(An exchange is not a purely commercial entity, it has to function as a frontline regulator, a utility (public goods) and a regulated entity, said SES' MD and founder JN Gupta. (Illustration by Suneesh Kalarickal)
The Securities and Exchange Board of India (Sebi) recently announced changes to the rules for market infrastructure institutions (MIIs) to improve governance standards.
The MIIs include entities that make up the backbone or infrastructure of the market, such as exchanges, depositories, clearing houses and share-transfer agents. The co-location server controversy and hiring lapses at the National Stock Exchange (NSE) may have been a contributing factor to the development, according to industry sources.
“That was not the only trigger,” says JN Gupta, who was also part of the committee that advised the market regulator on the MII reforms, in an interview to Moneycontrol.
Also read: Sebi proposes regulatory framework for index providers
Gupta is also the founder and managing director of Stakeholders’ Empowerment Services, a proxy advisory firm. In the interaction with Moneycontrol, he spoke of the intent behind these reforms.
What was the trigger for the MII reforms? Was it an event, like the investigation into the National Stock Exchange (NSE)?
Historically, every three to five years, changes have been made in regulation. Even in (former RBI governor Bimal) Jalan Committee, we had written that these regulations will have to be looked into from time to time basis, as things change in the marketplace. And it (regulations) is a quickly evolving thing when India is integrated with the (rest of the) world… (domestic markets) have to keep pace with what is happening around the world. When something new happens, one is bound to associate that with an event that has taken place (prior to that)…
Similarly, the market reaches a conclusion that perhaps the committee was formed after the co-location incident, I would still not call it is a scam because we do not know for sure if it was a scam or not. But yes, it is an issue (an indicator) that something was not correct and that it needed to be fixed. When it (the co-location incident) was being looked into, it gave an opportunity to look into the issue holistically. But, essentially the reforms were needed to keep pace with the changes that were taking place and (were drawn from) regulatory experience.
So the co-location investigation was not the trigger?
That was not the only reason for it, is how I would put it.
Why was it necessary to specify that there should be three different heads for different functions—critical, regulatory and compliance, and business development? Were any of the functions being compromised because of any overlap in responsibilities?
The (Sebi advisory) committee felt that there are three basic functions of an exchange (as given above) and that there have to be clear boundaries… or rather, we can say that these are three verticals in which the exchange must operate.
An exchange is not a purely commercial organisation. It has to function as a frontline regulator, a utility (public goods), a regulated entity and a commercial entity. (So the regulator felt the need to clearly define the verticals).
Sebi’s amendments have said that the MIIs should give higher priority to resource allocation towards critical operations and regulatory/ compliance/ risk management than towards the third vertical that includes business development. How would this resource allocation be measured by Sebi?
The media picks up what other people haven’t thought of (laughs)… I don’t think the idea of the committee was to aggregate (resources for) the first two verticals. I don’t think the idea was that the first two together should have more resources than the third. At the same time, no one is going to measure (implementation to the smallest detail)…
Whether half-litre here or 250ml there. The idea is that that MIIs should not lose focus of its regulatory and compliance functions. For example, it should not be that you put your brightest in business development and a dullard in compliance or regulatory. So (allocation of) resources isn’t in terms of money (remuneration alone) but also in terms of talent and so on.
I don’t think there is a metric for everything. For example, if I say that a CEO has to be a person of high integrity, how would you measure that?
Will it be tracked by the remuneration paid to the KMPs?
No, it also means that the staffing of the departments should be done (equitably)… You don’t staff regulatory and compliance minimally and then give business development an army of people.
Are you saying that the intent is what will matter…
Yes, not (compliance) in the letter (but compliance to the amendments in spirit). Otherwise, someone can raise an objection tomorrow, saying that the total salary for compliance was Rs 20 crore but for business development was Rs 20.05 crore… I don’t know what Sebi will do but the idea is to ensure that an MII acts in a fair manner, by not ignoring one function at the cost of the other.
I am not saying that the implementation of this will be left to the discretion of the MII, because that would mean that they can ignore it. I am saying that it (the regulations) won’t be prescriptive, like saying put 20ml of water, then add 50 ml of honey and so on. It is not prescriptive but it (the regulation) is meant to be followed in spirit.
About the appointment of public interest directors (PIDs), the amendments say that “MIIs will be required to mandatorily appoint PIDs with background and expertise in the areas of technology, law and regulatory, finance and accounts and capital markets”. Why was there a need to specify these skillsets? Were PIDs being appointed without the necessary skillsets?
It was simply streamlining the process. There are dozens of MIIs now and it became difficult to track the practices of each one of them. So it seemed better to have a system in place. What shouldn’t happen is that an MII hiring lawyers for all 10 PID positions because the Sebi regulations have listed competencies. It has to maintain a balance, like a multi-specialty hospital has doctors of different specialisations.
If you look at Sebi’s Listing Obligations and Disclosure Requirement (LODR), it says that a listed company’s board should have skill sets. When MIIs have to follow all regulations of a listed company, unless they are in contradiction with another regulation, then this (amendment for PID appointments for MIIs) is one way to bring the LODR thing (requirement) into MII, even if they are not listed.
What is the purpose of the Investment Committee?
Usually boards of stock exchanges decide when they want to invest (in another business). Now this investment committee will do that function. The committee won’t be deciding on whether the surplus should be put in fixed deposit or G-sec etc, it will be to deciding on investments that are of a (business) capital nature.
Overall, the (Sebi advisory) committee has not overhauled the regulations that were there. We have just said that what is already happening should be put in boxes so that these boxes can be better controlled.
What is the role of the chief risk officer? The new rules say that MIIs will need to appoint someone who will be in charge of all risks associated with the institution.
It is a simple and difficult question. He will have to have a wholistic view of the risks that an MII is exposed to, it could be from the trading system or from the competition or from investment. You could say that the chief risk officer would be the nucleus point (the central node) that tracks risks and controls it.
Does it seem like a critical role? Will there be a clearer definition of how this person will be selected and the function will need to be carried out?
Somebody had flown the aeroplane also for the first time. Where did that person get trained? So something has to be done for the first time. There is assessment of risk at stock exchanges happening even now, this is just to put that in a box (systematise it).
MIIs are also now expected to get evaluated by an external entity once every three years. Who will this be?
Certainly not SES. We will not do anything like it. It could be any of the human-resource companies that evaluate directors or any other proxy advisory company or those that provide evaluations of various kinds (like the Big Four).
