The Hindu Business Line : Make mandatory risk-disclosure

THE RESERVE BANK of India Governor, Dr Y. V. Reddy's suggestion to corporate borrowers to disclose voluntarily their risk exposure, especially to derivatives and foreign exchange, has come not a day too soon. With increasing integration of the domestic and global markets, risk perception has heightened in recent years. The margin for error in business decisions is shrinking by the day. Corporates can no more afford not to hedge their risks and must employ appropriate risk-mitigating tools. Admittedly, both lenders and investors have an interest in accurately assessing a firm's risk-management performance, apart from its underlying financials, to understand the risks assumed by the firm and those it has hedged or transferred to others.

Disclosure of risk exposure ought to have been a part of the corporate governance policy; but this aspect has been overlooked all these years, primarily because there has been no stakeholder pressure; and possibly because risk management systems are simply not in place. Currently, banks, as lenders, and shareholders, as investors, have no way of knowing how a company manages its risk, if at all. While Dr Reddy spoke of risk management and disclosure in the context of bank-corporate relationship, there is surely more to the idea. A large number of corporates with underlying exposure to commodities — for instance, metals, agricultural goods or energy products — do not hedge their price risk in recognised futures exchanges within the country or outside. In developed economies, the disclosure of hedged and unhedged positions, and reasons for the same, are known to impact share prices.

From a corporate governance viewpoint, full disclosure about commodity exposure and price risk management should be made mandatory. Indeed, vis-à-vis listed companies, the initiative ought to have come from the stock exchanges long ago. It would be interesting for analysts and researchers to examine how corporate bottomlines are impacted because of not or under-hedging by corporates, and how shareholder value is compromised. Instead of asking corporates to make voluntary disclosure about risk management, banks could make it a pre-condition, especially in financing commodity-based businesses.

It is useful for bankers to track the changing dynamics of corporate financing, Dr Reddy asserts. One way for commercial banks to mitigate the risk arising out of commodity price fluctuations could be structured financing which, essentially, is transaction-based lending (as opposed to balance-sheet-based lending, as in vogue now); the former ensures a measured flow of credit, avoids duplication of credit and wild speculation. For lenders, structured financing ensures better quality of asset (risk) and traceability of goods through the entire supply chain — from production to sales. Several foreign banks specialising in structured financing for commodities are doing well in the domestic market. It is a pity major Indian banks have not seized the opportunity. Across the world, lenders and borrowers are known to explore constantly newer, customised methods of finance. In India, banks still seem to think they are doing borrowers a favour by lending money. A mindset change is necessary.

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