Second thoughts

To what extent should rules be revised in response to the sentiments of the constituents without diluting the original intention of reforms?

Infosys Technologies boss Narayana Murthy recently bemoaned the lack of governance in India. Bureaucracy, he lamented, was out of touch with the changing landscape, and advocated scrapping of the Indian Administrative Service. Murthy is only half right. Governance, or rather lack of it, is just part of the problem. It would be a full-blown headache if the laws framed by our legislators crumble from any assault on them. The most glaring example is the shape of the budget by the time the Finance Bill is passed in parliament. Two recent instances show that the problem stems at the stage when laws are being drafted. The first example is of the revisions proposed in the Direct Taxes Code. The basic premise for a framework was to simplify rules for easy compliance, leading to better revenue collection. Exemptions were proposed to be scrapped altogether or to be taxed on maturity. This was in exchange for a lower tax rate. The code, thus, looked sensible. No sooner was the draft released, various lobbies jumped in with their objections. Investors in small savings should continue to enjoy a tax-free ride, and long- and short-term capital gain needed to be segregated for stability in the markets. Despite indications of a lower tax regime, the proposal to club capital gain with income was met with resistance. Eventually, a revised paper to the draft was released recently, diluting many of the original suggestions including retaining long- and short-term capital gain. It now remains to see how many of these revised proposals undergo a change before implementation. How did this come about? In retrospect, the failure to sell the original version was the inability of the government to give an assurance on personal tax rates. Instead of promising a moderate and stable tax regime over the next three to five years, the government indicated taxes could be subject to change depending on the demands of the situation. This naturally raised concerns that while the government would retain the flexibility of changing the rate of taxation, elimination of tax exemption would become a permanent feature.
The second draft, too, contains mischievous elements such as calculation of long-term capital gain and retention of securities transaction tax. The entire episode, right from writing the original draft by a committee headed by a retired bureaucrat to the revised proposal, demonstrates the limitation of bureaucracy, which either bows to implement the per projects of the current dispensation or formulates laws that are ideal in a perfect system but difficult to implement in a chaotic system that has be responsive to public opinion. The directive on 25% public shareholding for listed companies, too, reeks of bureaucratic bungling and ineptitude. The objective behind the directive is to make stocks liquid to enable investors to trade without causing price tremors as well as to reduce the scope for price manipulations. Like the DTC proposals, the intention is laudable but impractical. It assumes that low floating stock is a deliberate design by some companies either to keep control or gain from the fund-raising opportunity that listing provides. Allowing companies to list with just 10% public float was initiated by the predecessor, the NDA government. This was to prompt listing even by companies not in need of funds to revive the primary market following the dot-com bust. Lack of paper was responsible for the relaxation then. The situation seems to be in contrast now. Many companies want to tap the markets for funds for their capex to meet demand from the anticipated growth of the Indian economy. They are waiting for a definite turnaround in the secondary market to get richer valuations or to ensure good post listing performance. The experience of those that have issued shares over the past year has not been encouraging. There has been increasing investor indifference, culminating in timid response even to PSU FPOs.
The various reasons attributed for this phenomenon range from volatile markets, high pricing and the Dutch v French method of book building. The flood of paper by companies over the next three years to meet the listing norms would have crowded out issuers with genuine need for funds and sucked out liquidity from the secondary market, thereby affecting even the Rs 40000-crore PSU divestment, which depends on the feel-good factor. Instead of following a timetable that would segregate companies by market cap to dilute promoter stake to below 75%, the government’s solution, which again seems to have the stamp of bureaucracy, is to exempt PSUs from the 25% dilution requirement by permitting them 10% float. In the process, one important lesson seems to have been forgotten. The indifference of both institutional and retail investors to IPOs including PSU FPOs over the past year was not due to supply overhang. It was because of high pricing. Some reasonably prices issues got good response despite volatile market conditions. The second lesson is the difficulty in pricing PSU FPOs. Most listed PSUs are quoting at astronomical valuations not because of their monopolies but because of the illiquid counter. So far short-term gain of rich pricing, the government is sacrificing long-term investor interest of better price discovery on PSU counters. No wonder even foreign investors are turning lukewarm to PSU offerings from their earlier enthusiasm to divestment on the realisation that the entire exercise is similar to raising a bridge loan rather than attempt to make these entities market oriented. Nothing brings out this contradiction starkly than the overwhelming response of foreign investors to the recent US$ 19-billion IPO, the second biggest in the world so far, from Agricultural Bank of China, could make it the largest so far.

MOHAN SULE

Monitoring the regulators

An apex council can bring in much needed coordination between different bodies to smoothen out irritants

Look who is courting controversy! Invariably, it is the Securities and Exchange Board of India that is caught in the line of fire. Its textbook mandate is to fence the ground, level the field, and catch and punish wrong doers. On ground, however, Sebi is expected to ensure there are no bumps in the quest of all the stakeholders to become rich effortlessly. Issuers of capital want low entry barriers and intermediaries hassle-free trading, while subscribers demand cost-effective transactions. In the process, it comes out as unreasonable (ask asset management companies), arbitrary (in taking action against insider trading and price manipulators), harsh (check out investment bankers at the receiving end), and out of touch (poll institutional and retail investors). If there is a regulator who manages to antagonize all the sections of the market that it touches, the honour surely must go to Sebi. Very rarely is the market watchdog lauded for the orderly transition of the capital markets from outcry trading on broker-dominated stock exchanges to seamless and paperless execution of trades. Yet, there is no cause to complain of its recent clampdown on unit linked insurance plans. Where it erred was in allowing these products to be marketed. It was right on insisting that as a portion of the corpus of these products is invested in the equity markets, suspending their sale was within its regulatory ambit. But good intentions rarely make for good policy. The combination of insurance coverage and market-oriented returns was too enticing to be torpedoed. The issue was lobbed into the courts like all other explosive themes that are too hot to handle. But the issue encompassed too many stakeholders—investors, markets, mutual funds and insurance companies---to let it linger and fester. The ball eventually landed in the politicians’ court. The finance minister issued an ordinance to restore custody of the products with the Insurance Regulatory Development Authority (Irda).

Sebi, however, must have enjoyed the last laugh as the Irda amended certain features that loaded the dice in favour of issuers. Overall costs charged by Ulips have been capped on the basis of 10-year tenor and limits imposed on surrender charges, confirming that the capital market watchdog’s objections to these products was not without merit. The spat, nonetheless, hastened the process of appointing a super regulator. Undeterred by the braying to drop the idea of a Financial Stability and Development Council, the government introduced the Securities and Insurance Laws (Amendment) and Validation, Bill 2010, to replace the Ulip Ordinance. The bill, passed in the Lok Sabha last fortnight, seeks to have a joint committee to resolve the differences among financial regulators Securities and Exchange Commission of India, Irda, the Reserve Bank of India and the Provident Fund Regulatory and Development Authority (PFRDA). The finance minister will head the committee. Is Sebi upset with the supposed emasculation of power? By now it must be pretty used to getting its orders reversed by the Securities Appellate Tribunal, approached by subjects aggrieved over the market regulator’s rulings. Surprisingly, the disquiet came from the Reserve Bank of India, so far not used to its decisions being questioned. The government contends such a body is required for coordination between regulators and sort out disputes over turfs. The Sebi-Irda friction was the latest in the long list that included even an RBI-Sebi skirmish over NBFCs in the early days of Sebi’s birth. They had to follow business transaction norms laid down by the RBI and trading criteria prescribed by Sebi. In the same way, the Telecom Regulatory Authority decides on the operational aspects of telecom companies, which have to adhere to disclosure norms laid down by Sebi while tapping the markets for capital. Insurance companies, too, will face similar dual control once they get listed. So a formation of super regulator, with the finance minister in the chair and comprising other regulators, does make sense to ensure that there is no cross-connection.

India is not alone on this page. The US has proposed the Financial Stability Oversight Council to watch Wall Street despite the presence of the Securities and Exchange Commission. The Treasury Department will lead the nine-member council comprising regulators from the Federal Reserve, SEC, Federal Housing Finance Agency, Commodity Futures Trading Commission and other agencies including state securities, insurance and banking regulators and credit unions as non-voting members. The principle behind the UK’s new Council for Financial Stability, which the new government proposes to junk, was straightforward. The heads of the Treasury, Bank and Financial Services Authority will meet, probably quarterly, to analyse the state of the banking system and take action when deemed necessary. The basic difference between the supervisory councils in India and those in the US and UK is the latter’s narrow purview. The US council’s limited objective is to supervise the Wall Street, while that of the UK is to guide the Bank of England. In India, the scope is wide. Therefore, there is fear of the regulators losing their autonomy. There is a crucial difference that needs to be considered. Though the US president appoints regulators, drawing them even from the private sector, they need to be confirmed by the Congress. As their independence is derived from the people, the regulators are free to act on their own without approval or guidance from the government. In India, regulators are invariably selected from the bureaucracy of the public sector. Though autonomous, they often consult with the government. Besides, the boards of the regulators including those of Sebi and the RBI have govrnment nominees. While there should be no interference from the government in their policing work, a super regulator will ensure that they are on the same page. During the later part of the boom of 2003-2007, for instance, finance minister P Chidambaram was at odds with the money tightening policy of the RBI, whose main job is inflation control, while growth is primarily the responsibility of government by introducing appropriate fiscal policies. At a time like this, when developed economies are in recession and emerging markets including India is facing inflation, it is necessary that both the government and the regulators calibrate their policies so as not to hinder growth as well as let inflation go out of control. The RBI and Sebi may, for example, need to coordinate regularly to ease the path of Indian companies in acquiring cheap but strategic targets abroad and raise funds for the acquisitions. Irda and Sebi could require regular dialogue when insurance companies get set to launch their IPOs. A super regulator who would facilitate a structured mechanism for problem solving and policy formation anticipating future changes could be of immense help rather than a hindrance.
MOHAN SULE