Letters: Competition for regulation

This refers to the article “Should a stock exchange also be a regulator?” (January 10). The issue is quite critical from a governance standpoint, but it also needs to be discussed in the pecking order of market reforms. The primary argument underlying the segregation hypothesis (segregation of regulatory functions from business functions in a stock exchange) is that in pursuit of higher profits, the exchanges may overlook their regulatory role or could become party to some fraudulent activities. Let’s probe this argument. Assume Mr X is in a business in which he has to perform some regulatory functions.

To enhance the firm’s profitability, he is engaged in some activities that are detrimental to the interests of other stakeholders. In view of such activities, the government has bifurcated the firm into two. One, as a regulatory agency under the government’s supervision and, two, as a business firm under the management of Mr X. But what stops Mr X from capturing the management of the regulatory firm? He will continue to do so as long as the incremental revenue from such lobbying or capturing activities exceeds the costs he incurs on such capturing activities.

These are precisely the allegations against many regulatory agencies in India. In the securities market, many market participants have argued vehemently that the Securities and Exchange Board of India is becoming partisan and favouring a particular exchange. Therefore, though the segregation hypothesis appears good, it has two shortcomings. One, it is susceptible to the breaking of the firewall. Two, it is time-consuming.

What is the alternative? A market-determined solution, that is “competition”. Increased level of competition would make the markets more transparency. If multiple firms offer homogeneous goods and services, the slightest deviation from the benchmark would solicit huge reaction from market participants. Competition means providing alternatives to consumers. If a firm engages in fraudulent activities or appears to be doing so, it will lose its clients quickly. It will lose its credibility and it would be quite easy to determine such behaviour in the presence of several other such firms. Therefore, entry norms in the stock exchange business should be made more investor-friendly and the spirit of private entrepreneurship must be encouraged.

K Venkatachalam, on email