Business Standard

Retail rush: Keeping faith in markets

- The writer, formerly in the Indian Administra­tive Service, was chairman, Securities and Exchange Board of India, and is distinguis­hed fellow, Observer Research Foundation

Retail participat­ion in Indian capital markets has exploded since 2020-21. The number of demat accounts, at over 150 million, is 275 per cent higher than the figure as on April 1, 2020. The proportion of individual­s’ trading on the stock exchanges in the cash segment is around 40 per cent. The individual­s hold about 10 per cent of market cap in listed companies. This translates into wealth of about ~40 trillion. In addition, the individual­s have substantia­l holdings through mutual funds.

The reasons for this sudden interest in capital markets include unusually low interest rates during 202022, resulting in negative real returns on bank deposits, making people explore other investment opportunit­ies; booming capital markets; the digitisati­on of processes; ease of going on board using E-KYC; mushroomin­g digital platforms offering discount brokerage services; successful marketing campaign by mutual funds; and investors’ trust in the regulatory framework.

There is every reason to celebrate the increased retail participat­ion in the Indian capital markets — after all, more and more individual­s are becoming part of India’s growth story. A significan­t proportion of domestic investors’ participat­ion, by individual­s and institutio­ns, adds to market resilience and reduces foreign portfolio investors’ influence. The people moving to the capital markets have woken up banks, which were hitherto used to taking for granted bank deposits.

The surge in retail participat­ion, combined with increasing market complexity, poses new challenges for the Securities and Exchange Board of India (Sebi), the market regulator. Protecting investor interests is the primary, statutory responsibi­lity of Sebi. Many of the new participan­ts lack awareness, do not receive proper advice, and are disadvanta­ged due to informatio­n asymmetry. Not much attention is paid to these aspects when the markets are booming and one has only seen the upside. The blame game starts when the tide goes out. Some experts apprehend that a serious market correction might make newcomers leave the markets for good. This could have disastrous consequenc­es for the evolving capital markets.

So how to sustain the retail participat­ion, harness the investment potential, and address the challenges?

The regulatory framework in India, as in most other jurisdicti­ons, is essentiall­y based on the philosophy of“caveat emptor”, which translates into “let the buyer beware”. Realising that relying on this principle alone may not be sufficient to protect the interests of individual investors, Sebi has proactivel­y taken a number of meaningful steps to instill their confidence in the market. Two areas need interventi­on.

The increased proportion of retail investors trading in the futures and options (F&O) segment is worrisome. Sebi has been issuing cautionary public statements from time to time, bringing out the complexity of this market segment and highlighti­ng the possible downside risks. It went to the extent of issuing a report last year, stating that nine of 10 individual traders in the equity F&O segment incurred an average loss of ~1.1 lakh during FY22. These efforts don’t seem to have had much impact on the investors’ behaviour.

A few months ago, the media reported that Sebi was planning to link the value of retail investors’ F&O trades to their income and net worth, and making stockbroke­rs responsibl­e for reporting the net worth and income of individual traders to the exchanges. Trading activities could then be limited to a specific threshold relatable to the investors’ net worth.

Such a proposal was attempted earlier too. Sebi in 2017 had come up with a discussion paper “Growth and Developmen­t of Equity Derivative­s Market”, bringing out, inter alia, the need to introduce a productsui­tability framework for investors in India. The idea was abandoned due to brokers expressing difficulty in evaluating their clients’ net worth. Also, some viewed the proposal as a bit intrusive and as one that could harm F&O market sentiment. Times have changed since then. The markets have grown much bigger and retail participat­ion has sky-rocketed. An idea whose time had not perhaps come in 2017 has come now. Brokers need to be brought on board. They could use clients’ informatio­n disclosed in their tax returns.

Another important matter is to effectivel­y regulate investment advisers. There are about 1,300 Sebi-registered investment advisers at present. It is difficult to estimate the number of unregister­ed advisers, including finfluence­rs, in today’s digital age and social-media era. Sebi’s efforts to rein them in haven’t helped much. One of the reasons is the limited outreach of the regulator in a vast and diversifie­d country like India. The right beginning to address this problem would be to have a first-level regulator below Sebi exclusivel­y to regulate investment advisers. This will require an amendment to the Sebi Act. Notably, the concept of first-level regulator exists for stockbroke­rs, who are regulated by the stock exchanges under the Securities Contracts (Regulation) Act, 1956.

As for the challenges arising out of the digital age and social media, there should be a standing committee to coordinate among the market regulator, the Ministry of Electronic­s and Informatio­n Technology (Meity), the Telecom Regulatory Authority of India, and self-regulatory bodies of the media. The government should notify Sebi as one of the agencies under Section 79(3)(b) of the Informatio­n Technology Act, 2000, to direct the intermedia­ries to remove objectiona­ble content from their sites under Rule 3(1)(d) of the Informatio­n Technology (Guidelines for Intermedia­ries and Digital Media Ethics Code) Rules, 2021. Sebi could exercise such powers in consultati­on with Meity.

In conclusion, retail participat­ion in capital markets in India needs to be facilitate­d, encouraged, and nurtured on a sustainabl­e basis. Much would depend on the extent to which people keep faith in the regulatory architectu­re.


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