31 March 2017

SEBI needs to loosen up and keep its eye on investor interest using economics - 'Poke me'

I have a piece published online in Economic Times. In a new format, this piece invites your comments on the op-ed. It will be reproduced on the edit page of the Saturday edition of the newspaper with a pick of readers' best comments. So please add your comments at this link. Comments reproduced in the paper will be the ones that support or oppose the views expressed intelligently. Please add comment on the main site of ET not here if you would like to be considered for publication. Please find below the full piece:

"Last month, Ajay Tyagi took over as the new Securities and Exchange Board of India (Sebi) chairman. He will have priorities. But for starters, one hopes he will support more innovation. As with other things, there is a tradeoff between innovation and risk. If capital requirement in banks is increased from 5% to 100%, there will never be bank failures. But such an outcome will be disastrous for the economy. There should be more experimentation in the financial market space, particularly in the exchange space. For too long, we have chosen safety over innovation. The pendulum needs to swing more towards freer markets which are well regulated, the preamble to the SEBI Act itself mentions development of the markets as a goal of SEBI. 

There ought to be more evidence-based policy decisions on market microstructure, and more open debate on concerns related to high frequency trading. Two low hanging fruits include eliminating the 15% cap on shareholding of exchanges and introduce, like RBI, a 15 year roadmap to dilute shareholding. This will foster new exchanges and more competition. The second low hanging fruit is allowing alternate exchanges which will provide innovation to the marketplace and create new markets. The larger exchanges are not interested in this space as it requires some handholding of smaller companies and there is a need for such alternate exchanges. The US has over 40 of them. This is possible even within the current statutory provisions and current capital requirements.

Secondly, many of the securities businesses today have capital requirements where there is no need for capital. Examples include networth requirements for portfolio managers and mutual fund managers. This is anti-competitive and plainly hurts smart people and investors. It gives a message that India is more comfortable with robber barons than with IIM graduates starting a securities business. Businesses which should require smarts rather than deep pockets should require the right entry norms. Certain securities businesses do indeed require capital, like clearing corporations, but imposing it on mutual fund managers is anti-competitive and invites the wrong kind of people in the business, besides raising costs for investors who must ultimately bear the costs of pointless deployment of capital.

Third, while SEBI has been very effective in curtailing mischief by intermediaries, it has not been successful with problems which require more bandwidth, like enforcement against listed companies and financial shenanigans by persons conducting Ponzi schemes. Similarly, there has been virtually no action against mis-selling and broking fraud, where brokers empty out accounts of new clients by constant trading in derivatives and other inappropriate products. This issue has gained epidemic proportions and needs to be addressed with suitable enforcement action making such practices financially ruinous. SEBI inspections should seek information which indicates this practice.

Fourth, in line with regulatory action against miscreants, SEBI needs to take a softer approach against honest mistakes. Given the complexities of the regulations, many professionals in companies are sometimes left confused, and there are bound to be honest mistakes. SEBI needs to take a lighter touch approach to such mistakes or merely issue warnings. Recent statutory amendments also help the regulator in taking a rational approach. SEBI also needs to put a restraint on interim orders. Use of emergency powers may be required at times, but SEBI’s use of interim ex parte orders is disturbing as it beheads a person before the trial has even begun. SEBI then has years to relax, while the person is executed daily through economic harm.

Fifth, and most radical, there is a need to revisit the quota system for initial public offerings. By offering retail investors a special ‘quota’ in an IPO, investors are lured into a highly risky equity product with a dangled carrot of 'free money'. Nothing could be further from the truth. Investing in IPOs could be highly profitable, but it could also wipe away 80% of an investor’s saving in just two weeks. This is not a product for retail, and certainly not a product which should be luring retail participation. Freeing up the market to ordinary market forces without quotas would reduce the moral hazard and imperfections like IPO frauds substantially and eliminate subsidies to punters. SEBI’s eyes should be on investor interest, not on guaranteeing returns to flippers who want free money in 2 weeks. SEBI needs to use economics and ‘nudges’ rather than fight them.

Sixth, excellent progress has been made in the corporate debt market over the past ten years. Corporate debt markets should be allowed to innovate more and corporate debt markets should not be set up as replicas of equity markets (they are different animals and need different food). Ironically, the best policy is encouraging more off exchange trades, including electronic trades, which will create liquidity and expand the markets. This is so, because debt instruments, unlike equity, are traded infrequently and in very large transactions, sometimes in thousands of crores. Attempting to move that to an anonymous order matching platform is bound to fail as large trades push the market price beyond what is acceptable to any buyer or seller. Any mandatory push would in fact shrink the market. Alternate debt exchanges are one possibility and SEBI has had an applicant for that.


Finally, there is need for simplicity and constancy in regulations. I find many of the securities laws are spread over circulars, which are vague and ever-changing. It is not clear how ordinary companies can keep track with daily changes and excessive complexity of regulations. Complexity is the enemy of compliance. And confusion guarantees innocent violations on the one hand and crooks to breed on the other."

02 February 2017

Financial world, more of the same is good

I have an opinion piece in today's Financial Express titled Financial world, more of the same is good on the 2017 budget of India. The full piece is copied below and linked here:


Economists term the four factors of production as land, labour, capital and enterprise. This piece will discuss the third of these. But it would be useful to discuss the others briefly. There have been no major land reforms announced, but that is mainly because reforms have occured at the state level. Labour laws are intended to be collapsed and simplified into just four laws, which can be termed a big bang reform in that area. Enterprise is the most disappointing of the four. For enterprise to prosper, the government has to be much smaller in two ways. One, public sector enterprises in regular commercial activities like aviation and heavy vehicles should be privatized or shut where unviable. Two, more importantly, the extent of the bureaucratic interference with enterprise needs to be reduced. On both counts, the government has been timid.

One of the least expected turn of events in this year’s budget was the lack of change in the taxation eco-system. Besides lower taxes for the lowest tax slab of individuals and the medium and small enterprises, the entire tax structure of past years has been retained in structure and rates. This is a good thing. I believe we should broadly have steady tax policy and rates for extended periods of time. It provides certainty and ease of doing business. Similarly, a rude shock provided to foreign portfolio investors towards the end of December has been clarified and the dangerous ‘clarification’ has been revoked, which would tax investments in overseas jurisdictions.

On the divestment front, the FM has proposed listing of certain public sector entities but sticking only to previous divestment targets. Certainly, listing will provide a higher level of transparency and governance to such companies, but an aggressive divestment target would have carried the PM’s announcements over the years of the government getting out of regular commercial activity and reduce the oxygen sucking from the entrepreneurial world. Similarly, I strongly oppose the concept of divestment through public sector ETFs or exchange traded funds. They carry the worst of both worlds. They are often bought with public moneys run by the LICs and UTIs of the world and since there is no reduction in the control of the government, do not come with any improvement of governance and management.

FIPB (no need to remember the acronym any longer), the nodal agency which permitted foreign investment in certain cases is sought to be abolished. This is a good move. However, the purpose of setting it up was to reduce red tape of going to two/three ministries plus the RBI. If abolition means, making rounds of the various bhavans in Delhi, then it will not be a reform at all.

Finally, a bill to address illegal deposit schemes is welcome, but an institutional mechanism with state government’s assistance would be key to make it successful at the grassroot level in remote areas.

07 November 2016

CII's 7th Financial Markets Summit

The flagship financial/capital market seminar of Confederation of Indian Industry (CII) will take place on 10th November 2016.  The summit promises to be interesting as we have seen a change of guard at RBI and soon will see one at SEBI - giving a sort of tabula rasa for a new policy framework. I will be speaking on "Framing conducive policy and regulations for effective and efficient financial markets". Please do register for the same, details are as below:


03 November 2016

Did Sebi just score a self-goal on stock advice and free speech?

I have a piece in today’s ET “Did Sebi just score a self-goal on stock advice and free speech?” where I argue that the consultation paper of SEBI lacks internal logic, and would hurt investors rather than protect them. The restrictions on free speech would make Warren Buffet (if he chose to come to India, or commented on Indian stocks) a criminal. Please find below the full piece:

SEBI has come out with a consultation paper to modify the existing regulations of investment advisors, distributors and research analysts. The proposed amendments should be abandoned, commas and full stops included. As proposed, they would hurt investors, mandate un-suitable products to investors, fight the law of economics (unsuccessfully), outlaw honest conduct as fraud and place unconstitutional restrictions on your and my freedom of speech.

The current regulatory landscape is as follows. We have 80,000 odd distributors of mutual funds. These are agents of mutual funds and receive a commission from the funds. This is a conflicted model as it incentivises distributors to sell the products juiciest for themselves, not the most appropriate for the investor. This has been tackled by SEBI in a three-pronged approach. Limit commissions aggressively, strict disclosure norms of what is shared with the distributor and imposition of fiduciary standards on the distributors. Then there are advisors who advise clients for a fee and are not permitted a commission, though their distribution arm may charge such commission on a disclosed basis. Distributors of mutual funds are today exempt from registering as an investment advisor so long as they give incidental advice, which in fact they are obligated to give based on a 2011 circular of SEBI. Specifically, they are obliged to study the financial situation, investment experience, and investment objectives of the investor before recommending a product.

Now SEBI seeks to take away the advisory exemption to distributors. This seemingly innocuous move will have catastrophic consequences. While we have over 500 registered advisors, by my estimate, those who are advisors without any affiliated distribution function would run in single digits. It is not economically viable to be pure a play advisor. Dangerously, such a regulatory fatwa would force distributors, not to register as advisors, but rather to stop their advisory role. People assume this will hurt distributors. In fact, distributors will be happy to give up the advisory role which imposes a cost and a fiduciary obligation on them and little revenue. The sole loser of this move will be the investor. Distributors will not only obtain the ability to sell products without a basic check on the risk profile and risk appetite of the client, but the law will force the distributor to sell unsuitable products to investors, for without proper advice there can never be a proper sale. This is an avoidable regulatory self-goal.

The second proposal of the SEBI paper is to disallow a division of the investment advisor to provide distribution and execution or orders. Instead, it mandates the separate arm to be set up as a separate subsidiary. For this it relies on RBI mandating banks to set up separate subsidiaries to provide advice and not directly by the bank. The reason RBI has mandated the subsidiary model is not to help investors, but to protect the banks from investors claiming that they have been defrauded or sold unsuitable products by the bank. This too would be investor unfriendly.

The third proposal is the most innocuous sounding, but the most dangerous. It seeks to curb providing securities specific recommendations through SMS, email, blog, chats, social media etc. unless that person is a registered investment advisor. Not only that, it proposes to categorise such communications by itself as fraudulent. The charge of fraud requires proving intent to defraud, material mis-statement, causation and actual harm. All four seem not required to prove fraud if you share an honest opinion about a listed company on WhatsApp. In addition, it would make Warren Buffet (if he were based in India) a criminal as he shares his views on a large number of companies. The following statement from his annual letter to shareholders could land him in jail for up to 10 years “Precision Castparts Corp. (“PCC”), a business that we purchased a month ago for more than $32 billion of cash. PCC fits perfectly into the Berkshire model and will substantially increase our normalized per-share earning power.” However, a graduate who wishes to register with SEBI is fine commenting on all and sundry companies. The proposal will chill whistle blowing, chill factual and analytical communication about listed companies in general, and impose a constitutionally impermissible restriction on freedom of speech.

Finally, the paper discusses the Research Analyst Regulations of SEBI. Any person who provides research reports giving buy/sell/hold recommendations, or provides an opinion on listed companies is obligated to register with SEBI. The paper seeks to impose suitability obligations on the analyst ensuring “that the research service offered to the investor is based on overall financial situation and investment objectives of the client.” A research report is typically shared en masse often with thousands of people. Imposing a suitability requirement would be unworkable and is the task of the client’s investment advisors.


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SEBI is clearly the most open regulator in terms of listening to comments and it is hoped that they will abandon this entire project, perhaps retaining only the full stops.

30 September 2016

Corporate Governance in India

Delighted to announce the publication of book 'Corporate Governance in India' of which I authored one chapter - on Related Party Transactions.

Link to OUP site.



01 September 2016

Class action suits - Potent, yet problematic?

I have a short piece on class actions under the new Companies Act and its dysfunctionality linked here and copied below:

After the Satyam fraud, India, as a country, realized that shareholders, of Indian companies, who have faced fraud, could not be made whole. In contrast, the international shareholders could obtain US $125 million by filing a class action suit at a US court. The Irani Committee proposed the inclusion of class action law suits in the then proposed Companies Act.

Section 245 of the Companies Act provides a right to members and depositors to bring an action against the company, its directors, auditors, experts, or consultants, for any fraudulent act or omission committed or likely to be committed by them. This has so far remained a dead letter since we have not yet seen a single class action law suit since 2014. This is primarily because of what economists call the tragedy of the commons. An investor must fight alone bearing the costs of, and delays in, litigation, but the benefits are enjoyed by all investors. In addition, the provision is clumsily drafted, complete with a glaring typo, provides barely any benefit, puts an onus of collecting a sufficient number of investors or depositors, and even has a provision for imposing costs in some cases.

For class actions to be effective, the right place to introduce a beneficial provision is in the Civil Procedure Code and the provisions should have clear benefits, deal with the tragedy of commons, reduce the burden on the litigating investor/depositor and finally, for this to really succeed, there will need to be an introduction of contingent fees payable to lawyers.