SEBI’s Capital Market Reforms

In what
is clearly the most extensive set of capital market reforms in recent years,
SEBI announced a series of measures following its board meeting last week.
These are intended to boost the capital markets in India (both primary and
secondary), and also to streamline various process. The principal recommendations
have been divided into the following categories (in the words used in SEBI’s board
meeting press
release
):

steps to re-energise mutual fund industry;

reforms in the primary market;

regulations on investment advisors; and

amendment of SEBI (Issue and Listing of Debt Securities) Regulations, 2008.
Most of
these recommendations will have to find their way into specific regulatory
changes by way of amendments to relevant regulations or the operation of new
regulations (as in the case of investment advisors). Much of the impact of
these changes can be determined in specifics only when the detailed language of
these changes is available. Nevertheless, in this post I briefly touch upon only
some of the key developments and also the issues that some of them may pose.
Capital Raising By Issuers
Two
interesting issues emerge. One relates to the minimum public shareholding in
listed companies, and the other to continual disclosures by listed companies,
both of which are dealt with below.
In order
to achieve the minimum public shareholding of 25% (and 10% in the case of
government companies), two additional routes have been permitted. They are the
rights issue and bonus issue routes. It is understandable that promoters may
dilute their stake in case of a rights issue where they specifically opt not to
take up the rights, and where other shareholders subscribe to their rights.
However, in case of a bonus issue it would be interesting see how this idea
will be implemented from a company law perspective. This is because bonus
shares must, as a general matter, be issued pro
rata
to all shareholders of the company by way of stock dividend. Whether bonus
shares can be issued selectively to the non-promoter shareholders, or whether
the promoter shareholders can opt not to receive the bonus shares remain to be
seen. Whether such distinction in bonus issuances would militate against the
concept of all equity shares being pari
passu
is an issue that may have to be contended with. Of course, details
are yet to be available, and hence these are only some preliminary thoughts
(some of which might even be allayed once the detail emerge).
The
introduction of an integrated system of disclosures is a giant step towards
development of the Indian capital markets. SEBI’s decision is as follows:
To
provide updated information to investors, listed entities shall file a
comprehensive annual disclosure statement in addition to the existing
requirements on the lines of 20F filing prescribed by the US SEC. Such filings,
updated by the prospectus, shall also serve as a reference in the offer
documents for further capital offerings.
As previously
discussed
on this Blog, a sub-committee of SEBI had recommended such a
system of integrated disclosures way back in 2008. It appears that the recommendation
has been finally implemented only now. This would go a long way in streamlining
disclosures in the primary and secondary markets. It would enhance disclosures
standards in the secondary markets by requiring detailed filings as in the US,
and considerably improve secondary market disclosures which are dismal in India
as compared to the primary market disclosures which have significantly evolved
over a period of time. As far as listed companies are concerned, it would ease
the disclosure regime and facilitate more follow-on public offerings as
companies would be able to include information in the prospectus by reference
to previous filings made. This is a welcome move, and was long overdue.
Regulation of Investment Advisors
This is
also an important step, and brings within the scope of regulation an important
constituency in the stock markets that was hitherto outside the purview of
regulatory supervision. As Sandeep Parekh notes in this Financial Express column:
With
this regulation, the entire industry, which is involved in distribution of
securities products and even financial products, is sought to be covered.
Therefore, anyone peddling a security to an investor would be covered by the
regulation and any wrong advice and misconduct would attract scrutiny and
punishment by Sebi. Until today, Sebi was sceptical about introducing these
regulations because just the number of distributors would run into hundreds of
thousands and regulating such a large number would be outside the available
manpower and bandwidth of Sebi. Many of the ills of the financial industry
actually have their origin in distributors and advisors, some of whom are
unscrupulous and would sell the worst product for a given investor merely
because they get a higher commission from selling that product.
Debt Market Reforms
The
corporate bond market has been in a continuous stage of evolution for the last
few years. While substantial regulatory efforts have been made to enhance the
market for corporate bonds, those have been incremental in nature and have not
resulted in great success. This trend of facilitating the debt securities
market continues in the present phase of reforms as well. Some of the reforms
include standardization of format for presenting information (particularly the financials),
and also the provision of an enabling facility for shelf placement document in
case of frequent issues through private placement.
The
trend in the corporate bond market is that despite these regulatory
developments, there is an emphasis on private placements rather than public
offerings. While some of these efforts such as standardization may help address
some of the concerns of the market, there are other key impediments, as some of
us have observed elsewhere, such
as the lack of a robust corporate insolvency framework that may inhibit vibrant
corporate debt markets in India.

In the end analysis, this round of decisions
taken by SEBI can be considered to be a positive development, given the slow
pace of overall economic reforms lately in India.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

4 comments

  • If I remember right, Reliance Power issued bonus shares to only non-promotor shareholders in 2008 to compensate them for the significant fall in the price post listing. What SEBI seems to have done is to specifically permit this for complying with min. public shareholding norms. Even though the Companies Act does not contemplate it, I think no one would raise any objection as it is the promotors who are forgoing their bonus entitlement and consequently a transfer of economic (dividends) as well as voting rights from them to the non-promotors happens. Pretty cost effective too (a journal entry and informing the depositories and the Stock Exchanges). Will be interesting to see if the secondary market prices run up when a company decides to follow this route.

    And a doubt. “In order to encourage long term holding and to reduce churn and align the interests of the AMCs/ distributors with that of the investors, it was decided that (a) the entire exit loads would be credited to the scheme while the AMCs will be able to charge an additional TER to extent of 20 bps. This will not result in any additional cost to the investors.” (SEBI Press Release) What does it mean? 20 bps on what, and in which year?

  • Hi, It means the exit load charged to any redemption currently reduction of the NAV and is added to the income of the AMC. As per the new provision, the exit load will be added to the fund thereby enhancing the NAV but the MF will be allowed to deduct an additonal 20 bp from the AUM which will reduce the NAV. In SEBI's view this will not add any additional cost. However this is a fallacious arguement of SEBI. How does SEBI know that the amount added on account of exit load will always be equal to the amount deducted at the rate of 20 bp from the AUM?

  • Yes, in case of a normal bonus issue, prices should not run up, as the proportionate economic and voting right of the shareholders stay constant post the bonus issue. But here say the promotor and non-promotor shareholding is 80% – 20%, and only non-promotors get bonus shares, then by buying say 1% pre-bonus shares, they are entitled to 5% of the bonus issue, increasing their proportionate rights.

    Coming back to the 20 bps v Exit Load issue, Yogesh, thanks for the clarification. You are right that SEBI’s argument is fallacious. Moreover, I’m trying to figure out the logic. If the AMC never had any business gobbling up the Exit Load (EL), SEBI should have mandated crediting the EL to the Scheme and stopped at that. Probably most AMCs came to think of EL as a source of revenue, so SEBI is kind of compensating them with the extra 20 bps TER kicker in lieu of the loss of EL. The earlier system encouraged frequent churning of portfolio as it meant more EL, benefiting both the AMC and the distributors. Now there is no such incentive, as the AMC gets a fixed 20 bps advantage. In other words, it is akin to a `fixed to floating swap’, which would be in-the-money for the AMC as long as the EL stays below 20 bps level.

    -Mangesh Patwardhan

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