In an edgy market, Sebi faces its big test

Perhaps this was by design, to cover up the unnecessary faux pas regarding the Sebi chief’s appointment and reappointment by the central government. His first appointment notification in February 2017 was for five years. This was later revised to three years.

“Even when Tyagi was up for reappointment in March 2020, he had sought a full two-year term, but was only granted six months. The selection process was underway for the new chairman but nowhere close to completion,” said a regulatory official who declined to be identified. Now, Tyagi has 18 more months to lead Indian’s capital markets. In the covid-19 era, the market regulator—which has the twin responsibility of investor protection as well as market development—will play a crucial role. Needless to say, the economy needs all its gears to work smoothly, efficiently and quickly.

Tyagi has his task cut out. Thanks to the moratorium on loan repayment, and large parts of the economy stalling, India Inc is in dire need of funds. As things stand, the banking system is not managing to meet that need. Sebi needs to remedy any procedural kinks in equity fund raising and help Indian corporates think of the corporate bond market as a viable alternative.

Of course, it also needs to ensure that investors find participating in the equity and bond markets both easy and safe. It needs to keep an eagle eye on market manipulation in these edgy times.

“The extension of (Tyagi’s) tenure will ensure continuity in completing the unfinished agenda…to leave behind a rich legacy for our capital markets,” said Cyril Shroff, managing partner, Cyril Amarchand Mangaldas. Just what is the unfinished agenda before the market regulator though? What are the structural challenges that mark Sebi’s approach to regulation? And will Tyagi now be able to leave his mark on Sebi, like his predecessors did?

The tasks ahead

It goes without saying that right on top of Tyagi’s to-do list will be heightening surveillance when markets are extremely volatile, and protecting retail investors from getting burnt while investing. Shorter timelines for equity issuances and public offers is another key target for Sebi. This fund raising option has remained one of the most active parts of the economy during the pandemic.

Stressed non-banking finance companies (NBFCs) are largely raising money through right issues after the relaxation of rules. Banks and stressed companies are raising funds through qualified institutional placements (QIPs). Of course, barring Reliance Industries Limited’s ₹53,125 crore rights issue, fundraising activity has been dominated by the financial services industry. Other sectors are yet to join the rally. That said, despite the buzz, the timelines for approvals can be shortened. An initial public offer takes about 6-12 months to complete; a rights issue can be completed in 3 months’ time.

During the pandemic, Sebi adopted an out-of-the-ordinary approach to ensure the survival of corporates, mutual funds and brokers. Every regulation currently stands relaxed, particularly for fund raising. This is indeed unlike Sebi’s usual response which is largely governed by investor protection.

At this juncture, it is the debt and credit market which is in need of immediate attention. The pandemic exposed the problems in India’s credit market. There is an acute lack of liquidity and trading in the secondary market for papers rated below AA rating. In the past 5-6 years, we have seen the amount of outstanding corporate bonds in India growing from ₹15 trillion to ₹33 trillion in 2019-20, reflecting a CAGR of about 14%. But it is still only about a third the size of the banking credit system.

Sebi has mandated all primary issuances to happen through the stock exchange platform. But it is not mandatory for secondary market transactions. Sebi is moving to ensure that all secondary transactions also happen through stock exchanges for liquidity build up and transparency. Sebi made a modest beginning last month: it mandated mutual funds will undertake at least 10% of their secondary markets trade in corporate bonds through the Request for Quote (RFQ) platform of stock exchanges from 1 October. “Gradually mutual funds will do all secondary transactions through the RFQ platform,” said a senior Sebi official on condition of anonymity.

RFQ platform is an electronic platform where market participants can negotiate their deals in any of the eligible securities. “Sebi and the government are talking to other financial players such as insurance and pension companies to start subscribing to AA- and below rated investment-grade paper. In addition, to consider using the stock exchange platform for their transactions,” said the Sebi official.

Then, Tyagi has the radical idea of offering government securities (GSecs) in demat format and tapping new investors who have been crowding the equity markets. In the six months ended June, 3.9 million demat accounts were added, which now total 43.2 million. G-Secs are currently issued through auctions conducted by the Reserve Bank of India (RBI). As things stand, retail investors cannot directly bid for this instrument, but can do so through brokers. This radical idea, if implemented, will be a major reform. Tyagi will, of course, have to convince the government and the Reserve Bank of India. The other major agenda for Tyagi is to work on strengthening governance at Indian corporates and ensuring direct listing by Indian companies overseas. There’s also the highly polarising issue of ensuring that the chairman of a board has a non-executive role—this was deferred by two years. The extension ends on 13 January 2022, which is before Tyagi’s 18-month tenure ends. The chairperson would look at implementing this sea change that will impact 162 listed companies before he demits office.

Finally, Sebi last week streamlined its investor grievance redressal process to ensure that complaints do not fall between the gaps. But the regulator needs to also bring in efficiency in passing orders.

The challenges

Since its inception, Sebi’s institutional makeup has strengthened, but it still remains a top-led organisation. This is quite unlike its older peer, the RBI, where even if outside hires become governors, they implement their ideas in consonance with institutional knowledge.

Now, Tyagi has the unenviable job of reducing timelines for key reforms. On an average, the regulator, under Tyagi, has taken a minimum of eight months to push reforms, thanks to his committee-based approach. This has led to criticism that, while there have been changes brought in by the market regulator, the impact on the ground has been marginal.

To be sure, under Tyagi’s chairmanship, several regulations have gone through an overhaul—from insider trading, prevention of fraud, and listing and delisting norms to fund raising, mutual funds, portfolio management, foreign portfolio investor and governance norms.

In some cases, existing regulations have seen quick, successive tinkering. For instance, the regulations for Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) have seen five amendments in the past three-and-a-half years. Norms for credit rating agencies have gone through more than six tweaks in the past four years.

This, Tyagi has done, through more than 20 committees, working groups and task forces since March 2017. All these committees are chaired by outside experts, according to Sebi’s board agenda documents published on its website. Under the former chairman UK Sinha, who served a 6-year term, there were 11 such task forces.

But market watchers feel such excessive outsourcing does lead to a lack of ownership over key policy decisions and disproportionate tinkering of regulations. “Having a committee-based approach on rule making ensures that decisions are not taken from the ivory tower, but too much representation from the industry could lead to regulatory capture and using such forums for lobbying purposes,” said a former board member of Sebi who declined to be identified.

According to Bhargevi Zaveri, senior researcher, Finance Research Group, it is the uncertainty of tenure which leads to heads of key financial regulators adopting a risk-averse approach. “Tenure uncertainty might induce a bias towards the status quo where no decisions are taken or are entirely outsourced to task forces and committees under the expectation that the next person in office may choose to implement or abandon them,” he said.

The investigations

Indian corporations still believe that fewer disclosures are always better. Take a recent example: A Mint analysis of disclosures made by Nifty50 companies in their March quarter earnings showed that they made selective disclosures, failing to observe the intent of the regulation.

In such cases, Sebi is supposed to investigate, pass orders and impose monetary penalties. But of its 700-employee workforce, only about 200 employees are in investigations and enforcement. Clearly, Sebi doesn’t have the bandwidth to tackle each and every disclosure violation. For comparison, the US Securities and Exchange Commission (SEC) has close to 1,500 employees doing this role.

As per the latest data, a whopping 408 enquiry proceedings are pending with the Board. These are over and above the close to 1,400 probes and investigations pending with individual officers at Sebi.

In his report, Justice AR Dave wrote that a considerable amount of time is taken for the completion of a case which hampers the regulatory effectiveness of the enquiry proceedings.

As per industry observers, Sebi, on an average, takes 5-6 years to complete an investigation and pass final orders. “The efficiency of a regulator depends on faster and quicker orders; this ensures boosting investor confidence. Long-pending cases just result in continued market abuse,” said a former justice of the Supreme Court who did not wish to be named.

Sometimes, the action taken is misdirected. In 2018-19, it was observed that share pledging as a strategy to raise funds was being misused by promoters. In June 2019, Sebi tweaked the already comprehensive and all-inclusive definition of pledged shares. Instead, it should have picked up cases of blatant violations and passed strict and timely orders.

Fact is, the final orders have not yet been passed in many prominent cases: alleged corporate governance lapses at Raymond; disclosure lapses at Sun Pharma; governance lapses at Indigo; illegal gains made by brokers who had unfair access to NSE’s co-location platform; and alleged insider trading in the shares of Aptech Ltd by Rakesh Jhunjhunwala.

According to Stakeholder Empowerment Services’ Gupta, it is the system which prevents the regulator to discharge its investigative responsibility with efficiency. That said, Tyagi can be credited for passing orders in long-pending high profile cases. This included passing the final order in the fraud case by Reliance Industries Ltd after nine years; banning Price Waterhouse for its role in Satyam Computers scam after eight years; and the unfair access case at NSE after three years.

Sebi has also come out with a settlement scheme 2020 for entities which misused the stock exchange platform for tax evasion.This one-time settlement scheme could reduce the case backlog at Sebi by at least 10-15%.

If we look at the past three Sebi chairmen, they have all ushered in big reforms. Under M Damodaran, it was cracking down on the opaque syste