Can SEBI clarify its roadmap to clean up the market ?

SEBI has undoubtedly been one of the pillars of India's robust financial regulatory structure along with the RBI and, being a relatively new institution, it has often reflected the characteristics of the incumbent leadership's thinking in shaping policies, its public postures and indeed the entire narrative of market regulation.

The new SEBI chairman must thus clarify the current roadmap for the next phase of market regulation. A clinical review of SEBI’s recent actions suggests some inconsistency in its thinking. It recently released a discussion paper on the equity derivatives market in India. This well researched paper made three core conclusions : the Indian equity market is a speculator's den ; the use of derivatives by retail investors is hugely disproportionate to its use by financial institutions ; and derivatives trading , though up 30x since 2005, has not helped in increasing the market efficiency in raising capital for economic growth. An interesting snippet is that retail investors in India traded stock futures more than the combined value of this riskiest instrument across exchanges in Hon Kong, Singapore and Europe in 2016.

That a systemic risk exists is undeniable and SEBI, as a market regulator, must take policy measures to prevent this before an impending implosion. After all, policy measures such as the inverted STT structure between equities and derivatives in 2005, and reducing STT on Options in 2009, by UPA’s FM, P Chidambaram was directly responsible for creating this situation. Preventing the small investor from hurting himself would be the overarching policy objective of SEBI in this case.

The second announcement made yesterday led to an abrupt suspension of trading of 331 undefined, and suspected, "shell" companies based on a two month old list released by the Ministry of Corporate Affairs. This included MNCs such as SQS BFSI and largely tracked, functioning companies like JK Infra and Pincon. Whilst operators with access to shady financing may have taken a fancy for these stocks, can a public company and its small shareholders be penalised for this ? After all operators have positions in many stocks and this is a reality of all marketplaces in the free world. Measures to curb this, if at all possible, would have been welcome but not at the cost of either the company or its small shareholders. How suspension of trading will help the small shareholder who is already invested beats all logic. Secondly, since shell companies itself have not been defined there is considerable uncertainty where such steps will now be applied. SQS for example is a dividend paying German MNC with a 53% promoter holding ! Prakash Industries paid taxes to the extent of Rs.600 cr in a 3 year period.

The impact of this move are many : the withdrawal of liquidity from leveraged trades, which as I mentioned, is the preserve of retail shareholders (the systemic market wide impact due to an immediate liquidation of positions based on margin funding of these suspended scrips is obvious) ; volatility in the market due to sheer uncertainty ; and confusion amongst genuine investors, including overseas ones, undermine overall confidence unless policy clarity is restored. After all, who will it impact next remain unknown in this vacuum.

Disclosure and transparency is the bedrock of the capital markets and SEBI tasks all participants to comply …. should it not do so itself ? These outcomes most impact adversely the retail investor which, as we saw earlier, form the bulk of trading in the leveraged market.

Suspension of price discovery, withdrawal of liquidity and inducing uncertainty are amongst the worst outcomes possible in capital markets.... the wisdom of the regulator in precipitating this, on mere suspicion and without criteria being publicly declared, is suspect.

SEBI will thus do well to clarify its policy objectives and a roadmap. What does it want to achieve ? Crackdown on black money ? Prevent  gambling on the markets ? Reduce of systemic risks created by policy measures of the Government itself in earlier years ? Transform  Indian capital markets from a speculator’s den to an efficient mechanism for capital raising ? Many of these are laudable objectives but steps taken out of ideological enthusiasm for free, clean and efficient financial markets will not help achieve these.

Unlike other agencies tasked with cracking down on money laundering vehicles where the actions are localised, SEBI would do well to consider the widespread impact its measures will have on the unsuspecting retail investor in the market as laundered money could well have found its way into any virtually listed stock ……and could hence affect just about anyone. If it finds a mechanism to take punitive measures against the actual defaulters, erring companies and colluding directors - without affecting the legitimate investors - most will support such moves to cleanse the system.

I just hope the government has learnt the socio-economic lessons of inflicting demonetisation on the ordinary people.... a lot of pandemonium and hardships on the weakest rung of the society but, as evidenced by repeated seizures of huge stashes of cash with politicians and others in the nexus, without any impact whatsoever on the hydra of corruption.

SEBI would do well to traverse its chosen path keeping this in mind without following the pattern of its political masters and inflicting a demonetization moment on the markets.

The edited version appeared in The MINT dated Aug 09, 2017 as an Op-Ed article under Opinion> Article

(PRABAL BASU ROY)

Prabal Basu Roy is a Sloan Fellow from the London Business School and a Chartered Accountant: the writer presently manages a PE fund, advises start ups and has formerly been a Director and Group CFO in various companies.He is one of LinkedIn's Top Voices ; his views are frequently published in the national media on the intersection of current affairs, leadership and strategy with matters of finance, public policy, financial markets and corporate affairs.

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