Big bang reforms are done; time to fix the nuts & bolts

New Sebi chief Ajay Tyagi has to build upon proposals mooted by his predecessor, say experts

When UK Sinha took charge as chairman of the Securities and Exchange Board of India (Sebi) in 2011, the market regulator had begun the process of revamping the takeover code, one of the most important securities market regulations. Six years later as Sinha passes the baton to Ajay Tyagi, there is no crying need for any regulatory overhaul. “I would like my successor to set his own priorities,” Sinha had said when asked if Sebi had identified any area that would need Tyagi’s attention on taking charge. Business Standard lists proposals that were mooted during Sinha's time and which Tyagi could act upon.

 
New framework for algorithm or high-frequency trading (HFT): Sebi on August 5, 2016, had floated a discussion paper on “strengthening of the regulatory framework for algo trading and co-location”. In the paper, Sebi had proposed checks and balances to ensure market integrity and fairness amid increased usage of algo trading and co-location services. The discussion paper had received “strong comments” from stakeholders and the regulator has not firmed up its action on the matter. Tyagi will have to act on the issue as the bulk of trades is shifting to algo, arguably putting small investors in a disadvantageous position. Some say any measure to artificially slow HFT could be disruptive for the markets. “Sebi's proposal did not demonstrate the presence of a market failure or evidence about the costs and benefits of the seven kinds of interventions. If interventions are proposed, it would be wise to bring them about in a small, controlled manner, to measure the impact, before pushing them out on a market-wide scale,” wrote Nidhi Aggarwal and Susan Thomas of the Indira Gandhi Institute of Development Research (IGIDR) in a recent Business Standard column.

 
Review of stock exchanges, depositories and clearing corporation regulation: Sebi recently proposed to review the Stock Exchange and Clearing Corporation (SECC) regulations to increase its oversight of stock exchanges and their boards. The move was in line with the Bimal Jalan Committee recommendation to review regulations governing market infrastructure institutions (MIIs) every five years. Sebi has issued a discussion paper on this. However, it has kept it open-ended, and market players will have to suggest changes. Legal experts have a view that there is scope for making relaxations in the 2012 framework. “Sebi has gone wrong with prescribing a net worth of Rs 100 crore for exchanges and Rs 300 crore for clearing corporations. The first is too high as exchanges are merely technology platforms with no risk attached,” said Sandeep Parekh, founder, Finsec Law Advisors. “Besides, a rule mandating handing over 25 per cent of profits by an exchange to a clearing corporation’s guarantee fund suffers from being an absolutist rule,” he added. Given that the systematically important nature of the SECC regulations, this is another area where Tyagi will have to tread cautiously.

 

Changes to the takeover code regulation: The Takeover Code is meant to determine when an open offer is triggered in mergers and acquisitions (M&As). To address this issue, Sebi in March 2016 floated a discussion paper titled “brightline tests” for the acquisition of “control” under its takeover regulations. In this paper, Sebi had discussed two options. The first was to prescribe a framework of protective rights, which would not amount to control. The second was to set a numerical threshold of 25 per cent and exclude other means such as special rights from open offer requirements. The discussion described the second option as one which would reduce “uncertainty” and “bring clarity”. Lalit Kumar, partner at J Sagar Associates, pointed out that the concept of control was subjective. “It is based on a subjective test of right to control the management or policy decisions of the company,” he said.

Kumar suggested the brightline test proposed by Sebi in its paper could clear this subjectivity. The test considers either a numerical threshold of acquisition of at least 25 per cent shareholding to result in control or when a person has participatory rights in the company. However, Sebi clarifies that certain prescribed reserved matters, being protective and not participatory in nature, will not result in control.
 
Reclassification of shareholders of listed companies: Shareholders in a listed company are classified under two broad categories - promoters and ordinary shareholders. Often a need arises for promoters to classify themselves as ordinary or public shareholders. There are informal guidelines that do allow such re-classification. However, Sebi had intended to formalise the process. In June 2015, it issued a discussion paper in which it laid down conditions for a re-classification of promoters as public shareholders. However, Sebi is yet to issue final regulations on the matter. “The current Sebi norms on a re-classification of promoters are a little stringent for promoters. This is particularly true in the case of professionally run companies that do not have an identified set of promoters,” said Tejesh Chitlangi, partner, IC legal.

 
Development of the commodity markets: “Stability first, development later” was the approach Sinha took for the development of the commodities market. As things have fairly smoothened out following the merger between Sebi and erstwhile commodities market regulator, Forward Markets Commission (FMC), Tyagi will have to work towards the development of the commodities markets. A better integration of commodities and securities market intermediaries, allowing newer products and investors and introducing options trading are some of the key changes that Tyagi may have to consider.
 
Infusing life in new instruments like municipal bonds, Reits, InViTs: During Sinha's regime, Sebi had introduced numerous new trading platforms and instruments. Some of these include a separate listing platform for startups, listing and trading municipality and green bonds, and fund raising through new real estate investment trusts and infrastructure investment trusts. Most of these products are yet to take off.

 
The road ahead

• Final regulation on high-frequency trades (HFT) or algo trades
• Review of stock exchanges, depositories and clearing corporation regulation
• Changes to the takeover code regulation 
• Reclassification of promoters of listed companies
• Development of the commodities market
• Infusing life in new instruments like municipal bonds, Reits, InViTs

 
Key reforms during U K Sinha tenure (2011- 2017)

• Centralised KYC for all securities market intermediaries
• Revamp of 20-year-old insider trading regulations
• New regime for foreign investors to ease entry
• Tightening of p-notes regulation
• New corporate governance code for India Inc
• Implementation of minimum public shareholding rule
• New takeover code
• Overseeing Sebi-FMC merger
• Steps to improve MF penetration
• Cut in listing timeline for IPOs, curbs to reduce listing day volatility
• Shutting down defunct regional exchanges
• Regulations for research analyst and investment advisors