Stifled by regulations

In India, they certainly don’t make it easy for you to be a law-abiding citizen. Ever since the financial crisis broke out, Indian regulators have been hyper-active in their zeal to clean up the system.

This has meant that every few days, the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI) or others announce new additions or tweaks to existing laws that tighten the screws, just a little bit, on entities that fall within their purview.

Unregulated entities, however, continue to flourish in a blissful vacuum.

Fund raising travails

The most recent reminder of this came from the SEBI-Sahara case where, even after a Supreme Court verdict, the unlisted Sahara firms have been leading SEBI on a merry chase, stalling refunds to investors. These firms raised a sum larger than any Indian initial public offer (IPO), purely from retail investors, without the benefit of a prospectus, regulatory approval or even proper documentation of subscribers.

Contrast this with the travails of a company that wants to legitimately raise money through the IPO (initial public offer) market. After finalising a project with a concrete funding plan, it has to file a bulky prospectus with the regulator that lays bare all its finances and risk factors. With SEBI’s blessings, it then has to invite bids from the public, with quotas reserved for institutional investors.

Even if it is prepared to jump through all these hoops, a company today has no guarantee of being able to actually raise that money. For, recent changes to IPO rules endow SEBI with discretionary powers to reject IPO offer documents, if it finds them unsatisfactory. Keen to resurrect the moribund primary markets, the market regulator has made over a dozen changes to its already elaborate new issue rules in 2012 alone.

Over-regulated

Stock market players such as depositories, stock exchanges and brokers have been kept equally busy by the regulator. In the past year, stock brokers have been the subject of over 25 SEBI circulars which enjoin them to do everything from pre-trade checks to conducting due diligence on foreign investors to publicising the Rajiv Gandhi Equity Scheme.

In a recent interview to Livemint , C. J George, founder of one of India’s leading brokerages asked why, of the three asset classes in India (gold, real estate and financial assets), only financial assets had to be so over-regulated for transparency and KYC norms. He pointed out that the speed at which new regulations were being introduced took away the ‘directional focus’ of these rules.

NBFCs Vs money-lenders

But such regulatory arbitrage exists in other segments of the financial market, too. To illustrate, the RBI, suspicious of the rapid growth of Non-Banking Finance Companies (NBFCs) that extend gold loans has come up with multiple rules for these firms in the last two years.

In 2011, bank funding to them was curtailed by removing the priority sector tag. In March 2012, their loan-to-value was capped at 60 per cent and they were subjected to higher capital requirements. However, this was not the end of the story.

Not satisfied with this, the RBI has had a working group thoroughly review the sector and come up yet another set of recommendations. The group has now suggested raising the loan-to-value norms from 60 to 75 per cent, but with a new cap on their interest rates. It also wants to impose Know-Your-Client norms on gold loan takers.

While these norms are intended to curb malpractices such as fencing and tax evasion, the reality is that the lion’s share of gold lending in India happens through the vast population of street corner money lenders, who would scarcely dig into the antecedents of their clients. What will prevent borrowers with dubious collateral from seeking out their services?

If one is looking for instances where regulators have single-handedly managed to stifle a sector, one need hardly look beyond microfinance.

Over-zealous regulation of the sector by the Andhra Pradesh Government led to snowballing defaults, finally forcing established players to completely shut shop in the State, which was once held up as the model for financial inclusion.

Burdens of listing

A yawning disparity in regulations is opening up between listed and unlisted companies too. Listed firms have to follow reporting and disclosure norms contained not only in the Companies Act but also in the Listing agreement with the stock exchanges, enforced by SEBI. In recent times, the spotlight on governance has prompted SEBI to impose many new reporting requirements via the listing agreement.

One new rule is for a listed company’s top management to separately highlight audit qualifications in the accounts and promise to restate the same, if SEBI directs it.

Then, there is the new ‘Business Responsibility Report’ which has the lofty objective of evaluating the steps taken by a company from an environmental, social and governance perspective.

This multi-page annexure to the annual report, which applies to the top 100 listed companies, requires them to disclose such items as ‘products and services that incorporate social and environmental concerns’ and the proportion of inputs sourced ‘sustainably.’

This begs the question: How much attention can a business whose primary objective is profits, afford to devote to the environment or social responsibility? And if environmental or social responsibility is indeed so critical, why is it critical only for listed firms?

The increasing compliance and reporting requirements for listed firms relative to unlisted ones, creates a fairly strong incentive for companies to exit the public markets.

Rising disclosures, taken with the minimum public shareholding norms, are in fact prompting some quality companies to opt for delisting. This should be a cause for concern for policymakers who are keen to deepen and widen the stock markets.

Overall, one cannot blame the regulators for being zealous in protecting investor interests or guarding against systemic risks. But after the regulatory overdrive of the recent past, it appears to be time to slow down the pace of change in regulations and focus more on enforcement. It would also be good to avoid frequent policy flip-flops that create so much uncertainty for their constituents.

With such large swathes of the market outside the regulatory purview, it may not take much for law-abiding firms to cross over to the other side, simply because life is so much easier there.

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