Opinion Note to Sebi: we’re not so special

The Jalan report on ownership of stock exchanges is flawed on so many counts that it is hard to imagine that anything more could have been added to the report to ensure that it should and/or will be rejected in toto. It is reasonable to speculate that this was perhaps the intention of the eminent committee. Why that might have been so will perhaps be debated over the ensuing months.My purpose here is to demonstrate the assumptions and logical flaws in the report. The overriding theme of the report is that India is unique. In olden days,the view was that “India was incomparable”. In 1985,some six years before the introduction of far-reaching economic reforms,looking out from the highest rooftop in Hong Kong,the area surveyed exported more than three times as much than all of India’s $12 billion. We excused our miserable performance by alleging that Hong Kong was a city state; China in the same year exported $30 billion,but it was a communist state,and so on. Twenty-five years later,the Jalan report makes the same wrong assertion that India is unique.There are two legs to the Jalan report. The first leg pertains to the assertion that policy on ownership and governance of stock exchanges in India in 2010 needs to incorporate the lessons from the great global financial crisis of 2008-09. If the report is to be believed,India escaped the crisis because of its hugely effective regulatory framework embedded in the RBI and Sebi. Factually,in the more than 200 countries that exist in the world,only a few large western economies had a banking crisis — there was no stock exchange crisis in the entire world,and no banking crisis in any developing country,or even developed economies like Australia,Canada or Japan. The natural conclusion,to most neutral observers,is that the financial crisis of 2008-09 has nothing whatsoever to do with regulations pertaining to banks or stock markets,and even less to do with the ownership regulations of stock exchanges. Previously,India was unique because well,we are like that only. Today,we are unique because we weathered the crisis when “no one else” was able to! Even more remarkable is the report’s conclusion that financial institutions like commercial banks are the best guardians of safety of stock exchanges. The fact that nearly all of the financial crises in the world have been caused by banks is lost on the authors. The apne pair pe kulhadi logic of the report continues with its assertion that a stock exchange is a public utility and needs to be treated as such. As we all know,a utility exists when there are externalities,but the report is more than inconsistent in its assertion that stock exchanges should be “viewed more as institutions which are suppliers of an indispensable public good for modern society”. Water and air are more indispensable public goods but we have no regulation on the ownership pattern of Pepsi or Tata Motors. The point about a utility is that there are large barriers to entry and/or last mile connectivity. It is understandable that a bank has some of a public good function,and certainly considerably more than a mere arena where speculators can support the price discovery process. In the few meetings that the committee has had with the public,the authors have reiterated the mantra that stock exchanges need regulation. But there is no one on this planet,let alone India,who says that exchanges do not need regulation. However,where the report errs hugely is in not recognising that technology has changed enormously in the last 20 years. This technological change now makes it almost trivial to identify any “wrongs” done by an exchange. Today,the regulator — Sebi — knows the origin of each trade,whether the trade is in the nature of circular trading,whether margins have been deposited,and even has algorithms to detect insider trading. Precisely because of this technological change,and the conflict of interest inherent in the operation of a stock exchange,most mature stock exchanges,and most mature regulators,approve of and encourage the setting up of an independent regulatory firm or firms. These firms are much like credit rating agencies,and yes,such agencies had a role in the latest financial crises. From that it does not follow,as the report seems to infer,that the only way to have an error-free credit rating agency is for it to be owned by the government or for it to be deemed a “public utility” whose profits are curtailed,whose management salaries are capped,etc,or whose ownership pattern does not allow a single investor to own more than 5 per cent of the company! Regulation or laws cannot eliminate scams or fraud or murder — and nor does a strong government role encourage governance,and nor does low individual ownership encourage or discourage good or bad behaviour. The report is left without any arms or legs with its final recommendation regarding the false uniqueness of India (as illustrated above,this recommendation does not logically follow anyway from any of the evidence,heuristic or otherwise,presented in the report). It argues against the listing of a stock exchange. Even in India it is recognised that a necessary,though not sufficient,policy for ensuring corporate governance is that a stock exchange be listed. One needs listing not to satisfy some investors — that argument is one among many obfuscations by the report’s authors. Listing is required so that an exchange is answerable to the public and not just to a friendly,or unfriendly,regulator. To argue against listing is the financial equivalent of stone age economics. It is revealing that the chairman of the report,Bimal Jalan,has disassociated himself from the no-listing recommendation.There is a vision of Indian financial markets,shared by most market participants and the authors of the report,that the future of India involves Mumbai as a major financial centre of the world. That is what the government,and the regulator,should be making policy about. That involves competition among the various participants,and stock exchanges. Let there be competition; and competition cannot be ensured if onerous ownership restrictions are imposed. By endorsing the outdated and egregious restrictions/recommendations of only one earlier Sebi report,the Jalan report is left with no legs,no arms,and most importantly,no soul.

Research on Indian financial markets at Oxus Investments is being equally funded by both MCX and NSE. An independent paper I wrote,‘Stock Exchange Ownership in India — Rules,Regulation and Policy’ is available at http://www.oxusinvestments.com

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The writer is chairman of Oxus Investments,an emerging market advisory and fund management firm