Securities and Exchange Board of India (SEBI) and Capital Market Reforms

Let us make in-depth study of Securities and Exchange Board of India (SEBI) and capital reforms by it.

Introduction:

The Securities Contract (Regulation) Act, 1956 empowers the Central Government to regulate stock exchanges in India.

The Government of India realised the need for an apex institution to regulate Stock Exchanges and to promote an orderly growth of securities market.

The Securities and Exchange Board of India (SEBI) was accordingly set up on April 12, 1988 through an extraordinary notification of the Government of India in the Gazette of India. In April 1992, SEBI was made a statutory body by an Act of Parliament. On January 25,1995, Securities and Exchange Board of India Act, 1992 was amended by an ordinance to provide SEBI additional powers so that it could work even more efficiently.

Objectives of SEBI:

In the securities market, the three parties which operate with vested interests are:

(a) Issues of securities.

(b) Subscribers to securities, that is, investors; and

(c) Market intermediaries.

SEBI aims at the development and regulation of securities market in the interests of investing public and healthy development of capital market.

The main objectives of SEBI may be spelled out as follows:

(a) To safeguard the interest of investors in securities through disclosure of such information by companies issuing securities, that enable the investing public to form a correct perception of risk and returns; and

(b) To regulate the work of brokers and sub-brokers in stock exchanges and to regulate the work of bankers to an issue, underwriters, merchant bankers and mutual funds to check all kinds of shady activities relating to securities market.

Capital Market Reforms by SEBI:

SEBI has effected the following reforms in the capital market in the last some years:

1. SEBI has issued guidelines to Stock Exchanges to make their governing bodies more broad- based. According to these guidelines, the governing body of a stock exchange should have five elected members, not more than four members nominated by the government or SEBI and three or fewer members nominated as public representatives.

2. SEBI introduced the system of registration of intermediaries, such as brokers and sub-brokers. The registration is on the basis of certain eligibility criteria such as capital adequacy.

3. SEBI has framed rules for making the relationship between client and broker more transparent and also for segregating client and broker accounts.

4. The system of periodical inspection of stock exchanges has been introduced by SEBI. SEBI inspected 8 stock exchanges till January 1993.

5. SEBI has advised stock exchanges to amend the listing agreement to ensure that a listed company furnishes annual statements to them showing variations between financial projections and project utilisation of funds made in the offer documents and actuals. This will enable shareholders to make comparisons between performance and promises.

6. SEBI vets the offer document to ensure that all disclosures have been made by the company in the offer document at the time company applies for listing of its securities (i.e., shares and debentures) to the stock exchanges.

7. The offer document of schemes to be launched by Mutual Funds are required to be vetted by SEBI. SEBI has also specified a procedure for calculating and declaring Net Asset Value (NAV) of each Mutual Funds scheme. This would help investors to judge the performance of mutual funds. Mutual funds have also been allowed to underwrite issues, as a part of their investment activity. Regular monitoring of Mutual Funds is undertaken by SEBI to ensure compliance with these regulations.

8. SEBI has brought merchant banking also under its regularity framework. The merchant bankers are required to follow the code of conduct issued by SEBI in respect of pricing and premium fixation of issues.

9. The abolition of the office of Controller of Capital Issues has led to the removal of control over price and premium of shares to be issued. However, companies can approach capital market, only after clearance by SEBI.

10. SEBI has introduced a code of advertisement for public issues for ensuring fair and truthful disclosures. Companies are required to disclose all material facts and specific risk factors associated with their projects while making public issues.

11. SEBI has issued guidelines for the allotment of new issues. According to the guidelines, preferential allotment is to be made to the extent of 20 per cent for the Mutual Funds, 20 per cent for the domestic financial institutions, 24 per cent for foreign institutional investors and 10 per cent for the issuer company’s employees.

The balance 25 per cent is to be issued to the general public. However, 50 per cent of the minimum public offering of 25 per cent of the total issue shall be earmarked for the small investors applying for up to 1000 shares. The unsubscribed portion in either category is fully interchangeable.

12. The practice of making preferential allotment of shares at prices unrelated to the prevailing market price has been stopped and fresh guidelines for this purpose have been issued by SEBI.

13. SEBI has relaxed the guidelines for the issue of bonus shares.

14. SEBI has introduced regulations governing substantial acquisition of shares and takeovers.

15. As a part of the process of establishing transparent rules for trading in stock exchanges, the badla system was banned by SEBI in December 1993.

16. SEBI has allowed Foreign Institutional Investors to have an access to Indian capital market after getting registered with it. SEBI registered 286 foreign institutional investors by the January-end 1995.

17. SEBI has notified regulations for primary and secondary market intermediaries, bringing them within its regularity framework.

18. SEBI has taken several initiatives to promote dematerialized trading in securities through the promotion of the network of depositories. This will eliminate the risks of bad delivery and fake or forged shares. The depositories provide a system to record ownership details of securities in a book entry form without physical handling of securities. Thus, dematerialized trading is paperless trading in securities.

19. SEBI put ban on short sale of securities on June 15, 1998 with a view to containing volatility in share price. It prescribed additional volatility margins (AVM) with effect from July 6, 1998. The daily price band was reduced from 10 per cent to 8 per cent. Weekly 25 per cent band was removed to introduce graded margin system.

20. Derivatives Trading. SEBI has accepted the major recommendations of L.C. Gupta Committee on Derivatives Trading. Under this system, derivatives contracts would be treated as ‘Securities’. The derivatives trading, as trading in Stock indices, would provide investors a hedging instrument to manage risks and help in improving the liquidity of secondary markets in India.

21 SEBI has exempted infrastructure firms from certain norms, while floating a public issue. They would be exempted from making a minimum public offer of 25 per cent of equity, minimum subscription of 90 per cent and five shareholders per Rs. 1 lakh of offer.

22. SEBI has formulated the regulations governing buy-back of shares by Indian companies. Buy-back has been permitted for the purpose of capital restructuring but not for treasury operations.

23. SEBI has given freedom to companies to determine the par value of shares issued by them thereby removing the requirement to issue shares at fixed price value of Rs. 10 and Rs 100.

24. In order to encourage Initial Public Offers (IPOs), the existing SEBI norm for IPO has been relaxed by stipulating “ability to pay” in place of “actual payment of dividend”.

Comments:

SEBI has attempted to introduce improved trading practices and greater transparency in both the primary and secondary segments of securities market in India. These are imperative in the context of Liberalisation, Privatization and Globalisation (LPG) of Indian economy.

The aforesaid reforms in Indian Capital Market would help to build up a strong financial mechanism, to assist the financing of growing private sector in the liberalized environment of business. Since public sector units are also approaching the capital market instead of State Exchequer to get funds for expansion, so these units would also get support from the strong capital market.

Thanks to the regulations by SEBI, the Indian Equity Market has become highly transparent and liquid attracting investors from all over the world. The National Stock Exchange (NSE) is now the third largest in the world in terms of transactions in, a year. However, there has been little progress outside the equity market and the corporate bond market in particular has remained underdeveloped.

The investor base in corporate bonds has remained restricted because regulatory guidelines severely restrict the ability of banks and other financial institutions to invest in corporate bonds. Without development of all segments of the capital market, it will be difficult for India to become a global financial centre. Further, our equity market suffers from a great shortcoming. The frequent changes in stock prices make it quite volatile and therefore risky for small or retail investors.

Therefore, retail investors still continue to invest their savings in traditional mediums like post-office savings, Bank deposits, NSCs and bonds besides traditional commodities like gold and silver. If one were to account for yield or return of investment from these instruments after providing for tax and inflation, they are not good enough to provide adequate returns to the small investors.

A recent survey reveals conclusively that retail investors have been running away from not only the equity market, but also from mutual funds. According to the survey, only 3.5 million Indians – from a total working population of 321 million people under 18-59 years age group-invest in stocks.

Overall, only 7.2 million people invest in stocks, either directly or through mutual funds, which works out to just 2 per cent of the total working population In this context, the RBI data also reveals that only 5 per cent of the total savings finds its way into the securities market including equities, Gilts, MF as against 34 per cent in the USA. In our view, to encourage small investors to invest in corporate equity the problem of large volatility has to be tackled.