The Telegraph
Since 1st March, 1999
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- Sebi needs direction from the top

There is much jubilation that 2006 saw Rs 80,000 crore worth of debt being raised in the market. The question needs to be asked, however, whose debt it was; three-quarters of it was raised by government banks. It may be that the banks were borrowing in the debt market and lending to clients. However, although the Reserve Bank raised the cash reserve ratio in November, by and large, banks were not short of liquidity. The reason why they raised so much money in the debt market was that the rise in their lending had brought them close to breaching the Basel norms of minimum capital. Being owned by the government, they are not allowed to raise equity; so they raised long-term debt. This is a subterfuge; if the government is intent on keeping banks in its ownership, it should buy their equity when they need core capital.

Net of the debt floated by banks, the debt market raised Rs 20,000 crore for corporates. This was about the same as the total of equity issues. Even at a time when Indian industrial growth touched new peaks and software exports were booming, companies did not raise much share capital in the market.

It may be thought that they were flush with money and did not need to raise much money. But they were all swarming to the private equity market. The figures are a bit hazy; they range from $5 billion to $7.5 billion, or Rs 22,000-33,000 crore. The private equity market has been more important as a source of capital than the domestic stock market.

These figures should interest the Prime Minister, who talked last year of bringing full convertibility on capital account and of making Bombay an international capital market. This is the market from which Indian companies themselves have been shying away; they have resorted to foreign markets whenever they were allowed. If Indian companies find the domestic market unattractive, it is hardly realistic to expect that foreign companies will flock to India.

Since computers run markets these days, Bombayís systems are as good as anywhere else; this is reflected in the fine margins. The cause of its unattractiveness must be sought in the quality of regulation. When Sebi was set up almost two decades ago, it was with the idea of replacing the ponderous, heavy-handed regulation of the finance ministry by a more lithe, lean body. It has, however, turned out to be much of the same if not worse. If joint secretaries once ruled the roost, it is now retired and transferred functionaries of the governmentís sundry arms such as customs and excise. Caution is their second nature, and rule-making their passion. They bring religious zeal to petty punishment, as the rash of fines related to retail investor applications illustrates.

An index of Sebiís quality would be the proportion of its rulings that is overturned by the Securities Appellate Tribunal or higher courts. The SAT, especially, has been harsh on Sebiís rulings. But reversed rulings would themselves give too favourable a view of Sebiís quality. For many small brokers and financiers whom Sebi punishes do not take the trouble of appealing; and even bigger operators would think twice before antagonizing Sebi. Add to it the fact that appeals take years to come to verdict. It is thus clear that decided appeals cannot give a fair picture of Sebiís quality. And because the appeals mechanism is so slow and corrects such a small proportion of Sebiís zealous interventions, it does not really repair the damage Sebi does. And reversals of its decisions do not teach Sebi anything; it goes on blundering and damaging the capital market in its own inimitable way.

At least some people in the government are aware of the poor quality of Sebi; they had hoped to set things right by making M. Damodaran, a manager of exceptional quality, in charge. Till now, Damodaran has been quite ineffective in Sebi. He is not unaware of the problem. He thinks it is due to the quality of the staff. He has been urging bright IIM graduates to join Sebi. But given its performance, given its surfeit of customs and excise officers, which young man in his senses would want to join it' And if he did, what impact would he have' Sebi needs direction from the top. Damodaran must do a few things on his own if he wants to rescue Sebi.

First, he must abandon all controls on IPO pricing. The way to do this is to give up rationing public issues, and to replace the present elaborate rules by an auction designed to get the maximum issue price for the company. It would be a serial action in which subscribers progressively modify their bids until demand matches supply. There would be no attempt to favour small investors; but small investors should have the same right to bid and the same chance of getting an allotment as large ones. With modern computer power, there is no bar to such an auction.

Second, he must minimize defaults. To this end, every investor must deal through a bank; and where an assurance of payment is required ó for instance, with share applications or with a buy order ó the bank must invariably and automatically give it. A shareholder must be equated to a bank account.

Third, he must abolish the requirement of MIN. Every investor should have a bank account; the Reserve Bank insists that the bank know its client, and a bank account number is an adequate verification of the investorís identity.

Fourth, he must make companies fund the depositories, and free investors from all depository charges. Before dematerialization, it was possible to hold shares without having to pay anything to anyone; dematerialization should make no difference. Every depository account should have a matching bank account.

Fifth, he must make companies trace all their shareholders and ensure that every share is dematerialized and credited to a depository account. Dematerialization has resulted in a shrinking of the personal investor base, and has effectively disenfranchised all the shareholders who failed to dematerialize their shares. They must be brought back into the investor base.

Finally, he must derecognize Qualified Institutional Investors. There must be no class system amongst shareholders; and there must be no requirement that new issuers issue any proportion of their shares to such special shareholders. Any company should be allowed to issue shares as long as it follows the prescribed auction process. This will open the market to new and small companies, and bring to the market rich people who are prepared to take the risk that such companies involve. The function of the stock market as the source of risk capital must be restored. Sebi should not interfere in the entry of either companies or investors into the market, except to ensure that companies give out adequate and accurate information.

If Damodaran achieves these six things before he steps down, he will be remembered as a hero. He will be remembered much longer than his political masters. He will then be in the same league as film stars and cricketers. But if he dilly-dallies, the Indian capital market will move abroad, and Sebi will be left regulating an empty shell.

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