SEBI’s Push for Governance: Are MIIs Being Over-Engineered?

I have a piece in today's Financial Express on SEBI's proposed amendment to stock exchanges and other MIIs governance with Navneeta Shankar and Purva Mandale. We argue that SEBI's micro-management is not a good idea and creates a moral hazard of 'SEBI certified' combined with a power vacuum at the top as the MD's powers are sought to be curtailed and who reports to whom is also prescribed. The full pieces is as below:

India’s capital markets regulator, SEBI, is once again in the spotlight with its latest consultation paper on the governance of Market Infrastructure Institutions (MIIs), released on June 24, 2025. While the paper aims to reinforce systemic accountability and operational transparency, it has triggered a strong resistance from within the very institutions it seeks to regulate. The proposed framework is a classic instance of regulatory overreach, one that risks undermining the foundational principles of effective governance, blurring the lines of accountability, and constraining the operational flexibility essential for market resilience and innovation. It has shadows of the erstwhile regime where senior SEBI officers sat on the board of MIIs, a practice which cannot adequately be condemned.

SEBI’s efforts to enhance governance within MII are not new. From the Kania Committee in 2002 to the Bimal Jalan and R. Gandhi Committees in 2010 and 2017 respectively, and more recently the Mahalingam Committee in 2022, there has been a steady evolution of oversight frameworks. However, a growing concern is that the regulator’s posture has shifted – from enabling strong, principle-based self-governance to imposing rigid, top-down structural mandates. A similar push last year, in the November 2024 consultation paper, proposed direct SEBI involvement in the appointment and termination of key managerial personnel (KMPs) of MIIs through an external agency-led process. That proposal was met with firm opposition and ultimately not taken up by SEBI in its subsequent board meetings.

One of the most controversial proposals in SEBI’s recent consultation paper is the mandatory appointment of two Executive Directors (EDs) to separately head Vertical 1 (critical operations) and Vertical 2 (regulatory compliance, risk, and investor grievance) of the MIIs, and further, to induct both into the Governing Board, when necessary. For MIIs, this not only blurs the fundamental distinction between management and oversight, but it also risks weakening the effectiveness of Public Interest Directors (PIDs), who are statutorily tasked with protecting market integrity and public interest. More importantly, introducing parallel power centres into an operationally complex environment could lead to confusion, overlapping authority, and weakened coordination. At the heart of this resistance is the belief that a single point of executive authority, i.e., the Managing Director (MD), is essential to ensure clarity, alignment, and accountability across the institution.

Another significant concern is SEBI’s attempt to prescribe in granular detail the roles and responsibilities of the MD, EDs, and specific KMPs like the Compliance Officer, Chief Risk Officer, Chief Technology Officer, and Chief Information Security Officer. SEBI’s proposals fail to consider that these functions are already embedded within the MIIs’ internal policy frameworks, are subject to extensive Board oversight, and regularly reviewed through SEBI’s inspection and audit processes. Codifying them at the regulatory level may inadvertently create rigidity, duplicate existing obligations, and reduce the institution’s ability to adapt. Many within the industry would argue that SEBI should focus on setting broad principles and let MIIs determine how best to implement them, through Board-approved structures suited to their specific scale and operating models. This is also in line with the Mahalingam Committee’s vision, which advocated a balance between rule-based and principle-based regulation.

On the global front, this prescriptive approach appears out of sync with the prevailing international standards. The Principles for Financial Market Infrastructures (PFMI), issued by the Committee on Payment and Market Infrastructures and the Technical Committee of the International Organization of Securities Commissions (IOSCO), stress the importance of clear and transparent governance structures. Importantly, they stop short of prescribing internal hierarchies. The PFMI framework leaves room for jurisdictions to shape governance in ways that reflect local conditions, so long as the end goals of safety, efficiency, and market stability are met. In most mature jurisdictions, MIIs are regulated through outcome-based principles and not organizational templates. By contrast, SEBI’s proposals risk binding all MIIs into a one-size-fits-all framework, regardless of whether the underlying risk justifies such intervention.

Another key proposal in the consultation paper is the treatment of external directorships held by senior MII leadership. In a welcome shift from its earlier restrictive stance, SEBI now proposes to allow MDs to hold directorships in government companies and not-for-profit entities, subject to prior approval and appropriate disclosures. This marks a more balanced and pragmatic approach. While restrictions on commercial board memberships are justified to avoid conflicts of interest, a complete ban would have been unnecessarily limiting. Senior executives often contribute to such bodies in non-remunerative capacities, and their involvement can support sector-wide coordination, knowledge-sharing, and policy alignment. SEBI’s revised position acknowledges the value of such engagements, and ensures that MIIs can continue to benefit from experienced leadership without disconnecting them from the broader market ecosystem.

What is perhaps most concerning to many MIIs is that the proposed reforms could unintentionally erode the authority of the Governing Board itself. By prescribing who must occupy key management positions, who reports to whom, and who must sit on the Board, the proposals effectively constrain the Board’s ability to shape the organization’s executive structure – a power that is fundamental to good corporate governance. There is little evidence to suggest that the absence of designated executive positions has led to any governance failures within MIIs. The objective that SEBI seeks to achieve from the appointment of EDs, particularly ensuring highest priority to public interest, technology and operations, and risk and compliance, over commercial considerations, are already being discharged under the supervision of KMPs, PIDs and the Board of the MIIs. This raises questions about whether the creation of additional executive roles is necessary or justified under the existing, functioning framework.

The issue at hand is not whether MII governance can be improved – it can and should evolve with time. However, governance reform must be based on proportionality, trust, and evidence rather than an assumption that regulatory micro-management is the only way to safeguard the public interest. By preserving the MD’s executive leadership, ensuring robust Board oversight, and allowing MIIs the freedom to design their internal frameworks, SEBI can achieve its goals without sacrificing the flexibility and responsiveness that are essential in a fast-moving market environment. 

Ultimately, the regulator’s challenge lies in finding the right balance, i.e., strengthening accountability while letting the MDs run the show, the Boards to effectively govern and the MIIs to breathe without stifling their autonomy. In fact, SEBI needs to travel in the other direction, relaxing the limits to compensation (currently at 0 beyond sitting fees) for independent directors and removal of such nomenclature as ‘public interest’  directors, as if the other directors are compromised acting in self interest. 

Regulating AI in the Securities Market

 I have a piece with Parker Karia and Varun Matlani on regulation on AI in securities markets in today's Financial Express today:

In one of the first measures undertaken by a regulator in India towards regulating the use of AI, last month, SEBI issued a consultation paper, seeking feedback on its proposals to regulate the use of AI / ML in the securities market. 

Broadly speaking, and as defined in the consultation paper, AI refers to technologies that allow machines to “mimic human decisions to solve problems”. ML is a sub-set of AI, and refers to the automatic learning of rules to perform a task by analysing relevant data. 

Currently, SEBI requires market infrastructure intermediaries such as stock exchanges, clearing corporations, depositories, etc., and intermediaries such as mutual funds, to report to SEBI on AI / ML systems employed by them, thereby giving SEBI an insight into its use-cases. 

Use cases of AI 

SEBI has identified that AI / ML is being used for various purposes. For instance, stock exchanges are leveraging AI for sophisticated surveillance and pattern recognition, and brokers are deploying it for product recommendations and algorithmic order execution. Further, AI is also used for customer support. 

Based on who is creating an AI / ML system, they can be classified into two categories viz. systems that are built in-house, or sourced from a third party. In this context, it is also important to remember that AI / ML systems can be integrated with each other, as well as with present systems. Further, the capabilities of AIs are expanding rapidly, with AIs making near-accurate predictions in finance and generating model portfolios that could, in not too long from now, give a fund manager a run for his money.

Proposed regulatory framework

In a forward-looking approach, SEBI’s consultation paper proposes guidelines to be framed with five core principles, which are a model governance framework, investor protection, testing mechanisms, fairness and bias, data and cyber security.  

Importantly, SEBI has proposed that the services provided by third parties would be deemed to be provided by the concerned intermediary, and thus, be liable for any violation of securities laws. Further, SEBI has extended the applicability of investor grievance mechanism in respect of AI / ML systems as well. 

Regulatory Lite Framework 

SEBI has proposed a ‘regulatory lite framework’ seeking to segregate between AI / ML systems that have an impact on the clients, and those which are used for internal business operations. Further, even if the AI ML system is outsourced, intermediaries will be liable. The real challenge for intermediaries lies in building the sophisticated internal teams, the robust audit trails, and the technical capacity to manage AI / ML systems. In this context, it is worth considering if SEBI should revisit this approach, and borrow a leaf out of its own playbook. 

Earlier this year, in February, SEBI introduced a revised framework for safer participation of retail investors in algo trading. In view of the fact that there were several entities providing various algo strategies to customers, and the consequent risk, SEBI decided to introduce a new class of regulated entities, viz. Algo Providers. While they aren’t directly regulated by SEBI, Algo Providers would have to become agents of stock brokers and be registered and empanelled with the stock exchange(s). 

A similar approach can be evaluated in respect of AI / ML systems, and a new class of persons, i.e., ‘AI Providers’ can be introduced. While it is not necessary that SEBI directly regulates such persons, it could result in better oversight and understanding of the evolving nature of the AI industry and its nexus and impact on the securities market. Further, liability can be affixed onto the person or entity actually responsible if a AI / ML system goes wrong, specially if the intermediary had no role in the violation. The alternative, results in a cascading round of litigation, as the investor would sue the intermediary, which in turn would seek to recover losses from the third party vendor (AI Provider). While the investor grievance mechanism is proposed to be extended to AI / ML systems, introducing a new class of semi-regulated players in the securities market could have a better impact on fostering growth in a transparent and accountable manner, with appropriate oversight. 

Leveraging the Regulatory Sandbox

SEBI’s proposal includes testing requirements at the time of commencement as well as on an ongoing basis, to ensure that the AI / ML systems are working in the expected manner. In this regard, a key reform which could further propel the growth of AI / ML systems is to allow players to access the regulatory sandbox framework to test their products and systems. This would result in a heightened scrutiny of key AI / ML systems, and allow SEBI to work with emerging players in the AI industry. This would also provide SEBI with key data points, thereby aiding in evolving best practices across the board. This kind of a framework would help SEBI become a proactive regulator as opposed to reacting to technological developments, and would be the first step in transforming SEBI into a regulator whose regulatory frameworks lay down the foundation for further innovation and advancement. This method will allow the regulator to be an enabler rather than impose roadblocks to new technology.

Risks of AI in the Securities Market

The paper highlights potential dangers of AI. The regulator explicitly flags the threat of generative AI being used for market manipulation through deepfakes and misinformation, the systemic concentration risk if the industry leans too heavily on a few dominant AI Providers. The identification of concentration risk is particularly salient, as there exists a danger of unregulated technology providers becoming systemic chokepoints for the industry. Further, since there are only a handful of foundational models, the risk emerges of synthetic data loops, wherein everyone uses the same AI model, trained on the same data, which may cause risk of collusive behaviour and herding.

There is much to applaud SEBI’s proposal of a principle based regulatory-lite framework, that reflects the regulator’s intention to adapt to innovation in technology that would shape the financial markets in the future. At the same time, there are steps it can take to not only regulate, but design a  regulatory framework that is ahead of the curve and supports growth and innovation.

Finsec Law Advisors completes 15 years

 Thank you everyone for your wishes and goodwill over the past 15 years.

From Boiler Rooms to Broadcasting: SEBI Needs a Stronger Hold on Finfluencers

I have a piece with Aniket Singh Charan and Yash Vardhan in today's Financial Express on SEBI's Hobson's choice on dealing with new age manipulation, the likes of pump and dump schemes. The difference from older similar schemes is the scale -as it is now far easier and cheaper to reach millions of investors, who are often ready to be duped with free money schemes or easy 'tips'. The problem is as much as investors to be aware as is SEBI's to enforce. The full piece is as below:

The weapons of financial deception may have evolved, but the script remains drearily familiar: misinformation, manipulation, and a trail of burned retail investors. The Securities and Exchange Board of India recently passed an order in the pump-and-dump case involving Sadhna Broadcast Limited (SBL), shedding light on how digital platforms are now central to such schemes. Today's con artists have swapped cold calls and call centres for content creators and clickbait thumbnails with the result their reach has grown exponentially.

A pump-and-dump scheme involves artificially inflating the price of a stock using false or misleading information, only for manipulators to sell off their holdings at the peak, leaving retail investors with steep losses. In the SBL affair, SEBI uncovered an orchestrated campaign of circular trading and deceptive YouTube videos, with a scripted price action. 

It began with promoters and related entities engaging in circular trading—essentially tossing the stock back and forth among themselves to create the illusion of market activity. With SBL’s shares suffering from low liquidity, even small volumes could cause large price movements. Enter stage left: the “finfluencers.” YouTube videos, peddled by certain notices, promoted SBL as the next multi-bagger, dressed up in the language of financial literacy but dripping with hype and half-truths.

Retail investors, seduced by visions of quick returns and slick presentations, poured in. The exit liquidity provided by their enthusiasm allowed the manipulators to “dump” their shares with perfect timing—a wolf in sheep’s clothing disguised as a financial guru.

SEBI’s order in the SBL case connected the dots between price manipulation, paid digital promotions, and the orchestrated dump of shares. The regulator ordered disgorgement, imposed monetary penalties, and barred several individuals and entities from the market. These measures send a strong message that such conduct will not go unpunished. However, such regulatory actions are remedial and retrospective by their nature. 

Not long ago, these schemes lived in the shadows of boiler rooms and SMS spam campaigns. Their reach was limited by manpower and mobile networks. Today’s digital ecosystem, however, lets financial misinformation scale with frightening ease. Finfluencers—part educator, part entertainer, and occasionally part illusionist—now command audiences in the millions, often with little more than a Wi-Fi signal and an alarming degree of confidence.

It is therefore pertinent to note that in an age where pump-and-dump schemes are amplified by finfluencers and social media campaigns, ex-post facto enforcement is necessary but not sufficient. SEBI’s task is undoubtedly difficult. The primary challenge in regulating such platforms and content lies in distinguishing financial literacy content from investment advice. The distinction between the two often collapses when creators promise guaranteed returns or package unverified claims as credible investment ideas. Similarly, it is important to preserve free speech and distinguishing it from investment advice can be hard. Imagine if all stock specific views were considered investment advice, then an Indian Warren Buffet talking about Coke as a great investment with great potential would be considered illegal .

SEBI has attempted to regulate this space by imposing obligations primarily on registered intermediaries and regulated entities to verify their identities with online platforms before publishing investment-related advertisements – where the regulator has in fact gone too far in over-regulating. The intent here is to curb fraudulent promotions and ensure that only verified entities publish financial content. Furthermore, SEBI has issued directives restricting the nature of content that can be disseminated. For instance, a circular prohibits finfluencers from using live stock prices in their educational content, mandating instead the use of price data that is at least three months old. This is intended to prevent "educational" platforms from being subtly used to provide time-sensitive, unregistered investment advice. Regulators globally agree on preventing publication of unregulated financial content online. 

We are not unsympathetic to the challenges faced by SEBI in this task, particularly in regulating the distribution of such content through encrypted platforms like WhatsApp and Telegram. However, with respect to other non-encrypted social media platforms such as YouTube, Twitter, etc. there is a growing consensus that such platforms must assume greater responsibility for the financial content they host. This includes implementing robust and proactive mechanisms for identifying, flagging, and removing misleading or fraudulent financial promotions. In India, the Information Technology Act, 2000, provides a "safe harbour" to intermediaries (social media platforms in this case), absolving them from liability for third-party content hosted on their platforms, provided they comply with prescribed due diligence requirements. In this regard, while SEBI has undertaken consultations with such platforms, there is a need to prescribe a formal and public mechanism for faster takedown of content that is violative of extant laws, clearer definitions of harmful financial promotion, stricter verification procedures and due diligence thresholds for paid financial promotions and marketing campaigns, and formal cooperation between platforms and financial regulators. 

Ultimately, the strongest line of defence is an informed investor. Regulatory frameworks, platform accountability, and enforcement actions must be complemented by financial literacy efforts that teach skepticism as much as they teach strategy. How often does anyone walk upto you in a market place handing over 500 rupee notes? It is about almost as probable that anyone would give you free advice on the internet or other channels on how to find underpriced assets. We live in a financial ecosystem where every smartphone is a trading terminal, and every influencer a potential advisor.

But the problem is deeper than mere manipulation—it’s one of trust. Retail investors are increasingly relying on internet personalities rather than regulated advisors, not because they are foolish, but because the former speak in plain English, not financial Esperanto. The accessibility and relatability of finfluencers give them credibility, sometimes more than the institutions themselves. This is both a strength and a danger.

Moreover, the monetization model of these platforms is complicit. Algorithms that reward engagement do not pause to verify the truth. A video hyping a penny stock might receive ten times the traction of a cautious explainer on index funds. The system is tilted in favour of the loud, not the learned. In essence, we need a modern-day financial Hippocratic Oath for those dispensing advice—first, do no harm. Until then, perhaps investors would do well to remember: not every ‘expert’ with a ring light and a YouTube channel is looking out for your wealth. Sometimes, they’re just chasing theirs.

Clear Lines of Independence: Rethinking the Ownership of India’s Clearing Corporations

I have a piece in today's Financial Express with Navneeta Shankar and Pranjal Kinjawadekar on the market micro-structure of Clearing Corporations - the heavy lifter, but uncelebrated, in the exchange ecosystem which ensures securities and money move without nearly any risk. The recent proposal of SEBI to push for diversified shareholding may not be a panacea and may in fact cause problems in the future. As Socrates said: a slave with two masters is free. Here is the full piece: 

 

The long-delayed listing of the National Stock Exchange (NSE) has once again taken center stage – not due to valuation hurdles or market sentiment, but because of a deeper, structural concern. This seemingly narrow issue is, in fact, a flashpoint in a larger conversation about how India governs its market infrastructure institutions.

While stock exchanges are always under the market glare, with upticks and downticks discussed breathlessly every micro-second on electronic media, the real grunt work is done by the arcane institution called clearing corporation. These are the entities which transfer funds and securities and manage risk and collateral. They also act as guarantors to every trade, acting as a buyer to every seller and as a seller to every buyer. They work under immense pressure managing both concentrated risk and hard timelines. Though, not celebrated, they are the unseen heroes who ensure the stock markets don’t suffer even if multiple large traders default at the same time. In a way, their lack of limelight is a good sign of health for the markets.

Under the current regulatory framework, clearing corporations must be majority-owned by one or more recognized stock exchanges. This 51% minimum holding was designed to ensure close coordination between trading and post-trade infrastructure. The introduction of interoperability in 2018 between clearing corporations brought in added competition.

In November 2024, SEBI proposed a reimagination of this structure through two alternative models depending on the applicability of the Payment and Settlement Systems (PSS) Act, 2007. The PSS Act brings all payment and settlement service providers under the Reserve Bank of India’s (RBI) regulatory framework. However, clearing corporations are currently excluded from its purview—largely because they remain majority-owned by SEBI-regulated stock exchanges. If this ownership structure is diluted, the rationale for their exclusion becomes less certain, raising the question of whether such clearing corporations should then fall under RBI’s supervision.

But whether diversified ownership automatically translates into institutional independence remains an open question. Replacing a single dominant shareholder with a loose federation of financial entities does not necessarily eliminate conflicts. In fact, large financial institutions and banks owning the clearing corporation introduces new conflicts between ownership and users. Banks or their subsidiaries would have multiple roles in the clearing ecosystem including as bankers, clearing members, custodians to name three. A 100% exchange-owned clearing corporation is at the very least structurally answerable to a single, regulated entity with reputational skin in the game. Not just skin, but virtually every organ. Fragmented ownership, in contrast, may lead to diluted responsibility and strategic drift, especially in times of market stress. Socrates said that a slave with two masters is free. Thus, a clearing corporation with a dozen owners would be free as well, free of accountability and responsibility.

This brings into focus a critical question: Is the goal structural independence or effective accountability? If it is the latter—as it should be—then the solution must go beyond just rebalancing shareholding patterns. It must address the real sources of influence and control.

One such source is the boardroom. SEBI’s proposals remain vague on who would govern these newly independent clearing corporations. What would trigger oversight thresholds for influential shareholders? What safeguards would prevent cross-holdings from intermediaries with commercial interests elsewhere in the market? Without clearly defined caps on board composition, voting rights, and conflict mitigation, diversified ownership could become a shell exercise, less a check on power than a redistribution of it into a vacuum. A range of newly introduced conflict of interest would require hundreds of pages of rules on minimising such conflicts.

There is also the fundamental issue of capitalisation. Clearing corporations are not passive entities; they are capital-intensive institutions, expected to invest heavily in technology, risk management systems, and, most importantly, in their Settlement Guarantee Fund (SGF)—the second-last line of defence in case of a broker default. As of April 2025, NCL’s contribution to the SGF stood at ₹12,083 crore, the bulk of it funded by NSE and NCL from their pockets. If parent exchanges are mandated to exit and these institutions are spun off into independent, diversified entities, it is unclear who will step in to meet future capitalization needs.

SEBI assumes that clearing corporations will remain viable, profit-making entities without needing to raise investor-facing fees. But this assumption may prove overly optimistic.

International examples offer no clear blueprint. While entities like DTCC and Euroclear have diversified ownership, others like LCH and ASX Clear remain exchange-owned. Moreover, many such global clearing corporations benefit from different capital frameworks, public guarantees, or deeper institutional markets. Importing their structures without contextual calibration may do more harm than good. Most of the entities are regular profit driven entities, with several like DTCC being listed.

SEBI’s concurrent proposal to preserve a multi-entity clearing ecosystem is thus a welcome counterbalance. A diverse clearing landscape ensures competitive discipline, offers market participants more choice, and avoids over-reliance on any single institution. It also serves as a buffer during systemic events. But here again, SEBI must resist the temptation to micromanage outcomes. It should not be prescribing how many clearing corporations India needs. Instead, it should set clear rules of the road and let market forces decide how clearing evolves—whether through consolidation, specialisation, or competition.

What SEBI must continue to do, and do well, is enforce governance standards, ensure transparency, and demand robust capitalisation. Every clearing corporation, regardless of size or ownership, should meet high regulatory thresholds for risk management, operational resilience, and investor protection. That is the essence of good regulation: not directing institutional architecture, but supervising it with rigour, something SEBI has done well over the past quarter century.

Clearing corporations perform a quasi-public function and must be structurally insulated from solely commercial pressures. But ownership is not the problem, and changing it is not the cure. Real independence will come from better governance protocols, functional separation, meaningful user representation, and perhaps most importantly, a regulatory framework that evolves with the market.

Mandating that exchanges fully relinquish control may be a problem rather than a solution. A more market-driven approach, informed by commercial viability, systemic risk, and public interest, may offer a better path forward. After all, institutional resilience depends not just on who owns the system, but on who is accountable when it is tested. Ideally, neither a minimum nor a maximum ownership should be prescribed and it should be left to the market to decide which model to adopt. Clearing corporations should of course be very intrusively regulated and supervised and be run more as a utility. Finally, it would be a bit unwieldy for one regulator to supervise the clearing corporation which is otherwise regulated and understood by another. Recall what Socrates said.

Brokers get a side hustle

I have a piece in yesterday's Financial Express with Navneeta Shankar and Manas Dhagat on the important reform brought by the Finance Ministry - which increases the regulatory perimeter allowed to brokers, who can now do more allied businesses (without jeopardising client interest). 

India’s broking industry has long operated under a framework that restricted its ability to diversify or expand, despite evolving client expectations and the changing nature of financial services. New-age investors increasingly prefer platforms that offer a full range of financial services, beyond just stock trading. For decades, Rules 8(1)(f) and 8(3)(f) of the Securities Contracts (Regulation) Rules, 1957 (SCRR), imposed a blanket prohibition on brokers from engaging in any business outside securities or commodity derivatives. This regulatory architecture, rooted in a different era of market activity, came under increasing stress as new-age brokers evolved into multi-service platforms, competing not only with peers but also with fintechs, NBFCs, and wealth managers.

In a significant move poised to recalibrate the regulatory perimeter for brokers, the Department of Economic Affairs (DEA) has now issued a gazetted notification dated 19 May 2025, amending Rules 8(1)(f) and 8(3)(f). The amendment clarifies that investments made by brokers from their own surplus funds will no longer be deemed as engaging in “business” – provided they do not involve client assets or create financial liability for the broker. This change addresses longstanding ambiguity that had clouded investment activity, particularly in group entities and other adjacent sectors. 

Rules 8(1)(f) and 8(3)(f) of the SCRR have long stifled brokers, restricting them from engaging, either as principal or employee, in “any business” other than that of securities or commodity derivatives, except as a broker or agent not involving personal financial liability. The intent was to ensure that a broker, whether applying for admission to a stock exchange or already registered, did not expose itself to unrelated business risks that could compromise client interests or undermine market stability. The purpose was straightforward: to ring-fence client assets and ensure that a broker’s other activities do not undermine its core responsibilities in the capital markets.

But over the years, these rules began to suffer from excessive literalism, and the lack of clarity over what would “any business” entail and left the phrase vulnerable to increasingly restrictive interpretations for brokers. A series of circulars issued by the National Stock Exchange, probably with SEBI’s directions, in 2022 — to clarify the scope of permissible activity — went on to prohibit brokers from investing even in group companies engaged in non-securities businesses. These included passive, capital-only investments made from retained earnings, and not involving client funds. The circulars expanded the scope of “any business” so broadly that virtually any strategic capital allocation outside traditional broking could be construed as a violation.

The result was not only interpretive overreach but also regulatory uncertainty. The distinction between business operations and capital deployment began to blur, making it difficult for brokers to determine what was permissible and what was not. This interpretation found its way into enforcement actions and market-wide compliance pressure, pushing brokers into a position where even commercially sound decisions became regulatory risks. 

In one such high-profile case, Kotak Securities challenged NSE’s circular before the Bombay High Court, arguing that the stock exchange had no legislative mandate to effectively rewrite the contours of Rule 8 or, consequently, to direct Kotak to submit a restructuring plan over its legacy investments. Interesting, the Ministry of Finance through its department of economic affairs, in its affidavit before the court, endorsed this view, emphasizing that interpretative or substantive changes to the SCRR could only be made by the Central Government itself. Importantly, the DEA in its affidavit drew a critical distinction between doing business and making investments, noting that the former entails recurring engagement and financial liability, whereas the latter, when ring-fenced and responsibly managed, did not pose systemic risks. 

Recognising the operational challenges created by the earlier regime, the DEA issued a consultation paper in early 2025 to revisit the rule. It acknowledged that the broking ecosystem had moved beyond traditional models and now demanded flexibility to manage surplus funds, expand services, and grow responsibly. Importantly, the paper argued that blanket prohibitions on investment were excessive, particularly when brokers were already segregating client assets under SEBI’s framework. This ultimately paved the way for public feedback, evaluating whether the long-standing interpretation of Rules 8(1)(f) and 8(3)(f) had outlived their regulatory utility, eventually culminating into the new amendment.

The amendment that follows, strikes a careful balance. It does not dismantle the guardrails around client asset protection, nor does it open the gates to indiscriminate diversification. It simply affirms that investments made by a trading member shall not be construed as engaging in “business,” except where such investments involve client funds, client securities, or arrangements that create financial liability on the broker. This is not a blanket exemption. The carve-out is narrowly tailored, preserving the regulatory objective of protecting client assets and maintaining systemic integrity. What it does change, however, is the treatment of surplus fund deployment. Brokers may now invest in group companies or other businesses, provided such investments are made using proprietary funds, do not lead to contingent liabilities, and are routed through appropriate corporate structures.

For the broking industry, this reform brings both relief and opportunity. Diversification into non-securities businesses can provide brokers with additional sources of revenue, thereby reducing their dependency on market-linked income. Restricting them to narrowly defined securities-related activities not only stifles innovation but also distorts competition, especially against unregulated or differently regulated players such as fintech platforms, NBFCs, or wealth managers. The ability to invest in adjacent verticals offers brokers a path to diversify revenue streams and reduce reliance on transaction-linked income. For instance, a group entity may provide tax planning, estate advisory, or loan distribution services, which complement core broking activities but fall outside the regulatory definition of securities business. This, in turn, enhances financial resilience, particularly in cyclical markets where trading volumes may fluctuate sharply.

For too long, the interpretation of Rule 8 was guided by maximum compliance rather than risk-based assessment. This change marks a shift towards regulatory proportionality – where conduct is assessed based on its effect on market integrity and investor protection. For a sector that plays an increasingly important role in capital intermediation, especially among retail investors, this course correction was overdue. It reinforces the principle that regulation must keep pace with innovation, not to encourage risk, but to avoid rigidity. The government’s move to realign regulatory intent with market realities is an example of responsive governance that listens to market feedback. It not only restores balance but also sets a precedent for financial regulators for evidence-based policymaking, one that preserves the fine balance between prudence and progress.

Meeting the Finance Minister Smt Nirmala Sitharaman

It was an honour to speak to Hon’ble Smt Nirmala Sitharaman on the future of and regulation of financial markets. She was generous with her time, thoughtful and made several keen observations. I presented a copy of my book on Fraud, Manipulation and Insider Trading in the Indian Securities Market.