The proliferation of fintech platforms for stock and bond market investments over the last two years poses a unique challenge to regulators — how can they be brought under regulatory purview without throttling their businesses? The Securities and Exchange Board of India’s (SEBI’s) discussion paper on unregulated online bond trading platforms does a fine balancing act. The paper suggests that these informal platforms which have mushroomed during the pandemic should be allowed to function but with adequate regulatory oversight, using common standard practices and with investor redressal processes. The paper also suggests merging these platforms with existing stock market intermediaries and routing all transactions to the stock exchanges and clearing corporations. This should indeed be the manner in which fintech innovations should be approached; the attempt must be to harness them to improve the current financial market ecosystem.
The extremely thin participation in the publicly listed debt securities market is partly responsible for the growth in these online platforms. Ninety-eight per cent of the primary issuances of debt securities on stock exchanges are done through private placement, which are completely absorbed by institutional buyers. The online trading platforms are currently acting as a conduit for making available these listed debt securities to non-institutional investors, imparting much-needed liquidity and demand for debt securities. But there are some concerns that need to be addressed. Many of these platforms are not complying with PMLA guidelines or SEBI KYC requirements. Also, investors do not have any recourse if there is a default on these exchanges. The proposal in the discussion paper that the platforms register themselves as a broker with SEBI or that they should be run by existing brokers, addresses such concerns. Registered brokers are required to follow standard practices while onboarding clients, have adequate net worth and their sales and advertising practices can be controlled by SEBI. The suggestion that all transactions on online bond platforms should be routed through the debt segment of stock exchanges is well thought through. Not only will it protect investors from settlement risk as the transaction moves through exchange clearing corporations but the liquidity on bond platforms of exchanges will also get a boost.
There are, however, some facets which have not been addressed by the discussion paper. Currently, the lot size for trading in bonds on stock exchanges is pegged quite high, in order to dissuade smaller investors from dabbling in them. On the other hand, the lot sizes on the online platforms are much smaller. The regulator could consider doing away with lot size restrictions for trading on debt securities on exchanges to align them with the online platforms, in order to increase participation. Disclosures regarding the securities traded need to be improved vastly on online platforms. They should be asked to update all relevant background information regarding the securities on their websites and also bucket the securities in various categories, based on their risks. Finally, by asking these online bond platforms to trade only listed securities, SEBI is creating yet another unregulated market for unlisted debt securities. There appears to be demand for unlisted securities too. Rules can be framed for trading of these securities too on online platforms, albeit in a special category, with sufficient disclosures about risks involved.