In a somewhat unconventional order, SEBI has on April 20, 2010 issued “advisory instructions” in a matter involving the Bombay Stock Exchange Limited (“BSE”).
It arises out of a letter by the BSE to SEBI dated July 2, 2004 containing a proposal to introduce a market making scheme in the derivatives segment of the exchange. A unique feature of the scheme proposed by BSE was that it would reimburse any losses sustained by market makers indulging in market making in the derivatives segment. This was with a view to generate greater liquidity in the derivatives segment. SEBI advised BSE by letter dated September 29, 2004 that “such a scheme would expose it to the risks of market making and therefore, had not allowed BSE from taking ‘commercial risks as an insurance agency’”.
SEBI later noticed that the BSE had implemented a ‘Market Development Scheme’ engaging two market makers and that the market making activity had occurred between December 2006 and May 2008. It was therefore alleged that by introducing such market making scheme without the permission of SEBI, BSE had acted in contravention of the SEBI letter dated September 29, 2004.
A number of arguments were made by the BSE in defending its position. First, it was stated that the market making schemes operated by BSE were routine in nature and did not involve compensating the market makers for losses suffered by them. It was due to this unique compensation mechanism that BSE decided to approach SEBI in the first place. Second, it was argued that “there are no specific rules/regulations/circulars issued by SEBI which prohibit or otherwise seek to regulate the manner in which a stock exchange would implement market making in the derivatives segment”. In other words, if there was no requirement to obtain the approval of SEBI to carry out such activity, then BSE cannot be faulted for carrying on the same without such approval.
Although SEBI did not attempt to rebut each of BSE’s arguments, it made the following observations which are in the nature of “advisory instructions”:
BSE’s contention is that there are no explicit provisions that SEBI has mandated which required it to seek prior permission for launching the impugned market making schemes in the derivatives segment. However I am constrained to observe that since SEBI had issued a letter in a closely related matter, notwithstanding the stand of BSE that the subject matter in this instant case was different, it would have been in the fitness of things and would have been proper for BSE to have brought its new market development scheme to the attention of SEBI. For a market infrastructure institution of long standing like BSE, it should have seen that as a regulator for the securities market, SEBI has been and is at all times sensitive to the potential of any such activity or market making scheme jeopardizing the system and eroding the integrity of the securities market. I therefore, at this juncture, would advise BSE and remind it of its duty to bring such schemes which have wide and far reaching implications for the securities market, in future, to the attention of SEBI and seek guidance or approval wherever required. I however, stop short of prescribing what exactly a scheme would be or laying down yardsticks that would set apart schemes with far reaching consequences for the securities market, as I would still prefer to leave it to the better judgment of an Exchange.
On the one hand, it may be argued that since no violations of legal provisions by BSE have been established, no order ought to have been passed against it. On the other hand, this case demonstrates an increasing trend on the part of securities regulators (even worldwide) to resort to softer measures, for example censure (both private and public), where other legal remedies are either unavailable or inappropriate. Whether this trend will catch on in a more widespread fashion in India is hard to speculate. Whether the validity of such orders will be subject to reexamination at an appellate level is an even harder question because it may not usually be worthwhile for affected parties to appeal against such orders.