 "Sebi's job to ensure capital formation: Ananth Narayan at BS BFSI Summit")
The Securities and Exchange Board of India (Sebi) has a role that extends beyond preventing market misconduct; it is also responsible for facilitating capital formation.
Ananth Narayan, a whole-time member (WTM) at Sebi, emphasised the potential for investment growth in the country through technology and innovation at the Business Standard BFSI Insight Summit in Mumbai on Monday.
During his address, he said, “The three pillars of the service mandate, as articulated in the preamble to the Sebi Act of 1992, are investor protection, market development, and market regulation. Though not explicitly stated, this mandates Sebi to promote sustained capital formation.”
Narayan presented various data points to demonstrate how the securities market ecosystem is encouraging greater financialisation of domestic savings and, consequently, enhancing capital formation.
“As of March 2020, the number of unique mutual fund (MF) investors was about 22 million. By September, this number had surpassed 40 million for the first time. Likewise, the number of unique dematerialised account holders, which stood at about 42 million in March 2020 during the early days of the pandemic, has now exceeded 90 million. Since April 2020, MF equity and equity-related schemes have witnessed inflows of around Rs 7.6 trillion, which is over 3x the foreign portfolio investor (FPI) flows into equity markets during the same period,” Narayan highlighted, underlining the vital role of domestic investors in stabilising the domestic markets.
He acknowledged that there is still a long way to go, especially when considering the 510 million Aadhaar-linked permanent account numbers. Nevertheless, to foster this growth, Narayan stressed the importance of maintaining trust in the ecosystem.
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“Trust is the single-most important ingredient in attracting and retaining investors. This necessitates the continuous development of a robust market and technology infrastructure and ensuring a rules-based regime,” Narayan said, acknowledging the regulator’s dilemma of walking the tightrope between overregulation and underregulation.
“Simultaneously, we must ensure the ease of investment to channel these growing savings into fresh capital formation. Here, we encounter a dilemma. As an ecosystem, we could make two types of errors in pursuing the twin objectives of building trust while ensuring ease of investment. When the regulatory and market structure is deemed inadequate to prevent rule and regulation circumvention, it constitutes a Type-I error,” Narayan explained.
He said that “Type-I” errors, such as technology failures or the perception of uncorrected market misconduct, can seriously jeopardise the trust of investors and other stakeholders in the ecosystem.
“However, while focusing on addressing Type-I errors with multiple checks and balances, we might end up with a heavy-handed framework of rules and regulations that obstruct legitimate business and capital formation. This could constitute a Type-II error,” said Narayan, who joined Sebi a year ago after working as a professor.
In essence, we need a win-win set of solutions to minimise both Type-I and Type-II errors, he emphasised, calling for all stakeholders to collaborate constructively to achieve this objective.
Narayan cited two recent examples to illustrate this dilemma, including the formulation of rules to regulate FPIs and alternative investment funds (AIFs).
“As a nation, we need to continue attracting investments from global funds to sustain capital formation. However, questions and doubts have arisen about the investors behind these funds,” he noted.
“Over the past decade, there have been consistent efforts to strengthen FPI disclosure requirements; nonetheless, suspicions of certain FPIs circumventing regulations persist. This constitutes a Type-I error that needed to be addressed. The blunt approach would have been to require every FPI to disclose the identity of every natural person investor without regard to any threshold and regardless of the disclosure regime of their jurisdiction. However, doing so would have increased the potential for Type-II errors, with even legitimate FPIs being tasked with onerous disclosure requirements,” he explained.
To resolve this dilemma, Sebi has taken several steps, including the formation of a committee under the leadership of a former WTM to conduct a comprehensive review of FPI regulations to enhance the ease of doing business.
Regarding the AIF industry, Narayan revealed that Sebi has encountered instances of circumventing existing regulations concerning the recognition and disclosure of stressed assets, bypassing shareholder limits, and valuing private equity assets.
“Such issues must be addressed in a manner that ensures the regulatory architecture does not stifle legitimate business. I strongly urge industry participants and associations to be forthcoming about any such practices within their community to preserve trust in the ecosystem,” he said, adding that the regulator is in the process of re-evaluating the regulatory framework for AIFs.