Time the regulatory system woke up

Market imperfections happen. The crying need is an anchor for leadership

DN Ghosh

The recent happenings in the capital market have put the regulatory agencies on the firing line. The primary target is the Securities and Exchange Board of India (Sebi). Its chief, in the defence of his organisation, has put a counter-question to his critics: Has the recent crash in Nasdaq raised any doubts about the credibility of the Securities and Exchange Commission (SEC)?

This is a difficult question to answer. Euphoric bubbles and traumatic busts are endemic in a free-market system that is driven by the assessment and expectations of millions of investors. The chief of the US Federal Reserve, the guardian angel of the market, has been struggling with a tough dilemma: How and when to curb “irrational exuberance” but not stifle the spirit of free markets. Simultaneously another set of concerns haunts the other regulatory watchdogs: The market dealings have to take place with fairness and equity with no manipulative price distortion. That responsibility rests primarily with the SEC and it seems to have come out untarnished so far.

The market perception here is that a large part of the unusual volatility in stockmarket prices is attributable to manipulative price rigging by market operators, all of which could have been avoided had Sebi exercised greater vigilance. To be fair to Sebi, it has, over the past few years, taken several initiatives to widen its regulatory reach and lay down the rules of the game. More particularly, the modernisation of exchanges has made a qualitative difference to the speed, efficiency and transparency of transactions. All this notwithstanding, there persists an uneasy feeling that recalcitrant market operators succeed somehow to escape the regulatory net.

The penal measures announced of late, in quick succession over the last few days, and that too in respect of violations that took place some years earlier, are being interpreted by critics as rearguard action by Sebi to regain its lost credibility. Quality of surveillance and speed of enforcement are the intellectual capital for any regulating agency, giving it the respect and authority it needs. Critics today are unrelenting: when the regulator appears denuded of credibility and perception of competence, little merit is seen in improvised clever packaging.

The ambience in which capital markets function has a large determining impact on the degree of success for its regulator. Sebi, it must be conceded, has had a run of several frustrating experiences in enforcing its mandate. The broking community does not work in isolation; they work in tandem with powerful business groups, many of whom are reported to be in close alliance with the political class. How else, can one explain the near defiant attitude of many of the prominent members in this community, clinging tenaciously to their incestuous club culture. The failure in changing the governing structure in a few exchanges is a classic instance of regulatory forbearance, for which Sebi and government have their own share of responsibilities.

Two observations on the way market expectations are managed by the business groups and their accomplices: It is a sight to see a new breed of market analysts, turned by the media into farsighted seers and sources of wisdom, forecasting share prices. Independent analysts are an endangered species today.
Second, the daring brokers are joined in by the heroes of the credit market, with money and stock markets no longer segregated. Today the stock market has become a subset of the power and profit driven ambitions of big business and their house-brokers, foreign and domestic. In this ambience while regulators are targeted for their failings, the invisible hands guiding the market movements remain shrouded in secrecy. Market operators are always ahead of regulators; their strategies are cleverly adapted to the ground realities of each institution, taking advantage of its organisational weaknesses, the deficiencies of its risk management systems and the absence of systematic and continuing coordination among the different institutions and regulatory agencies. The recent happenings has highlighted in no uncertain terms that no single regulatory agency working in isolation can ensure integrity of market operations.

The strategies of the regulators have to match those of the operators. Today the regulatory structure is designed for segmented activities, with each regulator responsible for its own allotted turf. With the market activities getting increasingly interlinked and with the blurring of lines between different credit and financial institutions, regulatory overlaps are becoming far too common; of far more serious concern are the regulatory gaps, a kind of no-man’s-land, that crop up from time to time. We have situations when the agencies engage in unseemly battles to stave off intrusion into their “own” territory. On occasions, they are blissfully unaware of the destabilising implications of the transactions that pass through their hands. Such regulatory confusion is a standing invitation for unscrupulous operators to beat the watchdogs.

Our regulatory system has to be made to wake up. Plugging one loophole after another, as it surfaces, has its limitations. We need to recognise that the increasing sophistication of the market and its instruments, coupled with and the emergence of powerful interest groups in the deregulated ambience, there has to be far greater sharing of information on a real time basis and harmonising of supervisory practices. We need to move forward and set up a transparent institutional mechanism for a continuous evaluation of regulatory gaps and overlaps in the money, banking, credit and corporate institutions. The system needs, if one may use the expression, a kind of anchor for regulatory leadership.

Every market has its imperfections; even the developed market throws up shocking deficiencies though the general standard of compliance and the quality of enforcement are far superior to what prevails in the emerging market economies. No regulation can be foolproof; there will always be sharp operators to skirt round it. There will be lapses but the press and the politicians, in their outbursts of outrage, should not drive the system to irrational panic. That would be the surest way to kill the spirit of enterprise itself.

Mr Ghosh is chairman of Investment Information and Credit Rating Agency (Icra) and former SBI chairman