1 Effects Of Reforms In Capital Market An Evaluation M. L. Soneji * Although the process of envisaging and effecting reforms in capital market has its genesis and been in place for several decades, it got the required impetus when the Ministry of Finance, Government of India, appointed a High-Powered Committee under the Chairmanship of former Chairman of Unit Trust of India, Mr G S Patel, setting out the following reference: To make a comprehensive review of the functioning of the recognised stock exchanges in India, as an integral part of the national financial system. This covered wide ranging terms of reference on various aspects of the functioning of the securities industry in India such as the organisation and management of stock exchanges, terms and conditions of admission to membership, listing of securities, cost of public issue of capital, bye-laws and regulations relating to trading, simplification of procedures for security transactions, safeguarding the interests of investors and member, improving overall service to the investors, methods of acquisition and financing of premises for stock exchanges, etc. The Committee, which comprised of eminent personalities and experts in the capital market viz. Shri D R Mehta, Dr S M Dugar, Dr S A Dave, Mr S S Nadkarni, Dr D H Pai Panandiker, Shri K V Shanbhogue, Mr M J Pherwani, Mr M R Mayya, Mr E R Krishnamurti, Dr L C Gupta and Mr Paul Joseph, submitted its report and recommendations to the Ministry of Finance. The Government then initiated the process of vetting the recommendations and adopted various recommendations at different points of time and as such directed the stock exchanges to amend its rules/bye-laws as the case may be. However, this process of effecting changes in the rules/bye-laws at the stock exchanges was remarkably at a slow pace. As the Government of India established the Securities and Exchange Board of India (SEBI), as a regulator for the capital market, first as administrative body in April 1988 and then conferred a statutory recognition in January Sr. Vice President, NSE. The views expressed and the approach suggested is of the author and not necessarily of NSE.
2 1992, SEBI then took over the responsibility of getting these recommendations and directives of the Government of India implemented by the stock exchanges as also initiated various reform measures from time to time through various Committees formed for the purposes. These reform measures encompassed various areas and hence for the purpose of easy appreciation and understanding, they are grouped as under: 1. Organisation structure 2. Management structure 3. Overall administration, supervision and control of stock exchanges 4. Membership related 5. Listing related 6. Public Issue related 7. Trading related/market structure 8. Simplification and minimising delays relating to stock transactions. 9. Measures to improve services to investors 10. Public issues - post repeal of CCI Act 11. Reduction in minimum public offer 12. Withdrawal of badla and introduction of Modified Carried Forward System 13. Screen based trading 14. Weekly settlement cycle 15. Uniform Good/Bad Delivery guidelines 16. Compulsory auction and close out for short delivery 17. Know your clients broker client agreement 18. Focus on Surveillance responsibility vested in ED 19. Settlement guarantee fund establishment of Clearing Corporation 20. Comprehensive risk management system 21. Dematerialization of securities 22. Trades through matching algorithm of the trading system of the Exchange 23. Certification programs for brokers and their employees 24. Enforcement of arbitration awards against brokers 25. Introduction of derivative market Index as a product and other products 26. Rolling settlement
3 It would be worth analysing the above reform measures from the perspective of when were they in fact envisaged and how have they been implemented in reality. In the following paragraphs, each of the above reform measures is discussed with this perspective and background: 1. Organisation Structure 1.1 The Committee had recommended a uniform model for the organisation of the stock exchanges in the country on the lines of the companies limited by guarantee without share under the provisions of the Companies Act, 1956. This recommendation was not accepted and thus not implemented by the Government until 2002. SEBI appointed a Committee in March 2002 headed by Former Chief Justice of India, Mr.M.H.Kenia, which, after detailed study of various laws having direct/indirect impact on the process of demutualisation of stock exchanges, recommended in August 2002 modus to go for demutualisation of the stock exchanges. Based on the recommendations of the Committee, the Budget for the financial year 2003-2004 has made certain specific provisions in the relevant laws relating to income tax, stamp duty etc., to facilitate the process of demutualisation and corporatisation of stock exchanges on uniform basis. 1.2 To have common Memorandum and Articles of Association. For this purpose, the Memorandum and Articles of Association of Madras and Pune Stock Exchanges be taken as a model with suitable modifications as required. As the stock exchanges are governed by the rules, bye-laws and regulations framed by themselves and approved by the Central Government/SEBI under the Securities Contract (Regulations) Act, 1956 and the rules made thereunder, SEBI appointed a Committee headed by Mr.M.R.Mayya in the year 1997, which has already submitted the Model Rules for the stock exchanges which SEBI has directed all the stock exchanges to adopt these Model Rules. The Model Bye-laws and Regulations for stock exchanges are being drafted and are expected to be submitted to SEBI for its adoption shortly. The provisions, contained in the Model Rules and are
4 applicable in relation to the Articles of Association in case of a stock exchange being a company, will be required to be adopted accordingly by such stock exchange company. This is imperative for concerned stock exchanges since the provisions categorically provide that the specific provisions contained in the Model Rules shall prevail. 1.3 To regulate the activities of all other associated with the stock exchanges or regulating the activities of those concerned, directly or indirectly, with the securities industry. After establishing SEBI in the month of January 1992, SEBI has taken various initiatives to frame rules and regulations with an objective to provide appropriate legal frame work for regulation of various activities relating to securities industry viz. Stock exchange operations, merchant bankers, registrars, share transfer agents, custodians, portfolio managers, issuers, foreign institutional investors, managers to the issue, consultants/advisors to the issue, collecting banks, depositories, approved intermediaries etc. This has not only helped to have a proper regulatory frame work in place but also ensure orderly development, improved knowledge level and inculcating improved compliance culture. A host of such initiatives by SEBI has brought about enhanced level of discipline and accountability, sine qua non for efficient and effective regulation of any market or its activities. 1.4 Stock Exchanges which are companies limited by shares, they should follow the procedure for reorganisation as laid down in Sections 391/394 and under Sections 100 to 104 of the Companies Act, 1956 and thereafter to seek approval of the Central Government under Section 25 of the Companies Act, 1956. As indicated in point 1.1, while now the Central Government has made necessary changes in various legislations facilitating conversion of stock exchanges from association of persons into corporatisation and effecting demutualisation to divest management control, the Central Government/SEBI, in the previous period, gave permission to stock exchanges as a company under Section 25 of the Companies Act, 1956 (recognising as non-profit making) or under Section 12 of the Companies Act, 1956 (recognising as profit making). 1.5 Stock Exchanges which are companies limited by guarantee with share capital should take suitable steps to get approval from the Central Government under Section 25 of the Companies Act, 1956.
5 This recommendation was not pursued. However, as indicated under point 1.4, now the changes are effected in the structure and constitution of stock exchanges to bring in corporatisation and demutualisation in place, where they are not a company or though being a company, not demutualised. 1.6 For the stock exchanges which are association of persons or company limited by shares, with a view to expediting the reorganisation, the Government to bring about the changes in the organisation structure through amending the SC Act rather than waiting for reorganisation by these stock exchanges on their own volition. As indicated in point 1.1 and 1.4, necessary changes have now been effected by the Central Government though making changes in the laws relating to income tax and stamp duty etc., to facilitate the process of corporatisation and demutualisation and thus bringing about the much-awaited change in the organisation structure. 2. Management Structure 2.1 The Committee recommended to broadbase the Governing Boards to make them fully representative of various interests. The Central Government issued a circular to stock exchanges in the year 1991 directing them, interalia, to broadbase the governing boards by having 50% of the members of the governing boards from outside, for ensuring that the management of the affairs of the stock exchanges is carried on in an objective manner in the general interest of the investors. This recommendation was not implemented by stock exchanges until November 2002 when SEBI issued a directive under Section 8 of the Securities Contract (Regulations) Act to the stock exchanges in November 2002 requiring them to amend the rules/articles of association by making the provisions incorporating the requirements of having 6 members of the Exchange, 3 persons appointed by the Central Government/SEBI as its representatives, 3 persons nominated as public representatives, and one Executive Director. This was implemented by most stock exchanges by maintaining 50:50 ratio but having more members of the Exchange and correspondingly more persons from other categories on the basis of the directive in the year 1993. In respect of certain stock
6 exchanges, SEBI had to amend the rules as above. However, the stock exchanges did not provide for Chairman to be any member of the governing board but provided for Chairman to be one among the elected members of the governing board. 2.2 Composition of the Governing Boards to be 50:50 basis, elected and non-elected members, not exceeding 18 in number, excluding the Chairman and Managing Director. As explained in point 2.1, changes providing for composition of the governing board on 50:50 were carried out by most stock exchanges by 1993 and where the stock exchanges failed even after expiry of the stipulated period, SEBI exercised its powers to amend the rules making the provisions of incorporating the above requirements. 2.3 Financial Institutions to appoint their nominees, not exceeding 2 in number on the Governing Board, if financial assistance is availed by the stock exchange. Where the stock exchanges were promoted by financial institutions, the composition of the governing board was based on the nominees of the financial institutions, besides government/sebi nominees, public representatives and the Managing Director. 2.4 Elected members should be from among the existing members of the stock exchanges. 2.5 1/3 rd elected members should retire every year by rotation. 2.6 Elected members to have a maximum 2 consecutive terms of 3 years and after break of one term, eligible for re-election of further 2 terms of 3 years. 2.7 No member to hold the office of director for a period exceeding 12 years in aggregate. Recommendations under 2.4, 2.5, 2.6 and 2.7 were communicated to stock exchanges in the year 1991. However, SEBI issued a directive as above in November 2002 to the stock exchanges reiterating about these recommendations. As indicated above, most stock exchanges amended the rules in 1993 making the provisions incorporating all these requirements and where the stock exchanges failed in giving effect to incorporating these provisions, SEBI amended the rules of these stock exchanges under the powers vested in them.
7 2.8 Non-elected directors to be nominated from Government departments, development banks/institutions, investment institutions, RBI, economists, industrialists and professionals having necessary expertise in stock and capital markets. 2.9 Non-elected directors to be adequately compensated by the stock exchanges. The changes emanating out of these recommendations (2.8 and 2.9) were simultaneously carried out by the stock exchanges in 1993 along with the changes relating to restructuring of the governing board and provided for adequate compensation as well as representation from experts in the fields of economics, law, management, finance, accountancy, judiciary etc. 2.10 Position of the President of the stock exchanges be dispensed with. Chairman to be appointed by the Government of India. This requirement was not accepted and thus not communicated to the stock exchanges by the Central Government/SEBI. SEBI, in its directive issued in April 1993 to the stock exchanges categorically specified to have the President of a stock exchange elected from amongst the members, and no approval from the Central Government or SEBI would be required for appointment of any person as the President. However, while carrying out changes in the restructuring of the governing board of the stock exchanges, the requirement of having the President from among any of the members (elected or independent) of the governing board was not insisted upon by SEBI and thus only the elected member held the position of the President. In the year 2001/2002, SEBI directed all the stock exchanges abolishing the positions of office bearers, i.e. President, Vice President and Honorary Treasurer and provided for having a nonexecutive chairman from among independent members (i.e. SEBI nominees or public representatives). 2.11 Chairman to be an independent person not having any direct or indirect interests in the trading activities. As indicated above, this requirement has been accepted and implemented by SEBI in the year 2001/2002 by directing all the stock exchanges to provide for non-executive chairman, who will be an independent person not having any direct or indirect interests in the trading activities.
8 2.12 Tenure of the office of the Chairman be for 5 years and be eligible for reappointment for only one additional term of 5 years. This recommendation was not accepted. As indicated in 2.11, the position of the Chairman is provided as non-executive and from amongst independent persons by SEBI vide its directive issued to the stock exchanges in January 2002, and no restriction of tenure of the office is provided. It is left to the governing board of the respective stock exchanges to choose their Chairman. 2.13 Vice Chairman to be elected from among the elected members. As indicated in point 2.10, positions other than the non-executive Chairman have been abolished and it is left to the stock exchanges to choose any independent member of the governing board as the Chairman. 2.14 Stock Exchange to have a Managing Director, possessing the requisite expertise in the field and not having any direct or indirect interests in dealings in securities. Terms and conditions to be decided by the Government of India. The Managing Director to have a term of 5 years, further extendable at the discretion of the Government, not beyond the age of 65 years. This recommendation was also not accepted. With an objective to strengthen the position of the Executive Director in the stock exchanges and also to provide a model legal framework for the stock exchanges, SEBI appointed a Committee in the year 1997 under the Chairmanship of Mr.M.R.Mayya. The Model Rules prepared by Mr M R Mayya Committee and adopted by SEBI in the year 2002 provide for a position of a Managing Director, who will be the Chief Executive Officer, an ex-officio member of the Governing Board and who will be possessing the requisite expertise in the field and not having any direct or indirect interests in dealings in securities. The Model Rules provides for superannuation age of a Managing Director as 60 completed years of age. 2.15 Stock Exchanges to have specialised departments dealing with different aspects of their activity. Stock exchanges, either of their own initiative or upon direction from SEBI, have established various departments specially to carry out various activities and functions with clear and pointed focus on its role.
9 In fact, over a period of time, various functions such as risk management, surveillance, market watch, investigation, inspection, investors grievance cell, system, corporate governance, corporate communication etc. functions have been separately being managed, recognising the regulatory and service role each of these departments is required to perform. 2.16 Two other committees, one for planning and development of securities business and other for audit recommended. After establishing SEBI by the Central Government, the role of development of securities industry is being undertaken by it. In this regard, SEBI has taken various initiatives in developing securities industry by pushing through various reforms in the securities market like having screen based trading, dematerialisation of securities, making it obligatory to have settlement guarantee fund by the stock exchanges, shortening of settlement cycles, bringing in rolling settlement etc. Also, with a view to strengthen the regulatory enforcement at stock exchanges, SEBI has required the stock exchanges to have various committees like disciplinary action committee, committee for settlement of claims against defaulters/expelled members, audit committee, committee for code of ethics, etc. While the disciplinary action committee and committee for settlement of claims against defaulter/expelled member are consisting of 60% independent members, audit committee and committee for code of ethics are comprised of the members of the governing board. 2.17 Stock exchanges to have adequate power and authority to institute civil and criminal proceedings against the members and non-members for breach or violation of securities related laws. As the Central Government has established a statutory body viz. SEBI to regulate the securities industry, the SEBI Act confers enough powers and authority on SEBI and thus SEBI plays major role in taking actions for breach or violation of securities related laws. Besides, the Model Rules of the stock exchanges have categorically provided for specific powers and authority with the Governing Board or Statutory Committees constituted by the stock exchange and the Managing Director to take various actions for breach or violations or non-compliance of the rules, bye-laws and regulations of the stock exchange as well as the orders or rulings given by the stock
10 exchange. Through the latest amendments to the SEBI Act carried out in December 2002, the Central Government has now conferred specific powers on SEBI to levy a penalty raising the limits in case of various violations, including Rs.25 crores or three times the profit in case of insider trading and seize documents in certain circumstances as provided in the amendments. Thus, now the SEBI is adequately empowered to take stringent actions any agency or intermediary, which is governed under any one or more of the securities law, for breach or violations thereof. 3. Overall administration, supervision and control of the stock exchanges 3.1 The Committee recommended Council for Securities Industry instead of a Commission akin to Securities and Exchange Commission as in USA. 3.2 The Council for Securities Industry should be a statutory body with adequate powers to function effectively. The Central Government for the first time in April 1988 constituted an administrative body viz. Securities and Exchange Board of India and in January 1992, the Central Government enacted an Act granting a statutory recognition to the Securities and Exchange Board of India as a regulator of the securities industry/markets. The SEBI Act has been amended from time to time to enhance the protection to the investors and to strengthen the regulatory framework for effective supervision, regulation and control of the stock exchanges and other market intermediaries. 3.3 The Governing Board of the Council to be consisting of total 10 members, 4 from stock exchanges, 4 from government, corporate finance, commence, accountancy, management and law and 2 from investment and development finance institutions. Composition of Securities and Exchange Board of India has been as provided in the SEBI Act, which, interalia, provides for the Executive Chairman, 2 officials from the Ministry, 1 official from the Reserve Bank of India and five other members, of which 3 members shall be the whole-time members, on the Board. Recently, the Central Government has amended this provision, paving the way for having three full time members on the Board and increasing the strength of the Board to nine (9). So far, the members of the Board comprised of
11 the senior officials from the Ministry of Finance, Department of Company Affairs and Reserve Bank of India and experts chosen from the Capital Market or from entrepreneurs so as to have independent and impartial representation. (To be continued)