Financial markets: Small, incremental changes won't cut it anymore

For those who are spammed by multiple brokerages today to open a trading account at zero brokerage, it is hard to fathom what it was like to be a stock trader or retail investor in the pre-1994 days.

It was a sunny winter afternoon in 1991. I was enjoying coffee at a famous public café in Connaught Place (New Delhi) with a couple of friends. All of us were waiting for our CA final (chartered accountancy) result, which was to be announced in a couple of weeks. My friends were senior to me and were already working, having completed their articleship two years ago. We were discussing the economic changes that were being unleashed in the country by the new regime that had assumed office a few months prior.

The economic changes had not impacted me in any positive manner by then. INR (Indian rupee) devaluation had led to inflation spike, disturbing our household budget. Some of my close relatives who were running micro and small industries (then called SSI) were deeply worried about the sustainability of their business as they were now exposed to competition from larger businesses and imports.

My cousins had their own set of worries. The implementation of the Mandal Commission recommendation was reaffirmed. The competition to get government jobs and admission into public educational institutions had intensified for general category candidates.

The aftershocks of former Prime Minister Rajiv Gandhi’s brutal killing, gulf war, Punjab terrorism, were still being felt in Delhi. Overall, things were not looking great from where I was standing that afternoon.

My friends who had started investing in stocks were, however, in high spirits. They had earned very good profits by trading. Their employers had promised them promotions if they passed their final exams. They already had a new idol, (the now infamous) Harshad Mehta, to look up to. That afternoon, they could not see anything wrong. Arguably, this was their best time in life.

Our discussion was obviously not harmonious.

About an hour later, a middle-aged man with very ordinary personality entered the scene. Tarun, my friend, excitedly jumped out of his seat to greet him. “Meet Mr Hemant Pandey, my stock broker. Hemant ji advises me and also helps in executing my trades at the Delhi Stock Exchange (DSE). He also knows brokers who can execute trade at BSE (the Bombay Stock Exchange),” he proudly introduced the man to us.

And here begins the story.

On enquiry, I found that Hemant, a college dropout, was an “authorized agent” of a “sub-broker” of a DSE broker. A friend of his friend was a remisier (a person authorized to go on trading floor) of a broker at the BSE. He was, therefore, able to place orders for his “clients” with brokers at the DSE and the BSE. Though it could usually take up to four days to execute a trade and get confirmation of trade. The brokerage charged ranged between 2% and 5%; and only “market price” orders were accepted. Delivery of physical share certificates with a valid transfer deed was not guaranteed. It was mostly on “best effort” basis.

That was the situation of the Indian financial markets when liberalization started 30 years ago. Having direct access to a stock brokers’ office was sufficient to make someone “important” in his/her social circle. Something similar to if you have direct access to a minister’s office today.

The people in their 20s and 30s who are spammed daily by multiple brokerages to open a trading account at zero brokerage, would never be able to fathom what it was like to be a stock trader or a “retail investor” in the  pre-1994 days.

Democratization of financial market is one of the most understated reforms of the past three decades. The impact of democratization of society in past three decades is visible in almost every sphere. People belonging to the bottom of the pyramid have done particularly well in politics, administration, sports, entertainment, business and professions, and science.

However, the easy and free access to financial and banking services has been the most remarkable achievement. Financial inclusion, as we call it popularly, is one of the core pillars of the entire socio-economic development endeavour in the past three decades. Technology (especially digitalization) and telecom infrastructure are two other strong pillars which have supported the financial inclusion as well.

The tendency to overregulate is one of the undesirable aspects of modern democracy, as it promotes chaos, rebellion and anarchy. Since the global financial crisis, we have witnessed this tendency to overregulate dominating the financial markets also. As a natural corollary, the chaos (heightened volatility), anarchy (unassimilated assets trading at unfathomable valuations) and rebellion (rejection of conventional wisdom in favour of untested experimental ideas) are also prominently visible in markets. Maybe the time is approaching fast when the democratization of financial markets that started three decades ago would also need an affirmative agenda for renewal.

Like Robinhood Markets of US, which pioneered the commission-free investing model and allowed many people to start investing, including those who otherwise would never have ventured into stock markets, many platforms have emerged in India also. Zerodha, for example, is now the largest stock trading platform in India in terms of number of clients.
There are multiple platforms for trading of unconventional financial products like cryptocurrencies (example, Bitcoin) and non-fungible tokens (NFTs).

The advent of new technologies, new products, new set of investors, new methods of valuations and different risk profiles perhaps require a fresh approach to the financial markets regulatory framework.

So far, the regulators and governments have adopted an incremental approach for regulating the emerging developments in financial markets. This is apparently resulting in overregulation, misregulation, rebellion and chaos.

Margining and disclosure norms which are not in sync with the current market realities; abundant trading in unregulated (grey) markets; mushrooming of unregulated crypto and NFT exchanges and platforms; participation of large number of individual investors with inadequate financial literacy and risk tolerance, etc., are some of the problems that are plaguing the markets.

Some of the problems that may require a totally new approach to regulations could be illustrated as follows:

- Under pressure from market forces, the market regulator SEBI has been forced to defer the implementation of proposed tighter margining norms.

- The managements are disclosing so much irrelevant and redundant information to the market, on the pretext of regulatory requirement. The relevant information many a times is getting lost in this overwhelming deluge of redundant information.

- There are numerous cases of offers for sale (in guise of initial public offers) where the existing investors have exited at an apparently unjustifiable price. The managers of these issues owe no accountability to the gullible investors who may lose substantial money.

- Trading in new assets (cryptos, NFT, etc.) so far is unrestricted. There are numerous traders who may not be adequately skilled to understand the risks. There is no visible effort from regulators so far to improve the literacy and awareness level of these traders. It is, therefore, desirable that for the time being, the trading is restricted to discerning traders only.

US President Joe Biden stated on the International Day of Democracy, “No democracy is perfect, and no democracy is ever final. Every gain made, every barrier broken, is the result of determined, unceasing work.” He has made it clear that renewing democracy in the United States and around the world is essential to meeting the unprecedented challenges of our time. He brought the global leaders from government, civil society, and the private sector together to a global democracy summit, to “set forth an affirmative agenda for democratic renewal and to tackle the greatest threats faced by democracies today through collective action”.

It is imperative that this principle is applied to the financial markets also. The promised new code for the regulation of financial markets must take a fresh approach to regulation rather than adhering to the usual incrementalism.