Business Other News 16 Nov 2016 Regulatory risk in f ...

Regulatory risk in firms

Published Nov 16, 2016, 1:33 am IST
Updated Nov 16, 2016, 1:44 am IST
Any investor would have to factor its impact and actually de-rate the valuation for such a stock.
There are some industries that are more vulnerable than others. (Representational image)
 There are some industries that are more vulnerable than others. (Representational image)

Regulatory risk is something that we do not factor in to our investment analysis as a routine. Unless there is an immediate incident, our focus tends to stray away and we presume that things will not change or go on as usual.

At one level, every business or company has some regulatory risk or the other. I am not talking about regulatory risks that are common to all. For instance, change in income tax rates affects everyone uniformly and does not kill any industry. A dividend distribution tax imposition may make an impact on the investment universe and not on any one company.


There are some industries that are more vulnerable than others. These are industries that are typically seen to have some social or political impact. For example, pharmaceutical industries are vulnerable to domestic as well as global retaliatory regulations. DPCO can hurt some companies more than others. And politicians find it convenient to make headline statements like make medicine affordable. Similarly, Indian companies are known to take short cuts in getting approval for products. And when they start threatening global markets, there could be regulatory reaction from overseas in terms of bans and tariffs.


If we take the NBFCs or HFCs, they are subject to a very high degree of regulatory risk. We are much cocooned in our thinking that nothing changes. We have seen sweeping changes that killed the leasing industry. RBI can kill the NBFCs by choking off the resources side to them. The banking and finance industry is generally playing with a timing mismatch of resources and applications. In this environment, any dramatic change can just kill.

PSUs have always been at high risk. However, investors seem to think that the government will let go of its manipulations and put money on them. It is a chance that the government will abandon subsidies on various industries. We are seeing the slackening of price controls, but the government is not really letting go. We will not know how the government will react when the global oil prices start going up. This kind of uncertainty is tagged permanently with some sectors that are politically sensitive and where company ownership is with the government of India. Such companies have hei-ghtened promoter as well as regulatory risk. Often, companies or industries enjoy some temporary benefits in the form of some tax breaks (sales tax, income tax, export sops, free trade zone sops) that give a kicker to earnings.


Any investor would have to factor its impact and actually de-rate the valuation for such a stock. Any company or industry that gets a regulatory bonanza is skating on thin ice. We have to look at any investment on its own merits. Similarly, we see imposition of anti-dumping duties on some commodities like steel. This can give a boost for some time and we have to get rational and assume that this will not last for long. Yes, some momentum traders will create a buzz and pump up the stocks.

GST is a big regulatory change that will impact some industries more than others. And the outcome will get known only after two years. Hopefully, companies that were disadvantaged because of unfair competition from the unorganised sector may see their fortunes improving.


Regulatory risks hit companies like providers of utilities (gas, electricity, energy, water etc) very hard. To encourage investment in this sector, the government may give some sops, which would be temporary in nature.

Over time, they will become limited or fixed income securities as social concerns link with politics and prevent free market in these. Ideally, we should move to a situation where there is competition. Telecom is a good example of a “utility” sector being relatively freed. It still has a regulator but the consumer is still given a choice. This means that there is more of free market in the industry rather than tight control.


Regulatory risks are a two-way thing. There is the businessman constantly lobbying to get favours for his business. And at the same time, there is a group of social activists who constantly scheme to reduce industry profits. And then there is a politician who is constantly trying to win votes by populist actions against industry in general.  All of this impact investment decisions by taking away the predictability of earnings. Yes, whilst we may be able to forecast or foresee a trend with some degree of certainty, the profits are not so easy to predict when the regulatory risk is high.


(The writer is a veteran investment advisor. He can be reached at