Jun 07

Restrospecting 25 Years of SEBI

SEBI is an important story in India’s search for sound public administration and it 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 equity market.

Formed by the Government of India in 1988, under the leadership of Mr. S.A. Dave, then Executive Director, IDBI, the Securities and Exchange Board of India (SEBI) got statutory powers after the SEBI Act was passed by Parliament in 1992. It was the year in which Rs. 5,000 crore Harshad Mehta securities scam hit Indian stock markets and this fixed income and stock market scandal finally prodded the Parliament to enact the SEBI Act.

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.


In the pre-SEBI days, capital market regulation under the Securities Contracts Regulation Act vested loosely with the Controller of Capital Issues, functioning directly under the Ministry of Finance.

Until the SEBI and the Insurance Regulatory and Development Authority (IRDA) came into being, regulation in those areas was slack, and the RBI, because of its sheer stature, was presumed to have the final say in all matters, even those not directly connected to its core areas of banking and monetary policy.

But since inception, the regulator has played a major role in cleaning up India’s equity cash market, established a modern equity derivatives market, and transformed the primary market through better processes and making the large shift from merit-based approvals to disclosure-based regulations. Besides, it has put in place clear and effective rules (well, mostly) for the segments it regulates. As a result, for instance, participation from foreign institutional investors has grown steadily over time, the takeover process is streamlined, and instead of having one large, malfunctioning mutual fund in the pre-SEBI days, India now has a well-regulated mutual fund industry.

In short, the securities market has gone through a sea change in the 25 years of SEBI’s existence. It has had seven chairmen so far excluding the incumbent U. K. Sinha.


Twenty-five years are a relatively short period to evaluate a financial sector regulatory institution. The SEBI is considerably junior in age to the Reserve Bank of India (RBI), which has, for a long time (78 years almost), been identified with the financial sector regulation in this country.

Most regulators have a typical life cycle—in the first few years, they are incompetent and clueless. They then get their act together through hard work and creative thinking, leading to some malpractices getting stooped and processes falling into place. As regulators mature, there’s nothing much original left to do, resulting in a highly conservative and bureaucratic organization. SEBI has largely followed this life cycle and has now reached a mature phase where it is left mainly with the extremely painful and thankless job of enforcing regulation.

SEBI ought to be evaluated on different yardsticks — as the circumstances under which it came into being, early handicaps it had to overcome in regulating well-entrenched entities like brokers, some of them, when SEBI came into being, were already more than 100 years old.

Stories of the erstwhile BSE are simply alien to us today. 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.

SEBI pioneered the transformation through experimenting new institutions successfully – NSE and NSDL. Regulatory and supervisory strategies for dealing with unruly private financial firms were setup – which have to be quite different when compared with the cozy dealings between government and PSU firms.

As a new regulator, SEBI had to start from scratch; there was nothing comparable to it before. One of the important handicaps the institution faced — and in many ways continues to face — is in recruiting and training qualified manpower. While its heads, drawn from the highest echelons of the government and public financial institutions, were people of high calibre, it is at the middle levels that the new regulator has faced major problems.

The tumultuous experiences from SEBI – both positive and negative – have generated our learning of financial policy. Here is a look at SEBI’s top achievements, major controversies and key challenges.


Dematerialization of Shares: The market regulator introduced dematerialized holding of shares and securities after the Depositories Act was passed in 1996, which did away with physical certificates that were prone to postal delays, theft and forgery, apart from making the settlement process slow and cumbersome. This also prevented the issue of fake share certificates floating in the market. It enabled electronic trading, with investors and traders even able to work from home.

Faster Settlement Process: SEBI is credited with quickly moving from a T+5 settlement cycle in 2001 to T+2 in 2003. Demat, T+2 settlement and the development of electronic markets are major achievements and we were ahead of several markets in all these fronts. With T+2, we are still ahead of the Western markets. The regulator is currently looking at reducing the settlement cycle to T+1, enabling investors and traders to take positions faster.

Stronger and Clearer Regulations, Orders: In the early years, powerful brokers’ lobbies controlled share price movements and could afford to ignore SEBI. SEBI has created fear and respect in the market, both among domestic and international market intermediaries. The quality of orders has improved materially over the past 25 years.

Recent instances of this include the orders against two Sahara group entities that were upheld in the Securities Appellate Tribunal and the Supreme Court and the case of front running by HDFC mutual fund.

Fostering Mutual Fund Industry: While the Indian mutual fund industry has grown manifold from being a monopoly until the early 1990s—when Unit Trust of India, set up in 1964, was the only game in town—their reach remains low outside India’s top 20 cities. SEBI has taken several steps to increase the popularity of mutual fund products and prevent mis-selling of products by distributors.

One of those steps is banning entry loads for mutual fund schemes in 2009, as investors would now only voluntarily pay the distributor for advisory services. Another initiative was relaxing ‘Know Your Customer’ (KYC) norms for small investors and widening the distribution network in rural India by roping in postal agents.

Foreign Institutional Investors: The Indian equity markets were opened to FIIs, in 1993 and they are now the key driving force behind stock movements. FIIs investment ceiling was raised to 49% in March 2001 while the dual approval process for FII registration, by the RBI and SEBI, was scrapped in 2003, when they came under the remit of the capital market regulator. Since 2004, SEBI has been consistently revising the FIIs investment limit in both corporate as well as government debt.

While the chunk of foreign money came in through offshore derivative instruments such as participatory notes (P-notes) where the identity of the end beneficiary is not traceable, SEBI has been consistently pushing to encourage holders of such securities to enter the market as registered FIIs.


ULIPs: In 2010, SEBI issued show-cause notices to a dozen life insurers and asked them to stop introducing unit-linked insurance plans, or ULIPs, without its permission as these hybrid insurance products mimicked mutual fund schemes that are regulated under SEBI’s collective investment scheme, or CIS, norms. The order gave rise to a battle between the capital markets regulator and the insurance regulator—Insurance Regulatory and Development Authority, or IRDA. The President of India had to pass an ordinance amending the CIS norms and keeping ULIPs under IRDA. Subsequently, IRDA went on an overdrive for a complete makeover of ULIP regulations.

Mutual Funds: In August 2009, soon after the panel headed by Dhirendra Swarup recommended abolishing agent commission for distribution of financial products, SEBI ordered scrapping of entry fees in mutual funds. The move was criticized by the industry and legal experts and the order forced thousands of mutual fund advisers to sell other products that offered better incentives, resulting in stagnation of assets under management.

Participatory-Notes: In October 2007, in the wake of an appreciating rupee, SEBI proposed to curb issuance of participatory notes (P-notes), a favourite investment route used by FIIs. SEBI was concerned about the quality of money flowing into India through P-notes but many say it was an attempt to curb excessive dollar flows. The BSE’s benchmark Sensex crashed 1,700 points the very day after the announcement and it led to suspension of trading for an hour. The crash forced the finance minister to clarify that the government was not against FIIs and there would be no immediate ban on P-notes.

Sahara Case: In November 2010, SEBI barred two Sahara group firms from raising money from the public in any manner, citing violations of capital-raising norms. Another directive followed in June 2011, asking Sahara firms to return money to investors with 15% interest. This marked the beginning of a legal battle between the regulator and the company as the latter argued that since unlisted entities were raising funds, SEBI has no jurisdiction over them. The case was heard in the Securities and Appellate Tribunal and later went up to the Supreme Court, which directed Sahara to refund the money.

MCX-SX: In a bid to ensure compliance of exchanges with market infrastructure regulations, SEBI got into a bitter legal spat with India’s newest stock exchange MCX-SX in 2009. The regulator fought a three-year long battle with the promoters of the exchange, alleging the latter violated norms by attaching put options in its share purchase agreement with investors and not following permissible routes for capital reduction. Later, MCX-SX was given a licence to start equity trading and given three years to reduce promoter holding in the exchange.


Enforcement Processes: Despite statutory powers on par with a civil court, SEBI hasn’t made much headway when it comes to enforcement. The regulator needs to engender greater confidence among investors and display greater consistency when it comes to enforcement of laws.

Some violations are ignored or go unnoticed due to the regulator’s limited access, insufficient resources or government intervention. SEBI should shed the image that big fish are spared and only small fish are caught. This is the worst allegation against SEBI. This does not mean catch big fish without any case and ultimately lose in SAT (Securities Appellate Tribunal).

In recent months, the regulator has been seeking to strengthen insider trading norms, expand its presence through branch offices, work with police and local enforcement agencies, improve corporate governance norms and boost control over deposit-taking firms.

SEBI should focus on clarity. Regulations on investment advisors and collective investment schemes are very vague even in their fundamental scope and coverage.

Deepening Capital Markets: SEBI needs to deepen the capital market. It has taken several measures to widen the scope of investment for all categories of investors—retail, corporate, foreign institutional investors and high-networth individuals in capital markets. The number of retail investors and the share of household savings flowing into the capital market haven’t risen by much. In real terms, the amount of resources raised through public issues is less nowadays than it used to be in the 1990s.

To create an equity culture, SEBI has simplified mutual fund investment norms; abolished mutual fund entry loads; eased investment norms for initial public offerings (IPOs) and other public issues; unified Know-Your-Client (KYC) norms; simplified disclosures by companies to help investors take informed decisions and most recently issued a discussion paper to introduce a mandatory safety net for retail investors in IPOs.

SEBI should work on deeper participation in equity by pension, superannuation and gratuity funds, developing a vibrant retail debt segment and reducing the cost of transactions drastically to improve investment markets in India.

SEBI needs to indemnify the fraudulent loss of investors. An investor, losing any money for whatever reason, except for market loss or his own negligence, and not compensated by the negligent or defrauding party or from the investor protection funds, must be indemnified.

Corporate Debt and Securitization: Despite numerous working committees and liberalization of listing and trading norms for debt securities, this remains unfinished business. Perhaps the most significant development on the corporate bond market was the migration from physical certificates to dematerialized holdings in 2000. This improved debt market volumes to an extent then but failed to attract sufficient liquidity in the following years.

Even after allowing the trading of interest rate derivatives on exchanges and the listing of securitized debt papers recently, the regulator has not been able to do much to create a liquid and efficient corporate debt market and these largely has remained part of the over-the-counter, or OTC, market.

Matching up to Global Standards: With the capital markets growing rapidly, regulators need to keep abreast of global standards. Key areas to focus on are establishing self-regulatory organizations (SROs), a better and transparent consent order mechanism, and rules over market intermediaries.

SEBI is just too small to regulate such large industries as distributors, investment advisors and sub-brokers, not to mention Ponzi schemes. An SRO like the Financial Industry Regulatory Authority of the US, overseen by the SEC, creates and enforces rules for members based on the federal securities law. An independent SRO that creates and enforces routine regulations gives the regulator time to focus on bigger issues. SEBI has started moving in this direction and recently notified regulations to set up an SRO for the mutual fund industry. It needs to extend this to other products and services.


The market regulator continues to face challenges in enforcing rules, some markets such as corporate bonds and interest rate derivatives are yet to take off, and while the exchange-traded markets seem liquid, many of them lack depth.

But this doesn’t at all suggest that what SEBI has achieved isn’t praiseworthy.

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.

And just as how the regulator has in the past been energetic and creative in setting right the equity cash and derivatives markets; it must pursue the formation of other markets, similarly, tackling the issue of market depth means getting the critically important government-run pension funds to invest in equity markets. Besides, doing away with the distortive securities transaction tax and regulating collective investment schemes effectively will first require clear regulations from the government.

It can find motivation from its own history—as an example, replacing the badla market with a modern equity derivatives market involved battles against powerful and entrenched market participants and steering changes in law through the parliamentary process.

Of course, the list of “to-dos” mentioned is not exhaustive. For instance, there’s a lot to do in the area of investor education; depth in most markets needs to improve. In sum, however, both SEBI and policymakers must reject the premise that all is well the Indian securities market. While SEBI has done well, thus far, there’s more left to be done.

In summary, over the last 25 years, SEBI was at the crucible of progress in Indian finance. When it started, there was no sensible finance in India; SEBI and the equity markets are the laboratory where India learned how to do finance.

Overall SEBI has done a decent job with some hits and misses and some failures, but what we need is a complete relook at financial sector legislation. Indian policy makers, learning from SEBI’s strengths and weaknesses, have guided the Indian Financial Code, and when it is enacted, who knows what will be the fate of SEBI and SEBI Act.