Primary markets should have a separate category of mutual funds

DC Patwari

Events in the capital market during the past decade go to show that the system in India lacks accountability. Every time a scam or colossal misuse of system surfaces, there is a talk of cleansing the system and bringing the culprits to book. Tragically, after a few years the same ugly scenario resurfaces with a vengeance, though in a different form. Today, things have come to such a pass that people’s confidence in the capital market system stands shattered, but the system buffeting it continues unabated.

The idea behind having an efficient capital market is to mobilise as also channelise the savings of people for industrial and other developments in the economy. Such mobilisation of savings is achieved through public issues, which is known as the primary market. Whereas promoters get funds for industrial and other projects through the primary market, the secondary market facilitates not only the development of the primary market by providing liquidity and capital appreciation, but also provides an exit route to investors after making profits.

There is no dispute about the fact that funds for industrialisation and growth in the economy are made available by the primary market. Unfortunately, the state of the primary market in the country today is pathetic. The last five years have not seen any major public issue, except some media and technology issues which are also being sold below their issue price.

The secondary market has also become volatile. It has become so unpredictable that investors are fast losing confidence in it. It has become synonymous with betting in cricket matches. Most of the equity mutual funds are also showing negative trends. Having suffered serious setbacks from public issues or the secondary market, mutual funds or deposits with finance companies etc, the only option probably left with the investor today is to keep his savings in fixed deposits with the banks. Even this option looks vulnerable in the context of the recent spate of reports about Madhavpura Co-operative Bank Ltd.

The need of the hour, therefore, is to immediately restore people’s confidence in the capital market system, more so in the primary market. This requires radical thinking, transgressing the boundaries of the present system. The efforts of governmental authorities or regulators or the players in the market have failed to make any dent in this direction because there is no built-in accountability in the system. This seems to be the only way in the present scenario to revive investor confidence in the capital market. The immediate task at the level of regulators and authorities should be to draw a foolproof system that will deliver even in extreme circumstances. Here are some suggestions that can help change the face of the capital market and restore investor confidence.

In the good old days, public issue prices were determined by the Controller of Capital Issues. But since the past 10 years, we have a system of free pricing. This has given birth to fly-by-night operators tapping the primary market at a huge premium without any investment needs. The freedom allowed in the system of free pricing has been grossly misused and the result is before us—virtual extinction of the primary market. All this has happened because the system lacks accountability.

It is therefore suggested that a system be devised for a separate category of mutual funds, which may be called ‘primary market mutual funds’. These should be allowed to be promoted only by professionals who contribute up to 20 per cent of the portfolio. These professionally-run mutual funds should have an investment portfolio of 60 per cent in primary market issues, 20 per cent in SLR Securities and the balance 20 per cent in the secondary market. Any public issue should first be subscribed by these funds up to a minimum of 25 per cent and the issue price should be arrived at by the book building route. Once these funds have invested a required level in the primary issues, only thereafter its public issue at that price should be permitted. This way, unscrupulous promoters will not be able to cheat innocent investors who will have the benefit of the study carried out by these mutual funds of the primary issues.

The accountability of such mutual funds also has to be ensured by making it mandatory for them to pay minimum 5 per cent return on investment to unit holders, by compulsorily liquidating them the moment their net asset value (NAV) goes below 80 per cent and distributing the proceeds to non- promoter unit holders. Investment by mutual funds in the primary market will not only ensure the genuineness of promoters, but also revive public confidence in the primary market.

The last few years have seen a big boost in secondary market volume. Various innovations such as screen-based trading, demat shares, automated lending and borrowing mechanism (ALBM) and rolling settlements have no doubt improved the efficiency, cost and liquidity in the secondary market. But problems like insider-trading, cartelisation and price rigging have increased, causing heavy volatility in prices, which is deterimental to the interest of small investors.

To tackle these problems a sound investigation and surveillance system, wherein the Securities and Exchange Board of India (Sebi) collects details of daily transactions in shares above some limit from all brokers, including their clients, and shares it with the Income-tax Department as also the Reserve Bank of India to monitor that unscrupulous operators do not indulge in any kind of price manipulation, has to be in place.

This may have a negative impact on the volume of trading in the short run, but will definitely bring fairplay in the market. Besides this, all stocks should be brought under rolling settlement. Risk management techniques, such as index futures and options, should be enocuraged for both hedging and speculation. Sound risk management tools with accountable capital market system can bring investors back to the capital market which is the backbone of real growth in economy.

(The writer is Joint Commissioner of Income-Tax. The views expressed here are personal)