The Securities and Exchange Board of India (Sebi) is planning to limit the equity exposure of individual investors to a proportion of their income or net worth, some news reports said earlier this month. This was soon after a Sebi-appointed committee on fair market conduct recommended a so-called affordability index to establish whether an individual can truly afford equity investments.

We’ll come to the intent of the committee in a bit, but any recommendation that furthers Sebi’s great desire to protect retail investors will expectedly get an enthusiastic response from the regulator.

So while the committee had a myriad number of other recommendations, what has mostly been discussed is Sebi’s plan to limit retail investors’ participation in the equity market.

This column has pointed out in the past that Sebi’s obsession with mothering retail investors in the equity markets has led to numerous policy missteps. These often result in unintended consequences, where savvy traders end up gaming the system

In the present case, the committee is trying to address a problem known as layering of funds, where accounts of individuals are used as fronts by those engaging in market manipulation or fraud. “In this context, it was suggested that a mechanism may be put in place to prevent use of such mule account, by requiring persons who trade to demonstrate their financial capacity to trade," the committee report states.

While the problem at hand is real, the solution offered is akin to the proverbial cutting off of the nose to spite the face. There are already laws to prevent the use of front entities by market manipulators or resorting to benami transactions.

Perhaps, policymakers have found that existing laws aren’t effective to curb these practices, spurring them to look for alternative means.

As one expert on market regulation puts it, “We want to regulate everything because we can’t enforce anything."

In other words, Sebi is considering a legislation that puts curbs on all individual investors and traders, simply because it hasn’t been able to book those who violate existing laws. The problem, then, lies largely with the regulator’s seeming inability to enforce its rules.

If it resorted to better surveillance and took harsh action in cases of market manipulation, those would serve as a far better deterrent, rather than having to resort to other extreme measures which affect all market participants. 

And if that wasn’t bizarre enough, even the method it is considering seems to have loopholes. According to news reports, brokers will be expected to check an individual’s income and net worth before allowing trades.

Of course, the nitty-gritty of the new scheme is still awaited, but by and large, the discussion seems to miss the fact that the notional value of trades has little meaning in cases where positions are hedged. 

Some market experts argue that a limit on retail investment in equities may not be such a bad thing after all, especially if the general limit exempts most participants, but at the same time curbs high levels of speculation.

The US Securities and Exchange Commission, for instance, has a somewhat similar criterion to curb participation by individuals in start-ups.

This argument may have had more credence if Sebi had offered data to show that speculation using equities had reached dangerous levels in the country. Without such data, one gets the feeling that the regulator is trying to address a market failure for which there is no evidence. 

Anecdotally, it seems that first-time investors in the equity markets are increasingly taking exposure to mutual funds in recent years. From a policy perspective, this is a welcome development; although, at the same time, it is the regulator’s responsibility to ensure that there is adequate investor education and the risks involved with equity investments are laid out clearly.

There are other tools at the regulator’s disposal as well in its attempts to protect individual investors. But the most potent one is better surveillance and enforcement. Sebi must get busy doing those two tasks efficiently; else, it will unfortunately be seen as a busybody framing needless new rules that have harmful consequences.