Deena A Mehta is managing director and co-promoter of Asit C Mehta (ACM) group, having presence in stock, forex broking and money market operations. A chartered accountant and MBA by qualification, she has been actively involved in capital market reforms as a member of the governing board of the Bombay Stock Exchange (BSE) and is on various experts panels formed by Sebi. In a freewheeling interview, she spoke to Sai Prasan and Jigar Pathak of The Financial Express on Sebis discussion paper on the issue of sales practices to be followed by the stock brokers and the negative impact of the Budgetary provisions of the Securities Transaction Tax (STT) Excerpts:
Do you think Sebis proposed guidelines on the KYC norms for brokers will help in strengthening market practices?
Regulation is framed to achieve an objective. The objective is derived from a need. Various methods are adopted to achieve the objective, and regulation is one of them. Each of these methods has a cost and benefit to the society. In the proposed regulation, no clarifications are available as to the objective or cost or benefit.
The KYC norms are very onerous and in fact the documentation required is excessive and costly. An investor has to give over 50 signatures if he wants to start trading in the secondary market. The number of participants in the secondary market is miniscule compared to investors in mutual funds (MFs) or those investing in the bank deposits. This is due to excessive documentation. Sebi now wishes to add more requirements. This would be counter-productive, since there will be more papers to sign and operational difficulties.
Some of the requirements are a repetition of what is already stated by Sebi in its Code of Conduct for brokers and Fraudulent and Unfair Trade Practices (FUTP) Regulation. It is also contrary to Sebi’s own circular on risk management where it was left to the brokers to manage the risk in terms of charging margins and giving exposures to their clients. The purpose for each of the requirements has not been spelt out in the discussion paper. Each requirement should indicate what is sought to be achieved. We appreciate that Sebi knows best, but following rules whose objectives are clearly stated makes compliance more voluntary rather than mandatory.
Are you saying the new norms are more complex and deter investors from participating in the market?
Yes. The new norms have disclosures from brokers and additional paperwork from clients. The requirements are not practical. Specially the requirement of giving exposures based on net worth stated in the discussion paper. Even in case of brokers, exchanges give exposures based on cash and collaterals deposited with the stock exchange and not on the balance sheet stated net-worth. The same norms should be applied to investors. Brokers act on behalf of investors, hence there cannot be different sets of rules for each of them. Even Mukesh Ambani, being the richest man in India, will not be able to open a broking account since his broker would need a recommender who has a similar networth to him!
Will the new norm impact the daily trading volumes?
Daily trading volumes are more a function of market movements rather than changes in compliance requirements. In the long run, all changes are digested by the market. Hence if the market goes up, say, 500 points every day, then volumes will come irrespective of compliance requirements. Hence, volumes may not be compromised. There would be fewer players participating in the same volumes.
Do you see any benefit at all from these new norms?
There are many risks that the investor faces while investing in markets; risk relating to integrity of prices, corporate governance, systemic risk in technology, risk relating to slow banking etc. Broker risk is one such risk. The compliance systems have improved immensely over last few years and the arbitration cases in stock exchanges until January 2008 had come down drastically. Several brokers have provided for losses in their balance sheet due to non-payment by clients. Arbitration awards are simply debited to the broker’s account whereas recovery from investors has to be done through the slow paced general legal system. Investors will be extremely inconvenienced in complying with the new norms and this will result in investors missing out on desired price levels.
But won’t the KYC norms help check frauds in the market?
Which frauds are you referring to? According to me, we have a very transparent system -- every client can see his trade on the exchange system and settlement of all trades is guaranteed. In fact, the trade guarantee norms in derivatives market provide for client margin safety also. If investors lose money, it is due to their inability to appreciate the risks associated with investing in the derivatives market. For the last
few years, investors have seen the markets go only one way and that is up. Now, when the markets have witnessed their first major correction in the past many years, people have begun shouting there is a fraud.
The new norms mandate analysts to disclose their conflict of interest. Will you recommend similar norms for the media covering the securities market, like there are in the developed ecomonies?
All members of media who wish to analyse and write about the markets should be mandated to pass certification exams about stock market operations to get a better understanding of how the markets work. It is the responsibility of every entity which influences investment decision to declare conflict of interest if any. It applies to companies, managements, brokers, politicians, bureaucrats, analysts, newspaper reporters etc. There have been very few cases of prosecution under insider trading world wide. This is a charge difficult to be proved; only self regulation can control it.
Recognizing the negative impact of the Securities Transaction Tax (STT) post-Budget, what are your suggestions for resolving the problem?
The first step is to make the government aware about the financial impact of the changes. We have tried to do the same by meeting the finance ministry officials and giving detailed workings on the increase in the statutory cost of transactions. Brokers have lowered brokerage rates over the last few years, but the government on the other side has steadily increased the levy. STT was 5% of the total direct tax collection when it was introduced, but today after four years, it is 2.5 % of total direct tax collections. This is on a bigger base, due to growth in direct tax collections over last few years. The stock market transactions are subject to service tax, stamp duty, education cess, additional education cess and now STT. If something is earned after all these then there is income tax. The statutory cost component that an investor pays besides brokerage is 86%. This is very high. Government takes great pride in comparing our markets with international markets but when it comes to statutory levies, I think we fare very badly in comparison to other emerging markets.
The trading community consists of only 10,000 odd people. Do you think that the government will accept your demands?
Why do we protect tigers? They are only 3000, but they are an important part of the nature’s ecosystem balance. Similarly, traders may be only 10,000 in number but their activity leads to increased liquidity and lowering of impact cost. The beneficiaries are millions of investors, companies who wish to use the stock market for raising capital and the government itself, which is the biggest shareholder.
Do you think the Indian tax structure now compares with the rest of the world?
Market makers / jobbers enjoy special status in most countries. The statutory costs are highest in India. In fact, there is no stamp duty when STT is introduced. Since we have a transparent system with complete audit trail, every regulator wants to use the brokers for various tax collections rather then collect the same directly from citizens. This appears to be more a price for efficiency.
People reacted when the STT was introduced. Do you think that this is a temporary phase and people will come back to normal trading?
As I said earlier, volumes are a function of the index and individual stock behaviour. The basic issue will not change and that is the issue of high statutory costs. The impact cost will be high; this was demonstrated by the impact during the 2 days during which jobbers abstained from trading. Several counters did not have quotes at all and average volumes also dropped.
Would these issues prevail even in a bull market or is it only because markets have fallen so much that this issue has erupted?
Cost is a cost. A bull market offers faster opportunities for entry and exit, and in a bear market entry and exits are slower. The basic imperfections in any market surface when the markets are in trouble; the impact in such times is more severe.
