Tackling New Breed Of Intermediation — SEBI’s Efforts To Regulate Platforms Market

Between July 21 and 22, the Securities and Exchange Board of India introduced two consultation papers, proposing regulatory frameworks for online bond trading platforms as well as platforms offering execution-only services in direct mutual fund plans. Online platforms that provide retail investors access to the bond markets have been in existence for a few years now, as have digital platforms through which licensed brokers and advisers provide execution-only services to investors, in direct mutual fund plans. Both these papers have sought public comments by mid-August and make for an interesting read, laying ground to usher in laws that will supervise the framework within which such marketplaces can operate.

In a well-studied and succinctly drafted paper, the bond platform consultation paper reckons with the prospect of regulating how debt securities are sold to non-institutional investors online, and examines their role as “organised trading avenues”, that corral buyers and sellers to execute debt trades. Outlining its key concerns, the paper focuses on certain key issues (dealt with below) and proposes that in line with international practice, all such online platforms should be regulated stockbrokers which will house the technology interface and clearing infrastructure to offer listed bonds to retail investors.

SEBI’s primary apprehension emerges from the lack of regulatory oversight over such technology platforms.

From the issuer’s standpoint, such platforms also blur the public issue-private placement line, which requires that securities cannot be offered for sale to more than 200 persons, without complying with higher disclosure and governance standards that apply to a public issue of securities.

And these are certainly credible fears for a regulator to solve. Across jurisdictions, ease of access on investment platforms amplifies concerns around misselling and the data on which investors make decisions. Suggesting that a stockbroker must now guard these gates ensures that a host of regulations, including a code of conduct, now become applicable to how these platforms onboard issuers and in their investor outreach as well. The settlement and risk management processes applicable to stockbrokers will also be drawn in such structures to ensure the availability of sufficient information on these issuers. SEBI has also suggested that products sold can be confined to listed debt only, in which case disclosure levels and the overall public domain information on issuers will self-solve some of the perceived misselling risks.

That said, ushering in a new era of regulation along the lines contemplated in this paper is likely to compromise the competitiveness of these bond platforms and the unique selling points they have formulated through the years to simplify their customer/user experience.

The differentiator of online bond platforms today has been their ability to host platforms that introduce issuers (from across the spectrum) to subscribers/buyers in the bond market in a cost-efficient manner. Requiring a broking license not only introduces better trading protocols such as KYC and due diligence checks but also comes with considerable compliance requirements on net-worth and infrastructure, subjecting such entities to periodic inspections as well. Many platforms that house their technology and intellectual property in a different legal entity within the group will have to consider if a structural rejig is needed, outsourcing arrangements out in place, now that the platform itself will need to be licensed. Even for issuers who were able to create effective leverage on such platforms, listing pre-conditions will result in increased costs and compliances.

But if one were to adopt a user-centric approach, perhaps a hybrid median can be arrived at, which allows platforms to obtain limited purpose licenses with SEBI as marketing agents of financial products and sell to investors above a clearly defined pocket size. This, coupled with principle-based disclosure guidelines for issuers as well as a reference roster for platforms on disclosures, display of information and disclaimers will ensure that the environment within such marketplaces operate remain sequestered and well defined, yet allow discerning users the flexibility to trade in a wider variety of asset classes.

This is similar in spirit to SEBI’s own proposal in the other paper on execution-only platforms for direct plans, where it recognises the seamlessness with which technology matches users to products of their choice. Of course, the characteristics of both these asset classes and their risk profiles differ widely, but there is certainly space to consider if introducing certain entry conditions for bond platforms can allow at least a few such players to consider a “lite-version” of licensing and compliance. The full scale of regulation can then be mandated for those who want to target the entire spectrum of users, across all investment sizes. Increasing compliance for intermediaries does not always correlate to higher degree of protection from misselling or errant issuers and it is possible to create exceptions that will avoid en masse extrapolation of the broker-dealer framework to all financial product marketplaces, by exploring the agency model for the informed user.

Shruti Rajan is a Partner in the Mumbai office of Trilegal, and a regulatory and enforcement lawyer in the financial services space.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.