Vijay Kumar Gaba

 It was a sunny afternoon in winters of 1991. I was enjoying coffee at a famous public café in Connaught Place (New Delhi) with couple of my friends. All of us were waiting for our CA Final result, which was to be announced in couple of weeks. My friends were senior to me and were already working, having completed their articleship two years ago. We were discussing the economic changes that were getting unleashed in the country by the new regime that had assumed office a few months ago.

The economic changes had not impacted me in any positive manner by then. INR devaluation had led to inflation spike disturbing our household budget. Some of my close relatives who were running micro and small industries (then called SSI) were deeply worried about sustainability of their business as they were now exposed to competition from larger businesses and imports. My cousins had their own set of worries. The implementation of Mandal Commission recommendation was reaffirmed. The competition to get government jobs and admission into public educational institutions had intensified for general category candidates. The aftershocks of former Prime Minister Rajiv Gandhi’s brutal killing, gulf war, Punjab terrorism, were still being felt in Delhi. Overall things were not looking great from where I was standing that afternoon.

My friends who had started investing in stocks were however in high spirits. They had earned very good profits by trading. Their employers had promised them promotions if they pass their final exams. They already had a new Idol in (now infamous) Harshad Mehta to look up to. That afternoon, they could not see anything wrong. Arguably, this was their best time in life.

Our discussion was obviously not harmonious.

About an hour later, a middle aged man with very ordinary personality entered the scene. Tarun, my friend, excitedly jumped out of his seat to greet him. “Meet Mr. Hemant Pandey, my stock broker. Hemant ji advices me and also helps in executing my trades at Delhi Stock Exchange. He also knows brokers who can execute trade at BSE”, he proudly introduced the man to us.

And here begins the story.

On enquiry, I found that Hemant, a college dropout, was an “authorized agent” of a “sub-broker” of DSE broker. A friend of his friend was a remisier (a person authorized to go on trading floor) of a broker at BSE. He was therefore able to place orders of his “clients” to brokers at DSE and BSE. Though it could usually take upto 4 days to execute a trade and get confirmation of trade. The brokerage charged ranged between 2% to 5%; and only “market price” orders were acceptable. Delivery of physical share certificates with a valid transfer deed was not guaranteed. It was mostly on “best effort” basis.

That was the situation of Indian financial markets when the liberalization started 30years ago. Having direct access to a stock brokers’ office was sufficient to make someone “important” in his/her social circle. Something similar to if you have direct access to a Minister’s office today.

The people in their 20’s and 30’s who are spammed daily by multiple brokerages to open a trading account at zero brokerage, would never be able to fathom what it was like to be a stock trader or a “retail investor” in pre 1994 days.

Democratization of financial market is one of the most understated reforms of past three decades. The impact of democratization of society in past three decades is visible in almost every sphere. People belonging to the bottom of the pyramid have done particularly well in politics, administration, sports, entertainment, business & professions and science.

However, the easy and free access to financial and banking services has been the most remarkable achievement. Financial inclusion, as we call it popularly, is one of the core pillars of the entire socio-economic development endeavor in past three decades. Technology (especially digitalization) and Telecom Infrastructure are two other strong pillars which have supported the financial inclusion as well.

The tendency to overregulate is one of the undesirable aspects of modern democracy, as it promotes chaos, rebellion and anarchy. Since, the global financial crisis we have witnessed this tendency to overregulate dominating the financial markets also. As a natural corollary, the chaos (heightened volatility), anarchy (unassimilated assets trading at unfathomable valuations) and rebellion (rejection of conventional wisdom in favor of untested experimental ideas) is also prominently visible in markets. May be time is approaching fast when the democratization of financial markets that started three decades ago would also need an affirmative agenda for renewal.

Like Robinhood Markets of US, which pioneered commission-free investing model which allowed many people to start investing, including those who otherwise would never have ventured into stock markets, many platforms have emerged in India also. Zerodha, for example, is now the largest stock trading platform in India in terms of number of clients.

There are multiple platforms for trading of unconventional financial products like cryptocurrencies (e.g., Bitcoin) and Non-fungible tokens (NFTs).

Advent of new technologies, new products, new set of investors, new methods of valuations and different risk profiles perhaps require a fresh approach to the financial markets regulatory framework.

So far the regulators and governments have adopted an incremental approach for regulating the emerging developments in financial markets. This is apparently resulting in overregulation, misregulation, rebellion and chaos.

Margining and disclosure norms which are not in synch with the current market realities; abundant trading in unregulated (grey) markets; mushrooming of unregulated crypto & NFT exchanges and platforms; participation of large number of individual investors with inadequate financial literacy and risk tolerance etc. are some of the problems that are plaguing the markets.

Some of the problems that may require a totally new approach to regulations could be illustrated as follows:

·         Under pressure from market forces, the market regulator SEBI has been forced to defer the implementation of proposed tighter margining norms.

·         The managements are disclosing so much irrelevant and redundant information to the market, on the pretext of regulatory requirement. The relevant information many a times is getting lost in this overwhelming deluge of redundant information.

·         There are numerous cases of offer for sales (in guise of initial public offers) where the existing investors have exited at apparently unjustifiable price. The managers of these issues owe no accountability to the gullible investors who may lose substantial money.

·         Trading in new assets (Cryptos, NFT etc.) so far is unrestricted. There are numerous traders who may not be adequately skilled to understand the risks. There is no visible effort from regulators so far to improve the literacy and awareness level of these traders. It is therefore desirable that for the time being the trading is restricted to the discerning traders only.

President Biden stated on the International Day of Democracy, “No democracy is perfect, and no democracy is ever final. Every gain made, every barrier broken, is the result of determined, unceasing work.” He has made it clear that renewing democracy in the United States and around the world is essential to meeting the unprecedented challenges of our time. He brought the global leaders from government, civil society, and the private sector together to a global democracy summit, to “set forth an affirmative agenda for democratic renewal and to tackle the greatest threats faced by democracies today through collective action.”

It is imperative that this principle is applied to the financial markets also. The promised new code for the regulation of financial markets must take a fresh approach to regulation rather than adhering to the usual incrementalism.

The principle and overriding function of the securities market regulator, The Securities and Exchange Board of India (SEBI) is to protect the interests of the investors in the securities market. The other functions, viz., orderly development and regulation of securities markets are secondary, in my view. However, there is overwhelming anecdotal evidence to indicate that the regulators have given precedence to market development and regulation over the principle objective of investor protection. There are many instances in past 3-4years alone to indicate this. In the episodes of IL&FS, Franklin Templeton, Yes Bank, Jet Airways, Karvy etc., the interests of the investors in these entities were compromised. Moreover, little efforts were made to ensure that prospective investors are given full disclosures about the risk and reward of investing in the securities of these entities.

Recently, we have seen repeat of this tendency. On Monday, the 7^th June 2021, evening, DHFL informed stock exchanges about the resolution plan approved by the Mumbai bench of NCLT. It was clear from the resolution plan that in the successful bid of Piramal Group “No value was attributable to the equity shares as per the liquidation value of the Company estimated by registered valuers”. Besides it was also made clear in the communication to the exchanges that equity shares of DHFL shall be delisted upon completion of the resolution.

Clearly, the resolution plan envisaged zero value for the shares of DHFL Limited. Despite this the stock was allowed to be traded on Tuesday, the 8^th June 2021. To make the matter worse, it was allowed to rise 10% (the maximum permitted as per the applicable price band). Over 14cr shares were traded on NSE alone and investors took delivery of over 9crore shares valued close to Rs200cr. All this money will be lost. No broker warned the investors on Tuesday. The exchanges did not advised the brokers to caution their clients. SEBI did not asked the exchanges to suspend the trading. To compound the mistake, the stocks continues to be traded on both the exchanges despite the company formally informing the exchanges that the worth of equity shares is Zero. About 5 million shares were traded on Wednesday also. To be fair, many brokers did advise their clients on Wednesday.

Many “knowledgeable” investors in DHFL have been allowed to unfairly transfer their risk to unsuspecting gullible investors in past two days.

In this context it is pertinent to note that the model bye laws prescribed for the exchanges require that—

“The Exchange shall provide adequate and effective surveillance and monitoring mechanism for the purpose of initiating timely and pro-active measures to facilitate checking and detecting suspected or alleged market manipulation, price rigging or insider trading to ensure the market integrity and fairness in trading. For this purpose, the Exchange may, from time to time, apply, adopt, determine and implement various measures, mechanisms and requirements, as may be provided in the relevant Regulations and as may be decided by the Relevant Authority from time to time.”

It is therefore also the duty of the exchanges to act proactively to ensure fairness in trading. In this case the exchanges could have easily anticipated that some people have advantage of knowing the details of the resolution plan. An analysis of trading data for Tuesday will clearly show that the trading in DHFL was not fair. Not suspending the trading this stock is even more unfair to “unaware” investors and traders.

A web series on the infamous Harshad Mehta scam of early 1990s seems to have triggered a debate on the present state of the financial regulation and risk management practices in India. The key point of interest is whether a scam similar to Harshad Mehta scam could recur!

During late 1989-1992, a Mumbai (then Bombay) based stock broker Harshad Mehta used the inefficiency and lacunae in the banking and stock market systems to create massive pseudo credit. The credit so created was used to manipulate stocks prices, causing the first major bubble in Indian stock markets. This was the time when Indian economy was struggling with unprecedented balance of payment crisis, political uncertainty and higher energy prices due to war between Iraq and US (an ally of Kuwait) in the Persian gulf. Given the despondent economic situation huge short positions were built by traders in Indian equities. In the summer of 1991 the Congress government led by P. V. Narsimha Rao assumed office and unleashed a slew of radical reforms. Using this pretext, Harshad Mehta squeezed the short sellers by using the pseudo credit he could manage by defrauding the nationalized banks. The bubble finally burst in April 1992 when the modus operandi of Harshad Mehta was exposed.

The immediate fall out the bubble burst were (i) promulgation of the Securities and Exchange Board of India (SEBI) Ordinance 1992 to establish an autonomous regulator for regulation of securities market in India; and (ii) up-gradation and modernization of interbank settlement system of government securities. SEBI immediately issued a slew of rules and regulation to regulate the operations of stocks exchanges and market intermediaries. The first fully electronic stock exchange (OTC Exchange of India) modelled on NASDAQ of US was established in 1992. A National Stock Exchange (NSE) was established in 1994, as a nationwide fully electronic trading platform. Establishment of NSE eventually led to elimination of floor based trading and closure of 27 of the 28 regional stocks exchanges. India thus became the first country in the world to have 100% electronic trading in equities. Later Depositories Act was passed to enable establishment of depositories, dematerialization of securities and settlement of trades in electronic form.

The improvement in trading and settlement systems; tightening of margining norms; tightening of compliance procedures to protect the interests of investors etc. have been a continuous process since then. Each instance of fraud & manipulation, accident, unethical behavior has resulted in some improvement in the regulatory process in past 28 years.

However, the continuous strengthening and tightening of regulatory has not deterred the manipulators, fraudsters, and unethical promoters & intermediaries from indulging in fraud and malpractices. The IPO and plantation companies frauds of 1994-1996, dotcom fraud (Ketan Parekh) of 1999-2001, Sahara public Deposit scam, PACL Chit Fund Scam, LTCG Scam, numerous cases of insider trading and front running by mutual funds and corporate officials, act of impropriety by mutual funds (e.g., Franklin Templeton, Kotak MF, Birla MF) etc kept rocking the market intermittently. In fact it has been a 28yrs long episode of Tom (SEBI) and Jerry (Manipulators) where both are consistently trying to dodge each other. Hence, there is no assurance that a Harshad Mehta like scam will not recur in Indian markets.

The best thing however is that Indian markets have remained amongst the safest in world in past two decades. We were perhaps the only market in India that did not impose any trading restrictions during global financial crisis.

The recent measures taken by SEBI and Stock Exchanges to tighten the margining norms to dissuade excessive speculation have been severely criticized by market participants. However, in my view, COVID-19 has warranted SEBI to consider Negative Commodity price and Act of Gods as White Swans for risk management system for securities market. I therefore expect even further tightening of margining and compliance norms.