By CKG Nair
The market regulator appears to be on a mission to launch new products, purportedly suiting different investor classes. Small-value mutual fund sachets, specialised investment funds — a product between mutual funds and portfolio management services (PMS) — fractional real estate investment trusts, and infrastructure investment trusts, etc. are all the innovations of the Securities and Exchange Board of India (SEBI). It is also reported to be proposing to allow securities-cum-insurance products. Of course, these products will be offered by service providers. SEBI has also come out with new participation modes/tools for retail investors like calibrated and regulated retail algo trading. The regulator’s objective, it appears, is to populate the securities market investment space with a number of products catering to investor classes with varying incomes and risk profiles.
It may be recalled that SEBI has been warning investors, particularly the retail ones, about the growing bubbles and froths in the markets. Particular attention was drawn to the extreme risks taken vis-à-vis derivative products, that too very often using unregulated third-party algos. The creation of products and processes with attendant guard rails could be seen as an effort to attract the growing investing classes (to “democratise the market”) with products having heterogeneous risk-return profiles in a calibrated manner. It is an effort to generate a sort of continuous risk curve, like the yield curves in the debt market. However, SEBI’s endeavour to experiment with specific new products in the market, unlike legally enabling the market to launch product classes like derivatives (futures, options in indices, stock, currencies, interest rates) starting from the early 2000s, raises a few pertinent questions. A fundamental question is whether it is the job of the regulator to actually design a financial product/service. Is it not for the market, the financial service providers, to design and launch them, with the approval/concurrence of the regulator wherever mandated?
The market regulator (and other financial sector regulators) have enabled the service providers through regulatory sandboxes to test/experiment new products and processes and to help innovations. The underlying objective is to help guide the market to develop new products/processes in a controlled environment under the supervision of the regulator. This sandbox approach is an explicit recognition that product/process innovation must come from the market and the regulator would approve launching those products/services that pass the latter’s test/conditions.
The achievement of the SEBI sandbox, however, has been muted. Though the sandbox regulations were initially notified in 2014, they were comprehensively amended in 2020 to make the process easier. Still, responses from the market had been very lukewarm. Four-year data on the status of sandbox applications as on December 26, 2024, available in the SEBI website, shows that from September 2020 to September 2024, out of a total of 13 applications received six had been withdrawn, six were rejected and only one got approved. (On the other hand, the sandboxes of the Reserve Bank of India [RBI] and the Insurance Regulatory and Development Authority of India [Irdai] have received a lot more responses. The RBI sandbox has been particularly active in the payments space, bringing out a number of major innovations in the last few years). SEBI’s newfound enthusiasm to take on the role of a product innovator could be an outcome of the market players themselves lagging behind in terms of innovation. Another issue with the regulator designing products could be the absence of their market test. Ultimately, all those products have to be launched and marketed by the market players, mutual fund houses, PMS providers, or trusts, etc. under the respective regulations and supervision of SEBI. Combo products like securities-cum-insurance features could also unleash regulatory turf wars, akin to that between SEBI and Irdai over unit-linked insurance products approved by Irdai in 2010 — leading to the intervention of the Union government and Parliament, which resulted in amending four legislations to legally fortify a product.
It may also be useful to recall an experiment of the finance ministry and SEBI in 2013-14 to launch a specific product/scheme for fresh retail investors, namely the Rajiv Gandhi Equity Savings Scheme. It failed to take off and was discontinued in 2017. It is a reminder that the market has its own mind and a product may not be successful, even when launched with good policy intentions. It may well be the reason why the service providers themselves are shy in bringing out new products, except in the form of replicating successful ones like the new fund offers by mutual funds. In such a context where the market players are shy in real innovations, the regulator anchoring such roles might create a moral hazard in addition to making the former more reluctant to enter the innovation arena.
This results in a vicious circle. In that sense, the extra effort of the regulator is a reflection of the history of India’s financial market development. Almost every major effort in financial sector institutional and product development had been a state- and/or regulator-led one. State/central governments took the initiative in creating statutory regulators, new exchanges, depositories, clearing systems, etc. The State and regulators have together worked in enabling derivatives and many other product classes.
The need for increasing the depth and width of the capital market by attracting a much larger investor base is an important policy objective. It has profound implications for the Indian financial sector. As such, the regulator extending its efforts in that direction by designing specific products and process may be necessary, though it is an unconventional paradigm shift.
The writer is former member, Securities Appellate Tribunal, and former director, National Institute of Securities Markets.
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