SEBIs Tightrope Walk

The market regulator is trying to strike a balance between what is good for the government and what is good for investors and markets at large. They are often not the same thing.

Aarati Krishnan, Business Line 23/4/2012


Ever since the government began to take an active interest in the stock market, life has been made difficult for India’s market regulator.

The Securities and Exchange Board of India (SEBI) is constantly walking on eggshells, trying to balance between what is good for the government and what is good for investors and the markets at large.

They are often not the same thing.


It started with the government coveting the ‘idle’ cash balances of PSUs. Taking stock of cash held by listed PSUs, the powers-that-be turned chary of sharing all that booty with public shareholders.

Why not have PSUs buy back shares from their promoter alone? – came the bright suggestion. Now, selective distribution of profits by a listed company to its promoters strikes at the very roots of minority shareholder rights. So SEBI was forced to scotch this plan.

But it did come up with an alternative. In January, it quietly tweaked its share buyback rules to say that, if one set of shareholders don’t participate fully in a buyback offer, the company could mop up more shares of others.

Now, what this means for retail investors is that if they fail to tender to a buyback offer, the promoter may avail more liberally of it. Isn’t this convenient for PSUs which launch buyback programmes?

Then, there was the problem of the lacklustre primary market, which made it very difficult for the government to offload its stakes in listed PSUs. With retail investors plainly disinterested and foreign institutions barely participating, how could these offers be pushed through?


Promptly came SEBI with the idea of fast-track offers for sale and institutional private placements — two new routes that allow promoters to sell their shares without having to reserve quotas for retail investors.

Age-old procedures for follow-on public offers — offer documents, detailed disclosures, price discovery through book-building — were dispensed with.

So was the ideal of broader ‘public participation’.

Instead, listed companies were allowed to put through quick ‘sales’ to select (domestic) institutions.


However, the latest regulatory move, where the government’s priorities are at loggerheads with investors’, is the Rajiv Gandhi Equity Savings Scheme. This scheme, mooted in the Budget, is the government’s brand new idea to revive retail participation in the stock market.

The scheme is yet to be notified, but details trickling in so far indicate the following:

Retail investors are to be wooed into stock markets through a tax exemption on their initial investment. Open only to those who earn an annual income of up to Rs.10 lakh, this scheme will provide an upfront tax exemption of 50 per cent on investments of up to Rs.50,000 in equities in a year.

Only first-time investors are eligible. Investors would need to open a separate demat account to participate in the scheme.

Brokers may be asked to provide ‘no-frills’ demat accounts, carrying zero upfront charges and annual charges of less than Rs.500, to encourage small investors to sign up.

The investments would carry a minimum lock-in period of 3 years. Recent reports suggest that it this could be reduced further, to one year.

Only PSU stocks or the top 100 companies may be eligible for this scheme.


Now, many of these proposals militate against what is good for retail investors and the long term interests of the stock market.

To start with, if one must lure first-time investors into the stock market (and why they should not be allowed to come in at their own pace, is not clear), direct equity investing is hardly the vehicle to do this.

Direct bets on equity, even the top 100 stocks, are not for the casual investor. In these days of high uncertainty, stock portfolios require careful selection, close monitoring and prompt action to deal with the many regulatory and business risks that hit companies with alarming regularity. For first-timers, routing the money through diversified mutual funds would be much better. That would also allow an investor to deploy money in equities in a phased manner through systematic investment plans. A lumpsum bet on stock markets can deliver poor returns, if the timing of entry is wrong.

Two, the heavy tax breaks offered may tempt the wrong sort of investors into putting money in stocks. If a retail investor is to stay on with equities, he must be comfortable with the risk that comes with it – that of capital erosion.

The upfront tax breaks may prompt risk-averse investors to take on equities unsuitable to their portfolio.

Same argument for the ‘no-frills’ demat account. If a person can’t afford the upfront charges on a demat account, must he be investing in equities in the first place?

Three, to sustainably increase retail participation in the stock market, investors must have a good return experience.

With boom-bust cycles in the Indian stock market typically lasting for three years, a person may need to hold on for five years at least to earn respectable returns. Investments with a 1 or 3 year horizon are likely to leave investors disappointed.

Finally, the main problem with the Indian equity market is that it already has too many short-term investors. It has taken a pretty long time for the Indian mutual fund and insurance industry to convince retail investors that equities are rewarding only if held for the long haul. Must we undermine this message?

SEBI has in fact been propagating precisely this, in its own communications to investors. ‘Don’t dabble directly in stocks if you don’t have the expertise. Use the mutual fund route and hold for the long term.’

But then, encouraging retail participation through the mutual fund route doesn’t help the government’s share sale plans. And now that it has made it clear that it wants direct retail participation, SEBI may not have much choice. It may have to step up to the plate and come up with a sub-optimal solution, yet again.


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