Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Sun, 26 Aug 2007

SEBI proposes fast track issuance of securities

The Securities and Exchange Board of India has announced its intention to allow fast track issuance of securities under certain conditions. It is nice to see SEBI doing something constructive to make the primary market smoother and more efficient.

A spate of investor complaints after the IPOs of 1995-96 led to a regulatory clampdown that has had a chilling effect on the primary market. In 1995-96, the capital raised through the primary market was more than 6.5% of gross domestic capital formation. Despite a revival in the primary market in 2005-06 and 2006-07, the capital raised in these years is less than 2.5% of gross domestic capital formation.

The regulatory clampdown has also led to the partial exporting of our primary market. In 2006-07, the capital raised in the foreign (ADR/GDR) market was about half of that raised in the domestic primary market. In 1995-96, the corresponding figure was only 11% and until 1996-97, this figure had never crossed 25%.

A lot needs to be done to make the primary market vibrant once again. The fast track issuance scheme addresses some of the needs of well established companies trying to do a follow-on issue. The needs of the IPO market also need to be addressed in course of time.

Posted at 19:57 on Sun, 26 Aug 2007     View/Post Comments (0)     permanent link

Mon, 20 Aug 2007

US regulatory framework and light touch regulation

An IMF working paper published this month forced me to rethink the often repeated contrast between the heavy handed rule based US regulatory framework and the light touch principles based system in the UK. The paper New Landscape, New Challenges: Structural Change and Regulation in the U.S. Financial Sector by Ashok Vir Bhatia argues that the US financial sector is divided into a tightly regulated core and a loosely regulated periphery. The tightly regulated core consisting of the banks and depository institutions, the housing sector federal agencies and the big five investment banks today account only for a third of the US financial assets. The remaining two-thirds of the assets are in the periphery which is subject to Bernanke’s “regulation by the invisible hand” of market discipline.

Bhatia argues in particular that “the Fed [serves] a singular role as guardian against more dirigiste temptations.” I think this is an important point – there is little doubt that the US Fed has a significantly lighter touch regulatory mindset than the US SEC. This is also an aspect that is often missed in the simple US versus UK dichotomy of rules versus principles based regulation.

Where the rules based approach is most dominant in the United States is in the area of consumer protection which is of course dominated by the SEC. The UK has shown the way in applying principles based regulation even here and this is a model that is worth emulating. However, the US model shows how great the benefits are of a light touch regulation applied only to the periphery. The vibrancy of the US financial sector is due doubtless to this light touch. For countries like India whose financial sector is repressed by heavy handed regulation, applying light touch to the periphery is a low hanging fruit that can be plucked quite easily and with low risk.

Posted at 16:44 on Mon, 20 Aug 2007     View/Post Comments (1)     permanent link

Thu, 09 Aug 2007

Regulating External Commercial Borrowings

Dr. Shankar Acharya and I participated in a discussion on the business news channel CNBC about the move by the Indian government to restrict external commercial borrowings. Both of us agreed that the ECB window was a very selective opening up of the capital account. My concern was that ECBs allowed the corporate sector to obtain cheap foreign debt while preventing individuals from tapping foreign markets to get cheap home loans. Dr. Acharya’s concern was that even within the corporate sector, the ECB window was being used largely by a handful of companies.

Both of us also agreed that in the long term, India needs a vibrant domestic financial system that is well integrated into the global capital markets. We disagreed about the timing and sequencing of these reforms. Dr. Acharya argued that the weaknesses of the domestic financial system (particularly the state owned banking system) need to be addressed first and that capital account opening must be gradual. My argument was that the best way to strengthen the domestic financial sector is to open it up to foreign competition and that we need to move rapidly on capital account convertibility.

Posted at 21:52 on Thu, 09 Aug 2007     View/Post Comments (2)     permanent link

Tue, 07 Aug 2007

SEBI Report on Dedicated Infrastructure Funds

The Securities and Exchange Board of India has published the Report and Recommendations of the Committee on Launch of Dedicated Infrastructure Funds by Mutual Funds

I have been a firm supporter of allowing domestic hedge funds, private equity funds, real estate funds and other alternative investment vehicles. I would also welcome retail access to these products with appropriate risk disclosures. Thus in principle, I have no problem with the proposed Dedicated Infrastructure Funds. My difficulty is that the report does not justify why an exception should be made only for infrastructure funds while keeping the lid shut on all other alternative investment vehicles.

From the perspective of a securities regulator, the justification for a retail product has to be in terms of the risk-reward profile that the product provides to the investor. The report is silent on this and talks only about the need for infrastructure for the economy. The most depressing statement in the report is the statement in the report that:

The nature of infrastructure projects ... will include a gestation period where the project could be loss making. Thus, the NAV performance of the [Dedicated Infrastructure Funds] may suffer during the initial periods. This could have a negative impact on the listed price and generate adverse reactions from investors who exit early. Hence providing a listing window of 24 months will help the [Dedicated Infrastructure Fund] to deploy a substantial portion of the funds as well as some investments might move beyond the initial construction / build-out period.

To my mind, this amounts to cheating the investors by deliberately concealing information from them. In a rational market, investors should be trusted to understand that there will be losses in the gestation period. If they do not, then they are not appropriate investors for the fund.

I strongly believe that permitting retail access to a financial products should be based primarily on whether the product fulfills an investor need and only secondarily (if at all) not on whether it fulfills the need of the issuer (infrastructure developer in this case) or the intermediary (the mutual fund in this case).

I also think that it is far better to liberalize regulations across the board to provide investors access to a wide range of financial products than to make an exception for one special interest group. The regulatory goal has to be to increase innovation, competition and market completeness. That calls for a wide range of alternate investment vehicles.

Posted at 17:43 on Tue, 07 Aug 2007     View/Post Comments (3)     permanent link