The new chairman of the Securities and Exchange Board of India (Sebi) must clarify the road map for the next phase of market regulation. A review of the regulator’s recent actions suggests some inconsistency in its thinking.
Sebi recently released a discussion paper on the equity derivatives market in India. This well researched paper made three main conclusions: the Indian equity market is a den of speculators; the use of derivatives by retail investors is hugely disproportionate to its use by financial institutions; and derivatives trading, though up 30 times since 2005, has not helped increase market efficiency in terms of 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 Hong Kong, Singapore and Europe in 2016.
That a systemic risk exists is undeniable and Sebi, as a market regulator, must take measures to prevent an impending implosion. Preventing the small investor from hurting himself should be the overarching policy objective of Sebi.
On Monday, Sebi made an announcement that led to the 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 such as JK Infra and Pincon. While operators with access to shady financing may have taken a fancy to these stocks, can a public company and its small shareholders be penalized for this ? After all, operators have positions in many stocks and this is the 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. It isn’t clear how the suspension of trading will help small shareholders. Secondly, since shell companies themselves 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 Rs600 crore over a three-year period.
There are many layers to the fallout of Sebi’s move: the withdrawal of liquidity from the leveraged trades, 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 a given); volatility in the market due to sheer uncertainty; and confusion among genuine investors, including overseas ones.
Disclosure and transparency make up the bedrock of capital markets and Sebi tasks all participants to comply. Should it not do so itself ? These outcomes most impact adversely the retail investor who account for the bulk of trading in the leveraged market.
Suspension of price discovery, withdrawal of liquidity and inducing uncertainty are among 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 therefore do well to clarify its policy objectives and present a road map. What does it want to achieve? Crack down on black money ? Prevent gambling on the markets? Reduce systemic risks created by policy measures of the government itself in earlier years? Transform Indian capital markets from a den of speculators? 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 localized, 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 Sebi finds a mechanism to take punitive measures against the actual defaulters, erring firms and colluding directors, without affecting the legitimate investors, most people will support it.
Sebi would do well to traverse its chosen path keeping this in mind without following in the footsteps of its political masters and inflicting a demonetisation-moment on the markets.
Prabal Basu Roy is a Sloan Fellow from the London Business School and a chartered accountant who manages a PE fund and advises start-ups. He has been a director and CFO in various firms.