Managing market infrastructure

Institutions need better governance structure

The Securities and Exchange Board of India (Sebi) Committee on Strengthening Governance of Market Infrastructure Institutions (MII) has submitted its report and the regulator has asked for public comments on the suggestions. MIIs in this context refer to financial exchanges, depositories, and clearing corporations. The committee was formed in response to the governance lapses at the National Stock Exchange during the tenure of Chitra Ramkrishna, when Anand Subramanian was appointed group operating officer with a huge compensation in defiance of all norms. The committee was chaired by Sebi Whole Time Member G Mahalingam. The report has made 24 key recommendations. Some of these will require deep thought and a radical reorganisation of MII structures to implement.

The committee suggests the functions of MIIs be divided into three verticals such as critical operations, regulatory compliance, and risk management, and other functions including business development. The key managerial persons (KMPs) heading the functions in each vertical should be on a par in hierarchy. However, in resource allocation, the first two verticals should receive priority. The board should comprise at least two-thirds public-interest directors, or PIDs, to strengthen its independence. The roles and responsibilities of all directors should be clearly defined. All board meetings should be videotaped. Provisions should be made to give Sebi the latitude to appoint PIDs, who should submit periodic reports to the regulator.

Further, the definition of KMP should be changed to cover employees on the basis of their tasks and their responsibilities in compliance with regulatory and risk management functions. The compensation structure for KMP should be amended to provide for a minimum (25 per cent) and a maximum (50 per cent) amount as the variable component of remuneration. Due weighting should be provided to regulatory, risk management, and compliance-related aspects, for determining the variable compensation. Existing codes of conduct and ethics at MIIs should be rationalised into one clearly defined code, which outlines good governance and regulatory compliance, and due diligence as essential components. Depositories already have mandatory codes of conduct and similar codes should be made mandatory for clearing corporations and exchanges. The net worth requirements of MIIs may be enhanced, or a variable component introduced to cover higher risks, given higher volumes of trading. For similar reasons, the adequacy of the Investor Protection Fund and Settlement Guarantee Fund should be periodically reviewed and a specific percentage of profits should be transferred to the Investor Protection Fund.

Sebi’s powers should be amended to include the levy of enhanced penalties and other disciplinary action on individuals of an MII, including directors, members of statutory committees, KMPs, employees, and persons associated with MIIs. Sebi may also explore harsher options of debarring MIIs from introducing products/services, restricting their activities, and so on. Any activity in conflict with an MII’s role and done by any of the MII’s investee companies should be phased out. Many of these suggestions are sensible. The enhancement of the Investor Protection Fund and data-management policies should be quickly implemented, alongside reviews of potential conflicts of interest between MIIs and their investors. However, the reorganisation of MII functions into three verticals, redrawing compensation structures, and giving Sebi more muscle will need detailed examination at the time of implementation.