Is SEBI being a nanny to investors?

India’s financial market regulators are often accused of focussing too much on the industries they regulate, while turning a blind eye to the plight of consumers.

But the Securities Exchange Board of India (SEBI) is an exception. Most of its regulatory tweaks and enforcement actions in recent years have been aimed at shielding investors from the misdoings of market participants. This has also won India high ranks for investor protection in the World Bank ratings.

Of late though, some of SEBI’s actions lead one to wonder if it is taking its zeal for investor protection too far.

Don’t do derivatives

The Indian stock market has been the victim of highly skewed growth in recent years with derivative trades now amounting to 15 times the trading in cash markets. A discussion paper by SEBI noted that equity derivative volumes leapfrogged nine times in the last 10 years, while cash volumes didn’t even double. Retail participation in futures and options is high (over 25 per cent) too, with individuals dabbling in risky trades such as options writing.

Expert committees, over the years, have offered many systemic solutions to address this skew: Raise margining requirements and lot sizes for derivatives, insist on all-cash margins, set a higher quality bar on stocks offered in F&O, promote stock lending, introduce physical settlement of derivatives, expand primary markets and so on.

But after implementing these selectively, SEBI has now latched on to a draconian idea to curb individual participation in F&O. It has recently suggested that all individual F&O traders present their Income Tax Returns to their broker, so that the broker can then enforce an ideal market exposure for each of them.

This has set the cat among pigeons in the trading community. A full-time trader, who quit his day-job years ago, says plaintively: “F&O trading is my profession. I chose to do this instead of being a lawyer, accountant or businessman. I am fully aware that I can make losses and it is very risky, but don’t all entrepreneurs take risks? My trading profits are treated as business income and I shell out a 30 per cent tax on it. I also pay multiple transaction taxes – STT, stamp duty. So how can the regulator tell me I shouldn’t pursue this business?”

Another investor asks: “How can income levels be a qualification to trade in the markets? I am a Chartered Accountant and have been trading with my own money for five years. I earn about ₹5 lakh a year. So, am I less qualified to trade than someone who runs a kirana store with a ₹2 crore turnover? Ask me to write a qualifying exam and see if I clear it!”

The angst is valid. To presume that all individual traders in F&O are gullible folks who need to be protected from the consequences of their own actions, is regressive. More so, as SEBI’s discussion paper puts the number of retail investors in F&O (5.7 lakh) at a fraction of the demat account holders (three crore). Over half of them also own large cash market exposures.

If SEBI wants to caution investors with poor loss-absorbing ability (such as students) from dabbling in derivatives, there are less intrusive ways of doing it. It can conduct boot camps in colleges on derivatives, conduct qualifying exams, require prior cash market experience or simply ask investors to self-declare their suitability.

But ideally, it should allow any individual, affluent or otherwise, to participate in F&O as long as he can cough up the required funds and doesn’t pose a counter-party risk. After all, market knowledge or trading skills cannot be acquired through earnings or textbooks; they come from real-world experience. From a market development perspective too, it would be healthier for SEBI to try and expand the cash market to catch up with derivatives, rather than shrink the latter.

MFs: Less is more

If the F&O proposal has traders in a tizzy, MF investors are currently scrambling to cope with SEBI’s recent rules on scheme categorisation, which have forced a ‘Ctrl Alt Del’ moment on the fund industry.

Earlier, if any fund house wanted to launch an open-end fund, it was free to choose between any style, market cap mix or theme of its choice, provided it avoided overlaps with its existing schemes.

In October 2017, the SEBI decided to simplify choices for retail investors by restricting the menu. It decided that fund houses could offer only 10 types of equity schemes, 16 types of debt schemes, six hybrid funds and two solution-based funds. To make schemes stick to their mandate, it laid down strict boundaries for every scheme type too.

Therefore, a large-cap fund must now compulsorily hold 80 per cent in the top 100 stocks, a mid-cap fund must own 65 per cent in the next 150 stocks and a focussed fund must own only 30 stocks etc. Managers have been asked to choose their large-cap and mid-cap stocks from an approved list, published every six months.

Star fund managers believe that the restricted shopping list will sharply curtail their ability to deliver alpha (outperformance) in the large and mid-cap funds.

AMCs are busy rejigging and merging their 800-odd open-end schemes, changing their names, mandates and portfolios to fit into the new pigeon-holes.

To newbie investors, these changes pose a challenge, because they render the past record of many popular schemes irrelevant. For long-time investors, this reboot means going back to the drawing board on portfolios.

One 55-year old quips: “This is like going to Saravana Bhavan and suddenly being told that I can only be served one type of dosa with one chutney, because someone thinks a ghee roast isn’t good for my digestion. I have good digestion, so why should I cut back?”

Mistakes help

While the SEBI’s keenness to simplify choices for first-time investors or enforce correct labelling is laudable, there are far simpler ways to achieve this. A vibrant passive fund industry is the best antidote to active MFs confusing investors with choices. Precise and quantifiable scheme mandates with penalties for deviation, can ensure truthful labelling.

But what’s wrong with the SEBI’s hard-line approach, if it helps protect the most vulnerable investors? Well, there are two disadvantages to framing regulations for the lowest common denominator.

It hurts market development and scale, deterring really large global players from entering India. For all the recent domestic interest in equities, let’s not forget that the Indian capital market is still at a nascent stage of development.

But even more important, it prevents retail folk from maturing as investors, by making mistakes. Ask a Charlie Munger or Rakesh Jhunjunwala how they made it big in the markets, and they will tell you that everything they learnt, is thanks to the school of hard knocks.

Cosseting retail investors by not allowing them to take risks, is akin to parents opting to keep their only child in primary school to protect her from brutal competition in the Board exams.

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