Sunday, August 19, 2012

SEBI’s Capital Market Reforms

In what is clearly the most extensive set of capital market reforms in recent years, SEBI announced a series of measures following its board meeting last week. These are intended to boost the capital markets in India (both primary and secondary), and also to streamline various process. The principal recommendations have been divided into the following categories (in the words used in SEBI’s board meeting press release):
- steps to re-energise mutual fund industry;
- reforms in the primary market;
- regulations on investment advisors; and
- amendment of SEBI (Issue and Listing of Debt Securities) Regulations, 2008.
Most of these recommendations will have to find their way into specific regulatory changes by way of amendments to relevant regulations or the operation of new regulations (as in the case of investment advisors). Much of the impact of these changes can be determined in specifics only when the detailed language of these changes is available. Nevertheless, in this post I briefly touch upon only some of the key developments and also the issues that some of them may pose.
Capital Raising By Issuers
Two interesting issues emerge. One relates to the minimum public shareholding in listed companies, and the other to continual disclosures by listed companies, both of which are dealt with below.
In order to achieve the minimum public shareholding of 25% (and 10% in the case of government companies), two additional routes have been permitted. They are the rights issue and bonus issue routes. It is understandable that promoters may dilute their stake in case of a rights issue where they specifically opt not to take up the rights, and where other shareholders subscribe to their rights. However, in case of a bonus issue it would be interesting see how this idea will be implemented from a company law perspective. This is because bonus shares must, as a general matter, be issued pro rata to all shareholders of the company by way of stock dividend. Whether bonus shares can be issued selectively to the non-promoter shareholders, or whether the promoter shareholders can opt not to receive the bonus shares remain to be seen. Whether such distinction in bonus issuances would militate against the concept of all equity shares being pari passu is an issue that may have to be contended with. Of course, details are yet to be available, and hence these are only some preliminary thoughts (some of which might even be allayed once the detail emerge).
The introduction of an integrated system of disclosures is a giant step towards development of the Indian capital markets. SEBI’s decision is as follows:
To provide updated information to investors, listed entities shall file a comprehensive annual disclosure statement in addition to the existing requirements on the lines of 20F filing prescribed by the US SEC. Such filings, updated by the prospectus, shall also serve as a reference in the offer documents for further capital offerings.
As previously discussed on this Blog, a sub-committee of SEBI had recommended such a system of integrated disclosures way back in 2008. It appears that the recommendation has been finally implemented only now. This would go a long way in streamlining disclosures in the primary and secondary markets. It would enhance disclosures standards in the secondary markets by requiring detailed filings as in the US, and considerably improve secondary market disclosures which are dismal in India as compared to the primary market disclosures which have significantly evolved over a period of time. As far as listed companies are concerned, it would ease the disclosure regime and facilitate more follow-on public offerings as companies would be able to include information in the prospectus by reference to previous filings made. This is a welcome move, and was long overdue.
Regulation of Investment Advisors
This is also an important step, and brings within the scope of regulation an important constituency in the stock markets that was hitherto outside the purview of regulatory supervision. As Sandeep Parekh notes in this Financial Express column:
With this regulation, the entire industry, which is involved in distribution of securities products and even financial products, is sought to be covered. Therefore, anyone peddling a security to an investor would be covered by the regulation and any wrong advice and misconduct would attract scrutiny and punishment by Sebi. Until today, Sebi was sceptical about introducing these regulations because just the number of distributors would run into hundreds of thousands and regulating such a large number would be outside the available manpower and bandwidth of Sebi. Many of the ills of the financial industry actually have their origin in distributors and advisors, some of whom are unscrupulous and would sell the worst product for a given investor merely because they get a higher commission from selling that product.
Debt Market Reforms
The corporate bond market has been in a continuous stage of evolution for the last few years. While substantial regulatory efforts have been made to enhance the market for corporate bonds, those have been incremental in nature and have not resulted in great success. This trend of facilitating the debt securities market continues in the present phase of reforms as well. Some of the reforms include standardization of format for presenting information (particularly the financials), and also the provision of an enabling facility for shelf placement document in case of frequent issues through private placement.
The trend in the corporate bond market is that despite these regulatory developments, there is an emphasis on private placements rather than public offerings. While some of these efforts such as standardization may help address some of the concerns of the market, there are other key impediments, as some of us have observed elsewhere, such as the lack of a robust corporate insolvency framework that may inhibit vibrant corporate debt markets in India.
In the end analysis, this round of decisions taken by SEBI can be considered to be a positive development, given the slow pace of overall economic reforms lately in India.


Anonymous said...

If I remember right, Reliance Power issued bonus shares to only non-promotor shareholders in 2008 to compensate them for the significant fall in the price post listing. What SEBI seems to have done is to specifically permit this for complying with min. public shareholding norms. Even though the Companies Act does not contemplate it, I think no one would raise any objection as it is the promotors who are forgoing their bonus entitlement and consequently a transfer of economic (dividends) as well as voting rights from them to the non-promotors happens. Pretty cost effective too (a journal entry and informing the depositories and the Stock Exchanges). Will be interesting to see if the secondary market prices run up when a company decides to follow this route.

And a doubt. “In order to encourage long term holding and to reduce churn and align the interests of the AMCs/ distributors with that of the investors, it was decided that (a) the entire exit loads would be credited to the scheme while the AMCs will be able to charge an additional TER to extent of 20 bps. This will not result in any additional cost to the investors.” (SEBI Press Release) What does it mean? 20 bps on what, and in which year?

Yogesh Kumar said...

Hi, It means the exit load charged to any redemption currently reduction of the NAV and is added to the income of the AMC. As per the new provision, the exit load will be added to the fund thereby enhancing the NAV but the MF will be allowed to deduct an additonal 20 bp from the AUM which will reduce the NAV. In SEBI's view this will not add any additional cost. However this is a fallacious arguement of SEBI. How does SEBI know that the amount added on account of exit load will always be equal to the amount deducted at the rate of 20 bp from the AUM?

Anonymous said...

Bonus issue does not necessarily amount to market price running up. It's a myth.

Anonymous said...

Yes, in case of a normal bonus issue, prices should not run up, as the proportionate economic and voting right of the shareholders stay constant post the bonus issue. But here say the promotor and non-promotor shareholding is 80% - 20%, and only non-promotors get bonus shares, then by buying say 1% pre-bonus shares, they are entitled to 5% of the bonus issue, increasing their proportionate rights.

Coming back to the 20 bps v Exit Load issue, Yogesh, thanks for the clarification. You are right that SEBI’s argument is fallacious. Moreover, I’m trying to figure out the logic. If the AMC never had any business gobbling up the Exit Load (EL), SEBI should have mandated crediting the EL to the Scheme and stopped at that. Probably most AMCs came to think of EL as a source of revenue, so SEBI is kind of compensating them with the extra 20 bps TER kicker in lieu of the loss of EL. The earlier system encouraged frequent churning of portfolio as it meant more EL, benefiting both the AMC and the distributors. Now there is no such incentive, as the AMC gets a fixed 20 bps advantage. In other words, it is akin to a `fixed to floating swap’, which would be in-the-money for the AMC as long as the EL stays below 20 bps level.

-Mangesh Patwardhan