRM features in common desktop programs such as e-mail calendar alerts and Excel name and address lists or they can make use of a variety of CRM software packages. One could start off with something as traditional as a birthday calendar.
There is a common perception that CRM is an Information Technology (IT) tool. It needs to be clarified that IT is merely a necessary, but not sufficient, condition for achieving effective use of CRM. IT perse contributes little to creating better relationships with customers. Hence it acts as a mere facilitator. Rather, a firm can emerge with superior customer-relating capability depending on how it is able to build and manage its organization.
The firm adopts a mindset that its topmost priority is Customer Retention. Its employees adopt flexible and nimble solutions to meet accord customized solutions to clients. Information is the final component: relevant and detailed information about customers is available through Information Technology systems in all parts of the company.
Execution Strategy
In order to strengthen the bond with clients, the audit firm can use the Internet to reach out to its clients. Some of the possible steps it could follow are:
a) Using hard copy surveys or online sites such as Google forms or www.surveymonkey.com to get clients’ opinions on ways & means where it could improve its service offering
The firm could get itself rated from clients on the following parameters on a scale of 1 to 10 and use the feedback.
- How does the client perceive the firm’s performance to be?
- How easy is it to do business with the firm
- Does the audit team exhibit a friendly/strong rapport
- Do the team members adopt an innovative approach and solve problems on the client’s turf, for e.g. how constructive is the firm’s approach when it comes to solving real time accounting issues that have emerged in a particular client
- What is the quality of the firm’s documentation? Often, it the documentation is of a high quality and easy to retrieve, the client may bank on the firm to trace some specific documents in course of a tax assessment.
- How does the client rate the technical expertise of the partners, managers as well as the junior team members? Are the seniors in the team Subject Matter Experts (SMEs)? Does the client feel that sensitive matters are handled adequately well? Is there someone in the team who is an expert on the particular business/industry, say, the telecom sector?
- Does the client perceive the fees to be high in relation to the value offered?
- Will the client reconsider the firm’s credentials for future business?
- Will the client recommend the firm to someone in his/her social circle?
Doing this would also make the client feel that the relationship is being viewed seriously by the firm and the ego appeasement always helps.
b) Set up an online system that facilitates online access to the financial accounts that the clients have with the firm and others.
This can be a great source of succor to the clients when urgent data retrieval needs emerge. This could be a situation where accounts in a particular branch of the client have got destroyed by fire and the client can retrieve key financials from this online system of the audit firm
c) Publish a permission-based e-mail newsletter.
In a bid to have a Top-of-mind awareness (TOMA) of the firm’s brand, the firm could engage in sending newsletters which capture the latest developments in the regulatory domains such as IFRS, XBRL, Companies Act 2013 etc. This practice is already followed by the ‘Big Four’ accounting firm and certainly leads to enhancement of the brand perception. This could also highlight the upcoming due dates for filings such as TDS returns. Service Tax returns etc
d) Monitor news of their company or industry
Often bring out sectoral trends, such as analyzing the impact of the global recession on the client’s specific sector, in form of a customized report could go a great way in enhancing the strength of the relationship. For instance, a client in the steel sector, especially a Small & Medium Enterprise (SME), will greatly value a report sent by the firm which captured the global dynamics of the industry in the current crisis, trends and forecasts and key mitigation strategies to manage the risk. This report could also capture the key moves of competitors as well as their financial performance
e) Birthday/Anniversary Reminders
(Source: Microsoft CRM)
Imagine a scenario of having a potential client. Sending a birthday greeting could be an effective mechanism to connect on the emotional front. Same holds good for a key existing relationship. Automated softwares and applications that are a core of a CRM package can help a firm immensely in these. The firm can take advantage of the scheduler packages to define the list of contacts to whom birthdays/anniversary needs to be sent, number of days in advance of the event for the reminder etc.
Some of the compelling benefits that can accrue to a firm from the CRM initiative are:
1) “One firm concept”
Normally it is a specific partner of an audit firm who services the client would be having an intimate knowledge of a client’s business needs, history and personal preferences. CRM would facilitate a transition in that anyone who works on that account can access information on everything pertaining to that client- from the client’s annual revenues to the names of the CEO’s children. This, therefore makes goodwill tangible, and thus emerges as a firm succession planning tool.
2) Measuring relationship capital & focused nurturing of relationships
The firm is able to analyse as to which are the key relationships to focus. The Pareto Rule is of utmost importance here. 80% of the firm’s revenues accrue from 20% of its clients. These are the crucial clients to focus. Once the clients are mapped on the relationship matrix, such a
If the firm adopts a ‘relationships-as-assets’ approach, it can priorities and focus on which clients it has to focus on. If the firm can make a realistic assessment of which clients are the true long-term assets, it will contribute to value creation.
Let us consider multiple scenarios
a) A client that offers large volumes and complex work becomes important right away. On the contrary, some clients are not interested in a long-term relationship.
b) A client may not want a long-term relationship or the firm would have to spend a disproportionately high amount of investment to get a mature relationship and thus it would be a futile exercise
c) A client may render high margins but its business model is risky, controls are always weak and thus the risk adjusted audit revenues may not be worth it.
d) A client may directly compete with other clients , say two major FMCG players and the firm has to choose who to partner with
Thus the detailed customer evaluation during the CRM exercise would really help in generating value for the firm.
3) Emergence as a one-stop solutions provider
The firm gets business on a repeated basis from the client as well as new lines of business. For instance, a client who is extremely satisfied with the Audit & Assurance function of a firm may also then also consider it favorably for Direct & Indirect taxation advisory services. Under the LLP concept, we will soon have multi-disciplinary firms where Chartered Accountants, Company Secretaries and LLs would work under the same roof. Promoting Customer Relationship Management
4) Client Referrals
Under Clause (6) of Part 1of the First Schedule of the Chartered Accountants Act, 1949, “Practising member prohibited from soliciting clients or professional by circular, advertisement, personal communication or interview or by any other means.”
Hence client testimonials and advocacy are one of the most effective ways to grow the practice, especially when audit firms cannot go for aggressive business development initiatives under the existing regulations of ICAI.
Conclusion
A carefully planned and consistently implemented CRM initiative in a firm’s practice can yield returns of upto 400% over the full life cycle. If CRM is implemented, the firm has the tools to get a 360 degree view of a customer and can deliver more robust solutions to the existing client base. Improved service quality leads to nurturing of strategic relationships that can go a long way in increasing revenues through cross-selling and referrals.
References
CRM Systems: Necessary but not sufficient. REAP the benefits of customer management,” Journal of Database Marketing, March 2002, page 267
Microsoft CRM, Retrieved from http://community.dynamics.com/crm/b/iotapcrminsights/archive/2013/05/14/event-reminder-happy-birthday-reminder-using-report-scheduler-for-microsoft-dynamics-crm-2011-online-and-on-premise.aspx#.UiWE89JxTOU
About the Author
CA Anurag Singal is the founder of CA Job Portal http://www.cajobportal.com/. He has authored a book titled “Auditing Mantras for CA IPCC” (http://www.auditingmantras.com/ ). He can be contacted at anurag@auditingmantras.com and contact@cajobportal.com
2) CA degree-Your tryst with destiny
The CA degree- your tryst with your destiny
“If the tax auditor certifies that these are the heads, the officer has no discretion. The Income tax Officer has to accept the tax audit certificate unless it turns out to be a patently false certificate. We will accept the certificate of the auditor.” Stated the Union Finance Minister, Mr. P Chidambaram on the floor of the Loksabha while replying to the debate on the “Finance Bill 2005”. He further added that the guidelines being laid out by the Institute of Chartered Accountants of India under the accounting standards would be taken as the base.
“Without the help of Chartered Accountants, we will not be able to reach out to the large number of dealers and assesses, and neither will be able to make them aware of VAT. If this does not happen, then VAT cannot be successfully implemented.” was what Mr. Rosaiah Konejeti, Finance Minister of Andhra Pradesh commented while addressing delegates in a seminar on ‘Emerging Professional Opportunities in the WTO regime’ organized by Institute of Chartered Accountants of India in the year 2005.
The above statements stand testimony to the credibility of this particular profession in India. Chartered Accountants play a catalyst role in the Indian financial and accounting services space. On numerous occasions, we have proved our mettle and emerged as strong partners in the nation building exercise. The Central and State governments have found Chartered Accountants as strong allies. No wonder, time and again, they have reiterated their dependence on this particular community and encouraged it to give strategic inputs in the arduous task of policy making.
Till 1991-92, a Chartered Accountant was viewed by society as a very conservative person who had confined himself to play quite a restricted role in society. As an auditor, he knew how to put his head down and use colored pencils for ticking vouchers. As a tax practitioner, it was primarily the task of filing annual returns and 3CD reports that was considered as his forte. And as an employee, his duty would be to have the trial balance tallied by scratching his head for long hours. But then came the three magic letters of LPG (Liberalisation, Privatisation and Globalisation). And the rest they say is history.
The hitherto segment service provider now donned a new mantle and responded tactically to the challenges thrown in by the new economy. The rapid mutation of the species resulted in Chartered Accountants playing pivotal roles in the following responsibilities:
· Investment Bankers
· Sector specialists (in the areas of telecom, banking, insurance, real estate to name as few)
· Internal control specialists
· Tax professionals in the Direct and Indirect taxes zone with exotic specialisms like Expatriate Tax, VAT, GST and International Taxation
· Informational Technology specialists with computers becoming the lifeline of organization’s day to day functioning
· Energy Audit specialist
New areas like convergence of Indian Accounting Standards with IFRS and investment in Sarbanes Oxley Act (SOX) compliance now offer exciting possibilities for Chartered Accountants.
Apparently, the sky has become the limit for this 150,000 odd community. While UK and US have one CA/CPA for every 500/800 people, currently in India we have one CA for every 8,000 persons. Opportunities are high and so is employability. And going by the current trends, things are only going to get better with each passing day. Each and every factor at play, whether economic or demographic, augurs well for the Chartered Accountant community.
“Standing at the road side, gazing at the sky
How will you reach there my boy, until you will try.”
The above was a clichéd statement often made by our Accountancy teacher in school. But this was what actually motivated us on to plan a career for ourselves, one that would help us carve a niche for ourselves in society. As we landed out of high school and entered college life, there was rampant confusion all around. Amidst the plethora of options CA, CS, CFA, ICWA and MBA, nothing seemed more worthwhile than slogging it out to become a Chartered Accountant, five years later, although honestly speaking, it had seemed too long a course duration at that particular junction. However wise people around made us realize that by the time we would be graduates, we would have already have sailed through two tiers of this course if we cleared in the first attempt. Just another couple of years of academic input and we would become full-fledged professionals ready to take up job responsibilities.
One would make no bones about the fact that the course is rigorous and heavily demanding in terms of the input it requires from a student on a continuous basis for five years. The unique blend of theoretical and practical training forces you to often stretch yourself beyond the limits of your imagination. You voluntarily put in hours burning the midnight oil and that too after spending an exhausting day at office serving your articles in an audit firm. The best part is that the course teaches you to endure it all with a smile. But then the course is meant to prepare you to for life. It offers you a voluminous syllabus, which putting in a state of mental dilemma. The Herculean task at hand makes you feel like a proverbial David pitted against the mighty Goliath, the little boy who is intimidated by the giant, challenging the prospects of his success with a smirk on his face. . Just before each of the three-tier examinations, in moments of despair, you seem to question the prudence/sanity of your decision of opting for such a demanding lifestyle and literally contemplate surrender. But then it is this pressure, which separates the men from the boys. The same hammer shatters glass but forges steel. This character building is what one finds to be the most exciting part of the Chartered Accountancy course. It imparts values and as that is something you will find rarely in a course. The quote goes “Success shall come and go but Values shall remain forever” The moment you qualify in the Final examinations, you are suddenly catapulted to the pinnacle of success, become the cynosure of all eyes and bask in the glory of your achievements. Needless to say, with the alphabets CA. now acting as a prefix to your name, all that remains is pure exhilaration.
What prevails against all odds is the Persistence Quotient, on which I am sure CA students would be ranked very highly. While the Goliath had seemed ‘too big to hit’ to the ordinary mortals who either lacked the courage to even join the course or concocted lame excuses like the demand factor and stuff to quit midway, the patient student who could rise to the occasion and display a judicious mix of sincerity and smartness, surprisingly found the monster ‘too big to miss’. Each time you face a daunting task ahead in life and the noxious worm of self-doubt inadvertently creeps in; a simple reminder of the grilling preparation put in during these five years to become a Chartered Accountant would be enough to take us ahead. Isn’t this reservoir of positive energy a priceless treasure on a personal front? And it would stay with you for life.
Since nothing is handed over to a student on a platter, there are no escape routes whatsoever for the ones looking for shortcuts. In our Indian society structure, distorted by gross inequalities, the sharp rich-poor divide hits you below the belt so often. In the midst of all this, the CA course stands as the symbol of social justice and equality. There is just one criteria of demarcation and it is your examination performance. A student who is not up to the mark as regards his academic credentials will not be awarded the degree, irrespective of his social, economic or political affiliations. He cannot use (or rather misuse) money or power to hide his shortcomings. This transparency stands in stark contrast to that of the MBA/Engineering/Medical Sciences space. There are institutes ‘ a dime a dozen’, both domestic as well as international, which offer on sale, these high-sounding degrees. Just throw up a few millions of currency notes and you may well land up in the prestigious Whartons and the Stanfords. But fortunately, there is no backdoor entry to our institute. You will get only you deserve and you don’t have the luxury of buying success. The powerful degree comes with no price tag. It is earned with your sweat and blood.
Unlike so many other professions, no one would ever have to give up his dreams of becoming a CA because of economic constraints. The Institute charges only nominal fees to bear the administrative costs. Compare this with the course fees charged by MBA institutes that amounts to no less than a few lakh of rupees.
In addition, a CA student does not need the crutches of electives to sail through examinations. You are forced to get out of your comfort zone and force yourself to meet the needs of each and every subject. E.g. ISCA in CA Finals
The arduous task of appearing for eight papers at a stretch in CA Finals can be undertaken successfully only by a student who is high on the physical and mental fitness front. This in turn prepares you also for a rigorous work regime ahead. The clause ‘ATTEMPT ALL QUESTIONS’ in papers like Accountancy and Direct Taxation intimidates you in the examination hall but in fact prepares you psychologically for life.
While the MBA degree often is perceived to be a strong competitor to our course, one needs to understand that the CA course gives you a broad based academic foundation, which an MBA course often may not. The Internet is replete with articles posted by Chartered Accountants who have subsequently gone for a PGDM course, which talk on similar lines. It is an established fact that the 18 subjects spread across the three- tier CA course have been structured so as to give a student quite a fascinating insight into a diverse range of topics, ranging from financial reporting to tax panning, from risk management to information systems audit. Never would you get the feeling that you were studying something superficially, just for the heck of it.
Moreover you have an edge in terms of your understanding of the regulatory framework. Legislation is a subject, which is vast and expansive and subject to frequent changes. Having the skills to comprehend the ramification of each clause and section on the fortunes of your business operations certainly gives you a competitive edge in the real life. For e.g. a Chartered Accountant not only would be able to apply Capital Budgeting techniques while evaluating an international project but will also be able to think from the FEMA and RBI approval angle. This course undoubted empowers us with an integrated view of the manifold facets of running a business and serves as the ideal launch pad in the financial domain
You get a firm footing in terms of financial reporting, a field, which has come into prominence with the rising number of Indian companies raising capital abroad via ECBs and GDRs and increasing FII inflows into India. The financial statements of Indian companies are required to live up to the expectations of the global investor community at large. Framing and executing the stipulations of the accounting standards is an onerous responsibility cast on the members of the Institute of Chartered Accountants of India to think global and act local. Similarly in the wake of the recent accounting scandals like the Enrons and Worldcoms, audit no longer remains as a gift but has turned into a responsibility that needs to be shouldered even more carefully. While the CEO/CFO of a company would swear by the rosy numbers, in the financial statements, only when they bear the stamp of approval of a Chartered Accountant that the doubts in the minds of stakeholders would be laid to rest. Ethics and trust is the lifeline of this profession. On so many occasions has Chartered Accountants refused to be deterred even by the fear of death in the discharge of their attest function. The joy of providing stakeholders credible financial information is simply like living the quote “With great freedom and power come great responsibilities”
No other course gives you this quantum of hands on exposure to the dynamics of the practical world while you are still studying. You get an insight into the real life application of concepts learnt in textbooks. You learn to work in a team and liaison with clients on your firm’s behalf. No wonder you often get a chance to interact with senior management of client in the league of CFO/CEO/Senior Manager Accounts. I believe that such an interaction eventually proves to be invaluable for someone in the learning stage of his life .You gets empowered with the drive to execute assignments with confidence. The experience will help you to assume responsibility as a mature and capable professional when you enter the job field.
The Institute has taken initiatives of the likes of the Compulsory Computer Training and the GMCS course to further equip its students skill sets found lacking in students as per popular perception.
While you are simply a part of the alumni association of any school/college/institute, once you clear the CA course, you are considered as a member of the Institute itself. Bread winning can never be a problem for anyone. If you take a certificate of practice and set up a practice of your own, assignments plethora would be offered to you merely by dint of your degree. E.g. Bank Audits allotted pro-rata to all members in practice.
The Institute ensures your Continuous Professional Upgradation (CPE) so that you continuously sharpen your axe. Recently this concept was extended even to members in service also.
Pursuing CA is like forging a relation of a lifetime with a professional body responsive to your needs and not just clearing an exam and getting a pass certificate
Life is like a cup of tea. You sit by the window, lift the cup and take a careless sip, only to realize that somebody forgot to add sugar.
Too lazy to go it, you somehow struggle through the sugarless tea till you discover lying at the bottom.
That’s life in general and the profession of Chartered Accountancy in particular.
Ultimately it is the individual who has to seize the initiative, overcome his lethargy and make things happen .IF he is able to do that, no one can stop him from achieving great heights in his career. In fact the sky would be the limit for him, irrespective of his academic credentials. However equipped with a powerful CA degree in his arsenal, his chances of doing the same are certainly brighter.
CA. Anurag Singal secured All India Ranks 22 and 25 in CA Final and Inter respectively. He has authored the book “Auditing Mantras for CA IPCC”. http://www.auditingmantras.com/ . He has also established a job portal exclusively for CAs. http://www.cajobportal.com/ . He can be contacted at anurag@auditingmantras.com and contact@cajobportal.com
Project Financing-Challenges & Opportunities
Executive Summary
One of the key assumptions underlying Modigliani and Miller’s irrelevance proposition (a widely acclaimed theory in Corporate Finance), is that financing structures do not affect firm value. Yet the fact that the global volume of Project Finance has grown at a stupendous rate to $354.6 billion in 2010 gives substantial evidence in favour of the fact that financing structures do, indeed, matter. Project finance is, still, one of the most important financing vehicles for investments in the natural resources and infrastructure sectors such as power plants, toll roads, mines, pipelines, and telecommunications systems. In the aftermath of the global financial crisis, governments of both developed and developing countries are searching for avenues whereby they can finance desperately needed infrastructure investments. Private sector participation and capital will have an increasingly important role to play and thus project financing would continue to remain in sharp focus. This article explores the intricacies involved in the process.
Detailed Article
Introduction
As per the Dealogic Global Project Finance Review for 2010, India, through 163 deals, accounted for $ 81.4 billion – more than a fifth of the total and higher than any other country of the project finance volumes globally.
If India Inc were to realize its full potential, the country would have to spend an estimated amount of US$1.7tr on Infrastructure development over the next 10 years. As per Planning Commission estimates on the state of India’s infrastructure development in the Eleventh Five Year Plan released in March 2010, the funding gap in the last two years is estimated to be ~ Rs.1.27 trillion , which translates into ~ 18 % of the total estimated requirement of Rs 7.07 trillion. The funds available for projects have reduced even further post the global economic meltdown. More recently, in the aftermath of the Eurozone debt crisis, accessing external resources by way of ECBs could also become difficult and this would also accentuate the funding gap
Thus there arises a critical need to explore funding avenues for infrastructure projects- one of them being Project Financing
Project Financing-Concept
Project finance is a widely accepted mode of financing infrastructure development projects/risky ventures since centuries. Project Financing techniques have been in vogue in periods as early as 1299 A.D. when the ones who undertook the exploration and the development of the Devon silver mines in England repaid the financiers – the Italian merchant bank, Frescobaldi, with output from the mines. The lenders were given the 1 year lease and mining concession, i.e., they had the right to mine as much silver as they could manage in a span of 1 year. In this instance, the key highlight of the debt structuring is that the project’s output or assets itself have been used to obtain the funding.
In recent times Project Finance has emerged as a popular vehicle for financing infrastructure projects. It is a method whereby a consortium of investors, lenders and other participants join hands to finance infrastructure projects that would be too large for individual investors to underwrite
The term Project Finance could be explained in multiple ways. An article published in the Harvard Business Review, defines project finance as the manner in which a key captive intensive project is financed under a structure where the banks do not have any recourse to the assets of the sponsoring company. In the World Bank terminology, project finance is defined as “using non-recourse or limited-recourse financing.”
Typically, a project financing structure would entail participation of multiple equity investors (sponsors) as well as a consortium of lending banks.
(The financing of a project is said to be nonrecourse when project cash flows are the only mode of servicing the debt or, in the event of complete failure, the same would be serviced from the value of the project’s assets. Some structures allow lenders a limited recourse to the parent company’s assets)
The funding options that are typically available to a project are as follows:
} Term Loan
} Rupee Term Loan
} Foreign Currency Loan
} External Commercial Borrowing
} Working Capital
} Corporate Bond
} Lease / Structured Finance
} Equity
} Promoter
} Private Equity / FDI
} IPO / FPO / Private Placements
A typical project finance structure would appear as follows:
In the past, the path for project finance has been fraught with quite a many failures as well. Motorola, the global communications giant had used project finance for Iridium, the $3.4 billion satellite telecommunications system. (The final cost of the project was almost $6 billion when it was completed. The value was approximately $25 million after it failed.) However the parent company was protected as because of the Project Financing structure, it was only the project assets that were at the disposal of the lenders to recover their dues.
Advantage of Project Financing
It is an undisputed fact that the complexity and cost involved and time taken to structure a financing deal for a project company is far greater than that it would entail under financing as part of the parent company’s balance sheet. For use of project finance, then, to be rational, it definitely brings significant countervailing benefits to offset the incremental transaction costs and time
a) This quantum of long term funds that can be raised for a particular project under this mode is more.
b) The balance sheet of the project sponsor is insulated from financial risks. It allows proper allocation of risk and thus enables the sponsor to undertake a more risky project than if it were to use its own balance sheet as a base. When non-recourse financing is adopted, the project company is structured as a Special Purpose Vehicle (SPV) with limited liability , and so the lenders' recourse will be limited primarily or entirely to the project assets (including completion and performance guarantees and bonds) in the case of default of the project company, thus protecting the project sponsor’s balance sheet
c) Project Financing leads to value creation by lowering the agency costs that are incurred while obtaining bulk financing assets associated with a specific transaction, and enables the parent company to raise capital and undertake highly leveraged projects of a quantum far greater than it would under be able to undertake under the normal “with recourse” financing mode, creating “stress” on its balance sheet. By not resorting to project financing, the parent company would lose out on the opportunity cost of investments in such projects. By resorting to greater use of leverage than in a straight commercial finance of a project, it can improve ROE (return on the equity capital).
Disadvantage of Project Financing
a) It is a complex financing arrangement that often takes a longer period of time to structure than equivalent size corporate finance.
b) Since an independent entity- the Special Purpose Vehicle (SPV) is created, the transaction costs are higher
c) As compared to normal “with recourse” financing, cost of funds obtained under “non-recourse” project finance” is higher by ~ 0.5% to 4% p.a.
d) The consortiums of lenders impose a host of restrictive covenants to protect their interests such as routine intense supervision of the management, prior permission to be obtained for further borrowing, change of management control etc. These can often border on intrusion and impede the operational flexibility enjoyed by management.
Project Finance: Valuation Issues - Appropriate Discount Rate for Valuation
The Equity Investments in Project Finance deals would typically valued using either the two methods
a) Derive Equity Value indirectly by discounting Free Cash Flows (FCF) using the Weighted Average Cost of Capital (WACC) and subtracting debt value
b) Value Equity directly by discounting equity cash flows (ECF) using the Cost of Equity
In either ways, most people use a constant discount rate for cash flows in all periods. In Project Finance investments, valuation issues arise as the project leverage changes over time. For the typical project, ratio of debt to total capitalization starts at 0%, increases to levels of 65-85% and then falls down to 0% in later years. Since cost of equity is dependent on leverage, both it and the WACC will change along with leverage. Thus using a single rate of discounting for all years is inappropriate.
Risk Allocation Strategies
The quantum of capital required to finance a project means that all the risks inherent must be mitigated or avoided through a careful structuring of the project finance matrix. The risks that are not allocated to any specific participant remain in the Project Company and thus impact the lender’s interests.
Gestation Period & Uncertainty in cash flows
Normally projects financed under this mode have a long gestation period – they would typically have large negative cash flows, with high degree of certainty (such as the initial capital expenditure to develop a coal mine) in the initial years followed by positive cash flows with a high degree of attendant risks (because of uncertainty in economic situation, market demand-supply for coal etc). It is a difficult as to how would the lenders giving funds under limited/no recourse financing would factor in such risks. The expectation of the lenders in form of more interest rates and transaction processing fees increase in direct relation to the risk involved.
Commercial risks
(a) Risks connected with developing and constructing, operating and maintaining the assets and finding a market for output of the project
(b) Broader economic environment risks related to interest rate changes, inflation, currency risks, international price movements of raw materials and energy inputs
Non-commercial risks
(b) Broader economic environment risks related to interest rate changes, inflation, currency risks, international price movements of raw materials and energy inputs
Non-commercial risks
(a) Legal and regulatory environment
(b) Political risks
(b) Political risks
In light of the above, it is evident that optimum structuring of project finance is a function of how effectively are the risks allocated between the parties. While there is no universally acceptable formula for this exercise, the rule of thumb is that the party in whose control the risk lies should be the one bearing the risk. This party would stand to gain from effective management of the risk and this project execution would be improved.
For instance, the risk of cost overruns and delays in an infrastructure project can be mitigated by either taking some sort of insurance or passing it to the EPC contractors. The sub-contracts contracts are fixed priced and turnkey contain liquidated damages for delay and have performance bonds.
Lenders might also insist that there be in place firm supply contracts for say raw materials such as iron-ore and coking coal with long-term commitments as to quality and price.
Political risk can be mitigated by obtaining political risk insurance while legal risk can be reduced by ensuring that the legal documents are drafted in a deft manner after thorough examination. Recent legislation such as the SARFAESI Act and the Commercial Courts Bill, the unenforceability risk will be considerably mitigated, which would be advantageous for lenders.
Since non-recourse debt entails highly asset-specific risks that are difficult to diversify, innovative structures that allow for equitable sharing of risks between the parties are coming into vogue
a) Lenders are using hybrid structures between project and corporate finance, where they do not have recourse to the sponsors, but they can diversify the risks specific to a particular project by financing a portfolio of assets as against just financing a single ventures.
b) Lender can obtain credit protection against political risk (explicit or implicit)
c) They can take credit derivatives for hedging themselves against risk of default
d) They can take futures/options/forwards against macroeconomic risks such as currency devaluations.
e) Securitizing project finance loans through Collateralized debt obligations (CDO) as well as open-ended funds have been launched to attract higher liquidity to project finance.
Indian scenario
If we were to identify cases of non-recourse / limited recourse lending implemented in India in India in the true sense of the term, we would find that the concept is still at an embryonic stage and often you would find lenders requesting for some form of sponsor support even where the transaction is structured as a "project financing. Let us consider the example of the Jamnagar Refinery Project undertaken by the sponsor, Reliance Industries Limited (RIL). Though RIL did not provide any sponsor guarantee, , it gave the lender completion support for an uncapped amount. Similarly, GMR Infrastructure provided guarantees for both the Jadcharla-Farukhnagar Highway PPP (on the Bangalore-Hyderabad Highway) and the Adloor-Yellareddy-Pochanpalli Highway PPP (in Andhra Pradesh) projects.
Conclusion
Given the growth trajectory for the Indian economy, project finance is here to stay. It remains a lucrative mode of financing for both the lenders and the borrowers. However, since we are not living in a perfect world, market participants need to work closely together to have in place mutually acceptable structure in a given time frame. The same would take into cognizance the economic, financial, political and market realities. As more innovative risk management strategies/structures would emerge, the concept’s acceptability amongst participants and its usage in infrastructure financing would zoom to greater heights.
References
1) Infrastructure Financing in India – Progress & Prospects – Retrieved from http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/IFIC160112.pdf
2) Dealogic Global Project Finance Review for 2010.
You may send articles that you seek to publish at CA Job Portal to contact@cajobportal.com2) Dealogic Global Project Finance Review for 2010.
