Barring an unlikely extension of his tenure, these are U.K. Sinha’s last few weeks as chairman of the Securities and Exchange Board of India (Sebi).
This is reportedly in response to the findings that the National Stock Exchange of India Ltd’s (NSE) practices with regards to co-location services were unfair. Sebi has already done a fair bit to address this.
It took an active interest in the appointment of independent directors on NSE’s board, according to Bloomberg Quint. And one version of the turn of events at NSE is that it was the presence of these new board members that led to the eventual exit of the exchange’s chief executive officer and its group operating officer.
While all of this sounds good, the elephant in the room is the lack of penal action against the exchange.
Note that two separate investigations have found that the NSE provided unfair access to some trading members. And worse still, all accounts suggest NSE attempted a cover-up, which is a far worse crime.
NSE is going ahead with an initial public offering, or IPO, against the backdrop of a crisis of confidence and credibility.
Will Sebi penalize the exchange?
From the looks of it, this seems unlikely.
But Sebi and Sinha must realize that this creates a huge moral hazard.
If the regulator doesn’t take penal action against NSE, the message to the exchanges is that you can take such risks and get away without a penalty.
In other words, the benefits from such practices will always outweigh the costs.
The best way to avoid recurrences in future is to impose high penalties in such cases.
Venkatesh Panchapagesan, adjunct professor, finance and control area, Indian Institute of Management-Bangalore, says: “As exchanges transition into listed entities, it is important for the regulator to ensure that regulatory lapses are dealt with punitively. Otherwise, the desire for profits will always trump the costs associated with regulatory oversight. Self-regulation will fail then.”
To elaborate: while in theory Indian exchanges are expected to perform various regulatory roles, in practice these can be viewed as irritants—costs that eat into profits made by other divisions.
While this is a challenge with all exchanges, the problems are pronounced for listed exchanges, where profits are in focus far more regularly. One way to deal with this is to carve out regulatory roles into a separate entity, as suggested in this column earlier.
But as we await Sebi’s readiness to move in this area, the best alternative for now is to severely penalize any lapses that come to light. That way, the exchanges won’t dream about compromising on regulatory oversight of markets, trading members and listed companies.
All of this is crucial because even a mere perception of unfairness in an exchange can lead to a loss of investor confidence and result in costs to the economy such as an increase in cost of capital. Some investors could well look at an episode such as this and decide to stay away from the Indian markets.
On the other hand, if Sebi is seen as a proactive regulator, which doesn’t take regulatory lapses lightly, it will attract new investors to Indian shores.
In short, there’s a whole lot at stake, and it’ll be a pity if the only thing that Sebi comes up in its board meeting on Saturday is to tinker with the boards of stock exchanges.
At the least, it should make its findings against NSE public.
J.R. Varma of the Indian Institute of Management-Ahmedabad says in a blog post that this is material information about the operation of one of India’s most critical financial market infrastructure institutions and must be disclosed.
Another aspect that has become amply clear is that having caps on shareholding hasn’t helped in this case. It’s true that a dominant shareholder may run riot and it makes sense to avoid a repeat of the National Spot Exchange Ltd fiasco. But it’s also true that even a company executive with no shareholding can run riot by being overly profit- or market share-focused.
In this backdrop, all that the narrow shareholding caps have done is thwart competition for entrenched exchanges. This, in turn, has led to hubris—NSE’s appointment of its group operating officer on a contractual basis being a prime example.
Even now, market participants who are unnerved by the findings at NSE have no great options to move their business. Not too long ago, they had moved business from BSE to NSE because of concerns about the former’s governance.
Sebi must realize that encouraging competition in the exchange space will entail tremendous benefits to the marketplace. Of course, this will have to go hand in hand with a robust oversight of the markets by the regulator. But this can has been kicked down the road for far too long. It is high time Sebi revisits shareholding caps for investors in stock exchanges.
If it even allows companies to own a 26% stake, global exchanges such as CME Inc. and Intercontinental Exchange may find it attractive to enter the Indian markets, and it can lead to far better competition in the stock exchange space.
Of course, to Sebi’s credit, the listing of exchanges will result in positive outcomes, including a greater scrutiny of exchange practices.
A listed NSE would have witnessed a huge slump in value because of allegations of unfair access, and may have acted as a check on the management.
Even so, Sebi has far better tools at its disposal to ensure good governance at exchanges. It must use them.