The Securities and Exchange Board of India (SEBI) has finally decided to end its love-hate relationship with Financial Technologies (India) Ltd. The capital markets regulator said last week that FTIL is not a ‘fit and proper person’, and directed it to sell all the shares it owns in SEBI-regulated exchanges and clearing corporations in three months.
SEBI’s latest order rides piggyback on a 17 December 2013 order by the Forward Markets Commission (FMC), the commodity futures market regulator. One of the criteria to determine the ‘fit and proper’ status of a person is that there should be no adverse order by any other regulator. Essentially, SEBI has said that FTIL is not fit and proper because of FMC’s adverse order against the company.
Even so, given SEBI’s own tumultuous relationship with the Financial Technologies group in the past six years, a moot question is how this experience will influence the regulator’s policy making in the future. More specifically, will the regulator become more cautious about encouraging competition among stock exchanges and will it accelerate the process of separation between the regulatory and business functions of stock exchanges?
The misadventure with FTIL has brought with it charges of irregularities—the Central Bureau of Investigation has started a preliminary enquiry to find out the circumstances under which FTIL was given the go-ahead for its currency futures platform in 2008. Likewise, there have been questions about SEBI’s decision to allow the group more segments such as equity and equity derivatives in 2012, despite an adverse SEBI order in 2010. In this backdrop, the regulator might be inclined to play it safe and reject applications of new entrants. After all, once bitten, twice shy.
But clearly, it will be unfortunate if the regulator becomes increasingly wary about new entrants in the exchange space. To start with, it is simply naïve to assume that existing exchanges will always behave in the fairest manner. And while it’s true that an exchange plays a regulatory role, it is also a lucrative business. To discourage competition conversely means to encourage a monopoly or oligopoly. Robust competition drives innovation, reduces costs for market participants and generally enhances market quality. The regulator must, therefore, outline a clear process for new stock exchange applications and communicate clearly the reasons why an application was rejected. A case in point is the application by ICAP India to set up a corporate bond and fixed income exchange in 2012. Since then, there is no news on the status of the application.
Apart from an extremely cagey approach to new applications, regulators such as SEBI also tend to discourage competition by imposing upon business decisions of stock exchanges. For instance, Bombay Stock Exchange’s main ploy in winning back share from National Stock Exchange is to offer its broker members incentives to trade on its platform. But SEBI has a stipulation that a market making scheme can run only for a period of six months. So every six months, BSE is forced to shift its incentives from BSE Sensex derivatives to contracts on the BSE 100 index and vice-versa. Volumes dry up whenever incentives are withdrawn on any product, constraining the exchange’s ability to build lasting liquidity on one product.
The regulator must do away with all such anti-competitive measures. About five years ago, FMC took a similar, but extreme step of disallowing price cuts by National Commodity and Derivatives Exchange Ltd (NCDEX), which wanted to compete with Multi-Commodity Exchange of India Ltd. Recently, FMC did away with restrictions on pricing.
SEBI should also accelerate the process of the separation of regulatory roles from stock exchanges. And this is not merely to facilitate competition, as pointed out above. Even in the current scenario, exchanges are under great pressure to drive market share and profit growth. To assume that regulatory roles will never get compromised in the process is foolhardy, to say the least. Therefore, as much as SEBI and FMC would like to believe that they have managed to cleanse the exchange space by forcing the exit of Financial Technologies, the fact is that the risk of a regulatory race to the bottom hasn’t disappeared.
In April 2012, when SEBI announced new norms for ownership and governance of stock exchanges, it had said that the clearing function of an exchange will be separated into an independent corporation. But about two years since, there is no further news on this. The experience with Financial Technologies should serve a wake up call to fix these areas of concern sooner rather than later.