SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008

I have a piece today in the Economic Times which gives a 101 on SEBI's spanking new Securitised Debt Regulations. You were not expecting a critique were you?

Book review by Burton Malkiel etc.

Prof. Burton Malkiel has written a book review of "The either or investor, Clark Winter" in today's WSJ and suitably tears it apart. Though to really appreciate the review and find it convincing enough, you'll probably have to read his fantastic book "A random walk down Wall Street".

There is also a breezy piece on herd mentality in investing by James Surowiecki in the New Yorker.

Currency futures - back to control instead of regulations.

Today's Economic Times has a piece on currency futures regulations by Rajrishi Singhal which is spot on (pun intended). My guess, though it is a guess at best, is that these curbs (and possibly more) would be 'recommended' by RBI, and SEBI in its attempt to reconcile so that at least some movement occurs, would have accepted these terms. RBI needs to get away from the control era and SEBI needs to stand up to big brother if the above hypothesis is correct.

Indian stock exchange socialism

Today's Financial Express has a strident piece on Indian stock exchange ownership which caps one person's ownership at 5%. It calls the current policy 'strange' and 'ridiculous'. While the adjectives are not wholly misplaced given the governance vacuum at Bombay Stock Exchange (BSE) because of this policy, the piece doesn't go far enough in content. The piece is written on the assumption that some foreign players are just waiting on the sides for a 15% stake. To assume that a strategic investor will play a 'more active' role if it were to hold 15% instead of 5% is also not certain - does 15% in fact give a louder voice than a 5% stake? A foreign bourse is unlikely to be interested in a 15% stake - the number gives it no strategic importance on the Board of Directors and a say in the management, while it gives it a very large downside. Imagine giving US $130 million dollars with no accountability on governance or say in management (based on sale of stake over a year back at that valuation). This has already happened, both Deutsche Boerse and Singapore Exchange have lost heavily despite investing some $43 million dollars each in the BSE.

At the same time, I don't think the concern of the Ministry of Finance is wholly misplaced - they do not want corporate entities to run exchanges as these are critical institutions and can be used by companies to manipulate exchange functionality where their stock is listed. But the medicine is wrong. What can easily be done is that the amendment to the regulations can prescribe that only institutions with international reputation and competence in the financial sector without any non financial sector exposure (whether directly, indirectly or through affiliates) would be allowed to go up to 49% or 76% - of course that would not exclude reputed Indian financial institutions - thus ICICI may be in while Birlas would be out. There will also be a need to ensure that such entities have a say in the governance and management, and it should not again be killed on the grounds that such company is listed on the exchange - relevant safeguards may be implemented though without overdoing it.

See my previous posts here and here.

Law firm IPOs

And you thought securities law and staid law firms would never meet? In at least one jurisdiction, law firms have done an IPO and listed (Australia) - see how the firm is doing on the Australian Stock Exchange. An interesting article in the Economist (subscr required) concludes about a public listing of law firms:

"Another concern for potential investors is that lawyers are not proven business leaders. Clients frustrated with private-practice lawyers often accuse them of lacking commercial nous. Because most lawyers spend much of their time peering at small print, big-picture concerns can go unnoticed. Few managing partners know their firm’s profit per billable hour, even though that is the main product law firms sell. Cost control is often an afterthought, trailing far behind revenue generation.

Furthermore, lawyers have never had to endure the same pressures as the managers of listed companies, where the shareholders call the shots. In law firms, equity is held by a small number of partners. Outside investors are sure to be less sentimental and more critical when analysing a firm’s performance. For law firms that do decide to go public, success will depend on their managers’ ability to run them as public companies, rather than members-only gentlemen’s clubs."

Jury out on US short selling rule

If anyone had a doubt about the wrongheadedness of the US SEC's rule on short selling the jury is out. Check out the evidence, which clearly shows that market in those 19 stocks where the SEC has interfered has become less efficient. See also an update in the Economist: "Phantom Menace" on the subject (subscr. required), which relies on the study. The inefficiency has caused these stocks to decline over 10% points over their peers resulting in a 154 billion dollar loss to its investors according to the study.

But from a broader perspective, it is disturbing when a regulator begins manipulating specific stocks in markets. If it really was a pilot program why only select financial stocks rather than a broad swathe of stocks. While making bad policy is an occupational hazard in the regulator's job, manipulating select stocks and that too with poor outcomes, takes away the moral authority of a regulator from prohibiting others from manipulating stocks.

See my previous posts here and here on short selling.

New SEBI intermediaries regulations - Economic Times

I have written a piece describing the new umbrella regulation for securities intermediaries in today's Economic Times. Unfortunately, it is published only in the Delhi and Mumbai editions. So here it is, if you haven't read it.

While finalizing this regulation took a lot of effort, particularly getting the natural justice bit right while simplifying the disciplinary process, it requires two things to really get the philosophy and the substance of the new regulatory regime marching - a) get the new supplemental regulations in place e.g. an amended Stock Broker regulations which only prescribes regulatory norms which are relevant for stock brokers b) get the master circulars promised by SEBI over a year back out. The first of the master circulars was ready in April, but seems to have lost itself.

PS: The consultative paper on the subject is available here. This gives a more detailed background about the changes then proposed (at the consultative stage) . The new SEBI (Intermediaries) Regs. 2008 notified on 26th May 08 is available at the SEBI website.

PPS: The SEBI (Criteria for Fit and Proper Persons) Regulations 2002 and SEBI (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002 stand repealed and are substituted by provisions in the new regulations. The former is made more principle based and the latter is streamlined with a provision for benches of 'designated authority'. More on that in a future blog as there is a dramatic change from the previously mis-labeled 'enquiry' process.

Irrelevance of inequality

Manish Sabharwal has an excellent and rather non-intuitive argument against the overemphasis on income inequality in today's EcoTimes. Manish Sabharwal's securities market dopplegänger who I knew at SEBI is a highly persuasive thinker.

But one piece of advice for him - please do not stand for parliamentary elections :)

SRO development in the US

In a significant development in the US, FINRA the self regulatory organisation (SRO) of exchanges and brokers will "consolidate the surveillance, investigation, and enforcement of insider trading". This is an important step in the area of self regulation, while India is struggling to find a credible self regulatory organisation and giving it its imprimatur. See news item.

SEBI Board meeting - II. Integrated disclosures

The shortening of the rights issue cycle has been pending for some time and there is scope of some more improvements as well. In fact there is a dramatic scope of improvement in all public offerings. As has been criticised in DNA Money, several important things have been left out by the Board for which public comments had been sought several months back. One of which is the concept of integrated disclosures. Something with which I have been associated with and which has achieved finality in content after over 3 years of work. I had written a working paper on the subject, based on which Mr. Malegam had appointed a sub-committee on integrated disclosures (a sub-committee of the SEBI committee on disclosures of which he was Chairman) which I headed. After over 3 years of work at both the committee and the sub-committee level and also the views of independent experts, the report was finalized in draft form along with the contents of the work done and put out for public comment in late Jan 2008. To put it in brief the implementation of integrated disclosures would have the following benefits on capital raising in the country (from the report):

"Every disclosure made by a regulated entity has an effort and cost attached to it.
To the extent disclosures are detailed at the time of an issue and become
sketchy or inaccessible on a continuing basis after a company has got listed, the
paradox is clearly a matter of concern. To the extent the disclosures are
duplicative, the added cost of disclosures has no value addition and such
duplication needs to be removed. To the extent the disclosures are made but are
not fully or easily accessible by the public, there is a need to enable such
disclosures to be available in the public domain in an easily accessible manner.
To the extent disclosures are unnecessarily complex, lengthy and full of jargon,
the disclosures can become a tool of defense for an issuer and not a means of
dissemination of information, and such disclosures need to be simplified.

The pursuit of integrated disclosure refers to two objectives. First, to make
disclosures meaningful, non-duplicative and non-burdensome to the extent
possible. All disclosures must pass the test of relevance and non-duplication.
Second, to make disclosures truly available and accessible; particularly when
filings with a regulator makes a document theoretically public but the process of
access is made so cumbersome that the information fails to effectively enter the
public domain. This is aggravated when an investor must go to more than one
place to collate public information about a single company.

Reduced duplication of disclosures would reduce wastage of time by companies
which complain of being over-burdened with filling of huge amount of information,
many times repetitive and to multiple organizations. To the extent there is
unnecessary duplication, the company is distracted from its main economic
purpose into paper pushing to dozens of authorities and running the risk of
potential technical violations.

The streamlined and reduced filing would enable the regulator to use its powers
more effectively. The regulator would also be able to catch fraud and noncompliance
more easily as it would need to tap only one source to check data.
Fewer bottlenecks would also result in improved speed, reduced risk and more
agile corporates with reference to raising capital.

In other words the implementation of the report will: a) Improve the quality and frequency of disclosures by companies b) make companies more accountable to investors and indirectly improve corporate governance c) make all capital offerings 'shelf' in nature i.e. instead of a 500 page prospectus, only incremental information in say 50 pages is supplied - as the company information (as opposed to the transaction information) is already in the public domain d) make capital raising substantially faster e) make the continuous disclosures of high quality and less fragmented across various platforms like company website, Edifar, stock exchange website, RoC filings etc. This is as opposed to today's disclosure requirement which put lot of emphasis on quality of primary market disclosures but a leaner and less strict requirement on continuous disclosures f) reduce the burden on the regulator to sift through dozens of sources to investigate facts. g) introduce plain English disclosures instead of the jargon ridden disclosures of today which seem to be designed to hide information rather than disclose them.

SEBI Board meeting - I

There was unnecessary brouhaha and speculation over revision of Participatory Notes (PN) restrictions and even possible relaxations to the restrictions. This was highly unlikely, as the restrictions meant to curb inflows and the resulting inflation may have flagged, but there is no sign of waning inflation. Also, it would look fairly silly to amend the regulations just weeks after it was introduced in the regulations even though announced and implemented in October of 2007.

There has been some relaxation of QIP pricing norms viz. calculation of the floor price. This is a positive though ad hoc move. Whether there needs to be a more systematic modification of the norms needs to be debated rather than a rationalisation only for the bear market. In fact most capital raising from the market requires a bull market to be in place because it requires the price to be at the least a historical price (higher of 6month/2weeks) and has been introduced to prevent placement of stock to select people at a special price to which other shareholders are not eligible as in a rights issue. This is true of FCCB, ADRs, QIPs and preferential allotments.

SEBI splits investigation and adjudication

The Mint has posted an article on SEBI looking inwards and splitting investigation and adjudication to avoid conflict of interest. It says:
"Capital market regulator Securities and Exchange Board of India, or Sebi, has revamped its organizational structure by separating its investigation and adjudication wings, and assigning each to different members of its board. Earlier, both investigation into wrongdoing and adjudication, the legal process where an arbiter reviews evidence and arguments to make a decision, were overseen by former whole-time member G. Anantharaman. But, many market participants saw a conflict of interest in this. The arrangement also potentially weakened the regulator’s adjudication ability, leading to many directives being set aside by the Securities Appellate Tribunal, or SAT, the body that hears appeals against Sebi orders."

This is reading tea leaves.

Conflict of interest does not arise between the investigation and adjudication at the Board level. It occurs when the same officer does investigation and then adjudication - at the officer level, that never happens as the two departments are wholly segregated (and it has never happened in the past as well). I hope to publish a long post explaining the org structure and the role of investigation vs. surveillance vs. adjudication vs. enquiry vs. enforcement vs. other orders passed in a future post. The lingo used is in fact a big mess. To put it briefly, investigation is the fact finding part of the process and adjudication is (one of the) quasi judicial process.

The two were even previously under different members - of course after two members retired, everything fell under a single member viz. Dr. TC Nair. Clearly once the two new members were appointed, they were given various portfolios and this is only a routine assignment. Too much is being read into the move and calling it a revamp is clearly overkill.