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."

No comments: