Investment Outlook , Published Feb 19, 2020
The growth of the securities market and the overall economy will require introduction of investor friendly FPI norms, creation of a viable eco system for intermediaries, promotion of innovative financial products by reducing entry barriers, and improvement of corporate governance standards by providing substantive guidance.
In a 2017 report, Morgan Stanley had forecasted that by 2027, the Indian equity market would become the fifth largest in the world. This underscores the prominent role that will be played by the capital market as a catalyst for economic growth in the country. In the past, the Securities and Exchange Board of India (SEBI) has been responsive to the changing dynamics of the securities market and endeavoured to undertake policy and regulatory reforms to make the market more efficient and transparent. A few thoughts on potential areas of reform that can be explored for the Indian securities market to increase participation of market players and to create a more inducive investment environment for domestic and international investors are as follows:
Promoting FPI investments
To facilitate higher foreign portfolio investment (FPI) participation, SEBI may consider amending certain aspects of the new FPI regulatory framework. For instance, the investment limit for a single FPI investor may be increased from the existing limit of 10 percent of the equity share capital of a company to enable such investors to build meaningful positions in Indian companies without triggering the ‘control’ provisions.
Under the present regime, the total holding of equity shares of a listed company by an FPI investor including its investor group must be less than 10 percent of the total paid-up capital of the concerned company. If an FPI investor exceeds the threshold limit and fails to divest within the stipulated time, the investment of the FPI investor along with its investor group in the company will be considered as a foreign direct investment (FDI). After such re-classification, the entire investment becomes subject to the investment restrictions stipulated under the FDI regime, including the sectoral limits and pricing guidelines. Such restrictions have the potential to discourage FPI investors who generally maintain an anonymous relationship with companies and do not exercise any strategic control over them.
At this stage, it is pertinent to point out that even a shareholding of 15 percent to 25 percent in a company would not allow an FPI investor to acquire any strategic influence or control over the company. For instance, under the SEBI Regulations (Substantial Acquisition of Shares and Takeovers), 2011, the requirement to make an open offer is triggered only after an investor acquires 25 percent or more voting rights in a company. Furthermore, presently the market capitalisation of several companies in India (including mid-cap companies) are not sizeable. Enhancing the investment limit for FPI investors would help to attract participation from more long-term FPI investors. This will increase liquidity in the market and assist companies to improve their market capitalisation.
Doing away with net-worth requirements for certain intermediaries
Growth of the securities market cannot happen without strengthening the intermediaries, such as investment advisors, stockbrokers, portfolio managers, etc. For governing intermediaries, SEBI has prescribed various norms including requirements of a specific skill set in the field, sufficient experience, certification, appropriate infrastructure, capital adequacy, etc.
While conditions mandating appropriate/ competent resources, human and infrastructural, are essential and reasonable, the imposition of net worth requirements on intermediaries is unwarranted. Intermediaries whose activities involve directly dealing with clients’ monies or securities like stockbrokers, clearing members and depository participants, already have additional financial obligations levied by their respective stock exchanges, clearing corporations and depositories for guaranteed settlement and clearing of trades, and for protection of investors.
However, such financial conditions are not necessary for several intermediaries whose function is limited to only advising and assisting clients in making an investment decision (which may or may not be carried out by the client). Imposing capital adequacy requirements for such intermediaries may act as a needless entry barrier for many competent individuals/entities from entering the capital market merely on account of lack of resources. Such barriers stifle fair competition and inevitably harm the investors. Therefore, a complete re-assessment of all intermediaries should be undertaken by SEBI and capital adequacy requirements for relevant intermediaries should be done away with.
Presently, the regulatory framework is rigid and it creates entry barriers for new financial products, exchanges and other means of participation in the securities markets. SEBI should proactively make the legal framework more flexible in nature and encourage innovation in the financial markets. Laws should be made for enabling registration of other kinds of investment vehicles and innovative fund structures, and the formation of alternate exchanges should be encouraged. Further, stock exchanges should be granted greater autonomy to decide and permit listing and trading of new financial products under the overall supervision of SEBI. Additionally, product proposals sent to SEBI for approval should be deemed to be approved if no response is received from SEBI within a reasonable period of time (for instance within 30 days).
Improving corporate governance standard
Instead of introducing more regulations, SEBI can better address corporate governance concerns by strengthening the enforcement of existing provisions and fastening liability for directors who fail to perform their fiduciary duties. In this regard, SEBI could provide a principle-based guidance note which elaborates the context and examples of fiduciary duties of board members, such as duty of care, duty of loyalty, etc. and their principle responsibilities. Guidance notes with a best practice code will give board members of companies the flexibility to effectively implement better corporate governance standards.
Adopting the aforementioned recommendations may go a long way in the development of the securities market and the Indian economy as a whole.
About Sandeep Parekh
Sandeep Parekh is the Founder & Managing Partner of Finsec Law Advisors, a financial sector law firm, based in Mumbai. Prior to founding Finsec, Sandeep worked as an Executive Director at the Securities and Exchange Board of India, India’s securities regulator, where he headed the legal affairs and enforcement departments.
Investment Outlook 2020