Regulating investors is not Sebi's job

In the tumultuous years of the early 1990s, a time when exchange liberalisation was followed by one of India's biggest financial scams, there was a bit of passing the parcel game going on. While foreign money was welcome, it had to go through a gate. TheSecurities and Exchange Board of India (Sebi) was given the parcel of registering foreign institutionalinvestors (FIIs) in the Budget of 1992-93 not out of any philosophy but merely as a regulator who was somehow concerned with investors and capital markets.

This handing over of the mandate, if analysed, does not go with Sebi's mandate of regulating the market, developing the market or of protecting the interest of investors. While few people give it second thought, it is not the mandate ofSebi to regulate investors but it's rather to protect them. Further the mandate of protecting investors is not restricted to Indian investors but all investors. This is sensible because protecting all investors will further the cause of developing a well-regulated capital market which gives importance to corporate governance and accountability to shareholders.

The muddled regulations of FIIs andventure capital (VC), though born in 1992, arise from amendments made in 1995 to Sebi Act and this muddle is clear from the unclear language of the Act. Section 11 talks of registering and regulating "Foreign institutional investorsa¦and such other intermediaries" as may be specified. FIIs are investors and not intermediaries like brokers, merchant bankers, etc.

Doing violence to the language also does violence to the philosophy of why Sebi was set up. Similarly the same section also speaks of registering and regulating "venture capital funds and collective investment schemes, including mutual funds". Of course, mutual funds are neither collective investment schemes nor venture capital funds. In the same light, venture capital funds are pools of investors rather than intermediaries and don't need to be regulated.

So are there arguments in favour of Sebi registering and regulating FIIs? There are, though they don't hold water. The first argument is that Sebi needs to regulate large foreign investors because they have the ability to disrupt Indian capital markets with their huge cash inflows and outflows.

This can be dismissed in both theory and practice. It is not Sebi's mandate to regulate the inflows and outflows in the market. In addition, once anFII is registered, it has in fact no controls on how much money it can invest and how much it can take back the next day, which could be done by theReserve Bank of India (RBI) under exchange control regulations.

The second argument is that FIIs could be a vehicle for money laundering. Again, both the theory and practice refute this argument. Foreign money comes into India through banking channels and theRBI imposes strict money laundering restraints on the banking system. Having a second regulator does not add useful service to this remit.

rguments can also be made that Sebi provides important disclosure standards for participatory notes and other second-level investments by FIIs on others' behalf. Whatever disclosure standards that Sebi imposes can well be imposed by the central bank in a single window system of exchange control rather than create a pointless registration process with a second regulator.

Similarly, regulating venture capital is also not ideal. But the issues relating to VCs are more nuanced. Venture capital funds are pools of money contributed by sophisticated investors which are managed by a professional manager and invested mainly in highly risky unlisted equity and hybrid securities.

Sebi has two sets of regulations - one for foreign VCs and another for domestic VCs. In both, there are extensive sets of investment restrictions which prohibit, for instance investing substantial amounts in listed equity. In return, Sebi and the income tax authorities grant it certain beneficial treatment and tax exemptions. The unstated rule is that registering as a VC is optional and if one is willing to register and take on the investment restrictions, then one is entitled to certain benefits.

In addition, Sebi's investor protection mandate also comes into play as investors in the domestic VC are majorly Indian investors who need the regulator's protection. Sebi imposes a minimum investment of Rs 5 lakh per investor in a domestic VC to ensure that only sophisticated investors enter this high-risk investment arena.

While having optional registration is a welcome move, it would be useful if Sebi could make that a formal position stating the same. In addition, in order to prevent unsophisticated investors from entering this gladiator's arena where few investee companies do well or even survive, a threshold limit of Rs 5 lakh is too low and should be increased many fold to prevent unsophisticated investors from burning their fingers. Such a regime would serve the needs of investor protection remit of a securities regulator rather than serving as a shadow foreign exchange controller.

Source: http://economictimes.indiatimes.com/opinion/guest-writer/regulating-investors-is-not-sebis-job/articleshow/9402863.cms?curpg=2