Sebi’s failure to gauge market pulse delays development of key products

Mumbai: On 18 July, India’s capital markets regulator unveiled yet another set of proposals for real estate investment trusts (REITs).

It took the Securities and Exchange Board of India (Sebi) over eight years and multiple attempts to put the right rules in place to convince Indian companies to launch these products.

However, no company has approached Sebi for an in-principle approval yet.

Although Sebi cleared the launch of REITs in 2014, unfavourable tax structures and stringent holding norms prevented companies from starting such trusts, hence the latest tweak.

A week after that, Sebi put up another discussion paper suggesting easier regulations for start-ups—a year after the regulator proposed a start-up listing platform that would allow India’s 3,100-odd early-stage firms to raise money from the primary market.

These are only two of the many instances where the regulator has struggled to read the markets right. A laundry list of such examples would include real estate mutual funds, crowd-funding norms, a safety net for retail investors in new share sales, registering collective investment schemes, municipal bonds and deepening the corporate bond market (though this one has a lot to do with Reserve Bank of India rules, too).

To be sure, in the 28 years of its existence, the markets regulator has improved the disclosure framework and listing norms and introduced new products such as foreign currency exchange-traded futures.

Yet, the regulator’s failure at times to read the pulse of the market has led to delays in the development of some key products, market participants say.

One common complaint is that Sebi doesn’t sufficiently heed the advice of market participants.

It is wrong to believe that policy makers can envisage the architecture of a new product platform to the last detail and expect markets to adapt to the structure, said experts.

“Decades of experience around the world shows that this approach mostly does not work,” said Somasekhar Sundaresan, a Mumbai-based corporate lawyer, who also serves on the task force of the ministry of finance to create a financial sector appellate tribunal in India.

Consider the case of a mandatory safety net mechanism for investors in initial public offerings (IPOs) which a Sebi discussion paper proposed in 2012.

The regulator wanted issuers or their bankers to commit to buy shares back from investors at the offer price if the stock fell below a particular level within a certain period after listing. It was aimed at ensuring that issuers do not price their IPOs unreasonably high so that the investors are not exposed to large losses after the listing.

This proposal got stuck in the face of resistance from investment bankers, companies and brokerage firms.

“Completely untenable proposals that conflict with foundations of equity risk such as a safety net get suggested and pursued. Fortunately, this never really made it to law beyond some attempts at moral suasion and strong nudges to the merchant banker community to voluntarily adopt the measures,” said Sunderasan.

Sebi, on its part, says that it involves market participants before formulating rules.

“Sebi involves various advisory committees which have market participants as members and also follows a discussion process in policy formulation, taking feedback from various stakeholders,” a spokesperson for the regulator said in an emailed response. “Wherever inter–regulatory issues are involved, Sebi engages with other regulators. Sebi has always been open to suggestions from market participants on any issue.”

Typically, when Sebi looks at a new product, concept or regulation, it issues a consultation paper and then notifies the regulations on the same lines after receiving public feedback.

However, “on several occasions, the expert committees are later notified to evaluate the industry concerns and suggest ways to improve the deficiencies and remove impracticality in the regulation, which ideally should happen right at the conceptualization stage,” said Tejesh Chitlangi, partner at the law firm IC Legal.

Sometimes, it is just a matter of Sebi failing to gauge the market pulse.

Take the case of a start-up listing platform for institutional and high net-worth individuals. A year since it was conceptualised, it is yet to attract a single listing. The latest 29 July discussion paper proposes as many as 10 amendments.

While Sebi has eased restrictive clauses on the shareholding structure of a start-up that wants to raise money, the larger questions still remain about the ability of local investors to judge the value of early-stage companies and liquidity on this platform.

“Regulations are a good enabler of listing, but listing depends on other aspects such as creating an ecosystem for the investors and companies,” said Raja Lahiri, partner, Grant Thornton India LLP.

Another example would be real estate mutual funds (REMF) that have remained a non-starter. The regulator proposed this concept in May 2008. Sebi said it will allow an entity to launch REMF only if it has been in the real estate business for at least five years; every REMF has to invest at least 30% of its corpus directly in real estate assets, it said.

In May 2009, two real estate developers—Housing Development & Infrastructure Ltd (HDIL) and Kumar Housing Corporation Ltd—came forward and sought Sebi’s permission to float REMFs. According to the Sebi website, the applications are still being processed. Eight years have passed since the product was proposed, but not a single REMF has been launched, clearly because of a lack of appetite for the product.

Another non-starter, perhaps a regulation too far ahead of its time, have been the rules for crowdfunding. A discussion paper was put up in 2014, since Sebi thought this was similar to collective investment schemes or chit funds, but the idea has since been shelved.

“Crowdfunding is primarily based on projections and not historical data, products or services offered and not financial performance. Based on experience in other jurisdictions and the feedback from International Advisory Board of Sebi, the proposal has been kept in abeyance for the time being,” the Sebi spokesperson said in the emailed response.

Sebi was empowered to regulate collective investment schemes and act against illegal money-pooling activities in 2013.

Its cases against Subrata Roy’s Sahara Group and Kolkata-based Saradha Group are well documented. But its plan to get collective investment schemes registered, not only to track down illegal ones, but to encourage genuine ones, has not taken off. Only one firm has registered so far.

“One of the reasons that there are no takers could be that the regulation is unclear even today,” said Sumit Agrawal, ex-Sebi official and partner, Suvan Law Advisors. “There is overlapping jurisdiction of various authorities in such cases. There are multiple attachments by Enforcement Directorate, tax authorities, etc. Despite various states having State Protection of Depositors Act, investors do not get their money back and cases keep lingering on in litigation. Hence, the entire scheme needs a relook,” Agrawal added.

The government is now looking at introducing a new comprehensive bill to regulate such deposit schemes, finance minister Arun Jaitley said in this year’s budget.

Of course, Sebi has to contend with the jurisdiction of other policy makers about certain products; municipal bonds and corporate bonds are two examples.

A year has passed since the regulations were unveiled, yet the market is yet to see a single municipal bond listing. Sebi says it has been interacting with state governments about the situation.

On corporate bond sales, Sebi data shows that there were 20 public issuances in fiscal 2016 compared to 2,975 private placements.

“There are very few investors in corporate bond market and they are tightly knit with little trading mentality. With the advent of new investor categories, there will be more public issuances but the liquidity concerns would need to be addressed,” said Ajay Manglunia, head of fixed income at Edelweiss Financial Services Ltd.

“Wherever inter-regulatory issues are involved, Sebi engages with other regulators. Sebi has always been open to suggestions from market participants on any issue,” said the Sebi spokesperson. “Sebi is working very actively with RBI on the issue of development of corporate bond markets.”

There have been instances of products taking off after multiple instances of regulatory bungling such as the securities lending and borrowing; and interest rate futures.

Interest rate futures were launched twice in India: in 2003 and then in 2009. Both versions had drawbacks such as physical settlement of contracts, regulations pertaining to the bond attaining maturity in the short term and the calculation of closing price based on a zero coupon bond. In December 2013, Sebi redesigned the product and by June 2015, monthly turnover had reached Rs.62,055 crore.

“It is more of a corrective approach that Sebi follows on several products and policies, which rather should be pro-active. However, compared to a unilateral decision making of the past, at least the public consultation process has been adopted by Sebi,” Chitlangi of IC Legal said.