The Union government and the Securities Exchange Board of India (SEBI) on Monday said they have no objection to the Supreme Court constituting an expert committee to examine the existing regulatory regime and frameworks in the securities market to protect investors from share value meltdowns like those seen in the Adani Group, triggered by the US-based short seller Hindenburg Research report on the conglomerate.

But the Centre and SEBI urged a three-judge Bench led by Chief Justice of India DY Chandrachud to allow it to “suggest” to the court the committee’s mandate and the names of its members in a sealed cover in order to protect the market from any upsets.

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“We have no objections in Your Lordships constituting a committee, but the remit of the committee would be very, very relevant because any unintentional message to international and domestic investors that even a regulatory or statutory authority needs monitoring by a committee appointed by the highest court of the country may have some adverse impact on the flow of money.

So, if you may permit us to suggest the remit of the committee along with suggestions of the possible names for the committee in a sealed cover… They will be people of some caliber and standing,” Solicitor General Tushar Mehta, appearing for the government and the SEBI, assured.

Mehta explained that it may not be “appropriate” to discuss the government’s suggestions in open court as they “may or may not appeal to Your Lordships”. He said, “We would not like to undermine the competence of the agencies, including the regulator and the regime available.”

The court asked the Solicitor General to prepare a note on the proposed mandate of the committee and bring it on Friday, the next date of the hearing. “So that we have something on paper to apply our minds to. We will have a discussion and then pronounce the order,” Chief Justice Chandrachud responded.

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A 22-page submission note shared by the SEBI, also represented by advocate Pratap Venugopal, in court said the market regulator was already enquiring into the allegations made in the Hindenburg report as well as the market activity immediately preceding and post the publication of the report in order to identify violations of SEBI Regulations.

Not the answer

The market regulator attempted to allay fears by saying that the events concerning the Adani Group, following the Hindenburg report, were “localised to a single group of companies and that there is no significant impact at a market-wide level or at a system-wide level, that might warrant a system level review of the regulatory frameworks in operation”. However, it acknowledged that “entity level issues that have arisen have had a significant impact at the entity level and warrant detailed examination by the regulator”.

“While the shares of the Group have seen significant decline in prices on account of selling pressure, the wider Indian market has shown full resilience. The combined weight of the Group companies in Sensex is zero and in Nifty is below 1 per cent,” it noted.

It said Indian markets had seen “far higher turbulent times in the past, especially during the Covid pandemic, when Nifty fell by around 26 per cent during the period of March 2, 2020, till March 19, 2020 (13 trading days)”.

Even during such turbulent times, the note said, the SEBI had not resorted to banning short-selling, even though there were demands for banning it.

“The markets continued to function in a robust manner, recovering far faster than other global markets. Investor wealth (market capitalisation of all listed companies) which was around ₹145 lakh crore in February 2020 has almost doubled to about ₹270 lakh crore now. Further, overall market volatility in India is on par or lower than that in major developed markets,” the SEBI said.

Chain reaction

It said Hindenburg’s strategy was to take a short position in the bonds/shares of companies at the prevailing prices, (i.e., sell the bonds/shares without actually holding them) and then publish their reports. A chain reaction follows.

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“If the markets believe the reports, the prices of the bonds/shares start to fall. Once the fall starts, other institutions who have ‘stop loss limits’, also start selling their holdings irrespective of whether they believe the report or not thus triggering a downward spiral in share prices. The short sellers then buy the shares at lower prices, thus making a profit. The more the market believes their reports and the more ‘stop loss limits’ get triggered, the more the prices of the bonds/shares fall and the more money they make,” SEBI explained.

It informed that SEBI’s Additional Surveillance Measures (ASM) framework, designed to control excessive volatility in stocks (both price increase and decrease) was triggered on numerous occasions for long periods of time when there was a significant rise in share prices of the companies of the Adani Group.

“The Group has a number of USD-denominated bonds listed in the overseas market. Hindenburg in its report has stated that its short positions in the Group are in USD bonds in overseas markets and non-Indian traded derivatives,” the SEBI noted.

It said SEBI had installed several measures to protect the market from sudden and unusual price movements, excessive volatility, etc, and these include the Market Wide Circuit Breaker (MWCB) system.

“These circuit breakers, when triggered, bring about a coordinated trading halt in all equity and equity derivative markets nationwide,” the SEBI said.

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