Efficacy Of Securities Regulations In Domestic Market
Introduction
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some jurisdictions the term specifically excludes financial instruments other than equities and fixed income instruments. In some jurisdictions it includes some instruments that are close to equities and fixed income, e. g. , equity warrants. In some countries and languages the term security is commonly used in day-to-day parlance to mean any form of financial instrument, even though the underlying legal and regulatory regime may not have such a broad definition.
NSE was set up by a group of leading Indian financial institutions at the behest of the government of India to bring transparency to the Indian capital market. Based on the recommendations laid out by the Pherwani committee, NSE has been established with a diversified shareholding comprising domestic and global investors. The key domestic investors include Life Insurance Corporation of India, State Bank of India, IFCI Limited, IDFC Limited and Stock Holding Corporation of India Limited. And the key global investors are Gagil FDI Limited, GS Strategic Investments Limited, SAIF II SE Investments Mauritius Limited, Aranda Investments (Mauritius) Pte Limited and PI Opportunities Fund. The exchange was incorporated in 1992 as a tax-paying company and was recognized as a stock exchange in 1993 under the Securities Contracts (Regulation) Act, 1956, when P. V. Narasimha Rao was the Prime Minister of India and Manmohan Singh was the Finance Minister. NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The capital market (equities) segment of the NSE commenced operations in November 1994, while operations in the derivatives segment commenced in June 2000. NSE offers trading, clearing and settlement services in equity, equity derivatives, debt and currency derivatives segments. It was the first exchange in India to introduce electronic trading facility thus connecting together the investor base of the entire country. NSE has 2500 VSATs and 3000 leased lines spread over more than 2000 cities across India.
NSE was also instrumental in creating the National Securities Depository Limited (NSDL) which allows investors to securely hold and transfer their shares and bonds electronically. It also allows investors to hold and trade in as few as one share or bond. This not only made holding financial instruments convenient but more importantly, eliminated the need for paper certificates and greatly reduced the incidents of forged or fake certificates and fraudulent transactions that had plagued the Indian stock market. The NSDL's security, combined with the transparency, lower transaction prices and efficiency that NSE offered, greatly increased the attractiveness of the Indian stock market to domestic and international investors.
Research and Analysis
A dynamic and efficient capital market is a vital and indispensable part of a nation‘s financial infrastructure. Capital market provide direct finance to the corporate sector. Indian capital market comprising of equity, debt and derivatives market has witnessed tremendous growth in the last three decades. With massive flow of funds into the capital market especially from foreign institutional investors to Indian capital market, Indian stock market is the fourth best-performing market in the world. Retail investors account for nearly 97 per cent of total investors in Indian mutual funds accounting for nearly 47 million investor accounts. Securities market globally is characterized by asymmetric information between the provider of funds (investors) and the receiver of funds (firms). The seller (receiver) of funds along with financial intermediaries knows more about the sale item (securities) than the buyer (investor). So the buyer (investor) would be taking a risk buying these items- the risk exposure that exists before the money is lent (adverse selection) and the risk after the transaction (moral hazard).
Academic literature has referred to as the promoters problem - the risk that the corporate issuers will sell bad securities to the public (investors). This analytical framework provided the framework for understanding why disputes arise in securities market and the need to resolve these disputes efficiently and fairly. Resolution of securities market dispute could result in lowering the cost of equity/capital in the country. Secondly, dispute resolution platform provide a feedback mechanism of the regulation in the securities industry- which regulation is working, not working but needs fine-tuning. One of the basic question regarding securities dispute is why is direct negotiation between parties are not feasible. The behavioural finance literature provides answer to these questions. According to Robert Mnookin, there are four categories of barriers to direct negotiation: (1) strategic barriers arising out of game theory and economic analysis, (2) principal-agent problems, (3) cognitive barriers and (4) reactive devaluation (the tendency of people to discount the statements and proposals of those with whom they are in conflict). It is in this context, there is a role for dispute resolution by a third-party who is neutral. The natural candidate who satisfies the criterion of a neutrality is the regulator of the securities industry. World-wide there are two models of securities dispute resolution- arbitration model of SEC and Ombudsman model of United Kingdom (which countries like Canada, Australia, Hong Kong, Japan has embraced). The extant literature cites three attributes of a good dispute resolution system: accessibility, efficiency and fairness. It is on this basis, we evaluate the SCORES system in India. As far as the first criteria are concerned- accessibility to investors - SCORES fare very well. It has an open customer complaints recording system (not constrained by time or whether the complaint is escalated or not). It is a first level of redressal system - it accepts complaints even before there is an opportunity for the parties to redress their grievances among themselves.
With the web-based complaint seeking platform which came into existence in 2011-12, the SCORES is very investor friendly; it also adopts complaints in the non-electronic format as well. It also conducts investment education throughout the country about the rights and responsibilities of investors. This is all the more important as the Indian brokerage system includes brokerage entities, sub-brokers and other authorized entities. On the flip side, given the overtly inclusiveness of the SCORES system, it has the potential to create a number of hard-to-solve cases with weak information set which can impact adversely the reputation of the regulator. As far as the second attribute is concerned, viz. , efficiency, SCORES system also fares favourably. The redressal rate at 96 per cent in recent years is one of the highest among regulators world-wide. Similarly, the time taken also scores positively (less than a year). Most of the cases get resolved in the initial stages itself.
To improve the redressal rate further, it is recommended that an active mediation role as opposed to conciliation rule may be played by the regulator. This could further improve the redressal rate and satisfaction rate of investors. In terms of the fairness issue, the extant literature discusses the proposition that it is the must have with enhanced access to resources and their repeat plays that make them more successful in the court systems. There is limited research in this area and available evidence based on Ombudsman system using the complainants’ success rate has shown that this rate varies between 16 percent - 46 percent. We conducted a similar exercise for 2014 using the arbitration system for BSE and NSE and found that success rate is around 49 per cent. It would be interesting to examine how the complainants’ success rate varies over organizational settings and how these are shaped by the relative experience and resources of parties to dispute. In this regard, it is recommended that the SCORES system monitor repeat players (RP) who tend to play for rules to the disadvantage of individuals as one shooters‘ (OSs). Judged by another metric, the satisfaction surveys conducted by SEBI shows that it is around 60 per cent. In order to bring credibility to this process, it is recommended that the satisfaction surveys be administered by an independent party.
Presently, under SEBI‘s SCORES system, mediation and arbitration is confined only to the broker-related issues. There is no mediation and arbitration at the company level which are related to primary and secondary market issues. Presently SCORES depend on the companies themselves to resolve the issues which are monitored by SEBI. Lately they have barred companies not responding to investor complaints from accessing capital market; recently it has barred five firms from accessing capital market further for failing to attend to investor grievances. SEBI might consider bringing a mediation and arbitration system as it is present the broker category also to the company level. Communication strategy is crucial in building the reputation of the regulator. In the case of SCORES, the good record has hardly been noticed in the market rather the market has been focusing on the bad news. The extant literature has suggested that if an agency enjoys good reputation it can afford to keep silent since most of the criticism will not tarnish that reputation. SEBI has built a good reputation in recent years in the securities market but the fact that the good news about SEBI performance in securities dispute resolution is not getting across the market it is important to have a balanced approach. In this regard, the role of social media could be useful. With the imminent addition of various Forward Markets Commission‘s (commodity exchanges) into the regulatory portfolio of SEBI, it is quite possible that the magnitude of complaints could escalate and it is recommended that SEBI be pro-active and undertake a detailed study of the likely source of dispute so that its staff and institutional mechanism can handle prospective disputes involving commodity exchanges which has semi-urban and rural clientele.
Lastly, it is important to discuss the communication strategy of SEBI. Reputation of the regulator is a public good and the communication strategy is crucial in building the reputation of the regulator. The literature on the central banks‘ communication strategy suggest limited transparency arguing that release of information about the problems to segments of the financial system may potentially be harmful as it can trigger a run on the financial system. In contrast, no comment or silence could be interpreted as an acknowledgement of guilt SEBI has built a good reputation in recent years in the securities market and the natural recommendation from this literature is to keep silent. But the fact that the good news about SEBI performance in securities dispute resolution is not getting across the market it is important to have a balanced approach. In this regard, the role of social media could be useful. Social media could be used extensively in investor education and communicating the good news about the regulator. This requires a re-evaluation of the current strategy. Moreover, SEBI should consider outsourcing the satisfaction surveys to credible and independent third-parties so that outcome of satisfaction surveys become more credible.
Conclusion
In its critical assessment of the regulatory effectiveness of the Securities regulations, it can be concluded that the stock market still plagued by price-rigging, opaqueness of trade and a ubiquitous sub-broker system. Even the guidelines designed to protect investors' interests fail in their objective. The SEBI can ensure effectiveness by instituting collective decision-making in its functioning and by insisting on better monitoring of corporate governance.
