Will IFRS kill pre-IPO convertible bond financing in India?

If there was ever the case of the 'tail wagging the dog', this is it. Take the example of pre IPO financing by a strategic investor. Typical covenants include:-

1. Debt security with nominal interest(or even zero interest)
2. Call option-to convert the debt to equity at the IPO price/other reference price. This may even be adjusted with the performance of the company.
3. Put option-promoters/company to buyback the debt at a fixed IRR

Earlier, Indian companies were permitted to account for these securities as debt. But now IAS-39 mandates that the embedded derivatives(call option/put option)should be separately valued-even if not accounted for separately on balance sheet. And given the typical deal sweeteners, the option value by any model is likely to be high. And as the IPO approaches, the increase in option value will need to be expensed out by the company('issuer'). This may render it ineligible for listing/fetch low price on listing, due to the MTM losses on the derivatives issued by it.

Of course, the company could argue that investors should consider a proforma picture ignoring this adjustment, analogous to ignoring 'credit value adjustments' on own debt. But if this loss leads to an enhanced call option for investors/exercise of put option due to triggering earnings based covenants, then the company has a problem. This calls for top notch investor relations and legal experts to help cover all such bases during financing. But despite that, such transactions would need to be structured much more carefully because more the protective covenants, likelier is it that more embedded options exist.

FAQ on Islamic Finance

1. What is the big fuss about anyway? Finance should look the same in whatever form-ultimately the objective is to earn money That is correct-although the Shariah prohibits interest, banks still get their way around it by artful structuring/'sale and buyback' etc. But still, the main prohibitions are respected-no explicit interest, no investment in banned sectors etc
2. Why has it become so important all of a sudden? Because the wealthy Middle East/African investors are there(many of them conservative Muslims) seeking Shariah Compliant investments. So like in any free market, supply follows demand
3. But why are banks so fascinated with this market? One because of the lesser(so far) competition. Two because in this world of capital starved banks, Islamic finance with its primarily asset backed nature(thus low Risk Weighted Assets requirements for banks) is very attractive. Three because this allows entry into previously untapped markets, and at good profit margins AND to depict themselves as good corporate citizens
4. Give some examples of Islamic finance:- Suppose you need a loan but are prohibited from paying interest. No problem. Just arrange with a bank to sell it a commodity X and buyback at X+Y(Y represents the 'profit'-effectively interest. Or else you want to earn interest on a deposit. Just deposit the funds with a bank, which will give you close to market rates voluntarily to preserve its own reputation.
5. But why are you so cynical? So many people cannot be so absurd at the same time:- Well, like socially responsible investing, Islamic Finance has certainly helped society. But it is an open question whether the investors are better off in this mode or not. Certainly, the noble objective of investors sharing risk is diluted with investments in microfinance, subordinated debt, embedded options etc.
6. If this is so attractive, there would be risks also:- Yes there are. The same structure may be approved by one Islamic scholar but another may issue a fatwa against it. The sale and buyback transactions prevalent here may lead to indirect tax consequences for banks and/or make them residents for direct tax purposes. Or like in the Dubai bonds case, some structures have been legally untested, and may hold unpleasant surprises for investors.

Why investors STILL need intermediaries in this internet era

Whenever the topic of mutual fund fees, hedge funds carry, trading commissions, banking fees etc(basically financial intermediaries remuneration) is raised, the popular response is to propose that fees be regulated to the bottom, to maximize return. While competition does achieve this result at times, this post argues that fees have several justifications beyond the standard 'economies of scale' arguments. While a whole 'motivational' industry via books, seminars, tapes etc(mainly from retail brokerage side) has sprung up claiming that 'you can do it-do your own value investing', I feel that barring an index fund, using professionals is STILL the best alternative. Lets see some of the reasons of them below.

1. 'Economies of Scale': Intermediaries pay lesser costs(as % of portfolio) on advice, brokerage, fees etc. Also, they have market access which others do not(interbank markets, global markets etc) have, or would find too cumbersome to have
2. Get access to best brains:- If you want a Buffet/Watsa to help your investments, you have no choice but to invest in Bekshire Hathway/Fairfax etc. As they say, there are some things which money cannot buy
3. To identify solutions:-Good bankers will be able to size up the client's exposure, risk appetite, industry practices etc; and integrate that to propose a solution which the client may not have thought of at all.
4. Bundle risk/liquidity/cash flows on demand via OTC contracts:- The flexibility(albeit lesse nowadays but still prevalent) is something which only intermediaries can achieve.

I think that reason(2) is probably one of the best reasons to trust someone else with your money. That is why asset managers rake in the moolah.  

OTC and exchange traded derivatives-does any significant difference remain for clients?

Open a college financial textbook and you read the distinctions between OTC and exchange traded contract.I reproduce some of them below with my comments in italics.

1. OTC contracts give more flexibility and offer scope for customization. This is correct but purchasing a portfolio of 'vanilla' products can achieve the same result in most cases, subject to market access  and other constraints. 
2. No margin needs to be posted. This is incorrect. Open any ISDA contract and you notice provision for posting margin even in ordinary repo contracts!! Banks have got scared post Lehmann default and other Black swan events
3. OTC has counterparty risk unlike exchange contracts. With the tendency to demand collateral/other funding for derivatives contract, this fact may stay only for interbank transactions/transactions with A+ rated counterparties-with others having to give some security. Also, this is mitigated(specially where cross banking relationships exist) by the right of setoff, from the perspective of the bank/FI.

So stripped of the margin/collateral benefits, the only remaining feature is customization, for which the client pays a hefty fee, and is subject to opaque valuations if early exit is desired. The benefits of OTC contracts do sound more tenuous now.

The first Baccarat dollar probably costs $30 million a year-and other gaming industry economics

During his 1Q'11 conference call transcript(http://tinyurl.com/Wynn1Q11), renowned gaming industry veteran Stephen Wynn(majority owner of listed integrated resorts player Wynn Resorts) gave some good insights into the industry economics. Discussing the steep entry barriers to opening a gambling business, he explained that if a person who is in the resort and casino business, wants to have a Baccarat game, the price of admission is very high. You need to be constantly working that market, contacting and maintaining relationships with those customers. You have to have a sophisticated organization that can make the credit decisions and execute collection appropriately. Appropriate to a highly levered industry though, the the first dollar of Baccarat probably costs you $30 million a year. But then you can open the door to $200 million of it .

In fact, though the integrated resort theme was itself an effort to reduce the cyclical nature of gambling, it has ended up intensifying it. Casino operators in Las Vegas decided to make themselves hotel/convention centre owners, rent out space for luxury goods/entertainment shows like Cirque De Solil etc, all hoping that playing the dual themes of entertainment and business meetings would reinforce the core gambling business. This integrated resort theme has been imitated globally and in fact, the top operators are using this play to try cracking the last frontier 'Asia'. Anxious to brand themselves as tourism hubs(and not merely offshore gambling joints), countries like Macau/Singapore have fallen over themselves to offer entry to these resorts(despite the hiccups in the Cottai strip at Macau). But still, the cyclical nature and the operating leverage stay. Skilled staff are not people whom you can discard at leisure. And capex/opex savings can be only done to a point without compromising on the overall service experience. So I would say that investors in these resorts should note that the operating leverage at times exceeds that of airlines-after all you cannot avoid flying but you can avoid visiting these integrated resorts.

The powershift from wholesale to retail banking

If you are an undergrad(either degree or MBA) with an interest in finance, chances are that you would already have an area of interest laid out. Given the vastly different nature of the customer base(wholesale banks deal with mostly corporates/FIs/Govts-all sophisticated customers- while retail banks deal with not so financially savvy customers), retail bankers were looked down upon by their wholesale banking brethen-not least because of the 'inferior' growth and bonus prospects. But consider other factors too.

But in the new paradigm post 2008, there are many shifts which make retail banking more important

1. To avoid wholesale funding issues, banks have realized the importance of customer deposits. Retail banking achieves that, and the strategic importance as the net funds provider will grow, given the capital starved scenario in a post Basel III world. That way, it could still punch above its weight.
2. Given the technology innovations, the existing branch infrastructure could be leveraged to deliver value adding services, with all routine services going online. How to do this, is one of the most exciting challenges of the 21st century.
3. As the RBS UK retail banking head mentioned in an Apr-11 conference call(http://tinyurl.com/RBSApr11), When clients do go into branches they want real added value, so we need to make sure that the people are in there are good people. This has implications for talent mobility within the bank, recruitment strategies etc
4. Retail banking is the 'catch them young' way to bank with future private wealth clients. Personally, I would prefer to bank with the bank which sanctioned loans when I needed them the most(education etc). This 'balance sheet backed' relationships is exactly how it works in wholesale banking too.

So assuming both become equally attractive options(career wise), people with an operational/marketing flair would do well in retail banking while those more 'numbers oriented' would still like wholesale banking. This is though just my opinion.

You know you are a financial markets veteran when

1. You hear 'forward' and you think of a financial contract, and NOT about a football game position
2. Entering into a 'swap' has no other connotations than a financial contract(C'mon-people should be smart enough to figure about what I am referring to)
3. A person suggests 'morning' meeting and your immediate response is 'my time or yours'
4. You have 2-4 big computer screens-and still you want more
5. You hear 'put' and think of a financial contract, and not of the golf putt(though many people in financial markets DO play golf)
6. Bloomberg/Reuters are not mere news agencies but essentials of your life
7. It is already evening time outside but your main workplace(XYZ market) is just opening for business

I'll add to this list as it grows

Investing in a holding company? Read this first

Some industries(banks/infrastructure) have predominantly listed holding companies due to legal/contractual requirements, while others(conglomerates, MNCs) prefer it to encourage managerial autonomy, ascertain market valuation, ensure ease of divestiture, and ring fence other companies in the group from any one unit's bankruptcy. Whatever be the reason, investors should note the following points before investing in holding companies

1. Greater risk of fraud:- Forget management fraud, even employee fraud is difficult to track across so many companies. And if the operating subsidiaries have different auditors, then the resultant coordination problems may render fraud more hard to detect
2. Upstreaming of cash/assets may not happen:- Consolidated accounts implicitly assume that the subsidiaries/affiliates can upstream/side stream cash among themselves. If anything happens to restrict this free flow, then the value may fall(for example exchange restrictions). Watch for this disclosure in the company's annual report(s)
3. Subordination of debt to the subsidiary creditors:- Unless the subsidiary itself guarantees the parent debt, the holding company creditors will find themselves subordinated to the subsidiary's creditors/counterparties in case of insolvency proceedings. Note the disclosures in this regard.

Being cognizant of these risks, more holding companies(especially banks) try to raise capital locally, have their subsidiaries guarantee their share of parent debt, and use transfer pricing as a tool to upstream dividends in the guise of interest, fees, royalties etc.

The importance of activity based costing in financial markets

Any student of management accounting/cost accounting would have studied the classic examples of how enterprises undercost/overcost their products/services, often without even knowing it. If this is the case with tangible products with relatively well known costs, imagine the situation with intangible & complex financial products. For them, the main cost is the cost of funds. That can be determined in a variety of ways

1. Funding rate for that tenor('duration') in the open marlet
2. Existing cost of funds for the bank(as a whole)
3. Existing cost of funds for the bank(in that maturity bracket)

But this cost does not factor in the other strategic & tactical costs like keeping funds ready, alignment with bank objectives etc. For that reason, a subjective preagreed adjustment is often made via a spread to compensate for risks like illiquidness, refinancing etc.But factoring in the exact amount of this adjustment, is an exercise very close to calculating cost drivers in routine activity based costing. So given all this, one should not forget to price the products appropriately, which in turn needs a strong grasp of risk and liquidity. Else as Jamie Dimon(CEO, Bank of America) put it in his inaugural shareholders letter (Many companies
design products that lose money, and they do not even know it.). So for their grasp over the cost flow, management accountants and structurers are well equipped to advice on these aspects. In banks, the department which fixes the main funding cost(ALM-Asset and Liability Management) often uses these two skillsets in plenty.

First impressions of a trading floor

After reading the horror stories in Liar's Poker and other books, I was mentally expecting the worst(ambience wise) in my stint on the trading floor(in structuring). But I was pleasantly surprised. Rather than the bunch of battlehardened phone throwing screaming manics I was expecting, I saw rows and rows of screens, with serious faced faces on them. Even the TV in the backdrop was largely muted with only the headlines flashing. My initial impressions(in no particular order) are

1. Traders have 3-4 screens(with atleast one Reuters/Bloomberg terminal) to let them multitask-watch the market movements, check their mail, update the Excel sheets, execute trades etc. This may lead to information overload but hey they are paid handsomely for that
2. The phone line allows around 4-8 incoming calls at a time, with user friendly interface on a specially designed phone instrument
3.  Research/Capital markets are physically segregated behind glass walls(!) to preserve that Chinese walls needed by regulators. That makes interaction rather difficult-which IS the intention of course!
4. Interns are rarely asked to bring food for the entire team('desk'). Those old days are revived selectively but are no longer institutions.
5. Since quotes can be received/sent by terminals, phones are not used that much-so there is much less  noise than I initially supposed.
6. Temper tantrums(like in Liars Poker) and swear words do exist but that is individual specific. Even elsewhere, it is not a badge of pride to use expletives.

This post will be updated as time progresses. 

Will ISB's doing a Harvard(YLP program work)?

Harvard Business school(HBS) had launched a 2*2 program in which it admits undergraduates(obviously exceptional candidates) and admits them into its regular program after they get 2 yrs of work experience. This guaranteed admission is targeted at non business streams to attract people into management when they have other options(like pure sciences, CPA etc). Now, ISB has also launched its program titled 'Young leaders program' targeting undergraduates in their penultimate year. It will admit them and permit them to enrol after they get 18months of work experience. Now, unlike the Harvard 2+2 program, ISB's YLP program does not explicitly target unconventional backgrounds. And unlike HBS where it must filter out strong candidates from consulting, investment banking etc, ISB and other Indian Bschools largely deal with  an applicant base consisting largely of engineers with IT experience. So to bring in diversity via the 2+2 program, they would in fact need to target the other education streams like commerce and arts. But this brings in issues of comparability, fairness(aptitude) and also whether this is necessary for those who would anyway do a MBA. Anecdotal evidence suggests that the creme da lae of Indian students with research interests anyway do a M.S abroad and work there. For other streams like commerce & arts, there exist lucrative career options like CA, Actuary, IAS etc. So would this target segment bite at the ISB YLP program? Only time will tell

Why banks & their clients deserve the poor accounting standards they have

By now, post the infamous Lehmann 105 repo/Bear Sterns portfolio valuation etc, many laymen(and a not insignificant number of industry veterans) blame accounting for the subprime crisis. They argue that if financial instruments were required to be valued consistently at MTM(mark to market), the sudden earnings shock would not have happened.

This argument is flawed given that  the widening CDS spreads(insurance premium for insuring the bonds against default) were widening for the overall market quite early on-so there was enough of early warning. That said, the standards ARE a hogmash of inconsistent principles and valuation basis. But for that, the banks/their clients have themselves to blame.

1. Many of the cumbersome provisions in these standards(like hedge documentation, anti tainting provisions) were inserted to prevent financial engineering led abuse by structuring transactions to achive unintended results. 
2. And the standards are quite vague because when you give 'bright line' guidance, the effort goes to achieve the bare minimum effort necessary to do so. 
3. Also, when the standard setters wanted to apply a consistent fair value framework, doing so for financial assets was easier because of the excellent markets there. But banks lobbied the EU to prevent macro hedging and other rules from coming into place. And when politics enters the equation, good practice does tend to go out
4. Also, response to the discussion papers tends to be skewed and repetitive. As any reader of the various response letters would attest to, each take their own parochial limited views and argue for a rule benefiting them, instead of a rule which is fair, transparent and workable. In that context, even the standard setter has limited options to work with.

 Hopefully, my own future interactions with the standard setters will not commit the above mistakes.

Will Indian IT firms ever achieve the holy grail of non linearity?

Pick up the annual report/conference call transcript etc of any top Indian IT services provider, and a phrase jumps out at you 'non linearity'. Simply put, it means how do we grow without adding people in the same proportion. To understand this theme better, lets breakdown the businesses of these firms into labour intensive(support, development, BPO etc) and IPR intensive(licensing platforms, patents, products like SAP). Consulting is a curious hybrid of the two. Naturally, the latter(IPR intensive) is what carries the maximum bottomline boost, and it is this that companies aim to achieve. For this however, they need to invest in R&D and hire the right people. In this context, the Chief HR officer(and former CFO) of Infosys Mohandas Pai had some interesting comments in a Dec-10 investor presentation(http://www.infosys.com/investors/news-events/events/Documents/HR-trends.pdf). He said that they mainly needed three types of skillsets

1. Platform creators:-people with an integrated enterprise view(architects, designers, product engineers)
2. Operational:- People who could master a given system and become very productive at that
3. Domain experts: Mainly former consultants who can use their domain knowledge to enrich the platform by building in non linearity
   

At the factory level(operational), we can use BPO talent while we do have many domain experts.But it is at the platform level that the strategy may collapse. With the creme de la going for MS in USA or MBA in India, IT cos find it hard to retain talent in the industry long enough for them to develop that integrated enterprise view. And that may prove their Achilles heel. While some companies have managed sector specific non linear growth(such as Polaris in banking), there is still a long way to go. And given the rapid emergence of East Asian countries(like Philippines) in BPO and East European countries in value added services, the competition is becoming tougher. While cos are aware of this at the strategic level, the infrastructure and talent crunch may prove the last nail in the coffin

The marriage of corporate finance and accounting in IFRS/GAAP

Few people will be caught dead admitting to a liking for an accounting class. But those same people may like a finance class. This post explains how some corporate finance principles are used successfully to achieve a true and fair picture in the books of accounts. So next time you open those accounting rules(hopefully you would not need to!), try looking for more such examples

1. While accounting for financial instruments either as assets/liabilities, entities generally need to use the effective interest rate method, which is nothing more than a glorified version of IRR. And to make the resemblance more, the initial IRR itself is used for income/expense recognition throughout, like in capital budgeting problems.
2. Pension accounting uses the concept of risk free rate to forecast the return on pension assets, while like in financial modelling, assumptions need to be taken about the growth in salaries etc
3. In lease accounting, IRR is again used to allocate rentals between revenue and capital
4. While testing whether fixed assets have lost value('impairment'), a two stage DCF model is used to value the assets(singly or in blocks) to decide whether to book a charge.
5. And of course while recording, measuring, valuing or transferring financial instruments(again), a hogmash of principles are used.
6. While recording assets acquired in a M&A('business combination'), accounting rules need you to value each asset separately, which is more work again for the accountants/valuers.

I am not stating that accounting is always consistent with finance principles-often they are not. But a keen reader of accounting standards will find several such examples of applying finance in practice, and this I hope, will encourage more people to do the former when they need to(like CA Final exams). 

IFRS transition-more than just an accounting change

While the Big4(and others) have covered this in depth via white papers, this post just intends to bring up the major issues(with examples) for investors and non accountants  to be aware of. So next time your Finance Dept brings up the issue of IFRS adoption, you would hopefully be agog with questions about its impact on you and your Dept/profit centre. Following are the functions which would see major workload:-

• Corporate finance—If key numbers on which certain debt covenants are based change due to the transition to IFRS then early discussion and negotiation with the banks is critical. Though most agreements do have a clause covering accounting changes, it is still safer to run a test on that
• Tax—The tax team needs to be in the loop, so that they can properly account for the transition differences, and subsequent impact(s) in the tax returns.
• Human resources—Given the growing trend to use accounting based numbers for compensation plan(rather than shareholder return only), executives should be concerned about the impact of transition to IFRS on their key metrics and incentive plans.
• Technology—Changes are required in the consolidation systems and in the general ledger
accounting systems.Also, to present the required segment information, the systems would need to be built.
• Internal controls—IFRS requires a higher level of judgement and estimation than US
GAAP.  This means the controls and process surrounding accounting judgements and
estimate must be robust since it will be challenged by the internal controls testing process.Also, given the increased scope for fraud/mistake, the controls need to be fraud proof as far as possible.

• Investor relations—Investors need to be educated about the initial upfront changes(say in equity) and the subsequent income statement volatility when earnings smoothing is no longer allowed/much more difficult. This would impact companies with heavy pension liabilities, financial instruments etc.
• Operations—Given the asset component method for depreciation, impairment testing and other asset specific tagging requirements, Facilities/Operations would need much more information about their fixed assets than they have presently. This may lead to outsourcing of this labour intensive function

In passing, we will see much more activity on this in the coming year 2011-12 on the Indian front. Those of you interning in those companies may already get to see some of these changes

Why operations and marketing count big time in banks-beyond retail banking

Veterans of 1st year Bschool would almost certainly have realized the importance of both marketing and operations to create a successful retail banking franchise. You need to segment customers very well to decide the number, location and mix of branches, products, loan book etc. And for executing that master plan well to turn in a profit in an increasingly competitive environment, you need Operations to pitch in well by constructing branches on time, hiring people when needed and with the sufficient skill sets, ensuring the IT infrastructure is cost effective, scalable, safe and needs business needs..and the list goes on.

But the Wholesale banking arm also needs operational expertise, and not just the stud wizard traders/structure rs/researchers. Take for example a derivatives product which needs frequent margining, interest and other payments over the life term. Or even a trade finance product which needs frequent collections. Or that documentation management program for a key client. All these need precise levels of coordination, on shore presence and superb payment systems-which is the heart of the bank. In fact, a bank which is operationally sound has a strong moat which errects formidable entry barriers. And of course, the sales/relationship function in investment banks are all about marketing. So these two functions-operations and marketing-can break or make any bank, and that is why aspiring finance MBAs should not ignore them

Why the end of 'free content' looms ahead_and what consumers can do.

Barely an year ago(during my preparation for CAT), there was plenty of good quality legally free content online in terms of the NYT.WSJ/FT.com etc, which all permitted unlimited online access. And for those inclined to bend the rules, there were efficient filesharing websites(masalaboard, Avax etc) and filehosting portals(megaupload/ifileit etc), which permitted downloading(illegally) all sorts of content from ebooks to music to movies. Of course, the content was 'free' for the consumer but not the provider. Newspapers used online ad revenue or offline revenue to cover their incremental cost of hosting the content(as same content used as generated for offline version). Those uploading files used to earn with each download made using their links. But come to 2011, and the picture is starkly gloomy for those used to getting free reading material.

1. The good newspapers have mostly put of firewalls with a ridiculously low 'free articles' limit before the paywall message hits you. For example, FT/Economist/WSJ
2. And file hosters have shifted to hosting files on sites like uploading.com/filesonic which themselves have 'premium' subcriber accounts, that make free access virtually unfeasible.
3. New ebooks are being released in audio book form(about .8-1.5GB) against other formats which are hardly 1-10MB. Along with the braodband fair usage restrictions abroad(and in India) which degrade the speeds of heavy users, this would lead to less piracy.
4. Also, in EU/USA, industry is lobbying for stricter anti piracy laws to remove the internet access rights of frequent IPR infringers
5. Lastly, with the net neutrality pendulum swinging towards ISPs, we can expect content costs to go up as more media houses try to get their content to load faster and better. 

I guess the users can shift towards reading blogs, podcasts etc which are still free.,like Seeking alpha/FT/Economist blogs. Also, sometime we will need to get used to paying for content..for example a Singapore newspaper is SGD1(Rs 35) while good economic papers here are hardly 1/10th of it. Guess the price for development/IPR laws would be high..but hopefully worth it

Does your investee company make a mockery of accounting standards?

The accounting standards for segment reporting, interim reporting, inventory, impairment, events occurring after balance sheet date etc would have brought hope to some investors seeking additional information to understand the company better. But my sample of company annual reports(admittedly non exhaustive/non representative) brought out quite a few examples like

1. Not breaking out segments on plea of activity being 'single','integrated' even in cases where they are clearly not so. And even when segment disclosures are given, a large portion of segment assets/costs are loaded to the corporate pool on the plea of 'not able to identify due to common usage'. It fails me that when cloud computing SAP solutions/high tech options are available at low costs, how can companies take this excuse
2. Refusing to writedown impaired investments on the grounds that they are 'long term/strategic, intention to dispose not there', 'valuation reports support higher view etc'.
3. Ignoring events occurring after balance sheet data, especially if non financial. For instance, LIC Housing Finance did not even mention the arrest of its MD in its Jan-11 quarterly result. And the recent Arab/other crisis got short shrift in the Dec-10 ending results/annual report. I agree that investors equipped with Google News would anyway know this public information, but it is good to hear about the impact from the horse's mouth('company')
4. Despite the clear standards on inventory accounting, atleast one prominent diversified tea company is unable to break out its tea leaf production cost due to the 'integration of stages' etc. For a company subject to cost audit-which verifies this information and much more cost data, this excuse is pathetic.

I shall expand this list when more examples occur but this is all for now. 

Accounting tail wagging the tax dog-how accounting choices affect tax liability

Most people would know from Accounting 101/Tax 101 that USA corporations prefer LIFO basis of inventory accounting(prohibited by international accounting norms under IFRS) to save on their taxes in an inflationary scenario. But this just scratches the tip of the iceberg. There are many more serious implications of passing that accounting entry in your books, even if the tax records are maintained on a separate basis. Some of them are:-

1. Where accounting profits serve as an alternate basis of taxation-for example India imposes a 'Minimum Alternate tax' on the book profit(of course post certain adjustments for unrealized profits/losses)
2. Many countries mandate a reconciliation between the tax income and accounting income(or even the statutory tax rate and the effective tax rate paid by the company). Any major difference could invite a visit from the tax man.
3. Tax law typically stipulates penalties/fines/withdrawal of amnesty scheme options etc in cases where intention to evade taxes is proven. Where the substance over form doctrine in accounting mandates treatment overriding the legal form like
1. Characterizing leases as finance/operating irrespective of documentation
2. More importantly, The IAS 32 requirement on the issuer of financial instruments to classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument.  Specially where quasi equity instruments are structured to achieve the maximum tax benefit(read debt) but the company accounts for them as equity as per IFRS, the tax authorities could make out a case that the company was fully cognizant of the potentially differing treatment. 
4. In countries like Germany/France, where book profits serve as the taxation basis, companies straddle a thin line between inflating their profits(for external reporting) and minimizing tax payments. 
5. In case of withholding tax on international transactions, or even for some related party transactions, and more recently for Indian indirect tax liability(under service tax), the book entries take precedence over the date of the actual transaction.
6. Where separate businesses of the same legal entity are taxed differently,  then segment accounting and internal transfer pricing becomes much more important. An interesting example in this regard in the case of Ganesh Polytex was mentioned by me earlier at http://financeandcapitalmarkets.blogspot.com/2011/01/reducing-tax-payment-via-overhead.html

 While managers would engage internal accounting staff and external tax advisors to address these problems, a broad level understanding of the major issues pertinent to that geography is essential, to ensure that that 'big picture view' does not fall afoul of the tax man.

IF you require a diagram to explain a transaction then it is a structured finance transaction!

The building blocks of financial products are fairly simple-equity and debt. One can mix and match to get convertible debt, preferred stock, subordinated debt but finally they all boil down to a combination of those. Gone were the days where a transaction between A & B would mean a direct fund transfer from A to B. In today's era of risks, tax, legal structures, contractual protection etc, even simple transactions are routed through SPVs. But where legal vehicles are used to split the cash flows, risks and contracts, there are issues there and structured finance comes in then.

Take the typical project finance example. Lenders would demand inbuilt safeguards of SPVs, holding operating cash flows in trust to repay their dues etc. Also, expropriation scarred MNCs may demand an offshore vehicle to hold the assets with a domestic vehicle typically guaranteeing the debt. One can make the structure as complex as possible mixing and matching LLPs, firms, companies, trusts, JVs, association of persons etc(thereby enriching their lawyers/accountants in the process). And at times, it is commercially justified to become more complex if by that, you can split your assets into different pools(with lower credit risk) and issue debt in tranches(thus expanding your investor base). The reason that infrastructure, pharma and banking companies have such complex structures(and plenty of jurisdictions), is to be able to use the right structure to tap an investor base at the best possible rate.

StanChart-the bank with a difference

With just a week's internship with StanChart(Financial Markets, Singapore), I am hardly qualified to discuss the bank with any level of analytical rigour. Still, initial impressions themselves are so vivid that I feel they deserve a mention even if they are revised later(which I hope they won't!).

1. The very first training we had was on HIV/AIDS awareness, duly supplemented with a mandatory online training to be completed by all new joinees
2. Even during campus presentations, StanChart was the only bank which devoted substantial airtime to to their social/CSR initiatives, and their recruitment strategy/other policies follow it. Right from separate bathrooms for the disabled(on all floors), to the number of stammerers/persons with disabilities in various sections of the bank, StanChart has displayed its heart by its actions
3. Remuneration system includes an evaluation of how people live the bank's values
4. 'Here for good'-promising that StanChart sticks by its customers during thick and thin-this was substantiated by its actions during the Dubai/African unrest when it stuck by its customers. Incidentally, it runs its Zimbabwe retail operations at a loss to support its customers who have few choices.
5. With separate halal microwaves and fridges, the level of cultural sensitivity is amazing
6. As a perusal of their 2010 Annual Report would show, they are the only bank to implement the sustainable lending principles('Equator Principles' in all lending areas(whereas other banks do it only for project finance). 
7. Also, unlike some others trying for regulatory arbitrage of the new capital/remuneration norms, StanChart has adopted them in letter and spirit by raising capital in late 2010(even at a substantial haircut) and then following the FSA remuneration code.
8. Also, this is a genuinely nice place with people uniformly pleasant and fun, and who are ever willing to help. I think the HR does look for this type!! I shall add to this post as the time progresses.  
9. There is a real thought given to safety and recycling. For example, to avoid accidental burns by switching on the hot water tap, there is a safety button to be pressed to start the hot water flow. Also to encourage recycling, they do not have any individual dustbins. Employees have to use the 4 recycling bins for metals, plastics, paper and Misc.

Structuring-the art of making the 'impossible' into reality

People managing the Sales & Distribution functions in a complex indirect tax environment (like India) like India, have long known that sometimes you sacrifice commercial rationale to achieve the most efficient post tax outcome. Luckily, such sub optimal structures are less common in financial structuring, where the client and bank jointly work to tailor existing products to the client needs. To use an analogy, a structurer does not create value out of thin air, he merely stitches the threads of accounting, legal, tax, financial, capital etc together to obtain a structured product. While structured products were blamed for the financial crisis, and are still accused as being too complex(and thus hard to value), we should note that their purpose is to solve a client problem. And that basic need does not change even for structures aimed at regulatory arbitrage.

So how does the impossible become possible? Lets see some examples

1. You are a mutual fund prohibited from investing in certain asset classes, which would aid your strategy. Try investing in a structured note(seemingly debt) that mirrors your investment view. The payoff diagram would then hopefully achieve what was earlier prohibited
2. As an investor, you cannot exceed your ownership limits in listed securities without making an open offer. Try a total return swap to get economic ownership without the hassle of legal title
3. You want principal protection yet need a good upside-which conventional debt products do not permit. Take a principal protected note which is a zero coupon bond(or variants) with the balance invested in very risky instruments to achieve the upside for the entire amount
4. You would like to participate in a derivative product but the dealers will only deal with other banks/or margin requirements may be too high. The bank would therefore package this into a structured note.
5. As a bank/private company, you want to reward your top people with market linked incentives but cannot/do not want to issue shares. Offer performance shares/restricted stock etc

 I can go on and on but the message is clear. The job of Structuring is to design a way for an investor to express his investment view. Where restrictions/internal issues do not permit for conventional products, then structured products prevail. Some of them get internalized into every day jargon like convertible bond, repo etc.