If Narendra Modi asks why India has so few investors when the markets have hit all-time highs on his arrival, he will get many excuses. Here are the real answers
May, when a huge Modi wave and the Bharatiya Janata Party’s (BJP) return to power was evident, the Sensex surged over 1,400 points to touch a high of 25,000. Clearly, traders were in tune with the slogan: achche din aanewaale hain!
But what about investors who look for long-term wealth creation?
Media reports on 18th May provided the answer. Chairman UK Sinha of the Securities & Exchange Board of India (SEBI) sought more tax sops for retail investors and mutual fund investment and wanted the flop Rajiv Gandhi Equity Savings Scheme made more attractive.
What is a bigger signal of a failed and flawed regulator than the fact that it has to lobby for tax sops to attract investors when a powerful new bull run is in the offing? Moneylife has long argued that investors pulled out of the stock market because they found it unsafe and complex.
India’s investor population dwindled from 20 million to just 10 million (according to a SEBI-NCAER survey of 2011) in the 25 years under SEBI’s watch. This has happened, despite automation, trade guarantees, tax concessions and a sharp decline in brokerage charges, over the years. But investors went out in droves because SEBI stood by and watched their investments get decimated due to shady practices with no availability of redress.
Barring occasional blips, the primary market remains dead and mutual funds are also unable to attract retail money. The biggest indictment of SEBI’s poor regulation is that people prefer to put their money into taxable bank fixed deposits knowing fully well that inflation is gnawing away their savings. Or invest in dangerous ponzi schemes, gold and real estate.
How can the Narendra Modi government change this? First, by making financial regulators accountable to their core constituency—the investors or savers. Ironically, it may be time to remember Dr G Mohan Gopal, who is now in the news for his role in Rahul Gandhi’s disastrous 2014 election campaign. This former head of the National Judicial Academy and professor of law at Harvard used to be a member of SEBI’s board. He was humiliated for daring to indict the National Securities Depository Limited (NSDL), in what was called the multiple-application scam, during CB Bhave’s tenure as SEBI chief.
In 2011, after Dr Gopal completed an unhappy term at SEBI, he wrote an explosive letter to prime minister Manmohan Singh which, among other things, identified four ‘structural fault lines in the legal framework for securities regulation’. Dr Gopal understands law and his views had the support of the late Justice JS Varma, one of India’s most respected chief justices of the Supreme Court. More importantly, the issues he raised remain relevant even today. These were:
1) Inadequate transparency, public accountability and parliamentary oversight over SEBI.
2) ‘A serious deficit in investor voice’ with regulators extending selective patronage to ‘friendly’ investor voices and being hostile to others.
3) An ineffective framework for law enforcement. Overlapping enforcement and punitive provisions lead to select entities being harassed by multiple procedures or let off without punishment through opaque consent orders or faulty adjudication.
4) An outdated governance structure. While there was little public oversight, transparency and accountability at SEBI, there were ‘too many explicit and implicit levers of bureaucratic and political control’. The regulator, he said, was ‘run by an informal caucus’ of bureaucrats rather than domain experts.
What happened to this strong letter? Dr Manmohan Singh completely ignored it, despite Dr Gopal’s closeness to Rahul Gandhi. The finance ministry treated it with even more contempt, although P Chidambaram was a fellow lawyer and Harvard alumnus. SEBI continued with its controversial decisions.
Within a year after Dr Mohan Gopal’s letter to the PM, other problems with SEBI’s capricious supervision began to surface. Some of these are being probed by the Central Bureau of Investigation (CBI) after the Rs5,300-crore National Spot Exchange Limited (NSEL) scam. A key issue is the granting of a licence to MCX-SX to trade in equities where the role of former chairman CB Bhave and other officials is being probed.
But this investigation may ignore a bigger scandal that is being buried quietly with a merger of the Bombay Stock Exchange (BSE) and United Stock Exchange (USE). The Reserve Bank of India (RBI) and SEBI jointly regulated the currency derivatives exchange. These regulators permitted Jaypee Capital, a controversial brokerage firm, to hold a significant shareholding in USE and have a board position.
Shockingly, it was later discovered that Jaypee Capital, which created a huge trading bubble in the initial days of trading, virtually controlled the bourse. Jaypee Capital even prevailed on the USE to amend its articles of association without SEBI’s approval to say that no quorum for board meetings would be acceptable unless its nominee directors and those of the BSE and Federal Bank were present.
The USE had no hope of survival because it had no income, having waived membership fees as well as transaction charges. The BSE, which had also launched a forex derivatives segment with fanfare, had shut down its own business in just three months and acquired a 15% stake in the USE. Our queries about this outrageous business model were ignored by SEBI, BSE as well as USE.
At the same time, SEBI was at war with the now-discredited MCX-SX to bring promoter holding below 5% to be permitted to trade equities. It was also around then that SEBI directed that stock exchange boards will not have a single broker director (as opposed to 50% that was initially allowed as part of the demutualisation process). The USE, which flouted norms and predictably failed, is quietly being merged with the BSE when trading volumes have shrunk, losses mounted and the minimum net-worth criteria is likely to be breached. The merger, probably at SEBI’s behest, brings an end to a sordid chapter in market regulation. There has been no investigation and no accountability.
The lesson: So long as SEBI worked in cahoots with officials of the finance ministry, nobody questioned its capricious actions. What helped SEBI was that the members of parliament (MPs), barring rare exceptions, were ignorant and uninterested in regulation, governance or investor protection issues. Hence, nobody questioned these strange decisions.
Mr Modi’s government, which has promised a clean and rule-based administration, must ensure that these mistakes are never repeated. If Mr Modi is to succeed in recharging economic growth and investment, a safe and vibrant capital market and return of the long-term retail investor should be important to his plans. This will only happen if regulators are forced to focus on rebuilding investor confidence and ensuring strict disclosure norms and an effective grievance redress systems. What is the way forward to achieve this?
The UPA had set up the Financial Sector Legislative Reforms Commission (FSLRC) to create a super-regulator and bring about uniformity and fairness in regulation and ensure consumer protection. The report of this Commission was unceremoniously buried after intense opposition by financial regulators. Instead, the SEBI Act was extensively revised through an ordinance giving it more policing powers without a proper public discussion. The FSLRC needs to be revisited with modifications. A single regulator will ensure the following:
First, uniformity of rules and better accountability to prevent an NSEL scam or USE-type fiasco. It can also stop the pernicious mis-selling of third-party financial products by banks.
Second, end expansionist tendencies of regulators, such as SEBI, IRDA, FMC and RBI. The investor pays the price for mindless expansion because regulators recover costs by imposing innumerable registration fees, deposits and certifications costs on intermediaries. These are either passed on to consumers directly, or drive intermediaries out of business, ultimately reducing choice and competition for consumers.
Third, the regulator’s performance must be judged annually on the basis of clearly identified metrics to show increased investor confidence or market participation.
is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected]