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Saturday, March 26, 2011

How criminals can profit from the financial markets-I(terrorists, short selling)

Today, I just finished a book 'Power Down' by Ben Coes(click here for the flipkart page). While the book theme flogged a dead horse('terror attacks affecting USA's energy security), it had a few novel elements mainly
  1. Anticipating a M&A, and planning terrorist acts months in advance
  2. Using the equity and commodity futures market to bet against the victims of a terror attack, to make profits of $20BN+.
  3. But one theme which I did not appreciate was the stereotyping of Arabs as architects of terror. Even other nationalities have reasons to hate the USA! Anyways, the novel needed a scrapegoat and in this case, Arabs were it. 
Anyways, the book got me thinking about how such a thing would work in the Indian context. Luckily(or not), most Indian securities are not traded on foreign exchanges-both stocks and derivatives. Even ADRs are pretty illiquid. So even if a terrorist manages to profit on man made disaster(say attack on the RIL Jamnagar refinery, 26/11 Mumbai attacks etc), the regulator could declare the derivative contracts void in case unusual activity spurt is noticed-specially through the PN route. Given that the erstwhile Finance Mnister Mr Chidambaram had warned of terrorists using Indian stock exchanges, it seems that the establishment is cognizant of this, and will react to any such threats.

But consider stocks like HSBC, Citi, GE, BHP, Exxon etc which trade on multiple stock exchanges in multiple countries. Energy stocks typically have dual/multiple listings and are vulnerable to such attacks. And for contracts executed on major financial centres like Singapore, HK, London etc(specially of offshore issuers), the regulatory authorities would be reluctant to go on a fishing expedition. And by the time they realize it, the positions may have been closed out and the funds transferred.

In this world of strife and uncertainty, the KYC(Know your customer norms) and sectoral position limits(step up from individual limits) become paramount. Else with an attack costing less than $1,00,000, profits may be made in the hundreds of millions. Atleast, If I were a terrorist, I would exploit the weak money laundering regime to ensure that my funding is self sufficient!!

This pithy statistic sums it up all...
Cost of staging 9/11 World Trade Centre attack=some $million(max)
Potential gain for people long oil futures======$Billions
Such outsized gains may spur 'venture capitalists'/'investors' to fund these attacks-or atleast pay for advance information on them. For that reason, the USA Govt had proposed a 'terror exchange' where public bet on the chance of certain events-so that Govt can probe further..but that mission failed.


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Miheer Desai said...

Casino Royale shows James Bond foiling the plans of an international outfit, which planned an attack on a newly launched plane and simultaneously short the stock of that aircraft manufacturer.

However strictly one imposes KYC, people will always find ways around it. Sectoral caps will be unfair to big traders like banks and companies (like RIL) they trade for. Even if you assign a larger cap to RIL, caps will in general be unfair for speculators who play an important role in stabilizing prices.
How about inserting a clause that makes the either the entire contract, or price movement post-event, void in case of terrorist attack?

Anandh Sundar said...

@Miheer-I had read the book not the film-so interesting point.Sectoral caps when combined with KYC norms(lower caps for reputed clients with stringent KYCs) would still work I think. And the 'force majure' clause you suggested is a good idea..maybe terminate the contracts as of the previous day.