In the early 1990s, when the economy was grappling with macroeconomic issues like the fiscal and balance of payments crisis, a stock market scam came into light in 1992. This gave reasons to address problems in the Indian capital markets. Until then, much of the stock market activity was done by the Bombay Stock Exchange, which was seen as a broker’s club. The idea of a professional stock exchange was conceived the same year and took shape over the next two years. Then Finance Minister Manmohan Singh made several proposals related to capital markets in his 1993-94 Union Budget speech. Consequently, the National Stock Exchange (NSE) emerged as the poster child of India’s economic reforms.
In this backdrop, SEBI’s order saying that NSE did not exercise due diligence in its own co-location services came as a shock. Under the co-location issue, it was alleged that NSE gave preferential treatment to select brokers. This allowed them to get access to trading data faster than others, leading to information asymmetry and higher profits.
After long deliberations (investigations started in 2014), SEBI did not really find any strong evidence, yet charged NSE in its ruling. The exchange has been asked to pay a hefty penalty. It has also been barred from launching its own IPO and introduce new products for 6 months. Further, some key officials have also been penalized and barred.
This case joins several cases which have emerged in the Indian financial system in recent times. What is more worrisome, though, is the way the Indian financial sector story is unravelling. When the global financial crisis stormed financial markets, misconduct was found in financial institutions across countries from Lehman Brothers in the US to Barclays in the UK to several banks in Europe. Penalties on these institutions continue until today. Several central banks studied the issue of misconduct and their analysis revealed how culture in finance has declined across activities from cheating depositors to inflating credit rating agencies to manipulating Libor rates.
For a while, it was felt that India is safe from all such conduct and practices. The Indian economy recovered quickly from the 2008 crisis and most domestic financial institutions were unscathed. But in the last few years, we have not just seen a huge NPA crisis but also misconduct across several financial institutions of eminence. Even though SEBI has not found much evidence against NSE, it has been penalized to send a strong signal that there will be zero tolerance in such matters. As NSE is a very important financial institution, this case had to be tackled carefully as one could not be too harsh as it would undermine market confidence.
The case also adds to what RBI has been doing in recent years. RBI as a banking regulator has been penalising banks and NBFCs for multiple reasons, with most of them summarised as non-compliance of regulatory guidelines. Recently, RBI also penalised prepaid instrument issuers and international remittance providers. Thus, there is a wider purpose shared by Indian financial market regulators who are acting with a stick to rectify misconduct and malpractices. Both the regulators have also been criticised for the ongoing failures and they want to correct that perception as well.
The only saving grace in the Indian story is that these events have not led to a systemic crisis like other countries. But we have seen that systemic risks materialize much faster than anyone can imagine. This columnist has earlier argued that the Indian government should set up its own committee to study this decline of culture in the financial sector. Why have abuses in the financial sector and pervasive greed become so common across the world?
In a way, the set of events have come a full circle for both the regulator and the NSE. First, for a long time, SEBI has been accused of giving favourable treatment to the NSE but with this ruling, it’s no longer true. Second, NSE was seen as an institution which could do no wrong but is also being questioned now. Third, now NSE is accused of similar problems for which BSE was once accused. Apart from economic reasons, NSE was also founded to check the monopoly powers of BSE and some of its top management who were running the exchange in an autocratic mode. Reading SEBI’s order, we see how a few individuals are being guilty of running NSE in a similar fashion as well.
Jean-Baptiste Alphonse Karr, the French critic and writer famously said, "plus ça change, plus c'est la même chose" which means "the more things change, the more they stay the same”.Amol Agrawal is faculty at Ahmedabad University. Views expressed are personal.