The laws governing India’s securities markets and the powers of one of its most powerful regulatory agencies – the Securities and Exchange Board of India, SEBI, are up for an overhaul. Last month, the Finance Minister tabled the Securities Markets Code Bill, in Parliament, proposing to replace decades-old laws governing SEBI, securities contracts, securities markets intermediaries, stock exchanges and depositories. The Bill has been referred to a select parliamentary committee for consideration.
Most aspects of financial markets policy and governance are not sufficiently politically salient to trigger deep Parliamentary scrutiny. Parliamentarians take notice of securities markets governance when there is a scam or there are other shocks like Hindenburg Research’s allegations against the Adani Group. Even so, the SMC Bill’s significance for the country is hard to overstate. If passed as a law, it will, for the foreseeable future, determine how Indian companies raise capital, how secure investors feel when they trade, and—most importantly—how independent and accountable SEBI remains.
In short, this is no routine legislative exercise and deserves much more attention from the lawmakers, for they are ceding extensive powers and policymaking space to a formidable regulatory agency. For the next few weeks, this column will discuss–to put it in financial markets jargon—the upside and downside of the SMC Bill.
The Bill significantly improves SEBI’s processes for making regulations. However, it falters equally significantly by the unconstrained expansion of SEBI’s existing direction-making powers.
Progress on regulation-making
Regulations are much like the law. Codifying SEBI’s powers to make regulations for the securities market, the SMC Bill introduces the norms of transparency and proportionality in regulation-making. It requires SEBI to publish draft regulations, invite public comments, and respond to them. The Bill also requires SEBI to periodically review its regulations, underscoring the emphasis on keeping up with reality.
A noteworthy reform is the Bill’s recognition of the fact that SEBI often enacts regulatory measures through circulars, guidelines, and other instruments of various nomenclatures. For example, a study of SEBI’s regulatory measures from 2014 to 2016 showed that nearly 70 per cent of such measures were issued through “circulars”, none of which were tabled before Parliament, and less than 10 per cent of which underwent public consultation. The Bill, to its credit, constrains SEBI’s power to enact regulatory measures through such ad hoc instruments.
Additionally, the SMC Bill requires the SEBI Board to “review its performance and functioning, including proportionality and effectiveness of the regulation” made by it. To the sceptic, these may seem like motherhood and apple pie statements. Hardcoding such normative provisions in the law nevertheless creates scope for contesting disproportionate regulatory measures.
Extraordinary direction-making powers
On the downside, the Bill not only retains but also expands SEBI’s open-ended direction-making powers. It empowers an adjudication officer of SEBI to issue directions to any service provider, market participant, or any person associated with the securities market.
The directions may be issued in “the interest of investors”, “orderly development of securities markets”, or to “secure the proper management” of any market participant. That is, these directions may be issued not only when someone is suspected of violating the securities markets laws, not only because of an impending systemic risk to the market or the like, but on much broader grounds. The duration of these directions continues to be open-ended.
The scope of these powers is not defined, and an indicative list in the law of what such directions may look like does not inspire confidence. For example, take the power to annul and reverse trades on stock exchanges, or to suspend the clearing of contracts by clearing corporations. Contracts and trades executed on stock exchanges are sacrosanct. Trading with anonymous people on a stock exchange works because of the assurance that once a trade goes through, it will be honoured. Under the current law, only stock exchanges are allowed to annul such contracts in “exceptional circumstances” as per a rather stringent process under their bylaws. Against this backdrop, empowering a SEBI adjudicating officer to annul trades and contracts is deeply troubling—and risks shaking confidence in the very idea of exchange-traded markets.
SEBI has earlier used such powers to punish and pre-empt what it perceives as wrongdoing in the market. A study of SEBI’s enforcement actions over ten years showed that 30 per cent of its enforcement actions were taken through “directions”. The most commonly issued direction involves restricting persons from accessing the securities market. SEBI has also used these powers to ban or suspend financial products, such as derivatives on specific agricultural commodities. As many have argued earlier, the ban had zero impact on the wholesale prices of the underlying commodities, even as it killed fledgling segments of the commodities market.
There are several concerns with these open-ended direction-making powers in the SMC Bill. First, SEBI already enjoys reasonably high success rates in its enforcement proceedings. Its powers to issue interim orders and cease desist orders, pending the completion of the investigation process, are separately provided for. What then justifies the retention of such open-ended direction-making powers?
Second, through caselaw and practice, SEBI generally grants hearings before issuing such directions to a market participant. The SMC Bill, however, strangely omits codifying this practice. Third, while the SEBI Act empowers a whole-time member of the SEBI Board to issue such directions, the SMC Bill empowers any adjudicating officer to issue such directions.
The problem with SEBI’s open-ended direction-making powers is exacerbated by the SMC Bill, like the current SEBI Act, simultaneously empowering the government to issue directions to SEBI. While the Bill requires the government to issue such directions in writing, it does not obligate SEBI or the government to publish such directions. The implication is that SEBI may use its direction-making powers, open-ended as they are, to further the government’s policy preferences with respect to the Indian securities market. If we are indeed comfortable with this scenario, we need to ask more fundamental questions about whether we need an independent regulator at all for the Indian securities market.
Parliamentarians must ask why, in a law that purports to provide a modern legal framework for a modern securities market, such wide-ranging direction-making powers have been retained. To what end have these powers been expanded and are likely to be used, and what explains the dilution of the standards for issuing such open-ended directions?
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Conclusion
Reforms of the scale and kind as the SMC Bill do not, and should not, occur at a high frequency. That a consolidated securities markets code has seen the light of day after years of recommendations by committees such as the Financial Sector Legislative Refroms Commission is encouraging. And yet, as increasing swathes of the economy come under the purview of unelected regulatory agencies, questions of delegation of power can no longer remain confined to committees, courtrooms and classrooms.
How much power is delegated, how will it be used, and how can it be contested and checked, are real questions affecting the lives of thousands of capital issuers, intermediaries and investors. The Parliamentarians owe it to them to scrutinise this Bill closely—and to ask questions about every power it delegates to SEBI.
Bhargavi Zaveri-Shah is the co-founder and CEO of The Professeer. She tweets @bhargavizaveri. Views are personal.
(Edited by Ratan Priya)