Ajay Tyagi, and the job of a Sebi overhaul
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Mumbai: For a man with a three-year mandate to oversee India’s stock and commodities markets and their intermediaries, Ajay Tyagi would have been excused for taking his time to ease into the hot-seat job.
Tyagi, 58, who became the ninth chairman of the Securities and Exchange Board of India (Sebi) on 1 March, surprised the markets when he hit the ground running.
In the three months he has spent in the corner office at Sebi Bhawan in Mumbai’s Bandra Kurla business district, the regulator has been a man in a hurry.
Under Tyagi, Sebi has moved forward on long-pending disputes, launched new products such as options contracts in commodity derivatives trading and clamped down on so-called participatory notes, or P-notes, a controversial derivatives instrument.
Less than a month after Tyagi, a 1984 recruit to the elite Indian Administrative Service (IAS), took charge, Sebi ruled on a nine-year-old dispute with energy giant Reliance Industries Ltd (RIL).
Sebi banned RIL from accessing the equity derivatives market for a year, and directed the company to part with the profits made by allegedly breaching rules on unfair trade practices when it sold a stake in its erstwhile unit Reliance Petroleum Ltd (RPL) in 2007.
RIL was asked to pay Rs447.27 crore, along with an annual interest of 12% dating back to 29 November 2007, which translates into a penalty of around Rs1,300 crore.
RIL, which has denied the allegations, is contesting the 24 March order in the Securities and Appellate Tribunal (SAT).
More action followed in April, when Sebi announced sweeping changes in norms relating to mutual funds, public issues, capital raising and commodity derivatives after its board met for the first time under Tyagi.
The regulator allowed new investment and redemption routes in mutual funds; tightened initial public offering (IPO) norms to ensure funds raised are not misused; eased existing capital-raising norms to help banks deal with rising bad loans; and announced changes in securities contracts norms for better integration of the commodity derivatives market and the securities market.
Sebi also allowed options contracts in commodity derivatives, and integrated broking activities in equity markets and commodity derivatives markets under a single entity.
Some of these moves are in sync with the finance ministry’s thinking, such as the need for stronger regulations for the highly fragmented commodities market, bringing in rules for commodity spot markets, channelizing more household savings into equities, curbing black money in the system, and checking illegal money-pooling activities through Ponzi schemes.
One example of a market instrument on which Sebi is aligned with government thinking is the 29 May proposal to ban P-Notes with equity derivatives as the underlying assets, unless it is meant to build a hedging position.
Sebi proposes to levy a $1,000 fee on foreign portfolio investors (FPIs) for each participatory note (P-Note) issuance in an effort to cut down on speculative investments.
These are moves which show the regulator’s discomfort over the potential misuse of these instruments for money-laundering and round-tripping of funds by wealthy domestic investors.
The value of such instruments stood at Rs1.68 trillion at the end of April, about 6% of total foreign investments in Indian stocks and equity derivatives.
Tyagi may have got off to a rapid-fire start, but the tasks ahead are vast in an evolving market which is grappling with technological changes and antiquated laws that haven’t kept pace with these changes, say experts.
“The key areas of focus for the Sebi chairman could be allowing introduction of alternative exchanges for different products, a complete overhaul of the insider trading norms, re-looking the capital requirement for businesses which don’t require any capital and, thus, act as entry barriers,” said Sandeep Parekh, founder of Finsec Law Advisors and a former executive director at Sebi.
Sebi should also “initiate serious enforcement action for mis-selling of financial products and simplify regulations where the costs of implementation exceed the benefits to the markets and investors”, he said.
Since Tyagi took charge, Sebi has focused its energies on clearing the backlog of cases. The dispute with RIL was just one. According to Sebi’s own annual reports, 7,000 cases are pending adjudication or final orders.
The number of cases has piled up after the regulator decided in 2012 to exclude insider trading, front running, violating open offer norms, and breaching the fraudulent and unfair trade practices from the scope of its consent mechanism—a window for settling disputes by paying a fee.
At the same time, an increasing number of orders are also being challenged at SAT and being sent back by the tribunal to Sebi for a re-look.
By 2016-17, one out of every three orders challenged at SAT were sent back to Sebi. This has raised concerns at the regulator about its ability to clear cases in a fair and time-bound manner.
It also invited the wrath of the Supreme Court on one occasion.
In January, the apex court pulled up the markets regulator for “dragging its feet” in concluding an enquiry against accounting firm PricewaterhouseCoopers in the corporate fraud at erstwhile Satyam Computer Services Ltd and directed it to dispose of the matter by July.
People working closely with Tyagi say that the chairman is focusing on strengthening Sebi’s enforcement department and rationalizing consent mechanism norms in the backdrop of the substantial backlog of cases awaiting Sebi’s directions.
Tyagi has now tasked five senior officials with speedily resolving some of the high-profile cases out of the 7,000 pending ones, two people said on condition of anonymity.
“As a priority, Sebi is first looking at resolving the cases in which external agencies such as Central Bureau of Investigation, Income Tax Department, Securities Appellate Tribunal (SAT) and Supreme Court have issued observations,” one of the two said.
Currently, Sebi has only around 35 adjudicating officers and three whole-time members who can pass orders, and the markets regulator is hiring more junior officials to beef up enforcement, these people said.
Tyagi declined to be interviewed for this story.
A related area is pending cases under collective investment schemes. In 2013, Sebi was asked to regulate the schemes; it has since banned nearly 200 illegal money-pooling schemes.
Sebi typically orders operators of illegal collective investment schemes to cease operations, repay investors in three months and file a winding-up report. Not even one of them has filed a winding-up report so far, illustrating how difficult oversight of such schemes is.
Sebi usually has no clear way of identifying the assets of these firms and recovering them. Often, promoters disappear once Sebi steps in.
Additionally, three years after the Supreme Court empowered Sebi to recover money from the Sahara Group to refund 30 million investors, the regulator is still struggling to process and refund around Rs40,000 crore (including interest).
In 2011, Sebi said two Sahara companies had collected around Rs25,000 crore through bonds illegally issued in 2008. On 31 August 2012, the Supreme Court directed Sebi to recover and refund money to investors.
According to four people, including two Sebi officials with knowledge of the refund process, Sebi has managed to refund merely Rs80 crore so far since only 13,000 investors were found to be genuine.
Sebi recently decided to relinquish its powers to regulate and act against collective investment schemes.
A formal announcement is yet to be made by the government because the move will require an amendment to the existing law by the Parliament.
A key issue pending a Sebi ruling are the allegations against the National Stock Exchange (NSE) that it provided unfair access to some brokers on its algorithmic trading platform.
With a market share of 86.22% in equity and almost 100% in equity derivatives, NSE has a virtual monopoly position among Indian stock exchanges. Resolving these allegations one way or another will not only restore confidence in the markets, but also pave the way for an IPO by NSE.
Sebi’s technical advisory committee had first submitted its report on NSE’s lapses in March 2016 and later told NSE to park its earnings from algorithmic trading in an escrow account. But a final order is still pending—the regulator will have to decide whether to penalize the exchange or whether it was just an honest lapse on the part of a few officials.
An email sent to a spokesperson of NSE did not result in a response.
“NSE is working with the regulator to resolve the issues. NSE is committed to launching its IPO by the end of year after the co-location issue is resolved,” said an exchange official on condition of anonymity.
Sebi has stepped up its probe and sent a show-cause notice to 14 NSE officials, including its former CEOs Ravi Narain and Chitra Ramkrishna. Narain, who was serving on the board as vice-chairman since 2013, has stepped down from the board following Sebi notices.
Audit firm EY is in the process of conducting a special systems audit of NSE and a report on this is expected to be prepared in the next few weeks.
A direction from Sebi is likely only after the report is submitted.
A related issue is regulations on high frequency algorithmic trading in general: Sebi is trying to create a level-playing field for small investors and large, sophisticated ones using algorithms that can potentially execute thousands of orders in less than a second in what is called high-frequency trading (HFT).
On 5 August 2016, Sebi had released a discussion paper stating that it was examining concerns on HFT and later appointed an external expert from the Indian Institute of Technology-Madras to recommend changes.
HFT is one of the technological changes that Sebi’s laws need to catch up with. HFT orders, which made up 65% of overall orders in the cash equity segment in 2011-12, rose to 94% in 2015-16, while HFT turnover as a percentage of overall turnover rose from 25% to 42%.
HFT is not the only area where evolving technologies are demanding new laws and regulations.
Take, for instance, the use of new payment mechanism such as e-wallets and the unified payments interface for buying investment products.
After a round of discussions, Sebi’s board—after the first meeting chaired by Tyagi—allowed investors to instantly redeem their liquid mutual funds up to Rs50,000 a day.
Earlier, money from redeeming a mutual fund used to get credited to a customer’s account only on the next working day or two days after the request if it was not done through the immediate payment service (IMPS), placing liquid funds at a disadvantage to bank fixed deposits.
The regulator also allowed investors to purchase fresh units using the e-wallet route, up to Rs50,000 a financial year, a move that could potentially increase inflows into India’s Rs18-trillion mutual funds (MFs) market.
“Sebi’s moves are positive for the MF industry in the long run and will attract more small-ticket investors,” said Milind Barve, CEO of HDFC Asset Management Co. Ltd, the country’s second largest asset management company with average assets worth Rs2.37 trillion.
New products and reforms are emerging not only in mutual funds but also in commodities.
This is a new area for Sebi, after the capital markets regulator’s September 2015 merger with the erstwhile commodity markets overseer, the Forward Markets Commission (FMC).
It was a shotgun marriage, orchestrated by the government in the wake of a Rs5,500-crore payments crisis at National Spot Exchange Ltd (NSEL). It is still the subject of investigations.
“The NSEL scandal has deeply dented India’s credibility overseas, there needs to be a clear cleansing of the situation as the way it has dragged on implies India is dysfunctional at resolving problems,” said Patrick L Young, a capital market expert and chief executive officer of crowdfunding platform Hanza Trade. “In addition, India needs to be open for business and current share caps on ownership of exchanges are an impediment to a thriving market structure. The Indian regulators should embrace more openness to foreign shareholders and investors.”
Since the merger with the FMC, Sebi has been attempting to organize the commodity derivatives market, reviving trade on commodity bourses and streamlining norms to avoid default risks such as the one occurred at NSEL.
After the merger, it was expected that new investors such as foreign portfolio investors, banks, mutual funds and other financial institutions would come in.
At its 11 February board meeting, Sebi, under its former chairman, U.K. Sinha, had decided to allow new participants to trade and hedge in commodity derivatives in a phased manner.
Although Sebi has tightened a few commodity norms after merger announcement, and introduced new products such as options contracts in commodities, a lot more remains to be done.
“Sebi needs to move faster to ensure that the commodity exchanges that it inherited from their erstwhile regulator quickly reach the level of sophistication of the security exchanges in terms of products, participants and systems,” says J.R. Varma, a professor at Indian Institute of Management-Ahmedabad.
Till date, the commodity derivatives market does not have enough participants as hedgers, a transparent price-discovery mechanism, liquidity and exchange-traded products.
This is one of the biggest challenges facing Sebi at the moment, which Tyagi has to deal with.
G Chandrasekhar, an independent commodity market expert, says that in the commodity derivatives space, some of the biggest challenges before Sebi include increasing trading volumes, enhancing hedgers’ participation and pricing agricultural commodities -- a politically sensitive issue.
Internally, Tyagi has the job of appeasing and bolstering the morale of Sebi employees who are up in arms over vigilance inquires by external agencies such as the Central Bureau of Investigation; they want these issues to be examined in-house first, a practice followed by Reserve Bank of India (RBI).
Around 80 Sebi officials have been questioned by external agencies in the past three years.
Sebi employees have also complained about unfair processes followed by the regulator’s top management in recruiting executive director-level employees from outside instead of promoting existing eligible employees.
Vexed by Sebi’s hiring policies, the union dragged the regulator’s top management to court in December 2016. To put the house in order, the Sebi board under Tyagi has attempted to address employees’ concerns by ensuring that internal candidates have a higher share of executive director posts.
Sebi was established in 1992 “...to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto”.
Besides overseeing stock exchanges, Sebi also supervises market intermediaries including brokers, mutual funds, FIIs, rating agencies and investment bankers and thousands of listed companies.
Tyagi, who keeps a low profile, moved to the finance ministry, where he worked in the capital markets unit, from the environment ministry in November 2014. A post-graduate in economics, he has a master’s degree in public administration from Harvard university, according to his official resume.
“As India has grown to become a large emerging market and a member of the G20, Indian regulators and even market participants have failed to upgrade their vision and aspiration. The urge to play a more important role regionally if not globally is sorely lacking. I think Sebi should take the lead here in first overcoming its own inhibitions and then encouraging Indian exchanges, mutual funds, depositories and securities firms to increase their regional and global footprint,” said Professor Varma from IIM Ahmedabad.