M. Damodaran’s biggest challenge as chairman of the Securities and Exchange Board of India (Sebi) will be to live up the high expectations raised by his success at the Unit Trust of India (UTI). And given the situation at Sebi, it is going to be a tough job indeed. That’s because Sebi has covered a lot of ground in the 13 years since it got its statutory teeth. Most systemic changes are in place, regulations have been framed to cover all market segments and intermediaries and they have been repeatedly refined to plug obvious loopholes and respond to changing situations. Margining and risk management systems have also been successfully tested in the dramatic collapse of May 17,2004 and are among the best in the world.
What remains to be fixed is more difficult but seemingly simple. Damodaran needs to restore the credibility of Sebi as an effective regulator by tightening supervision, implementing regulation, improving the quality of its investigation and punishment. A couple of months ago, when Damodaran was still talking about ‘‘giving the State Bank of India a run for its money’’ and had no plans to be India’s capital market watchdog, he gave me his views on the capital market as part of another interview. His thoughts indicate that Damodaran is very clear about Sebi’s strengths and flaws and while his takeover speech may have been all diplomacy, he has some radically different ideas about capital market development.
Here are some of the issues that may be on his priority list. Damodaran is clear that the big challenge is to bring the retail investor back to the capital market. Despite the recent IPO successes, he said, ‘‘The average retail investor with investible surpluses is not coming to the market in a big way. All the investment is either institutional or by high networth individuals.’’ If the retail investor were back, at least a small portion of the investment would have found its way to mutual funds, even though they haven’t acquitted themselves terribly well, he said. This situation has changed in the last couple of months, going by the enormous subscription to mutual fund IPOs. So the Sebi chief’s job would be to ensure that retail investors are not disillusioned all over again.
His other concern is that entry barriers to new investment are much too high. Damodaran said the first time investor is bound to compare equity investment with the simplicity and assured return of a bank fixed deposit or a post office savings scheme. He believes that the modern capital market has raised entry barriers to the point where investors hesitate to enter. There is a significant cost involved even before the first investment. He has to register with a broker, open a demat account (which includes various kind of charges and often a bank deposit) and pay custody charges before his investment has any hope of making money. ‘‘My pet peeve is the cost of compliance ‘who is paying it?’’’ Ultimately, most of the costs imposed on market intermediaries are being passed on to investors in one form or another. A first-time investor is easily daunted by these costs and procedures and reluctant to enter unless the markets promise safety and returns that make the effort worthwhile. On the efficiency of shorter settlement cycles, Damodaran understands the need to move to global standards and meet the demands of large foreign institutional investors, but as far as the retail guy is concerned, he says, ‘‘I don’t think T+2 gives him satisfaction. He is happy with T+5, so long as it is not T+ six months or T+infinity.’’
Damodaran’s solution is to simplify procedures, break down entry barriers and reduce costs. For instance, on Initial Public Offerings (IPOs), he thinks that there has to be a way to stop unscrupulous IPOs. ‘‘You have to put excellent regulation in place, prevent fly-by-night operators from accessing the market and come down heavily on errant promoters,’’ he said.
‘‘When it comes to IPOs, you are simply dumping an enormous amount of information on to the investor without bothering about whether or not he understands it.’’ Language is also an issue, he says. ‘‘IPO documents, including those of mutual funds go by the belief that language is given to man to conceal his thoughts, and they make a good job of concealing a great deal. Yet, investors are expected to read those tomes and understand them.’’
His other worry is that investors today are subject to high selling pressure by insurance companies, mutual funds or agents for small savings instruments. All of them want to push an investor’s entire investible surplus into their specific product. What is lacking is investor education or a specialised class of investment advisors who help to plan diversified portfolios to suit various individual requirements, says Damodaran.
His views on market structure are also different. Damodaran says, ‘‘Currently most of our regulation works against the first-time entrepreneur because everybody wants a track record. Banks require a track record, market access also needs a track record and entrepreneurs are unable to provide it. We need separate exchanges for small cap companies but the BSE and NSE are not really interested.’’
BSE has already launched Indonext as a platform for small cap companies, but it is clearly not enough. It remains to be seen how hard Damodaran pushes for small cap bourses and whether he has any plans to revive the OTC Exchange of India. It must be remembered that these were Damodaran’s thoughts from outside Sebi. Once in the hot seat, his biggest challenge will be to restore the credibility of Sebi’s supervision and its disciplinary actions. But this change can only come about if Sebi has the right people for the job. Damodaran believes that Sebi can find people with multi-dimensional expertise only by paying the right price for the right skills and looking for people who will come on a three-year contract. At UTI AMC, Damodaran successfully pushed for an incentive-based payment structure; it will be interesting to see if he succeeds in introducing it at Sebi and making the watchdog ferocious again.