Bridge the governance deficit

The new Sebi chief should first straighten out things at the bourses

The appointment of Madhabi Puri Buch as chairperson of the Securities and Exchange Board of India (Sebi) heralds a new era for the regulator. Ms Buch is not only the first woman inducted to this post; she is the first individual from the private sector to helm Sebi. Several decades of experience in financial markets should help her deal with big challenges, both new and lingering.

Perhaps the most urgent task is to review and overhaul internal governance mechanisms at the financial exchanges, one of the key market infrastructure institutions (MIIs) that form the backbone of the capital markets. MIIs are systemically important institutions, such as stock/financial exchanges, clearing corporations, and depositories. Financial exchanges are the first line of defence against irregularities in the financial system and the “yogi” scandal at the National Stock Exchange (NSE) highlight gaping holes in their governance systems.

While these are supposed to be self-governing institutions, an overhaul is necessary. Lax governance is not confined to the NSE. There have also been scandals at the Multi Commodity Exchange (MCX) of India and the National Spot Exchange (NSE). These should not have occurred if the governance structure and internal oversight mechanisms there were adequate.
 

There is also the issue of competition. The NSE and the MCX control monopoly marketshare in segments of the financial markets. This is not a healthy situation. If the functionality of either of those institutions is affected, trading in a wide array of assets (commodity futures, index derivatives, forex futures) would grind to a halt.

Arguably Sebi also needs to review the illiquid secondary market in bonds and debt instruments. There would be more takers for debt, and better pricing for government treasuries if the regulator could foster more activity in secondary debt.

The NSE is among the world’s largest exchanges with assets of over $3 trillion listed. It hosts huge trading volumes across multiple segments. The co-location scam made it apparent that access to information was being kept deliberately asymmetric, and favoured traders could take advantage. The “yogi” scandal lays bare the lack of internal governance, which allowed this to happen.

The NSEL was arguably run even worse. Non-existent physical assets were “traded” in circular fashion to create what was a clandestine market for unsecured lending at exorbitant rates. Huge losses were inflicted on duped innocent investors, when defaults on fake contracts cascaded. The MCX is alleged to have invested its own funds in dubious mutual fund schemes, bypassing the controls of the internal investment committee.

Increasingly, households are committing their hard-earned savings to financial assets, such as equity, via mutual funds as well as direct investment. There is a great public interest in alternative assets such as cryptocurrencies and non-fungible tokens, and in new-age technology companies (NATC), which are launching initial public offerings (IPOs). To its credit, Sebi has proposed overhauling IPO disclosure norms in NATCs to ensure better investor understanding.

While such assets are subject to market risk, the regulator’s duty is to ensure these are listed and traded with due diligence and equitably, with market participants given better access to information. This will involve maintaining oversight on financial exchanges.

New brooms sweep clean and it could be a good time for Sebi under a new chairperson to convene a committee of experts to determine how to improve governance at exchanges. It would be a great way to ring in a new era.