New regulatory ideas

The chairman of the Securities and Exchange Board of India, M Damodaran, is apparently keen on taking stock market regulation further. With this in mind, he has aired a number of far-reaching proposals that are yet to go formally to the Sebi board""the intention may be to elicit public opinion first. This is a good method to follow.

The most far-reaching proposal is to introduce mandatory ratings for public issue of shares""with the leading stock exchanges and Sebi funding the exercise from their investor protection funds. The idea has been frequently aired and has now been endorsed by the primary market advisory committee, chaired by Deepak Parekh. The intention is praiseworthy, given that many retail investors are drawn to the IPO market without necessarily being equipped to figure out what is an attractive issue and what is not""and an independent rating could provide some guidance. That does not mean, however, that mandatory credit rating is the answer to the problem.

Some of the burden of an issue's success or failure will devolve on the people involved in the rating exercise, and when these include the exchanges as well as the regulator, there are credibility issues that come into play. It should not be forgotten that rating a share issue when markets can be volatile is a different kettle of fish from rating a bond""a company may have a Triple A bond rating but its over-priced share issue could be a risky investment. If a few highly rated share issues end up losing value on the market, then investor ire could well be turned against the exchanges and the market regulator. If a rating is to be done, it should be financed by the company raising the money""and as with credit ratings, Sebi should wait for the idea to catch on rather than make it mandatory at this stage.

A side issue this raises is the way in which the various investor protection funds should be used. Three are already in place, and a fourth is run by the ministry of consumer affairs. Large sums, running into hundreds of crores of rupees, are available with these funds, but those in charge of them don't seem to have too many ideas on how the money should be spent. Till such time as they do, less money should flow into these funds.

Meanwhile, Sebi has proposed revival of a variation of the Mapin (market participants' identification number) system, which had been suspended sometime last year. This is to be welcomed, though it is not clear why the exercise has to be handled by multiple agencies, when one agency was doing the job perfectly well.

Finally, Sebi has proposed a super-self-regulatory organisation (SRO) to cover market participants like mutual funds, merchant bankers and such. This is an idea which has been tried out in other countries, and seems to work well there, but in India there is always the danger of people being soft on others of their kind, and the exercise therefore becoming a repeat of something like the Medical Council of India""doctors on the Council are reluctant to take action against other doctors in the dock, as a result of which the MCI has rarely moved against medical malpractice (which is known to be rampant) and rarely withdrawn doctors' licences. In the same way, chartered accountants on a market participants' super-SRO may get into a mutual back-scratching exercise because everyone may feel vulnerable to action at some point, and no one wants to make enemies. It is better to have a proper policing system in place, so that such sensitivities do not come into play.