[Vaishnavi Srinivasan and Philip Oommen are lawyers based in Mumbai, and graduates of the National Institute of Securities Markets]
In a pioneering move, the Securities and Exchange Board of India (SEBI) has established the Brokers Industry Standards Forum (BISF). Initially proposed in July 2023, the formation of the Industry Standards Forum by SEBI aims to establish regulatory standards, drawing on industry feedback and stakeholder consultation, for the effective implementation of regulations and circulars. This marks a significant step towards fostering collaboration, enhancing ease of business, and strengthening investor protection in India’s financial markets.
Background
SEBI has made significant strides in ensuring investor protection over the years. It has introduced numerous disclosure requirements for listed companies and established mechanisms for redressal of investor grievances, thereby boosting investor confidence in the securities market. In addition, SEBI has strategically empowered market infrastructure institutions (MIIs) by delegating a substantial degree of regulatory authority and responsibilities to them. This strategic empowerment recognizes the uniquely advantageous position of MIIs, given their role in providing essential infrastructure for trading, settlement, and recordkeeping.
However, one group that has been largely overlooked in the regulatory policy-making process is the stockbrokers. Despite serving as a crucial link between the MIIs and investors in their roles as trading members, clearing members, or depository participants, stockbrokers have rarely had an active role in regulatory policy-making. This is primarily due to the absence of a dedicated platform that allows SEBI to consider the practical and operational challenges the stockbrokers face in implementing the regulatory regime. Even though broker organisations such as the Association of National Exchange Members of India (ANMI), Bombay Stock Exchange Brokers Forum (BSF), and Commodity Participants Association of India (CPAI) exist, SEBI has seldom engaged with them for consultations in the formulation of regulations.
Recognizing this gap in policy-making, SEBI adopted a more inclusive approach that acknowledged the unique insights and experiences of stockbrokers. This was done by the initiation of consultations with the BISF on several crucial regulatory aspects.
An Overview
The BISF is a diverse consortium that brings together representatives from various facets of the securities market. This includes the three prominent broker associations: ANMI, BSF and CPAI. Additionally, the BISF comprises representatives from MIIs, qualified stock brokers (QSBs), custodians, and high-frequency trading firms. The BISF also includes representation from back-office and front-office vendors, as well as investor associations.
Under the proposed model for the BISF, SEBI sets the agenda by determining the points that need to be deliberated. This essentially answers the question of ‘what’ needs to be addressed. Once the ‘what’ is established by SEBI, the BISF steps in to determine the ‘how’. This involves recommending methodologies or processes on how the identified points can be effectively addressed. In essence, while SEBI provides the direction, the BISF utilizes its practical proficiency to recommend the most effective path forward.
Impact of the BISF
Since its inception, the BISF has swiftly emerged as a pivotal entity in the effective implementation of the regulations and circulars of SEBI. One of the key contributions of the BISF has been in the formulation of relevant standards. For instance, in November 2023, SEBI entrusted the BISF with the responsibility of formulating the ‘Most Important Terms and Conditions’. This initiative was aimed at ensuring transparency and clarity by highlighting key aspects that could potentially be overlooked by investor clients due to the extensive documentation involved in the initiation of broker-client relationships. Additionally, the BISF has contributed to the development of the framework for trading members to provide a facility to voluntarily freeze/block client’s trading accounts on account of suspicious activities.
Another significant contribution of the BISF has been in ensuring ease of conducting business. In the normal course of functioning, stockbrokers report data to MIIs, relating to various aspects of its functioning. However, some of those reports became unnecessary owing to the routing of data to the MIIs directly from primary sources. Therefore, in furtherance of the recommendation of the BISF, such duplicate reporting of data was done away with by SEBI.
Lastly, the BISF has played a crucial role in the removal of operational difficulties. For the quarterly/monthly settlement of client’s funds, the stockbrokers were required to distribute the funds back to clients during the small window of Friday evening, which had undesired consequences for clients, stockbrokers, and the banking system. Therefore, based on the recommendations of the BISF, the requirements of reporting were tweaked to allow settlement on Friday and/or Saturday with adequate safeguards. Additionally, for the upstreaming of the client’s funds, a revised framework was issued by SEBI based on the recommendations of BISF for the removal of operational difficulties.
The Way Forward
SEBI’s initiative to involve practitioners in the formulation of regulatory policies is commendable. However, to ensure market integrity and investor confidence in such involvement, the following measures could be considered.
Firstly, given that BISF’s proposals come from expert practitioners, SEBI must assemble a proficient team, preferably with participation from MIIs and investor associations. This team would meticulously scrutinize proposals to identify any potential hidden consequences that could adversely affect investor interests. SEBI needs to bear in mind the potential conflict of interest that arises when recommendations about the regulation of stockbrokers come from an industry body, which itself has significant representation from the stockbrokers.
Secondly, the rising inequality in the broking industry necessitates that the BISF makes provisions for small stockbrokers to articulate their concerns. As of 2023, the market shares of the top 10 and top 100 stockbrokers accounted for 53% and 82% respectively. Furthermore, the top two stockbrokers alone controlled nearly 40% of the stockbroking industry’s market share. This trend is alarming as the interests of small stockbrokers could be overshadowed by the growing influence of large brokerage firms. Therefore, the BISF can act as a platform for small stockbrokers to voice their concerns about regulatory compliances, thereby ensuring active participation and fostering competitiveness within the stockbroking industry. It is important to note that various aspects of stockbroker regulation could potentially escalate compliance costs. Therefore, the impact of such cost increases must be considered, particularly from the perspective of smaller brokerages. While the introduction of heightened compliance requirements for larger stockbrokers, referred to as QSBs, is a laudable initiative, it is equally crucial to strive towards reducing compliance costs for smaller stockbrokers as much as possible. Such a balanced approach would ensure that regulatory measures do not disproportionately burden smaller entities in the industry.
Exploring the Possibility of Self-Regulation in the Indian Stockbroking Industry
As markets expand, there is a marked escalation in both the quantity of regulated entities and the intricacies involved in their regulation. Globally, it has been observed that when such expansion occurs, self-regulation often emerges as a viable solution. Considering the growth of Indian markets, the prospect of having a self-regulatory organization (SRO) for the Indian stockbroking industry may come under consideration in the near future. In such a scenario, the BISF, with its experience in setting standards, could have a distinct advantage.
Insights can be gleaned from the extensive history of self-regulation in the United States of America (USA). The Financial Industry Regulatory Authority (FINRA), a not-for-profit SRO, is authorized by the United States Congress to regulate the operations and conduct of broker-dealers under the oversight of the Securities and Exchange Commission (SEC). Notably, FINRA’s operations are funded by contributions from the broking industry, effectively reducing the burden on taxpayers. FINRA’s enforcement powers include the authority to levy fines, impose sanctions and other measures, against stockbrokers who violate regulatory provisions.
Nevertheless, the delegation of regulatory authority to an industry-led body may not invariably align with investor interests. Inherent in self-regulation is a conflict of interest that arises when an organization both serves the commercial interests of and regulates its members. Such a scenario could infringe upon the fundamental tenet of natural justice that no individual ought to judge their own cause, due to the overlapping interests of the constituents of an SRO and the stockbrokers they govern. Furthermore, the complexity of these conflicts could intensify if disparities within the industry grow, leading to SRO’s increased reliance on larger entities for financial support. In the USA, this potential for conflict has prompted recurring concerns, with accusations directed at members of FINRA’s Board of Governors.
Self-regulation was introduced in USA by Congress through the Securities Acts Amendments of 1975. The primary rationale for introducing SROs rested on the premise that with increasing complexity, government regulation would be both cost-prohibitive and inefficient. Furthermore, the SROs, with their specialized expertise, were better positioned to define comprehensive standards of business conduct.
Given that India is a developing nation, the argument for cost-effectiveness may be relevant as funds allocated for regulation could potentially be redirected towards developmental initiatives. However, the applicability of this argument in the current Indian context is somewhat limited. This is primarily due to the substantial role that MIIs play in regulating and enforcing actions against stockbrokers, thereby reducing the burden on SEBI. Furthermore, to ensure effective regulation, a comprehensive framework was issued by SEBI stipulating the powers and responsibilities delegated to the MIIs. Consequently, the financial burden on Indian taxpayers is minimal, as the MIIs generate their revenues from industry-related activities.
While the potential for a conflict of interest does exist within MIIs, more specifically the stock exchanges, due to the juxtaposition of commercial and regulatory interests, the impact of such conflicts is less pronounced compared to SROs. This is because of the demutualized and corporatized structure of the stock exchanges, which ensures that the influence of the stockbroking industry on the regulatory departments is kept to a minimum.
Conclusion
Upon considering the aforesaid aspects, the mechanism presently in force and put in place by SEBI encompasses both cost-effectiveness as well as harnessing of expertise from the industry. While cost-effectiveness is ensured by the delegation of regulatory functions to MIIs, the expertise is harnessed by holding consultations with BISF. Since BISF does not hold the status of an SRO, these consultations offer the dual advantage of leveraging industry expertise while avoiding the potential pitfalls associated with SROs.
Moving forward, it will be fascinating to see how SEBI navigates the delicate balance between investor and stockbroker interests. The test for SEBI is in its ability to draw upon industry expertise and resources, while concurrently maintaining the autonomy of regulatory mechanisms from industry influence.
– Vaishnavi Srinivasan & Philip Oommen