Securities market: On the cusp of change

Para 68 of the Budget announcement of 2021, exactly 30 years after 1991, could be the beginning of the next round of financial sector reforms

July 1991 was 30 years ago. A great process of economic reform was initiated then. One important element of that was financial markets reform. Starting with the Securities Exchange Board of India (Sebi) Act, 1992, there have been till now 14 legislative amendments to the laws relating to the securities markets and one constitutional amendment (to facilitate dematerialisation of securities) to reach the present state of the markets.

The main fruit of the reforms was a new level of functioning of the equity market. This involved joint work between the Ministry of Finance, Sebi, NSE, BSE and associated financial markets infrastructure institutions. These reforms were the foundations through which, today, we see that the overall market capitalisation of the equity market is ~230 trillion ($3 trillion) and foreign investors have a stock of investment in listed equities of ~43 trillion. The total market value of the equity holdings of foreign portfolio investors is about 19 per cent of the total market capitalisation. Practical people delight in today’s dollar values. However, few realise that the foundations of this lay in a 30-year journey of high thinking, collaboration across institutions and persons, and remarkable implementations.

However, the task of establishing the policy environment for a capable financial markets system is far from complete. After the merger of Forward Markets Commission into Sebi, which took place in 2015, the work programme has been largely stuck.

There are problems in the working of regulators. Regulators in India are unique in having concentrated power, with the fusing of legislative, executive and judicial functions. This extreme power, placed into the hands of officials, sits uneasily with constitutional norms in a liberal democracy, and creates a problematic level of unpredictability for a sophisticated market economy.

There is a major gap in the bond market and its associated elements (the bond-currency-derivatives nexus). These weaknesses are increasingly holding us back. The government needed to vastly increase borrowing when faced with the pandemic, but faced constraints in the resourcing available through the present configuration of the government bond market. Many Indian firms are avoiding the traditional journey of maturity, of an initial public offering in India, and instead opting for overseas ownership/listing structures so as to avoid the infirmities of Indian institutions, including financial markets regulation. The funding of private firms urgently needs to shift away from banks to the bond market, and this transition has been hampered by policy constraints.

The third problem lies in establishing sound foundations of law that set regulatory organisations into motion for financial markets regulation. The present laws are not clear on the objectives, of consumer protection, prudential regulation, resolution, systemic risk regulation and certain specialised elements of securities law such as market abuse. The vagueness of objectives in the present law confuses the officials working on financial regulation, and creates uncertainty for the industry. As an example, the present law on market abuse, the Sebi Prohibition of Fraud and Unfair Trade Practices Regulations, confers unbridled discretionary penal powers in the hands of Sebi, and creates corresponding regulatory risk for private persons.

With the benefit of hindsight, when we look back at the legislative activism of 1991-2011, there were great limitations in the intellectual capacity of the time.

Numerous amendments were made to the law, but inadequacy of knowledge held back the work, and as a consequence these three classes of issues were not raised and not addressed. This knowledge has built up gradually, through experience, through the development of a research literature, and most notably through the work of the Financial Sector Legislative Reforms Commission or FSLRC (2011-2015).

Alongside this, one major force of change is the judiciary. As an example, in 1998, Arun Jaitley represented Hindustan Lever when Sebi had made allegations of insider trading, and questioned the constitutionality of the then-prevalent arrangements. When these questions bubbled up to the Supreme Court, the Ministry of Finance was forced to backtrack, to agree that the law was unconstitutional, and create an appellate arrangement, the Securities Appellate Tribunal.

When we think of the foundational concerns about the separation of powers, rule of law, and the enormous power that has been concentrated in regulators, at first the courts were indulgent. In the Clariant International case (2004), the Supreme Court recognised that there were constitutional concerns but endorsed the status quo for the time being. A new jurisprudence has started emerging in recent years. In two landmark cases, the Supreme Court has demanded democratic legitimacy in regulation making (against TRAI in 2016) and proportionality in state intervention (against the RBI in 2020). The more recent rulings about the National Tribunals Commission potentially raise concerns about the legality of judicial hearings conducted by regulatory officials. These new rulings open up a path to a whole new jurisprudence on regulators. This new jurisprudence is aligned with modern thinking on regulation in India.

In this backdrop, there is important progress in the Budget speech of February 2021, which seeks to put financial markets law on a new footing. In paragraph 68 of the speech, the finance minister said that she proposes to consolidate the provisions of the Sebi Act, 1992, Depositories Act, 1996, Securities Contracts (Regulation) Act, 1956, and Government Securities Act, 2007, into a rationalised single Securities Markets Code.

This work is required for addressing the felt needs of the Indian economy at the present state of sophistication. This work also lays the foundations through which the Ministry of Finance can solve the ticklish situations that can arise in courts in coming days. The task ahead lies in moving beyond this and pulling together (1) The FSLRC material on the working of regulators, including the role and composition of the board, refreshed and updated, reflecting the 20152021 experiences on the ground, (2) Clarity of objectives of financial market regulation where the FSLRC work is broadly complete and (3) Financial agency architecture surrounding the bond-currency derivative nexus and Public Debt Management Agency, which involves picking up the threads from the reforms announced in the 2015 Finance Bill and later withdrawn. Hopefully, the short announcement in para 68 is the harbinger of that larger task.