India’s capital markets regulator is likely to set strict compliance norms for investors looking to purchase or trade in shares of exchanges.

This could mean that individual investors, even after declaring themselves fit and proper at the time of investment, would be scrutinized by Securities and Exchange Board of India (Sebi) and depositories, said two people familiar with the regulator’s thinking.

Both declined to be identified.

For investors with more than 2% and 5% shareholding, the rules would be stricter, the two people said.

Sebi last week said it would make it easier for exchanges to list. Following a board meeting, the regulator said that all investors would need to declare themselves “fit and proper", as per Sebi norms, every time they trade in the stock issued by an exchange.

An email sent to Sebi on Friday remained unanswered.

There are two options being considered by Sebi to ensure compliance with this rule, said one of the two people cited earlier.

“While trading in the stock issued by a stock exchange, every time a trade takes place, a compliance note will be displayed along with the trade settlement note issued by the concerned depository. The compliance note will require investor to give a declaration that he is fully aware of the amended SECC (Stock Exchanges and Clearing Corporations) norms and is a ‘fit and proper’ entity to be a shareholder of the exchange," he said, adding that in the contract note, every shareholder will also need to authorize Sebi and the competent authorities to take action if at any point of time the investor fails to meet the “fit and proper" norms.

“This will ensure that in the event of any violation, Sebi and the exchange will be able to take appropriate penal measures and liquidate the shareholder’s holding," said the person.

As a second option, Sebi may ask the listed exchanges to secure a declaration from every shareholder on a regular basis.

Exchanges can then submit a compiled report to the regulator on a quarterly basis.

To effect the changes, Sebi will modify the existing SECC regulations. Final guidelines and modifications to SECC rules will be put out following consultations with stock exchanges, which are likely to take place starting next week, said both the people cited earlier.

While the more onerous task will be to ensure that every shareholder in a listed exchange is fit and proper, Sebi will keep an even stricter watch on those who hold more than a certain percentage of shares.

The final listing guidelines will require every shareholder to take approval from Sebi on “fit and proper" criteria each time his or her holding crosses 2% in a listed exchange, said the second person cited earlier.

“The investor buying 2% or more in an exchange will need to intimate Sebi within 15 days of the acquisition and take Sebi’s permission on the same. Also, every entity buying more than 5% in an exchange can do so only if he takes prior approval of Sebi," the second person added.

The entire process on compliance with shareholding norms will be monitored through the depository mechanism.

In the final guidelines, Sebi is likely to discourage self-listing of exchanges.

“Sebi is considering to allow only cross-listing, which means the shares of a stock exchange as a corporate cannot be listed and traded on its own exchange trading platform but only on the platform of a competing stock exchange, to ensure that there is no scope for conflict of interest," said the first person.

Though the market regulator allowed exchanges that are more than three years old to float initial public offerings (IPOs) in June 2012, many clauses in the SECC regulations were ambiguous and made it unviable for the bourses to get listed.

Currently, Multi Commodity Exchange of India Ltd (MCX) is the only listed exchange.

The country’s two main stock exchanges, BSE Ltd and National Stock Exchange of India Ltd (NSE), want to sell shares to the public, primarily to provide their older stockholders an opportunity to sell their investments.

BSE had filed share sale documents with Sebi for an IPO in 2013 and is waiting for the regulator’s approval.

“BSE will try to expedite the listing process based on regulations. Listing of exchanges is expected to bring additional transparency to the working of exchanges," said a BSE spokesperson on 30 November after Sebi’s board meeting.

NSE, which is facing pressure from its investors to list, has said that it would consider listing at an appropriate time.

NSE will take up the listing process “immediately" after the market regulator clarifies regulations on exchange IPOs, said Ravi Varanasi, head of business development, NSE, told Bloomberg in an interview on 3 December.

In response to an email from Mint, a BSE spokesperson said, “BSE has applied to Sebi for in-principle approval in January 2013 under the Sebi’s SECC regulations, 2012. We are currently not privy to the options being considered for fit and proper criterion as suggested by you. We will be able to comment on the same once the detailed regulations are available from Sebi."

On the matter of self-listing, the spokesperson said, “BSE has expressed its interest to comply with Sebi regulations in this regard. BSE is therefore not insisting on self-listing. Once the approvals are granted, to comply with the regulations, BSE plans to list on another exchange in India."

NSE and MCX didn’t respond to emails.

In the case of MCX, which is already listed, Sebi may give the exchange six months to comply with the new rules.

“Sebi will direct MCX to comply with the recommendations of the SECC norms and the forthcoming listing norms for stock exchanges to ensure a level playing field among all categories of exchanges. For such compliance, Sebi is likely to give MCX a deadline of six months," said the first person cited earlier.

After the merger of Forward Markets Commission with Sebi in September, The Securities Contracts (Regulations) Act, or SCRA, was amended and all categories of exchanges, including commodity derivative exchanges such as the MCX, were brought under the purview of Sebi’s SECC norms.

MCX listed itself on stock exchanges in 2012, a time when its businesses were governed by the erstwhile Forward Contracts (Regulations) Act, or FCRA. The Act was repealed in September following Sebi-FMC merger.

Sudhir Bassi, executive director at law firm Khaitan and Co. said this may make trading in shares issued by the stock exchanges difficult. “Taking a declaration from an investor on compliance with Sebi’s fit and proper criteria every time he is trading in shares of an exchange is something that is possibly going to happen for the first time in the secondary market. This practice may make the overall trading process onerous for brokers as well as investors, which in turn will lower the chances of retail participation in the stock issued by exchanges. Also, once the stock is listed, the number of investors could be large and it will be cumbersome for Sebi also to scrutinize and verify the fit and proper status of each and every investor," he said.

“Ideally, similar to the shareholding norms laid down by the RBI (Reserver Bank of India) for banks, in case of exchanges too, Sebi should stipulate a shareholding threshold, of say 1%, beyond which the investor would need to declare himself as a fit and proper entity to be a shareholder in an exchange," Bassi added.

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