India At 75: The Evolution Of Securities Regulation In India
India has entered its 75th year of Independence and it's an apt time to take a look at the evolution of the financial infrastructure that has popularly been termed as the ‘backbone’ of the nation’s economy—the securities market.
To those who aren’t entirely versed with the events leading up to the metamorphosis of the securities market into the sought-after global investment destination it is today, its state in the period following India’s liberation may appear surprising and unrecognisable at best.
Ironically, at the time of India’s independence, the securities market could be described as anything but free. The existing framework adopted a segmented approach that appeared to conflict in spirit and contributed to the sluggish and limited growth of the securities market.
The primary market was subjected to extensive governmental control and intervention in terms of the timing, size and pricing of any public issue of capital. The impact of this merit-based approach often spilled over in the form of oversubscribed public issuances, which were usually offered at irrationally discounted prices in the market at the insistence of the government (except for the chosen few), entry barriers, high transaction costs and low liquidity.
The regulation of the secondary market, on the other hand, was delegated entirely to the stock exchanges without any substantial intervention from the government. While the secondary markets were unregulated, in the absence of new primary offerings, there were only a handful of securities.
Along with a handful of securities, there were just a few powerful brokers who tied up with the companies and often traded in a manner that would today be called fraudulent and full of insider trading.
Time For Reforms
Towards the closing decade of the 20th century, the regulatory perception of the securities market took an optimistic turn and set a number of crucial developments into motion. These series of reforms were chiefly motivated by the need to create an efficient securities market to ensure proper resource allocation and give way to the forces of liberalisation, which were rapidly gaining ground in the 1990s.
This ultimately led to the establishment of the current statutory regulator, the Securities and Exchange Board of India in 1992 (though formed in 1988 as an administrative body), to protect the interests of the investors and regulate the securities market, as opposed to controlling it—a function that was earlier performed by the Controller of Capital Issues to the detriment of the market, investors and new companies.
All in all, the idea behind setting up SEBI was to create a free-and-fair securities market in India. What followed as a natural consequence was the withdrawal of prior government approval for public issuances in the securities market, essentially empowering issuers to freely raise capital from the primary market, subject to making satisfactory disclosures in the offer documents.
Fairness and integrity of the securities market was intended to be ensured by mandating the disclosure of specified categories of information to secure parity among investors, backed by extensive liability for inaccuracy or misrepresentation.
Through this, it was observed that the control that the government once exercised over the securities market was sought to be vested in the hands of the public, by empowering them to make decisions on the basis of accurate, consistent and relevant information.
The disclosure requirements were further supplemented by necessitating strong corporate governance practices and principle-based accounting standards, to consolidate India’s position as a preferred investment destination with a reliable and efficient securities market.
The Indian securities market, which was once completely insulated from foreign investment, was now headed for integration with the international capital markets through the recognition of foreign portfolio investors who could invest with few, if any, restrictions on investments or repatriation.
While the introduction of SEBI marked a steady step towards progress, the 1990s were also known for multiple instances of market manipulation and fraud, which took the securities market by storm and caused disillusionment in the eyes of the public. These instances triggered a host of reforms and profound changes to the structure and design of the securities market.
In-person trading and the traditional out-cry system assumed the nature of electronic screen-based trading, and represented one of the initial yet commendable attempts at technological integration in the securities market.
India leapfrogged every western nation in the complete electronic trading and settlement of securities.
Subsequently, trading in physical shares along with the risks associated with delivery, including theft and falsification, was sought to be eliminated through compulsory dematerialization of shares, i.e., their conversion into electronic form. Even this journey was completed by the late 1990s.
A need was also felt for countering the systemic risk that market failure poses to the economy and counter-party risks, and to that end, risk management mechanisms, surveillance systems and suitable settlement mechanisms were adopted.
Existing mechanisms, such as leveraged trading or deferred settlement, were banned in the favour of rolling settlement, and risk was sought to be contained through the establishment of clearing corporations and the setting up of funds to guarantee settlement of trades in the event of default by brokers.
Moreover, SEBI gradually took steps to eliminate the chinks in its armor by implementing stringent regulations, prohibiting the practice of insider trading and market manipulation.
In addition to such measures, the infrastructure of the securities market witnessed a greater degree of diversification, with the setting up of multiple intermediaries such as depositories, registrars to issue, merchant bankers, etc., which were required to follow strict regulatory standards and a binding code of conduct.
SEBI was empowered to exercise oversight over such intermediaries by inspecting their operations and initiating disciplinary proceedings for any violation or non-compliance. The element of diversification extended well beyond market infrastructure to the emergence of innovative and hybrid instruments such as stock options, derivatives, futures, etc., which were carefully regulated through margin requirements and position limits.
While these measures had the effect of radically transforming the Indian securities market, they invariably brought about a drastic reduction in transaction costs, lower risks to investors, lower systemic risk, broader investment choices, efficiency, transparency, and an overall deepening of the securities market into its present form.
Regulation, however, is ultimately an evolutionary process. Past milestones and achievements can only remain relevant as long as the existing framework and approach is consistently reconfigured and reinvented in the face of evolving trends and practices in the securities markets.
In recent times, SEBI has evidently focused its attention on identifying and analysing emerging disruptive technologies, notions of sustainable finance and the like, with a view of molding the existing regime to accommodate such trends and regulate possible risks, where the need is felt.
However, the dynamic nature of the securities market precludes the formation of any concrete opinion or conclusion on the future trajectory of securities regulation in India. What the coming decades have in store remains to be seen, but broadly speaking, we have got the super-structure of regulation right. What will come in the future will likely be evolutionary and not revolutionary.
Sandeep Parekh is the managing partner and Rashmi Birmole is an associate at Finsec Law Advisors.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.