Breaking down complex structures

There has been a considerable disquiet among regulators the world over as well as among the cognoscenti about convoluted investment structure in corporates with both chain holdings and cross-holdings obscuring the line of vision for one trying to figure out who owns what in a company.

That a subsidiary is the holding company of another subsidiary and so on, culminating in an inverted pyramid with the one at the bottom of the heap being the weakest, in terms of being amenable to regulation, has been behind many a corporate shenanigan in this country.

It is often the case that the ultimate subsidiary in the line of obscure succession enures for the sole benefit of the promoters of the company, and to the detriment of the public shareholders perilously perched at the top. Apart from defying regulation, such a pyramid structure is also an accountant's and student's nightmare, especially if he is setting out to consolidate all the accounts.

No less self-perpetuating, self-aggrandising and grid-locking is the cross-holding mesh that stretches the investment structure horizontally, as against vertically, in the pyramidal chain-holding. ‘You invest in me and I invest in you' smacks of ‘you scratch my back and I yours'. Who owns and controls what in a chaotic web of cross-holdings spanning several companies is often more indecipherable than in a chain-holding structure. Cross-holdings by group companies not only make for a confusing criss-cross of investments but, coupled with chain holdings, completely obliterate the ownership trail and pattern, besides locking up the precious resources of operating companies in unrelated investments whose only objective is to guard the family turf.

Financial holding cos

Policymakers in India have, for quite some time, been allergic to the pyramid chain-holding structure which is why the Companies Bill 2009, as well as its predecessors Companies Bill, 1993 and Companies Bill, 1997 — that were given the quietus without a wisp of apology or explanation — have been plumping for a less complicated holding-subsidiary relationship — a subsidiary itself cannot be the holding company of another subsidiary. This is not, however, to say that a holding company cannot promote more than one subsidiary. In human life, the never-ending and labyrinthine great-grandfather, grandfather, father, son relationship cannot be wished away but in corporate life it can be for the overall good of the financial and business world if there are just one father and sons and/or daughters, if you will.

A holding company that itself is not a subsidiary makes for a clean corporate structure, lending itself to greater disciplining and control by the regulators. When the nascent Competition Commission sets out to zero in on monopolies in India it would be stymied in its attempts by the mutually reinforcing chain-holding and cross-holding structures it encounters. The RBI is thus right in thinking of ushering in Financial Holding Companies (FMCs) whose remit would be to manage the investments in disparate financial sector operations such as insurance, banking, mutual funds and merchant banking.

As it is, an operating company itself spawns subsidiaries in the financial sector and thus you have SBI Life, SBI Home Loan, SBI Mutual Fund and SBI Capital Services, all controlled by the banking major State Bank of India.

What the RBI wants is that State Bank of India itself must be the subsidiary of, say, a SBI Holdings Ltd, in parallel with other operating subsidiaries in various other financial businesses, such as mutual funds, broking, merchant banking, insurance, etc.

The imponderables

Apart from making for a neat and transparent control mechanism, such a structure would also be conducive to capital market operations with the operating companies alone being listed. Inevitably this would mean FMCs not owning all the shares of the operating companies. Indeed, operating companies using public funds should never be 100 per cent subsidiaries of their parents.

There is no unanimity on this issue as yet but it would be advisedly better to rope the public into the operating companies rather than in the holding company because the latter would truly be an investment company.

Investment companies in the private sector are more of a family investment vehicle, be it Pilani Investments of Birlas or Tata Sons Ltd of the Tatas. This is to keep investment matters and decisions away from the public gaze, though there is admittedly a contrary view that the FMCs themselves must be listed companies to make for greater transparency and provide an investment opportunity for public investors vicariously in a range of activities.

At any rate, this is a matter of minutiae and can be worked out without bringing in any rigidity. What is more important is the ring-fencing of various operations of a financial conglomerate without allowing an opinion to be built that the investment-operating company stands guard and is responsible for the activities of the downstream operating companies.

Liberal institutional funding and cross-border funding should be made available to the FMCs so that they can do without public participation in case it is thought prudent to keep them away from public gaze.

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