Regulating investors is not Sebi's job

I  have a piece in the Economic Times on why SEBI should not 'regulate' foreign institutional investors. SEBI's  job is to protect investors and not regulate them. To the extent registering is a vestige of exchange controls and to the extent money laundering or disclosure concerns arise, clearly RBI is better placed to do both jobs. Registering and regulating an investor militates against the basic ethos of SEBI. Here are some excerpts:

The first argument is that Sebi needs to regulate large foreign investors because they have the ability to disrupt Indian capital markets with their huge cash inflows and outflows.

This can be dismissed in both theory and practice. It is not Sebi's mandate to regulate the inflows and outflows in the market. In addition, once an FII is registered, it has in fact no controls on how much money it can invest and how much it can take back the next day, which could be done by the Reserve Bank of India (RBI) under exchange control regulations.

The second argument is that FIIs could be a vehicle for money laundering. Again, both the theory and practice refute this argument. Foreign money comes into India through banking channels and the RBI imposes strict money laundering restraints on the banking system. Having a second regulator does not add useful service to this remit.

Similarly, regulating venture capital is also not ideal. But the issues relating to VCs are more nuanced. Venture capital funds are pools of money contributed by sophisticated investors which are managed by a professional manager and invested mainly in highly risky unlisted equity and hybrid securities.

Sebi has two sets of regulations - one for foreign VCs and another for domestic VCs. In both, there are extensive sets of investment restrictions which prohibit, for instance investing substantial amounts in listed equity. In return, Sebi and the income tax authorities grant it certain beneficial treatment and tax exemptions. The unstated rule is that registering as a VC is optional and if one is willing to register and take on the investment restrictions, then one is entitled to certain benefits.

In addition, Sebi's investor protection mandate also comes into play as investors in the domestic VC are majorly Indian investors who need the regulator's protection. Sebi imposes a minimum investment of Rs 5 lakh per investor in a domestic VC to ensure that only sophisticated investors enter this high-risk investment arena.

While having optional registration is a welcome move, it would be useful if Sebi could make that a formal position stating the same. In addition, in order to prevent unsophisticated investors from entering this gladiator's arena where few investee companies do well or even survive, a threshold limit of Rs 5 lakh is too low and should be increased many fold to prevent unsophisticated investors from burning their fingers. Such a regime would serve the needs of investor protection remit of a securities regulator rather than serving as a shadow foreign exchange controller.