Jalan Panel Disrespects Parliament

Economic TImes, 15/12/10

Surprisingly, no one has commented yet on how insulting it would be for the Indian Parliament if the recommendations of the Jalan committee report are accepted by Sebi and enacted as Sebi regulations, in effect overruling statutory law.
The recommendations contradict several provisions and the entire philosophy of a previous committee headed by a former Chief Justice of India M H Kania (the Kania report) which counted stalwarts such as a former chief justice of a high court, Y H Malegam and importantly, no Sebi official.

The Kania report was accepted by Sebi and by Parliament, which extensively amended not only the securities laws to enable corporatisation and demutualisation, but also gave a special tax exempt dispensation to various entities. Sebi has publicly supported the Jalan report prematurely, even though it is still under a period when Sebi is seeking public comments on the recommendations.

Profits are evil: The Kania report accepted by Parliament mandated 22 not-forprofit exchanges to become for-profit by amendment to the Securities Contract (Regulation) Act (SCR Act). Now in a flip-flop , the Jalan report recommends stock exchanges to generate only ‘reasonable’ profits.

Reasonable has been defined as something over government securities’ return. The recommendation raises the false bogey of profitmaking entities being somehow inferior. The NSE as a profitmaking entity has consistently evaded scams but the BSE prior to corporatisation (as a charitable organisation) was involved in several scams.

Restriction on profitability will mean that no further investment will result in the sector and investors who invested Rs 10,000 crore based on the statutory amendment will not only lose a bulk of their investments but will have a share with the returns of debt (capped) and the risk of equity (possibility of losing all).

Listing: The Kania report recommends that a demutualised stock exchange may list its shares on itself or on any other stock exchange, though listing should not be made mandatory. The Jalan report recommends that listing should be prohibited because, “An MII (market infrastructure institution) should not become a vehicle for attracting speculative investments. Further, MIIs being public institutions, any downward movement in its share prices may lead to a loss of credibility and this may be detrimental to the market as a whole.”

This is an amazing conclusion. On the one hand, listing is so important for the economy that its market is called a public utility; at the same time, it is so horrible that exchanges can lose their credibility by being listed. The Jalan report thus results in the official implementation of hypocrisy that listing is good for all companies but is bad for exchanges. It is loss of credibility which causes fall in share price and not the other way round — the mirror doesn’t cause us to be ugly.

Further, the recommendation would result in poor governance, lack of accountability to shareholders and lack of transparency. Ceiling on ownership: The Jalan report suggests a ceiling of 5% on the equity shareholding (including warrants and other ‘value’ instruments) and allows only public financial institutions and banking companies with a net worth of at least Rs 1,000 crore to invest up to 24%. Interestingly, the report contradicts its own annexure (by misquoting it) by saying an ownership cap is the international standard.

In fact, the report’s own annexure shows that India is the only country in the world with an ownership cap. In fact, none of the countries listed in the annexure even has a voting cap. Other countries in the world only have disclosure standards or permission for crossing a limit to ensure fitness of such shareholders.

THE Jalan report seeks to give special status to banks and public financial institutions as anchor investors with around five times the shareholding permitted to others despite the fact that both JPC reports on stock market scams have implicated banks and public institutions for actively participating in the biggest financial scams in independent India.
One chapter of the 2003 JPC report is devoted to the role of banks and seven chapters of the report is devoted to UTI. In any case, banks and FIs are passive investors and invest for returns rather than for charity — given the cap on profit, it would take a very charitable institution to invest in an exchange.

The cap on ownership for others means there is no interest in setting up a new exchange as the promoter cannot own over 5% equity in an exchange. I have written an open letter to the Jalan Committee in this paper (ET, 12 May 2010) explaining why this cap is perverse.

Competition: While the Kania report recognised the need for stock exchanges to cope with competition and hence recommended demutualisation, the Jalan report actively recommends that Sebi should discourage competition, and that it should choose how many players should be allowed in the exchange space. “Sebi should have the discretion to limit the number of MIIs operating in the market, in the interest of the market and in public interest.”

Besides reminding one of an A Raja kind of allotment of 2G spectrum, this is an anti-competitive recommendation contrary to the Competition Act, 2002.

Executive compensation: The Jalan report introduces a recommendation on the remuneration of top management of stock exchanges to be a fixed sum without any variable component linked to the commercial performance of the stock exchange. This recommendation lays the foundation for destroying performance in exchanges which cannot incentivise their management (specially in a growing or struggling exchange).

What the market needs is more competition and better regulation rather than less competition and outsourced regulation. The Jalan committee takes us back not just in time but to the Soviet philosophy of 1970s. I hope that the readers of this column, unlike the committee, do not welcome the world of 1980s phone lines which also carried the public utility tag and an eight-year wait in public interest, or the choice of Ambassador and Fiat cars with a 10-year queue — in the national interest. Viva public ‘service’ death to profits.

(The author is of Finsec LawAdvisors. The firm has advised exchanges and its investors on the impact of the report.)

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