Japanese investment bank Nomura Holdings Inc. has also embarked on an inquiry into its India fixed-income business involving serious claims of inflating profits over the past years. This in-house investigation, which throws light on valuation activities in a niche yet important section of the Indian debt market, entails top officials in the bank rates section, who have been requested to establish the extent and nature of the possible misconduct. The relocation indicates an increasing question in the financial industry as to the accounting techniques used on complex fixed-income products.

Internal investigation and subsequent valuation

Nomura’s compliance department formally initiated the probe, which indicated a significant degree of internal anxiety about the valuation and accounting conduct of the firm. The centre of the investigation is the evaluation of the trading desk at the firm regarding the initiated trades of particular structured sovereign securities, termed as Strips. 

Strips is an acronym of Separate Trading of Registered Interest and Principal of Securities. These financial instruments are designed by issuing long-term government bonds and disaggregating their future cash flows, the principal repayment, and the various coupon (interest) payments into different, separately-tradable securities.

The compliance department started investigating the activities of the local primary dealership of the firm about a month ago. The internal audit is specific, and it will focus on whether the trading desk has employed certain valuation methodologies that could have exaggerated financial reports. In the case of Nomura, the quality of such valuations is crucial, particularly after the company had become a key player in the Indian sovereign debt market.

The main concern under scrutiny is the purported act of marking positions to hypothetical prices, which, as indicated by those who were conversant with the situation, was not relevant to the true market liquidity. These theorized valuations are believed to be used by the trading desk, not on a price that can be obtained in a real market sale, and this would have the impact of possibly inflating reported business. This particular accounting procedure is subject to close examination due to the fact that it enables the institutions to report unrealized profits on securities that are usually illiquid.

The process is formed by breaking the government bonds of long date into the separate principal and interest parts (Strips), allowing this process to result in the individual valuation of the different parts. The issue is that the future valuation of these components might have been artificially increased to inflate the financial performance of this firm in general. This type of use of illiquid securities, coupled with dubious assumptions of valuation, is a considerable threat to the accuracy of financial reporting. The Nomura compliance department is currently in the aggressive process of resolving this issue.

Market for Strips and a surge in demand

This research is conducted against the backdrop of the Indian sovereign debt market, which is growing fast. The Strips market can be described as a niche segment, but it is a rapidly expanding segment of the overall sovereign debt market in India, which is also priced at a massive $1.3 trillion. Nomura has positioned itself as one of the most important participants in this particular segment, and the results of this internal investigation are therefore especially important to the reputation of the firm in Indian finance.

The Strips market has seen phenomenal growth over the past few years, and this indicates its growing significance. According to the figures of the clearing house, Trading volumes in Strips were ₹2.47 trillion (approximately $28 billion) in the year ending March 31, which is a rise of over six times higher than the figures registered five years ago. This is a dramatic growth that has given it increased attention and, unfortunately, increased concern throughout the industry.

The demand for these instruments has been boosted mainly by the presence of certain institutional investors, who are mainly the insurance firms. These companies have intensely increased their buying of Strips since they are zero-coupon securities. This format is very appealing to insurance firms because it ensures their cash flows are not vulnerable to risks and uncertainties of interest-rate fluctuations, thus it becomes easier to manage the long-term liabilities. Risks to the accounting integrity are new, however, with the increasing complexity and volume of the market.

The probe that Nomura has initiated is not being done in isolation; it highlights a wider, armed issue in the financial fraternity. This market is actually an area that has been reported to be a hotbed of accounting practices that can exaggerate reported gains either by aggressive or inappropriate valuation. By raising this matter, the internal investigation underscores the importance of effective compliance and open valuation practices as the specialized debt market goes on a high growth spurt in India.

Conclusion

The internal review of its India fixed-income business by Nomura Holdings Inc. is an indicator of a serious commitment to the examination of valuation integrity in a complicated and rapidly expanding section of the market. The investigation, which focuses on the pricing of Strips and how profits can be inflated with the help of a theoretical approach to pricing that is illiquid, puts the compliance department at the bank squarely in the middle of a growing problem. Considering the significant presence that Nomura has in the $1.3 trillion Indian sovereign debt market, the result of this investigation will be highly monitored by both regulators and other market actors alike, since it touches on the serious industry issues concerning the aggressive accounting practices in the high-growth Strips market.