The equity markets – rest in pieces

I have a piece in today's Economic Times on the sad decline of the equity markets and why it's not just the volatility which is the market's enemy. Here is the full piece:

Those mourning the demise of the equity culture in India must look beyond the volatile markets of the past several years. Though volatility had a sure part to play in the disillusionment, far greater forces have ensured the virtual exit of the Indian investor. These need to be better understood to be able to address them. We also need the ministry of finance to take the initiative where a sectoral regulator may be uninterested or powerless to pursue the greater good of the financial market.

Regulatory fiat has made it so incredibly painful to invest in equities and debt whether directly or indirectly, that it is far better to invest in your bank's fixed deposits instead, which involves filling one short form. Even at the cost of a higher tax, this is preferable, even to me.

The pain starts from the account opening of a trading account. Even though one of the first issues raised by the present SEBI's chairman was to simplify the account opening form with uniformity and with 3-4 signatures, the reality is quite different. I have on my desk a form from a large private sector bank requiring over 40 signatures for the very same process. And that is for a single holder. God forbid, you are a joint account with two or three people. The signatures would multiply by that factor. This is of course just silly. You don't need multiple signatures for a contract to be enforceable even if it is between several parties in several parts.

A most bizarre thing happened two years back when I tried to get a passport for my infant son of 3 months. The passport office wanted all documents in the passport application to be certified true by the thumb impression of the infant child. So at the expense of making a small baby who couldn't even crawl, assert the authenticity of the photocopies, we were to make the application. Indian investors don't have it much better.

The second pain is in what is known as know your client process. Which basically can include anything and everything the financial institution thinks is right. Every financial regulator thinks their investors are unique and require a special set of know your client regulations. Even a single regulator has several forms of KYC. Add to that the government's fears of money laundering and the country has the perfect answer to it all, more paperwork. I don't think any of the forms that I have filled of KYC for any financial product has any understanding of my financial situation or whether or not I am committing money laundering. I remember during the swine flu scare, unlike the Chinese authorities, which had installed sensors to check body tempratures, the Indian government decided to have paperwork instead. Every passenger flying into India had to fill a form saying whether or not they had symptoms of swine flu. Obviously, everyone said they felt ok, rather being detained at the airport and quarantined. The answer to money laundering is better surveillance not the so called KYC which we have in place today.

The third is the wholesale cheating of investors by distributors, many of them employees of banks trying to make a fast buck. Countless middle class investors have lost large sums of money because they were directed to the financial products with the juiciest commissions rather than the best returns or the most appropriate risk profile. Even these products are then churned to maximise daily commissions. Some private banks have turned the knife so brutally into their customer’s wallets that those investors or even their distant relatives and friends are unlikely to ever touch the equity or fixed income market again even if through an honest intermediary.

Finally and very importantly, insider trading laws have made it painful to trade for many upper middle class investors. Employees of multinational companies, particularly those of financial multinationals must abide by the insider trading codes of so many countries that the company virtually puts a ban on all equity trades in any part of the world. Many go to the extent of barring even mutual fund investments. While the regulator imposes strict conditions and difficult to follow regulations, the employers end up putting far more burdensome internal codes to prevent any remote possibility of insider trading. Imagine a big four accounting firm or a large law firm. An employee somewhere in the world may have advised a listed company, with not more than 2-3 other employees knowing about it. In order to prevent a charge against all 100,000 employees of insider trading, the company would rather ban all equity trades as a matter of process. Add to the list of accounting firms and law firms, millions of people employed not just in the financial world and the corporate world but even in the BPO world and virtually anyone who is capable of investing in the equity market is barred through a contract from trading in equities.

One simple answer won’t solve all the above issues. But there can be dramatic and quick movement on account opening and KYC fronts which need to be simplified and made uniform across financial regulators, with one process being sufficient for all. On the slower side of possible reforms, swift, decisive and penal enforcement action should be taken against those who defraud investors. Finally, insider trading laws need to be rationalized and made more lenient for honest investors at the same time nefarious activities should be penalized with strict enforcement action. While these will not ensure the return of the equity culture in the near future, at least an honest attempt will help reduce the present hemorrhaging.