Improve Supervision before Allowing New Exchanges
In January this year, we were finalising the final proofs of our new book Absolute Power which documents the path-breaking rise of the National Stock Exchange (NSE) and the transformation it brought to the Indian capital markets. Parallel to NSE’s meteoric rise, India’s 23 stock exchanges and two national exchanges, the OTC Exchange of India and the Inter-Connected Stock Exchanges of India, disappeared leaving three survivors, with NSE enjoying a near-monopoly and the regulator too timid to supervise it effectively. 
Arrogance, hubris and regulatory capture accompanies NSE’s rise. We have documented how the Exchange has been allowed to bypass almost every rule that governs exchanges—appointment of key management persons, acquisitions, absence of standard operation procedures, influencing policy in its favour, destroying competition and, of course, permitting the infamous algo-scam that I exposed in 2015, based on a whistle-blower’s disclosures. It revealed how officials of the Exchange colluded with select brokers and allowed them to profit enormously by logging in first or to co-location (Colo) servers that had lower traffic.
Six years later, the Securities and Exchange Board of India (SEBI) has not been able to quantify this shocking compromise of NSE’s systems and illegal profiteering and has failed to fix responsibility on those who allowed the system to be gamed. Our book argues that SEBI officials do not have the technical expertise to supervise an exchange that runs on cutting-edge technology. 
We have documented in detail how SEBI and the finance ministry of the earlier regime actively participated in keeping NSE’s competitors stunted through partisan policies. For instance, on the very morning of August 2005, when the Bombay Stock Exchange (BSE) was all set to seal a comprehensive tie-up with NASDAQ, which was to acquire a 25% stake, the government issued a gazette notification amending Press Note 4, which said that no foreign investor could hold more than a 5% stake in an exchange. Nobody had a clue that this was in the offing. NASDAQ backed off, but believes that the press note was engineered to help NSE.
MCX-SX was threatening to be a serious competitor to NSE. But SEBI stymied it by setting up the Bimal Jalan committee in 2010. The committee came up with a set of absurd recommendations, of which SEBI cherry-picked a few to suit NSE’s plan. The committee was against listing of exchanges and even wanted them to be like utility companies with a cap on profits (linked to yields on 10-year government bonds, after adjusting for some risks). The latter bit did not suit the extraordinarily profitable NSE, which enjoys a stupendous operating margin of 73%, and was promptly junked. The committee also wanted banks and institutions to be anchor investors who could hold a 24% stake. The aggregate holding by such anchors was also recommended to be capped at 49%. There were other restrictions on board memberships and salaries too. Importantly, many of the Jalan committee’s recommendations were an about-turn from those of the justice MH Kania committee on corporatisation and demutualisation of stock exchanges. For instance, while the Kania committee had paved the way for listing of exchanges, the Jalan committee was against it. The Kania committee wanted exchanges to be for-profit institutions, while the Jalan committee wanted a cap on profits. 
The Jalan committee’s recommendations delayed the listing plans of BSE and MCX-SX. Meanwhile, SEBI separately hounded the MCX-SX promoters to reduce holding to 5%, a level at which no entrepreneur has any incentive to run a highly regulated exchange with stifling compliance requirements. It also rejected his proposal to convert equity to warrants. The argument was that concentration of shareholding in the hands of a private entrepreneur was bad for the system. 
So imagine our surprise when SEBI, in the middle of the COVID pandemic, felt the urgency to issue a discussion paper titled “Review of Ownership and Governance Norms for Facilitating New Entrants To Set Up Stock Exchange/Depository” that does a complete about-turn. The ostensible intention of the paper released in January 2021 is to promote competition among exchanges and depositories to improve overall efficiency and governance as well as to better adapt to new-age disruptive technologies.
The discussion paper offers no explanation for this sudden and radical change of heart except that it wants to encourage new ideas, entrepreneurs and technology! This is all very well, but is SEBI capable of supervising disruptive new players? 
Our book has documented how SEBI was clueless about dealing with Colo and algorithm trading which was a disruptive technology in 2010, when NSE was permitted to offer it without formal regulatory approval, without any SOPs (standard operating procedures) or regulations being put in place. It was only on 13 May 2015 that SEBI issued a detailed circular to plug all the holes that had allowed the algo scam to thrive and were detailed by the whistle-blower in February of that year. SEBI has still to complete its investigation into the algo scam of 2015 and has failed to quantify unjust profiteering by brokers who gamed the system.
Interestingly, SEBI’s discussion paper has been prepared by an internal working group (IWG). This is intriguing, since SEBI always set up high-powered committees with diverse stakeholder representation to discuss and recommend significant policy changes. Examples: three corporate governance committees (headed by Kumarmangalam Birla, NR Narayana Murthy and Uday Kotak, respectively), the Kania committee on demutualisation (2003), the Jalan committee (2010)  and the R Gandhi committee to review the existing framework for MIIs (2017-18). 
Consider this. A regulator that struggled for 15 years to shut down a score of regional exchanges and two experimental flops (OTC Exchange of India and Inter-Connected Stock Exchanges of India) has done another unexplained about-turn based on the wisdom of an internal group. For the record, the closure of the Calcutta Stock Exchange is reportedly still under litigation. Logically, shouldn’t a plan to permit new entrants be considered only after ensuring a level playing field between NSE, BSE and the Metropolitan Stock Exchange (formerly MCX-SX)? 
Here is a quick summary of the SEBI group’s recommendations.
  • It aims to address ‘dominance in trading and depository space’ leading to concerns about “possibility of excessive concentration and institutional tardiness in quickly responding to the changing market dynamics.”
  • It plans to permit a 100% stake in a market infrastructure institution (MII) to a ‘resident individual or domestic institution owned and controlled by a resident’, provided it is reduced to 51% or 26% in 10 years. As against this, there is currently a cap of 5% on holding for individuals and 15% for certain institutions. This means that after forcing existing exchanges to demutualise, it will permit a private individual to set up an exchange with 100% ownership at least for a few years! Every argument trotted out in favour of this structure about encouraging investment was pleaded by MCX-SX but ruthlessly rejected by SEBI. 
  • A foreign promoter from the jurisdiction of the Financial Action Task Force (FATF) would also be permitted to hold a 49% stake to start with, which would be reduced to 26% or 15% in 10 years. This opens the doors to acquisition of existing exchanges and depositories subject to SEBI approval if the holding is over 25%. Technically, it will allow NASDAQ to take a 49% stake in the BSE if it wishes, but only for 10 years. But the SEBI committee has clearly forgotten about Press Note 4 which stymied BSE’s plans. That press note would also impact any attempt to take over the Metropolitan Stock Exchange, which is drifting aimlessly after the removal of Jignesh Shah.
  • The SEBI report mentions how global exchanges (London Stock Exchange and NASDAQ, among others) are deploying block-chain technology and several “new fintech / techfin players have also emerged in trading space in these jurisdictions, who are increasingly deploying these disruptive technologies and challenging the traditional functioning of MIIs.” This is not new. It was happening abroad even in 2010 when the Jalan committee came up with regressive recommendations and wanted exchanges to function like a utility companies with a fixed return. So why is SEBI in a tearing hurry to ‘recast the legal / regulatory framework’ to ‘incentivise’ fintech players to enter the MII space? The report has no explanation. SEBI’s argument sounds especially hollow, given that a fintech firm, Zerodha, has become the biggest brokerage firm in India, by leveraging technology and reducing costs for investors, even while following every archaic rule of the regulator and the Indian tax authorities. 
In 2010, SEBI had a ‘special purpose committee’ to derail listing by BSE and MCX-SX and favouring NSE. Now, we have another regulatory volte-face through an internal report. Why is SEBI suddenly so keen to facilitate ‘disruptive technology’ and ‘new age’ structures, when it has not been able to fix supervision and control to even the spate of broker defaults? 
I have repeatedly pointed out that 20-odd defaults at the BSE in the early-1990s led to drastic change, forced demutualisation and disempowered brokers completely. But, in the past 20 months, we have seen 22 broker defaults on NSE that have inflicted losses running into hundreds of crores of rupees on ordinary investors. There was also a massive tech glitch at NSE that is still unexplained, which led to losses when investor positions were compulsorily squared off and no consequences to the bourse. In fact, rules threatening penalties in case of tech glitches were issued only last week.
The issue is not about allowing private enterprise to bloom – we are all for it and for competition. Our worry is about SEBI’s ability to regulate adequately, supervise comprehensively and protect investors adequately. Right now, retail investors are bleeding on multiple fronts. Can a regulator keep spinning new ideas and inventing regulation with multiple about-turns when its own record for supervision and investor protection is so questionable? 

Monkey Singh
3 years ago
NSE clearly is a fraud establishment. The so called SEBI complaint addressing mechanism goes like this. They forward it 3-4 months after you post the complaint to NSE grievance cell. Grievance cell forwards it to the broker who replies with lies or some copy-pasted answer and they forward that reply to you. Case closed.
3 years ago
Your efforts to educate lay people regarding financial matters is really cutting edge. Your book Absolute Power is very good and written in an easy to read fashion.
3 years ago
Very comprehensive article by Ms Dalal. However the following points should too have been covered

1. There are 3 more existing SEs- MCX , NCDEX and ICEX ( as after merger of FMC with SEBI , these three are also SEs )
2. There are over 2 dozens of regional Commodity Exchanges, which are also de-recognised like SEs
3. Presently ICEX and MSEI ( earlier MCX-SE) are on verge of closure and having no liquidity.
4. Additionally , since these draft regulations are not only for new Infrastructure Institutions but also allow any shareholder to own even upto 100% even in existing Infrastructure Institutions, so who is / are expected to be benefited ? Any guess ?
5. Surprisingly too in Existing Depositories , SEs, Clearing Corporations .
By the way for whom the 100% ownership is being allowed in MIIs .... how can they do ? It will be worse than pvt co.

Definitely there is some ulterior motive and is behind this move of SEBI
Replied to cfmatnsociety comment 3 years ago
Very interesting and important points. Even after 3.5 decades of writing ... i clean forgot that the commodity exchanges can now trade equity. Also, since the English media (including me) had not covered commodities and commodity exchanges in detail, we have no idea about what is going on with regional commodity exchanges. Hopefully some young journalist in the business press will do a detailed study and think fit to report it extensively.
Meenal Mamdani
3 years ago
Spot on, as always by Ms Dalal.
I do not have financial expertise but I can relate to the feeling of being completely at sea in a climate with new technologies and new data sets.
I was happy to retire when medical practice in USA became more complicated with genetic information. Genetic diagnosis was not something that I was taught when I graduated and was working as a clinical practitioner. But it became apparent to me that I would have to master it if I wanted to continue in my practice which combined clinical+academic teaching.
I thought that it was better that I retire than fall flat on my face in the face of the new science.

I wonder if the top honchos at SEBI understand the complexity of the current financial system. Perhaps they rely on their juniors to do the leg work and give them a prepared analysis that the seniors then flog as their own.

Could the lack of knowledge and understanding of issues be a reason for the dismal performance of SEBI?
Replied to Meenal Mamdani comment 3 years ago
Good points Ms Mandani... I think the biggest issue in the past few years is lack of accountability and the absence of pressure from the finance ministry and parliament by way of asking tough questions. Nobody understands what is going on under the cover of complex technology! And hence many vested interests flourish.
3 years ago
Cairn Energy-an agreed suggest an amicable settlement with the government of India. Where India can bargain with Cairn Energy or twist its arm?
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