Global investment bank Nomura Holdings has launched a significant internal investigation into its fixed-income operations in India. The probe was initiated over concerns that the reported profits within its rates division may have been artificially inflated during recent years.
The Focus of the Compliance Review
According to a Bloomberg report, the bank's compliance department is conducting this review. The inquiry is specifically centred on the valuation methods used for trades in a financial instrument known as Strips.
Strips, an acronym for Separate Trading of Registered Interest and Principal of Securities, are bonds where the principal and the periodic interest payments are separated. This allows investors to trade these components individually as distinct securities, rather than dealing with the bond as a single entity.
This financial product has become particularly popular with insurance companies. The reason for its appeal is that Strips enable firms to structure their cash flows in a manner that provides a shield against the volatility of interest rate fluctuations.
A Niche Market Experiencing Explosive Growth
While still considered a niche segment, the Strips market in India is expanding at a remarkable pace. Data from the clearing house, cited in the Bloomberg report, reveals a dramatic jump in trading activity. Trading volumes soared to ₹2.47 trillion (approximately $28 billion) in the financial year that ended on March 31. This figure is more than six times higher than the volumes recorded just five years ago, signalling a rapid adoption of this instrument.
Accounting Concerns at the Heart of the Matter
The core of the compliance inquiry is to determine whether the trading desk engaged in a practice known as marking positions to theoretical prices. The critical question is whether these theoretical values accurately reflected the actual liquidity available in the market.
If the positions were marked at prices not grounded in real-market liquidity, it could have led to an artificial inflation of gains. This is possible because Strips can allow for the booking of unrealised profits on securities that are not frequently traded.
It is crucial to understand that Strips are legitimate financial instruments. However, their accounting requires meticulous attention to ensure that any profits reported are a genuine reflection of prevailing market conditions and not based on optimistic theoretical models.
The investigation is reported to have commenced approximately a month ago. The compliance team is undertaking a detailed scrutiny of the valuation and accounting practices employed by Nomura's unit in India. At this time, Nomura has not issued any official comment regarding this ongoing development.
