SEBI at 25

Economic Times, 24 May 2013

SEBI is an important story in India's search for sound public administration. SEBI was and remains a unique independent regulator, featuring design elements which were not done before or after. It played a key role in a big achievement of economic reform in India: the the equity market. The tumultuous experiences from SEBI -- both positive and negative -- have generated our learning of financial policy. We are now ready for the next stage: the Indian Financial Code under which there will be no SEBI.

SEBI was founded by Surendra Dave and a small team from IDBI in 1988. This team drafted the SEBI Act and designed an organisation. Four long years went by, and the fixed income and stock market scandal of 1992 prodded Parliament to enact the SEBI Act. This teaches us three lessons. To achieve transformative change, we have to change the laws. We have to build capability inside a non-statutory institution before the law is passed. We have to be ready with a fully articulated program for reform ahead of time, for a crisis is a terrible thing to waste.

With G. V. Ramakrishna and C. B. Bhave, SEBI gave intellectual leadership to the transformation of the equity market. Stories of the erstwhile BSE are simply alien to us today. New institutions -- NSE and NSDL -- pioneered the transformation. Regulatory and supervisory strategies for dealing with unruly private financial firms were setup -- which have to be quite different when compared with the cosy dealings between government and PSU firms.

There was a tremendous battle of interests. The old BSE members stood to enjoy rents from perpetuating the old ways, but that arrangement was not good for the people of India. Over the 1994-2001 period, this story played out and the outcomes were remarkable.

SEBI was the first time in India that a meaningful establishment of a regulatory body took place. This required numerous amendments to the SEBI Act and to the Securities Contracts Act. SEBI issues regulations which have the status of law. It investigates offences (an executive function), and writes orders (a judicial function). Appeals against SEBI orders go to SAT, which shaped up as a high quality tribunal. This forced SEBI to start writing reasoned orders -- which is much more work, but forces better analysis.

SEBI deals with modern market arrangements: with mutual funds (where private and foreign firms have free entry, where the old PSU monopoly has been altered sharply) and FIIs. A rich ecosystem has developed: with participation by individuals and securities firms from all over India, and mutual funds with free entry, and foreign firms present in both the securities industry and mutual funds. The achievements in financial reform here dwarf the rest of Indian finance. With the success of the equity market, India looks like a good financial system among emerging markets; if this had not happened then India would have looked like a bad financial system among emerging markets.

Alongside these positive achievements, SEBI has also been a lab where we have understood how things go wrong. The quasi-judicial process within SEBI is a troublesome mix of prosecution and judge.

The objectives of SEBI were not adequately defined, and it has frequently pursued quirky objectives or succumbed to lobbying. The flow of regulations is of spotty quality. The temptation to do central planning -- that is rampant elsewhere in Indian finance -- has not been purged at SEBI. SEBI regulations are law -- but the process through which regulations are drafted leaves a lot to be desired. Neither regulation-making nor post-mortem analysis of regulations is shaped by evidence.

The appointment process and terms of appointment of members and chairmen has been messy through the last 20 years. Allegations of corruption by SEBI staff are frequently heard. The accountability mechanisms that envelop SEBI are quite poor. Extreme crises have prodded change, but an everyday feedback loop is lacking. Even though the SEBI board has considerable power in recruitment and HR policies, the organisational capability leaves a lot to be desired. This suggests difficulties in accountability mechanisms, in the functioning of the board, and the board composition.

The sectoral boundaries that define SEBI -- equity market, mutual funds -- have shaped up as a major design flaw. A unified treatment of all organised financial trading, and of all financial firms, is required.

In summary, over the last 25 years, SEBI was at the crucible of progress in Indian finance. When we started, there was no sensible finance in India; SEBI and the equity market are the laboratory where we learned how to do finance. The highest achievement of SEBI is that the learning from its strengths and weaknesses have guided the Indian Financial Code, and when this is enacted, the SEBI Act and SEBI will be no more.

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