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To help it better regulate the marketplace and strengthen its surveillance system, the Securities and Exchange Board of India (Sebi) has decided to adopt a supervision model based on risk levels for various market entities, including brokers and mutual funds.
Under the new model, various market entities would be divided into four groups — very low risk, low risk, medium risk and high risk — and the surveillance and number of inspections would increase in line with the risk level.
This new regime has been put in in place in line with the recommendations of an independent global consultant and the subsequent suggestions made by a task force at Sebi, while taking into account practices followed by many foreign regulators, a senior official said.
The move would help the existing surveillance system take care of most of the smaller offences, so the investigation resources are utilised more effectively to tackle serious violations in the market place.
The new model would follow four steps — assessing the risk posed by a market entity, assigning 'risk and impact rating' to it, determining the supervisory risk rating score and then adopting a suitable supervisory approach.
The overall risk profile of an entity would be computed as a function of two components —business or activity-specific risk and the impact risk arising out of default or failure.
The supervisory approach based on risk levels is being implemented in a phased manner, the official said. He added the first step towards its implementation had been achieved, with the finalisation of a report that provided guidance to the supervisory divisions to formulate policies.
In September, Chairman U K Sinha had told PTI Sebi was working on this model while becoming the first financial-sector regulator in the country to have done a study of its own regulatory impact.
He had added that specific metrics would be put in place to determine the risk that every firm posed to the system and based on which action could be initiated.
While the existing model has been effective, it was found the approach was loosely risk-based, where no formal risk ratings were assigned to regulated intermediaries and the current resource allocation approach did not allow for an assessment of risk concentration across all regulated intermediaries.
The new approach is based upon overall risk assessment of intermediaries rather than on individual factors such as turnover, complaints, penalties, etc.
"The total number of inspections per intermediary will increase and the new approach would involve a combination of comprehensive, thematic and off-site monitoring for inclusive supervision of the intermediaries," the official said.
As supervision is an ongoing process and based on experience, the divisions could gradually scale the risk elements as well as the supervisory action, the official said.
The new model provides for a combination of onsite and offsite monitoring of the intermediaries by Sebi and its front-line regulators.
"The entities falling in high risk group will be subjected to stricter monitoring (offsite) and comprehensive inspection.
"Thematic inspections, as a supervisory tool, will be utilised for specific purposes, such as, verifying compliance with recently issued regulatory requirements, on references received from departments within Sebi and other regulatory bodies, or where a focused review of assessing compliance in a particular area of operations is needed," he added.
"The supervisory risk rating scores for all intermediaries within the same class or type will be arranged in a descending order and divided into four distinct groups -- high risk, medium risk, low risk and very low risk.
"Alternately, the grouping may also be done separately on risk rating scores and impact rating scores. Further, the entities may be divided into four groups equally or based on predetermined thresholds," as per the proposed norms.
The new guidelines would also provide the procedure for determining the supervisory risk rating score for conglomerates and group companies that carry out multiple lines of regulated businesses.
The overall risk score for them would take into account factors like significance of their businesses in capital markets and the sub-score for each type of business activity carried out by the entity.
The system would identify specific risks posed by different business of an entity, such as credit risk, market risk and operational risk. These 'risk parameters' will be accompanied by the corresponding risk mitigating measures, termed as 'control parameters', which are mainly systems or procedures put in place to minimise risk.
Similarly, the impact parameters will be identified to reflect risks associated with impact of default or failure of an intermediary on the basis of size of operations of the intermediary, number of active clients, turnover, market share, etc.
The credit risk would take into account loans to group entities or related parties, debt levels, margins-related defaults and other issues.
The risk assessment templates have been developed for various market intermediaries, such as stock brokers, depository participants, mutual funds, custodians, merchant bankers, portfolio managers, registrars and transfer agents, credit rating agencies and investment advisers.
Risk and impact ratings would be assigned to each entity on a scale of 0-4, with zero rating being for those with completed absence of any risk parameters, and a score of four would indicate "Very high risk/ Very low compliance".
