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Sebi’s paper also talks of the use of blockchain that can challenge the functioning of traditional exchanges. MINT
Sebi’s paper also talks of the use of blockchain that can challenge the functioning of traditional exchanges. MINT

Sebi bowls a googly with bold ideas on exchange ownership

Rules proposed in latest paper include the possibility of 100% ownership by one entity in an exchange

The Securities and Exchange Board of India (Sebi) has started the new decade with a bang. Early this year, the regulator issued a discussion paper, with proposals for ownership in stock exchanges that are revolutionary by Sebi’s standards. The paper envisages 100% ownership by a single entity in an exchange, to start with. This is a far cry from the thought process in the Bimal Jalan committee report issued about 10 years ago. Ownership norms proposed back then were not only stringent, but there were also other extreme measures such as a cap on returns to shareholders. It was an indirect way of saying that new exchanges weren’t welcome.

In sharp contrast, Sebi’s latest paper talks of the use of blockchain and other disruptive technologies that can challenge the functioning of traditional exchanges. The tone and tenor of the paper are quite uncharacteristic of Sebi, leading to one view that this is perhaps a case of regulatory FOMO (fear of missing out). There is so much talk of distributed ledger technology (DLT), decentralized finance (DeFi) and the like these days that regulators are feeling compelled to set up committees or issue discussion papers related to the subject, just to be seen as being in step with times.

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This suspicion is even greater for a regulator such as Sebi, given its reputation of being highly prescriptive by nature and almost anti-innovation. Indeed, about a week ago, reported that Sebi had rejected the names of three candidates proposed by National Commodity and Derivatives Exchange Ltd (NCDEX) for the post of managing director. The reason, supposedly, was that the candidates didn’t have sufficient experience in agricultural markets. The above report, if true, just goes to confirm worries that Sebi’s tight-fisted approach with exchange ownership and governance can continue to throttle innovation.

Hirander Misra, chairman and chief executive officer of London-based Global Markets Exchange Group, adds, “Financial innovation typically faces constraints in India because the market structure is such that the regulator is heavily involved in new product introduction. The scope for competing through innovation is, therefore, limited."

But if Sebi is truly willing to embrace change, the possibilities are endless. Liberal ownership norms are a good starting point; a lot more will be needed—starting with a change in Sebi’s mindset—to see greater competition and innovation in the exchange space.

“There is much scope for new exchanges, especially in products such as tokenized securities. There is a gaping hole in India as far as these new products are concerned. Liberalized ownership norms for exchanges are a step in the right direction, but should also be backed up with freedom for new exchanges to innovate with such products," says Misra.

Tokenized securities are cryptographic representations of traditional shares of a firm. The token’s presence on a blockchain gives it many more features than a stock certificate, such as inbuilt smart contract systems that can incorporate regulations within the token. Exchanges such as Swiss Stock Exchange and SGX have already formed subsidiaries or partnerships to enable the trading of digital assets, on the back of estimates that 10% of global GDP will be stored on blockchain by the year 2025.

While there is an obvious case for new exchanges that introduce new products such as tokenized securities, what about the case for competition for existing products such as equity and commodity derivatives? One view is that since liquidity begets liquidity, it will be difficult for new entrants to capture share from established exchanges. Despite its financial might, NSE has struggled to capture share from MCX in the commodity derivatives space. But that shouldn’t stop the regulator from letting others try. “More competition brings with it the benefit of innovation and better services for the market, and should be welcomed," says J.R. Varma, professor of finance, Indian Institute of Management, Ahmedabad.

Sebi has traditionally been wary about giving permissions to new exchanges, and some of the foul experiences in the market in the past decade may have further reinforced that view. Although it wasn’t regulated by Sebi, the National Spot Exchange Ltd (NSEL) fiasco, and the related ouster of the founder of Multi-Commodity Exchange is a case in point.

But the possibility of a misuse of rules can’t be the reason for clamping down on competition. “The supervision problem cannot be solved through regulation. If there is a concern about abuse of rules, that should be tackled through better supervision, rather than clamping down the market with burdensome rules," says Varma.

"If there is a concern specifically about the possibility of lax supervision of brokers, this function can be carved out of exchanges and housed in an independent organization, or can be brought under Sebi," he adds.

A former exchange official says that another reform needed is a greater say for shareholders in the running of exchanges. Current rules give disproportionate power in the hands of incumbent managements, which has, in the past, led to abuse of power.

Sebi’s paper also voices a concern that excessive concentration may lead to abuse of one’s dominant position in the business. Now that it has set the ball rolling, Sebi should ensure it takes the revolutionary thoughts in its paper forward with some elegant solutions.

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