Report of the Advisory Group on Securities Market Regulation

Chapter I Background to the Report Chapter II Securities Market Regulation in India - An Overview 1. Introduction 2. Equity market 2.1 Nature of market prior to reforms 2.2 Equity market reforms since 1992 2.3 Results 3. De t market 3.1 Nature of market prior to reforms 3.2 Reforms since early 199!s 3.3 Results Chapter III Adherence to Best Practices Status and !uture Agenda 1. Introduction 2. Re"ulatory Issues 2.1 #he re"ulator 2.2 Enforcement of securities re"ulation 2.3 Cooperation in re"ulation 2.$ %elf&re"ulation 2.' (rudential issues 3. )e"al Issues 3.1 Institution&specific re"ulations 3.2 *ultiplicity of +cts $. *arket issues $.1 *arket infrastructure $.2 (rimary issues and transparency '. *utual ,unds Anne"ure I Anne"ure II

#hapter I Background to the Report #he %outheast +sian crisis underlined the need for the a-aila ility of stron" institutions in addition to sound macroeconomic policies. Reco"ni.in" this/ the international standards& settin" odies ha-e mo-ed in a si"nificant 0ay in makin" a-aila le the respecti-e standards and codes for financial markets and identifyin" principles for sound and sta le policies. 1hile the International *onetary ,und has prescri ed the standards and codes for monetary and financial policies and fiscal transparency and the 2ank for International %ettlements has prescri ed the 2asle Core (rinciples for stren"thenin" ank super-ision/ the I3%C3 has outlined the standards and codes for securities markets. ,ollo0in" these measures y the international odies/ the Reser-e 2ank of India/ in consultation 0ith the 4o-ernment of India/ constituted a %tandin" Committee on International ,inancial %tandards and Codes in Decem er 1999. #he mandate of the %tandin" Committee includes the identification and monitorin" of the de-elopments in "lo al financial standards and codes/ assessment of their applica ility to the Indian financial system and outlinin" a road map for ali"nin" India5s practices 0ith international est practices. In -ie0 of the enormity of the task as 0ell as its -aried nature/ the %tandin" Committee considered it useful to constitute ten +d-isory 4roups in different speciali.ed areas. #he +d-isory 4roup on %ecurities *arket Re"ulation/ under the chairmanship of %hri Deepak (arekh 0as one such "roup. #he %E2I and the R2I/ ein" re"ulatory odies/ 0ere made permanent special in-itees. #he R2I pro-ided the secretariat and infrastructure support. #he list of mem ers of the 4roup is "i-en in +nne6ure I. #he 4roup 0ould like to place on record its sincere thanks for all the "uidance recei-ed from %hri. %. %. #arapore and (rof. +7ay %hah and also to Dr. R. 8annan/ Con-enor and %hri. +. 8. *itra/ co&con-enor/ Dr. 9r7it (atel/ %hri. Nirmal *ohanty and %mt. 9sha #horat for their contri utions in finali.in" the draft. #he 4roup -ery much en7oyed 0orkin" to"ether 0ith this team. #he terms of reference of the +d-isory 4roup are as follo0s: #o study the present status of applica ility and rele-ance and compliance in India of the rele-ant standards and codes/ #o re-ie0 the feasi ility of compliance and the time frame 0ithin 0hich this can e achie-ed/ "i-en the pre-ailin" le"al and institutional practices in India/ #o compare the le-els of adherence in India vis--vis in industriali.ed countries and also emer"in" economies/ particularly to understand India5s

#he Report is su 7ect to comments from %E2I. 2

position and promote actions on some of the more important codes and standards/ and/ #o chalk out a course of action to achie-e the est practices.

+fter a fe0 deli erations/ the 4roup decided to limit the a"enda to a re-ie0 of the securities market re"ulations in India and to identify the important lacunae and issues in the li"ht of I3%C3 o 7ecti-es and principles/ 0hich could pro-ide a asis for chartin" out future reforms. 1hile %ection&II pro-ides an o-er-ie0 of the securities market re"ulation 0ith emphasis on reform measures introduced in the past decade/ %ection&III outlines the e6tent to 0hich the Indian securities market adheres to the I3%C3 principles and also sets out an a"enda for "ettin" the Indian market more in line 0ith I3%C3 standards.

#hapter II Securities Market Regulation in India - An Overview $% Introduction + sta le and efficient financial system pro-ides the foundation for implementation of effecti-e sta ili.ation policies/ more accurate pricin" of risk and more efficient use of capital. Efficiency of the financial system is "o-erned y the role of markets in mo ili.in" and allocatin" financial resources/ in pro-idin" liquidity and payment ser-ices and in "atherin" information on 0hich to ase in-estment decisions. %ta ility/ on the other hand/ is concerned 0ith safe"uardin" the -alue of lia ilities of financial intermediaries that ser-e as stores of 0ealth. #his also in-ol-es questions relatin" to prudential super-ision/ financial re"ulation and "ood "o-ernance. It needs to e added here that as financial systems "et increasin"ly "lo ali.ed/ capital mo-es not only in response to competin" monetary policies/ ut also to competin" financial systems. Inefficient and unsta le financial systems are therefore likely to e increasin"ly penali.ed. In India/ as in other parts of the 0orld/ securities re"ulations ha-e e-ol-ed in the face of t0o apparently di-er"in" trends. 3ne relates to a mo-e to0ard li erali.ation of financial markets/ 0hich entails elimination of measures of financial repression such as direct controls on interest rates/ mandatory in-estment in "o-ernment securities/ administrati-e pricin" of securities and so on. #he other force is to0ard stron"er re"ulation. #he need for stron"er re"ulation comes to the fore since financial markets are characteri.ed y si"nificant asymmetries of information/ 0hich contri ute to moral ha.ard and in e6treme cases leads to market failure. In sum/ an unre"ulated market can entail hi"h systemic risk. #his section riefly discusses the pro lems faced y the market prior to reforms and outlines the ma7or reform initiati-es of the 199!s 0ith 0hat results. &% '(uity )arket 2.1 Nature of market prior to reforms +s compared to other de-elopin" countries/ the Indian stock markets ha-e a fairly lon" history.1 <o0e-er/ the -olume of transactions in these markets remained limited until the late 19=!s/ ut "re0 rapidly durin" the 19>!s as the corporate sector turned increasin"ly to the equity market. +lthou"h the -olume of transactions increased/ the market remained primiti-e/ insulated from forei"n in-estment and continued to suffer from se-eral pro lems. *ost importantly/ to access capital markets/ companies needed to ha-e prior permission from the "o-ernment/ 0hich had to appro-e the price at 0hich ne0 equity could e raised. #he aim 0as ostensi ly to control flo0 of funds to the pri-ate corporate sector in -ie0 of the requirements of pu lic finance and also to pro-ide a ?fair -alue@ to in-estors. <o0e-er/ the practice effecti-ely penali.ed firms raisin" capital from the market: the Initial (u lic 3fferin"s AI(3sB of equity 0ere typically under&priced in relation to the price upon listin"/ and the ne0 issues y listed companies 0ere at a su stantial discount to the pre-ailin" price. 1hile the ne0 issue market 0as o-erly re"ulated/ there 0ere inadequate re"ulations of secondary market acti-ities. #he domestic capital market had no "lo al link. Information and transparency 0ere limited/ reflectin"
1

#he 2om ay %tock E6chan"e is o-er a hundred years old.

the indi-idual/ dealer& ased tradin" system. +ll these contri uted to hi"h transaction costs. In addition/ pu lic sector financial institutions such as the 9nit #rust of India A9#IB/ the insurance companies and the De-elopment ,inance Institutions AD,IsB 0ere dominant players in the stock market. #his had t0o si"nificant effects. ,irst/ the "o-ernment had ma7or influence on the domestic financial markets. 2 %econd/ it allo0ed promoters of pu lic companies to run their companies 0ith relati-ely small holdin"s of their o0n/ ecause pu lic sector financial institutions "enerally supported the status quo o0nership and mana"ement position/ unless somethin" drastic happened. 2.2 Equity market reforms since 1992 +s part of a road set of reforms/ the %ecurities and E6chan"e 2oard of India A%E2IB 0as "i-en the le"al po0ers in 1992 to re"ulate and reform the capital market/ includin" ne0 issues. #he equity market reforms since then can e di-ided into t0o road cate"ories: one that increases the le-el of competition in the market and the other that deals 0ith pro lems of information and transaction cost. #he most important initiati-e to enhance competition 0as the free pricin" of I(3 and formulation of "uidelines concernin" ne0 issues. #he ne0 re"ulatory frame0ork sou"ht to stren"then in-estor protection y ensurin" disclosure and transparency rather than throu"h direct control. %econdly/ the National %tock E6chan"e AN%EB 0as set up/ 0hich competed 0ith the 2om ay %tock E6chan"e A2%EB. #he N%E introduced an automated screen& ased tradin" system/ kno0n as the National E6chan"e for +utomated #radin" ANE+#B system/ 0hich allo0ed mem ers from across the country to trade simultaneously 0ith enormous ease and efficiency. ,aced 0ith stiff competition/ the 2%E adopted similar technolo"y. Competition 0as also enhanced throu"h an increased num er of participantsCforei"n institutional in-estors A,IIsB 0ere permitted to trade and pri-ate sector mutual funds came on the scene. #o deal 0ith market imperfection such as information asymmetry and hi"h transaction costs/ a num er of measures 0ere taken. +t the tradin" le-el/ transparency 0as facilitated y the ne0 technolo"y ANE+# systemB/ 0hich operated on a strict priceDtime priority. 3 +t the in-estor le-el/ transparency 0as au"mented y the re"ulation that required listed companies to increase the frequency of their account announcements. #o ensure transfera ility of securities 0ith speed/ accuracy and security/ the Depositories +ct 0as passed in 199E/ 0hich pro-ided for the esta lishment of securities depositories and allo0ed securities to e demateriali.ed. ,ollo0in" the le"islation/ National %ecurities Depository )imitedCIndia5s first depository&&0as launched. 3ther measures to reduce transaction costs included: aB a mo-ement to0ard electronic tradin" and settlement/ and B streamlinin" of procedures 0ith respect to clearance of ne0 issues. 2.3 Results ,ollo0in" these measures/ the Indian equity market has moderni.ed rapidly and its a ility to ser-e in-estors has increased considera ly. Competition amon" stock e6chan"es has intensified. 1ith all stock e6chan"es introducin" screen& ased tradin"/
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Durin" the 199!s/ this meant that pu lic sector mutual funds and other financial entities supported the "o-ernmentFs di-estment pro"ram. 3 + mem er places an order on the computer statin" the quantities of securities and the price at 0hich he 0ants to transact and the order is e6ecuted 0hen it finds a matchin" sale or uy order from a counter&party. It is possi le for market participants to see the full market/ 0hich has made the market more transparent. '

tradin" has ecome more transparent.$ 1ith the option of settlin" throu"h depository no0 a-aila le to in-estors in case of most of the liquid stocks/ it is possi le to eliminate risks of ad deli-ery and counterfeit shares. #he t0o depositories that are in operation no0 ensure faster/ cleaner and cheaper settlement. Demateriali.ed settlement no0 accounts for a out 9! percent of settlement settled y deli-ery. Disclosure standards y companies and financial intermediaries are hi"her. ,ollo0in" the introduction of prudential re"ulations/ stock e6chan"es ha-e ecome safer and more dependa le. 3ne area 0here there has een only limited pro"ress is in reducin" the dominance of pu lic sector financial institutions. *% +e,t Market

#he Indian de t market can e classified into three se"ments: AiB the "o-ernment securities marketG AiiB the pu lic sector units A(%9B ond marketG and AiiiB the corporate ond market. Each se"ment has its o0n distincti-e practices/ procedures/ institutional frame0ork and re"ulatory structure. #he focus of de t market reforms has een on "o-ernment securities market/ ecause not only does it dominate the de t market/ 5 ut also plays an important role in esta lishin" enchmarks for the rest of the market. 3.1 Nature of market prior to reforms 9ntil the early 199!s/ the de t market recei-ed -ery little attention. #he "o-ernment securities market/ 0hich constituted the ulk of the de t market/ remained dormant. #he reason for this 0as simple. %ince the "o-ernment could orro0 at pre&announced coupon rates at elo0 market rates from a set of capti-e institutions/ there 0as no need for the "o-ernment to directly place its securities on the market. #he capti-e institutions lar"ely held on to "o-ernment paper until maturityG 0hate-er little tradin" e6isted/ 0as aimed at ad7ustin" the maturity structure of the portfolio/ rather than at profit makin". +s a result/ the market did not de-elop. 3.2 Reforms since early 1990s De t market reforms e"an 0ith the esta lishment of a primary market for "o-ernment securities. It 0as follo0ed y the stren"thenin" of the le"al/ re"ulatory and payments infrastructure 0hich contri uted to the de-elopment of a secondary market. %ome of the important reform initiati-es undertaken since the early 199!s are "i-en elo0. #here ha-e een progressive restrictions on on-de)and govern)ent ,orrowing from the R2I. #he earlier system of issuin" ad hoc treasury ills has een replaced y a system of 0ays and means ad-ances/ 0hich are ein" made increasin"ly restricti-e. Auction for treasury ,ills of -aryin" maturityC1$&day/ 91&day/ 1>2&day and 3E$& dayCha-e een introduced. #o encoura"e a""ressi-e iddin"/ uniform price auctions ha-e een introduced for 91&day treasury ills. +lso/ to foster competition/ non&competiti-e ids are no0 kept outside the notified amount. #o 0iden the in-estor ase/ foreign institutional investors have ,een allowed to invest in govern)ent securities includin" treasury ills in oth primary and secondary markets.
$

Earlier/ rokers routinely inflated AdeflatedB the prices at 0hich they ou"ht AsoldB shares for their clients/ thus earnin" a hidden mar"in.
'

4o-ernment de t constitutes a out three&fourth of the total outstandin" de t.

#he R2I has introduced a +elivery versus Pay)ents -+.P/ syste) / 0hich ensures settlement y synchroni.in" transfer of securities 0ith cash payments/ there y acceleratin" settlement/ enhancin" transparency and eliminatin" settlement risk. AEarlier/ settlements in securities transactions et0een any t0o parties 0ere recorded 0ithout any direct link 0ith cash settlement et0een uyers and sellers/ 0hich entailed delays in settlement and counterparty risk.B + pri)ary dealer syste) has een de-eloped to channel securities from primary auctions to ultimate in-estors. (rimary dealers facilitate de t tradin" throu"h committed participation in primary market auctions and y creatin" an acti-e secondary market in securities y "i-in" t0o&0ay quotes. #he R2I is acti-ely pro)oting retailing of govern)ent securities y pro-idin" liquidity support to satellite dealers and dedicated "ilt funds to help them sustain their retail acti-ities. 4ilt funds also enefit from special ta6 incenti-es. +n active inter,ank repo )arket has een de-eloped/ 0hich has helped to oost liquidity in "o-ernment securities. #o pro-ide depth to the inter ank repo market/ a num er of measures ha-e een taken/ includin" permission for all "o-ernment securities to e eli"i le for inter ank repos.

3.3 Results #hese initiati-es ha-e resulted in a si"nificant transformation of the de t market. #he si.e of the market has "ro0n rapidly in the past four years. +cti-ity in the secondary de t market has also accelerated durin" recent years as reflected y the turno-er of traded securities risin" from 3.3 percent of 4D( in 199ED9= to E.= percent in 199>D99. #he market has not only "ro0n in si.e/ ut has ecome more efficient too. (rices for "o-ernment securities are increasin"ly market&determined. #he "o-ernment/ like any other issuer/ has to come to the market to raise its resources. #he a ility of the market to si"nal chan"es in interest rate structure has een au"mented throu"h re"ular auction of treasury ills of different maturity. #he market has een roadened throu"h primary dealers and the ,IIs. Introduction of DH( has enhanced transparency. #he mo-e to0ard price disco-ery throu"h a price& ased auction system has contri uted to the de-elopment of iddin" skills amon" market participants. +lthou"h reforms ha-e clearly achie-ed some success in the de-elopment of a modern/ 0ell&functionin" market/ the o-erall pro"ress to0ard moderni.ation has een smoother and more su stantial in the case of the primary market in "o-ernment securities than in the secondary market.

#hapter III Adherence to ,est practices Status and !uture Agenda $% Introduction #he I3%C3 has set out three o 7ecti-es&&protection of in-estors/ ensurin" fair/ transparent and efficient market and reduction of systemic risk&&0hich securities re"ulations need to address.E ,urther/ to enhance the a ility of the re"ulatory system to attain these o 7ecti-es/ the I3%C3 has also laid do0n a set of "uidin" principles. Asee +nne6ure IIB. +s 0e ha-e discussed in the last section/ the reform initiati-es taken in the past decade ha-e addressed these o 7ecti-es in -aryin" de"rees/ 0hich ha-e resulted in the emer"ence of a more modern and competiti-e securities market. In this section/ 0e attempt to e-aluate the e6istin" re"ulatory frame0ork roadly usin" the I3%C3 principles as criteria and to identify pro lem areas/ 0hich call for future reform initiati-es to stren"then the current system. #his chapter is di-ided into fi-e sections. #he second section deals 0ith re"ulatory issues: the re"ulatorsF mandate/ their autonomy/ po0ers and capacity to enforce re"ulation and their coordination to make re"ulations effecti-e. %elf& re"ulation as 0ell as prudential issues are also discussed under this section. #he third section outlines the le"al issues concernin" the securities market. #he fourth section deals 0ith crosscuttin" themes relatin" to the re"ulated market/ namely/ market infrastructure/ and issues relatin" to primary market and transparency. #he challen"es facin" the mutual fund industry are discussed in the fifth section. #he discussion in this chapter pro-ides some e6amples of current practices/ reco"ni.in" that these practices 0ill and should chan"e as the markets chan"e and as technolo"y and impro-ed coordination amon" re"ulators make other strate"ies a-aila le. &% Regulatory Issues

2.1 !e Re"ulator #he re"ulatory responsi ility of the securities market is -ested in the %E2I/ the R2I/ and t0o "o-ernment departments&&Department of Company +ffairs and Department of Economic +ffairs. In-esti"ati-e a"encies such as Economic 3ffences 1in" of the "o-ernment and consumer "rie-ance redressal forums also play a role. #he %E2I/ esta lished under the %E2I +ct/ is the ape6 re"ulatory ody for the securities market. 2esides re"ulation/ the %E2IFs mandate includes responsi ilities for ensurin" in-estor protection and promotin" orderly "ro0th of the securities market. #he R2I/ on the other hand/ is responsi le for re"ulation of a certain 0ell&defined se"ment of the securities market. +s the mana"er of pu lic de t/ the R2I is responsi le for primary issues of 4o-ernment %ecurities. #he R2IFs mandate also includes the re"ulation of all contracts in "o-ernment securities/ "old related securities/ money market securities and in securities deri-ed from these securities. #o foster consistency of the re"ulatory processes/ the %E2I is mandated to re"ulate the tradin" of these securities on reco"ni.ed stock e6chan"es in line 0ith the "uidelines issued y R2I. +lthou"h there is a clear di-ision of re"ulatory responsi ilities et0een R2I and %E2I/ and efforts ha-e een made to make
E

International 3r"ani.ation of %ecurities Commissions/ 199>/ #$%ectives an& 'rinciples of (ecurities Re"ulation) %eptem er. >

the re"ulatory process consistent/ the distri ution of re"ulatory responsi ilities amon" a num er of institutions can potentially create confusion amon" the re"ulated as to 0hich ody is responsi le for a particular area of re"ulation. #o ensure operational independence and accounta ility in the e6ercise of functions and po0ers y the re"ulators/ %E2I and R2I ha-e een constituted as autonomous odies and are esta lished under separate acts of the (arliament. 2oth re"ulators are accounta le to the (arliament throu"h Central 4o-ernment and the re"ulations framed y them are required to e laid efore (arliament y the Central 4o-ernment. = #here is also a system of independent 7udicial re-ie0 of the decisions of %E2I and R2I. +lthou"h the %E2I and the R2I are operationally independent/ the "o-ernment can issue directions to oth in policy matters. 2.2 Enforcement of (ecurities Re"ulation #he %E2I has po0ers to carry out routine inspections of market intermediaries to ensure compliance 0ith prescri ed standards. It also has in-esti"ation po0ers similar to that of a ci-il court in terms of summonin" persons and o tainin" information rele-ant to its enquiry. +ction is taken on the asis of in-esti"ation. #he enforcement po0ers of %E2I include issuance of directions/ imposition of monetary penalties/ cancellation of re"istration and e-en prosecution of market intermediaries. #o ensure effecti-e and credi le use of enforcement po0ers/ the %E2I has adopted measures such as de-elopment of a stock 0atch system/ uniform price ands and esta lishment of a *arket %ur-eillance Di-ision. > 1hile %E2I has po0ers of direct sur-eillance of the stock e6chan"es/ mem ers of stock e6chan"es and other market intermediaries re"istered 0ith it/ %E2I has no po0ers o-er listed companies. ,urther/ the present penalty le-els in many cases are not hi"h enou"h to effecti-ely deter market players from re"ulatory -iolations. In particular/ the amount of monetary penalty for non&compliance 0ith respect to disclosure/ information requirements/ insider tradin" and market manipulation is -ery inadequate. #o cite an e6ample/ a ma6imum monetary penalty of only Rs.1/ !!!D& can e imposed in case of failure to comply 0ith the pro-isions of listin" a"reement. %imilarly/ under the %E2I +ct the penalty for insider tradin" and non&disclosure of acquisition of shares and takeo-ers is only Rs.' lakh. #he 4roup elie-es that there is a need to allo0 %E2I enhanced authority and po0ers to impose penalty commensurate 0ith the "ra-ity of the -iolation Ai.e./ dis"or"ement po0ersB. 9
,or e6ample/ the re"ulations framed y the %E2I under the %E2I +ct are required to e laid efore each house of the (arliament/ and consequently pu lished in the 4a.ette of India/ there y facilitatin" a clear and consistent re"ulatory process. > #his di-ision o-ersees the sur-eillance acti-ities of the stock e6chan"es.
= ;

*n&er implementation+ !e ,inance -inister !as announce& on -arc! 13) 2001 in t!e 'arliament t!at t!e .overnment inten&s to propose le"islative c!an"es to /furt!er stren"t!en t!e provisions in t!e (E01 2ct) 1992 to ensure investor protection/.

#o "i-e an e6ample of po0ers of dis"or"ement/ the 9% %ecurities E6chan"e Commission can penali.e the "uilty y up to three times its profit made or loss a-oided throu"h a re"ulatory -iolation. Incidentally/ the R2I has dis"or"ement po0ers.
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+n additional pro lem relates to delays in takin" action a"ainst those 0ho commit frauds. + num er of companies/ 0hich had collected funds in the past throu"h pu lic issues/ cannot e-en e traced. #o take action a"ainst such companies and rin" their Directors to ook/ a num er of initiati-es ha-e een taken includin" the esta lishment of Central Coordination and *onitorin" Committee ACC*CB/ 0ith %ecretary/ DC+ and Chairman/ %E2I as its co&chairmen. <o0e-er/ only limited success has een achie-ed. Clearly/ the enforcement procedures are cum ersome/ time&consumin" and in-ol-e too many a"encies. #here is a need to streamline the procedures to quickly detect frauds and take appropriate remedial measures. In addition to the pro lem stated a o-e/ the slo0 response in case of frauds results from lon" delays arisin" from the o li"ation to follo0 due process. +s a re"ulatory ody has to e accounta le for its action/ y implication/ it "i-es the alle"ed institution an opportunity to sho0 cause 0hy action should not e taken. #here is a need to streamline the procedures relatin" to due process. +lso/ dealin" 0ith cases of suspected fraud often requires free.in" the situation/ 0hile the le"al process is ein" pursued. #his happens in India/ ut the decision to free.e the situation often takes time. 2.3 3ooperation in Re"ulation Harious se"ments of the domestic financial market are "ettin" increasin"ly inte"rated. #here ha-e also een pro"ressi-e linka"es et0een the domestic and international capital markets. +s a result/ the re"ulatory inter-entions or their a sence in one market tend to ha-e repercussions in other markets that are more serious and more 0idespread than in the past. ,urther/ 0ith the emer"ence of more and more financial supermarkets and "ro0in" comple6ity of financial transactions/ there are increasin" instances of the same market intermediary comin" under the pur-ie0 of multiple re"ulatory odies. #hese factors ha-e raised the potential for re"ulatory "aps as 0ell as o-erlaps/ there y underlinin" the need for "reater cooperation amon" -arious re"ulators. Currently/ coordination amon" domestic re"ulators is occurrin" throu"h the <i"h )e-el 4roup on Capital *arkets A<)4C*B comprisin" the R2I/ %E2I/ the IRD+ and ,inance *inistry. #he <)4C* has set up t0o %tandin" Committees: one for re"ulatory coordination and the other for coordination in matters relatin" to the de-elopment of de t markets. #he Committee meets periodically to e6chan"e information and -ie0s. 2esides/ to address specific issues such as D-( system or asset securiti.ation/ the R2I and %E2I ha-e een coordinatin" throu"h the institution of 0orkin" "roups. #he 4roup o ser-es that there is scope to further stren"then the coordination efforts. #here may e merit in formali.in" the <)4C* y "i-in" it a le"al status. 2esides/ the <)4C* needs to meet more frequently and its functionin" needs to e made more transparent. +lso/ a system needs to e de-ised to allo0 desi"nated functionaries Anot necessarily only at the top le-elB to share specified market information on a routine and automatic asis. +s re"ards coordination 0ith re"ulators in other countries/ the R2I has put in place a system of e6chan"e of need& ased information in respect of international operations. <o0e-er/ the po0ers of %E2I to assist forei"n re"ulators or to enter into *39s or other cooperation arran"ements are not e6plicitly pro-ided y le"islation/ althou"h %E2I has si"ned a *o9 0ith the %ecurities E6chan"e Commission of the 9%+. <ence/ the 4roup
1!

is of -ie0 that necessary le"islati-e chan"es need to e made to enhance %E2IFs scope in this re"ard. 2.4 (elf-Re"ulation #he %E2I +ct pro-ides for promotion and re"ulation of %R3s Ai.e./ stock e6chan"esB. #he stock e6chan"es are empo0ered to make rules and re"ulations for their mem ers and for re"ulatin" the conduct of respecti-e mem ers. <o0e-er/ self&re"ulation is not al0ays effecti-e/ ecause the current o0nership and "o-ernance structures of many stock e6chan"es allo0 scope for conflict of interest. 1! #hese e6chan"es are o0ned and mana"ed y mem ers 0ho en7oy e6clusi-e tradin" ri"hts. In the roker&o0ned e6chan"es/ rokers elect their representati-es to re"ulate acti-ities of the e6chan"e/ includin" those of the rokers themsel-es. #his raises fairness issues/ ecause the mem ers of stock e6chan"e "o-ernin" oards ha-e access to -alua le information a out market participants. Elimination of such conflict of interest throu"h demutuali.ation/ 0hich implies separation of o0nership of e6chan"e from the ri"ht to trade on it/ can promote fairness and reinforce in-estor protection. ,urther/ the slo0 e-olution of the +ssociation of *utual ,unds of India A+*,IB as a %R3 has meant continuation of su stantial re"ulatory urden on %E2I. In this re"ard/ the 4roup su""ests that %E2I assist the +*,I to de-elop into a full&fled"ed %R3. %imilarly/ in money and "o-ernment securities markets/ ,i6ed Income *oney *arket and Deri-ati-es +ssociation of India A,I**D+B and (rimary Dealers +ssociation of India A(D+IB are operatin" as industry le-el associations/ 0ho are "radually takin" on the role of %R3s. #here is as yet no re"ulatory o-ersi"ht of the R2I o-er these emer"in" %R3s. <o0e-er/ to facilitate these associations to emer"e as full&fled"ed %R3s/ the R2I is en"a"in" them in a consultati-e process/ 0hich needs to e further intensified. 3n their part/ to promote inte"rity of the markets/ ,I**D+ and (D+I need to esta lish a comprehensi-e code of conduct and est practices in securities transactions and also ha-e a mechanism to enforce such codes. #he R2I can play a supporti-e role here. 2.5 'ru&ential issues 1ith a -ie0 to contain risk/ secure market inte"rity and protect the interest of in-estors/ the re"ulators ha-e prescri ed ela orate mar"inin" and capital adequacy standards. In addition/ intra&day tradin" limit and e6posure limits ha-e een prescri ed. 2rokers are su 7ect to -arious types of mar"ins/ -i../ daily mar"ins/ marked&to&market mar"in/ ad hoc mar"in and -olatility mar"in. In case of e6cessi-e -olatility or percei-ed hi"her risk/ e6chan"es ha-e een "i-en the fle6i ility of imposin" hi"her mar"ins. 11 <o0e-er/ one lacuna that continues relates to the a sence of mar"in requirement for institutional trades. #he 4roup recommends that this lacuna e addressed.

1!

*ost of the e6chan"es are incorporated as I+ssociation of (ersonsI/ possi ly ecause of the ta6 enefits and ease of compliance that such a form entails. ; *n&er implementation+ #n -arc! 13) 2001 t!e ,inance -inister announce& in t!e 'arliament t!at a&ministrative steps 5oul& $e taken) an& le"islative c!an"es 5oul& $e propose&) if require&) in or&er to corporati6e stock e7c!an"es $y 5!ic! o5ners!ip) mana"ement an& tra&in" mem$ers!ip 5oul& $e se"re"ate& from eac! ot!er. !e process is currently un&er 5ay. 11 In case of primary and satellite dealers in "o-ernment securities/ the R2I has prescri ed detailed prudential "uidelines. 11

*%

0egal Issues

3.1 1nstitution-specific re"ulations #he le"al frame0ork constrains the R2I from e6ercisin" uniform po0ers -is&a&-is different "roups of players/ e-en thou"h the acti-ity re"ulated is the same ecause of a peculiar le"al arran"ement. #he amended %ecurities Contract Re"ulation +ct A%CR+B has conferred on the R2I the responsi ility of re"ulation of 4o-ernment securities and money markets/ ut not the necessary enforcement po0ers to re"ulate these markets. #o re"ulate these markets/ the R2I therefore resorts to its re"ulatory authority o-er the ma7or participants in these markets such as anks/ financial institutions and primary dealers throu"h separate institution&specific le"islation. 1ith respect to anks/ the R2I has statutory po0ers of inspection/ in-esti"ation/ sur-eillance and enforcement under 2ankin" Re"ulation +ct/ 19$9. +s re"ards financial institutions/ the re"ulatory po0ers are a-aila le to the R2I under the R2I +ct 193$. #he R2IFs re"ulatory po0ers o-er ,Is are not as comprehensi-e as o-er anks. 1ith re"ard to (rimary Dealers/ the R2I e6ercises re"ulatory po0ers on the asis of "uidelines issued y R2I and *39s si"ned et0een (Ds and R2I on a contractual asis. #his underlines the need for AaB the same le"islation to include oth re"ulatory responsi ilities and the authority to carry them out and A B the focus to shift from institution&specific re"ulation to market&specific re"ulation. 3.2 -ultiplicity of 2cts #he pro lem of multiplicity of re"ulators/ as referred to earlier/ emer"es from the e6istence of multiplicity of +cts "o-ernin" securities market re"ulation. #he le"al frame0ork comprises inter alia the %E2I +ct/ %ecurities Contract Re"ulation +ct A%CR+B/ Indian Contracts +ct/ Companies +ct/ (u lic De t +ct/ the R2I +ct and the 2ankin" Re"ulation +ct. %ome acts came into ein" to create re"ulatory institutions A%E2I +ct and R2I +ctB/ some to re"ulate contracts A%CR+ and Indian Contracts +ctB and yet others to re"ulate issue of "o-ernment securities A(u lic De t +ctB. +lthou"h the scope of the +cts is 0ell defined/ pro lems of interpretation ha-e led to confusion. #here is therefore a need to simplify and streamline the le"al frame0ork. In this conte6t/ the 4roup elie-es that consolidatin" the %CR+ and the %E2I +ct in line 0ith the recommendations of the Dhanuka Committee/ 0ill e -ery helpful. 1% Market issues It is important to reco"ni.e the trade&off et0een o-er&re"ulation and hi"h cost of compliance. 3-er&re"ulation may minimi.e market friction/ ut can potentially kill a market. #o dilute this tradeoff/ it is important to moderni.e the microstructure. A*icrostructure relates to the manner in 0hich a market is or"ani.ed and the tradin" and post&tradin" technolo"y the market adopts.B +s re"ulations ecome more and more comple6/ certain re"ulatory o 7ecti-es can e more easily attained throu"h chan"es in microstructure rather than further addition to re"ulatory la0. 4.1 -arket 1nfrastructure 4.1.1 (creen-0ase& ra&in" (ystem +s enunciated in Chapter II/ the equities market has 0itnessed a quantum impro-ement in tradin" technolo"y durin" the 199!s as it mo-ed a0ay from the open&outcry system of
12

tradin" to a computer screen& ased tradin". #he ne0 technolo"y has not only increased transparency in tradin"/ ut also facilitated the inte"ration of different tradin" centers into a sin"le tradin" platform. (ermittin" of internet tradin" has ena led in-estors across the "lo e to route orders throu"h the internet for e6ecution on the Indian stock e6chan"es. In contrast to the equities market/ the "o-ernment securities market and the market for money market instruments are lar"ely ne"otiated markets. +lthou"h the N%E esta lished a 0holesale de t market se"ment for e6chan"e tradin"/ mem ers "enerally use this se"ment only for reportin" trades undertaken y them in the ne"otiated market/ rather than tradin" on the e6chan"e. 4.1.2 Rollin" (ettlement #he stock e6chan"es in India ha-e traditionally follo0ed account period settlement system/ 0hich tends to distort the price disco-ery process since it com ines the features of cash as 0ell as futures markets. In contrast/ the current international practice is predominantly rollin" settlement on a #J3 asis/ 0hich introduces certainty of trades and reduces risk and delay in settlement. 2e"innin" last year/ compulsory rollin" settlement has een introduced in a limited num er of scrips on a #J' asis. #he slo0 pro"ress to0ard the introduction of rollin" settlement is on account of AaB lack of a-aila ility of electronic funds transfer across the country and A B a "eneral apprehension that such a mo-e 0ill reduce liquidity in the market. E-en thou"h a more effecti-e payment and clearin" system throu"h a 0ider a-aila ility of E,# is important for s0itch&o-er to rollin" settlement 12/ the 4roup is of the -ie0 that e-en the current payment infrastructure can support a faster phasin"&in. ,urther/ the -ie0 that rollin" settlement per se 0ill drain liquidity from the market is not orne out y international e6perience. #he 4roup also su""ests that R2I and %E2I e6pedite their scrutiny of the recent recommendations made y the 7oint task force of I3%C3 and 2I% on securities settlement systems/ for early implementation. 4.1.3 8epositories an& &emateriali6ation #o ensure transfera ility of securities 0ith speed/ accuracy and security/ the Depositories +ct 0as passed in 199E/ 0hich pro-ided for the esta lishment of securities depositories and allo0ed securities to e demateriali.ed. ,ollo0in" the le"islation/ t0o depositories AN%D) and CD%)B ha-e so far een esta lished. ,urther/ the compulsory demateriali.ation of shares for tradin" purpose has een introduced in a phased manner 0ith the aim of synchroni.in" the settlement of trade and transfer of securities irrespecti-e of "eo"raphical locations/ and eliminatin" the ills associated 0ith paper&
9nless the funds mo-e quickly&&that is on the same day or at est the ne6t day&&traders 0ill face liquidity pro lem. <ence electronic funds transfer is critical to the introduction of rollin" settlement. Currently/ E,# facility is a-aila le in 1$ centers. #he R2I is mandated to facilitate electronic mo-ement of funds throu"h the entire ankin" system 0ithin a year.
12 ;

*n&er implementation+ (E01 !as since &eci&e& to e7ten& rollin" settlement to more t!an 200 stocks 5it! relatively !i"! liqui&ity on a nation5i&e $asis from 9uly 2) 2001. !ese s!ares) 5!ic! account for over 95 percent of &aily market transactions) are to $e tra&e& only in rollin" settlement mo&e. -ean5!ile) on 2pril 2:) 2001 a (e$i "roup on rollin" settlement !as recommen&e& t!at from 9uly 2) 2001 t!e approve& &eferral pro&ucts inclu&in" 2utomate& ;en&in" an& 0orro5in" -ec!anism) 0orro5in" an& ;en&in" of (ecurities (ystem an& 3ontinuous Net (ettlement cease to $e availa$le for all t!e scrips an& t!at (e$i an& t!e e7c!an"es s!oul& 5ork to5ar&s intro&uction of in&ivi&ual stock &erivatives--suc! as options an& futures of selecte& stocks--5!ic! 5oul& su$stitute t!e !e&"in" functions currently $ein" performe& $y t!e a$ove &eferral pro&ucts. 13

ased securities system such as delay in transfer/ ad deli-ery/ theft and for"ery. +lthou"h the process of compulsory demateriali.ation is nearin" completion/ its full enefits ha-e not een reaped ecause of slo0 pro"ress in introduction of rollin" settlement. 1ith the appropriate infrastructure in place/ there is no0 scope for takin" further ad-anta"e of depositories to promote retailin" of "o-ernment securities. #he R2I has taken a step in the ri"ht direction y allo0in" N%D) and CD%) to ha-e a second %4) account for depository participants 0ho in turn can hold in custody "o-ernment securities on ehalf of the final in-estors. #his 0ill facilitate holdin" of "o-ernment securities in demat form. 4.1.4 3learin" 3orporations #he stock e6chan"es super-ise the uyin" and sellin" acti-ities of rokers/ ut financial settlements are "uaranteed y a clearin" corporation/ 0hich creates a settlement "uarantee fund to ensure settlement of trades irrespecti-e of default y tradin" mem ers. #his arran"ement/ y nearly eliminatin" counterparty risk/ has "i-en a tremendous oost to in-estor confidence in India. ,urther/ in contrast to the current Indian system of each stock e6chan"e ha-in" its o0n clearin" corporation or clearin" ank/ it may e appropriate to ha-e perhaps only t0o clearin" corporations in line 0ith international practice/ 0hich 0ould support many stock e6chan"es. %uch an arran"ement 0ould allo0 the clearin" a"ency to ha-e an o-erall -ie0 of "ross e6posures of traders across the stock e6chan"es and 0ould e much etter "eared to mana"e risks. 4.1.5 8elivery vs. 'ayment In the "o-ernment securities market/ D-( 0as introduced in 199$ for transactions put throu"h the %4) accounts maintained in R2I5s (u lic De t 3ffice A(D3B/ 0hich has "reatly helped in reducin" the principal risk. #he %pecial ,und ,acility introduced last year has to a certain e6tent reduced risk of non&settlement due to "ridlock. #he +d-isory 4roup on (ayments and %ettlement %ystems A<eaded y %hri *.4. 2hideB has made some su""estions for impro-in" the payments and settlement systems and this 4roup 0ould concur 0ith these su""estions. In the equity market there is currently no D-(. #he 4roup notes that %E2I and R2I are 7ointly tryin" to e-ol-e a mechanism/ 0hich 0ould seamlessly link the depositories 0ith the payment system throu"h the clearin" corporationD clearin" a"ency to ensure D-(. #he 4roup recommends that esta lishment of such a mechanism is e6pedited. 4.1.: (trai"!t-t!rou"! 'rocessin"+ %trai"ht&throu"h (rocessin" A%#(B in-ol-es -erification throu"h Internet of AiB the sellin" clientFs D( account for security alances follo0in" a sell orderG and AiiB the uyin" clientsF ank accounts for cash alances follo0in" a uy order. #his system can eliminate nearly all settlement and payment risk. #he si"nificant chan"es takin" place in technolo"ical and tradin" en-ironment 0orld0ide are dri-in" the "lo al securities industry to0ards %#(. <o0e-er/ at present/ all the pre&requisites for %#( are not yet a-aila le in India. 1hile automated tradin" and demateriali.ation ha-e een lar"ely
1$

achie-ed/ the limited a-aila ility of E,# and a sence of R#4% ha-e constrained the introduction of %#(. #hese constraints are likely to e eliminated in the near future. 4.2 'rimary 1ssues an& ransparency 4.2.1 'rivate 'lacement -arket <i"h costs of re"ulatory compliance associated 0ith pu lic issues of de t ha-e made issuers prefer the pri-ate placement market. #he pri-ate placement market has re"istered tremendous "ro0th in the last fe0 years. In 1999D2!!!/ pri-ate placements accounted for >$ percent of total resources mo ili.ed y the corporate sector. (reponderance of pri-ate placement can potentially strip the market of its a ility to discipline issuers and there y enhance systemic risk. 3nce in-estors ha-e used the pri-ate placement route/ they cannot si"nal their chan"in" e-aluation of the usiness prospects of the issuers/ ecause there is no market in 0hich they can sell. #he dominance of pri-ate placement in primary issue market possi ly reflects an a sence of re"ulatory le-el playin" field in the sense that pu lic issues may e o-er&re"ulated 0hile pri-ate placements could e under&re"ulated. %ome recent initiati-es such as the amendment to the Companies +ct/ makin" it mandatory for companies issuin" de entures throu"h pri-ate placement route to set up de enture redemption reser-es as in the case of pu lic issues/ can partially restore the alance. 13 #hese initiati-es need to e complemented y simultaneous efforts to ease some of the re"ulations "o-ernin" pu lic issues. 4.2.2 3orporate &isclosure 1ith a -ie0 to ena lin" in-estors to take informed decisions as 0ell as to promote transparency/ re"ulations ha-e o-er the years ecome more strin"ent y requirin" disclosure to e more frequent and 0ider in scope. Currently/ disclosure in India e6tends to material ha-in" a earin" on the price of a security/ and entities 0ho either ha-e si"nificant interest in a company or seek mana"ement control. + company offerin" securities is required to make a pu lic disclosure of all rele-ant information throu"h its offer documents. +fter a security is issued to the pu lic and su sequently listed on a stock e6chan"e/ the issuin" company is required to make continuous disclosures/ includin" throu"h pu lication of yearly audited alance sheets and quarterly un&audited financial results. *oreo-er/ the disclosure of material information/ 0hich could ha-e a earin" on the performance of the company/ has to e made a-aila le to the pu lic immediately. +mon" the dra0 acks/ the Ktimin"5 and Kcontents5 of disclosure of material e-ents that impact prices are not unam i"uously specified and follo0ed. Recently/ it has een decided that companies 0ould e required to make decisions re"ardin" di-idend onus and ri"hts announcements or any other material e-ent 0ithin 1' minutes of the conclusion of the oard meetin" 0here the decisions are taken. In terms of contents of disclosure/ the follo0in" initiati-es are necessary: AiB "roup company disclosures may e limited to top ' companies y market capitali.ation or turno-er/ to a-oid cum ersome e6ercise of "atherin" information from all companies fallin" under the definition of promoter "roupG and AiiB risk factors need to e "i-en in "reater detail as per international practices/ althou"h mana"ement perceptions of risks need not e "i-en. ,urther/ issuance to more than '! indi-iduals 0ill no0 deemed to e a pu lic issue. 1ith this/ it has ecome more difficult to dis"uise pu lic issues as pri-ate placement.
13

1'

4.2.3 ransparency in t!e &e$t market +s re"ards transparency in tradin"/ the de t market is la""in" ehind the equity market. #he cash market in de t securities throu"hout the 0orld prefers to operate throu"h ne"otiated deals either throu"h telephone or an electronic dealin" system like 2loom er". #his is ecause unlike the equity market/ the ond market participants are "enerally 0holesale institutional in-estors 0ho put in lar"e deals at a time/ 0hich may not al0ays e possi le throu"h the screen ased order dri-en system. It is only in the futures market that the principles of anonymity/ price time priority/ nation0ide market and settlement "uarantee are kno0n to 0ork. +s stated earlier/ 0holesale institutional in-estors ha-e yet to sho0 adequate inclination to use the anonymous order matchin" system for e6ecutin" their de t securities transactions. 9nder the circumstances/ %E2I has taken initiati-es to foster transparency throu"h re"ulatory fiat y prohi itin" ne"otiated deals on the e6chan"es in respect of listed corporate de t securities and prescri in" that all such trades 0ould e e6ecuted on the asis of price and order matchin" mechanism of stock e6chan"es as in the case of equities. <o0e-er/ ne"otiated deals are still continuin"/ al eit outside the e6chan"e/ and there is no market dissemination of information on such transactions. %ince almost all deals in the "o-ernment securities market are settled throu"h the %u sidiary 4eneral )ed"er A%4)B/ the daily dissemination of such information Aal eit 0ith a one day la"B has pro-ed to e important in the price disco-ery process.B #his/ to"ether 0ith the data a-aila le from the N%EFs 1holesale De t *arket A1D*B se"ment has contri uted to "reater transparency in the secondary market for "o-ernment securities. #ransparency 0ill e further oosted y the current initiati-e to put in place an electronic ne"otiated dealin" system for the %4) participants/ 0hich 0ill disseminate information on a near real time asis. 2% Mutual !unds %E2I is the principal re"ulator of the mutual fund industry. *utual funds in India are constituted in the form of trusts. #he fund5s sponsor e6ecutes the trust deed/ 0hich outlines the lia ilities and o li"ations of the trustees in relation to the unitholders. #he day&to&day operations of the fund are carried out y the asset mana"ement company A+*CB. 1$ #he oard of trustees o-ersees the fund5s acti-ities and enters into a mana"ement a"reement 0ith the +*C. %E2I has put in place standards for the eli"i ility and the re"ulation of those 0ho 0ish to market or operate a collecti-e in-estment scheme. Eli"i ility criteria ha-e een set in terms of net 0orth/ track record and internal mana"ement procedure. #he re"ulations lay do0n disclosure requirements/ procedures for calculatin" and declarin" net asset -alues AN+HB of mutual fund schemes/ accountin" standards and a code for ad-ertisements. Re"ulations are also prescri ed to ensure arms&len"th relationship et0een the trustees and the +*C. %E2I is responsi le not only for re"istration and authori.ation of schemes/ ut also for inspection of re"istered mutual funds and remedial action a"ainst any re"ulatory infraction.
1$

#he fund5s sponsor must contri ute at least $! percent of the net 0orth of the +*C. 1E

Disclosure standards of mutual funds ha-e een under re"ulatory focus. %E2I requires disclosure to e-aluate the suita ility of a collecti-e in-estment scheme for a particular in-estor and the -alue of the in-estor5s interest in the scheme. Re"ulations ha-e prescri ed specified format for offer documents as 0ell as a disclosed asis for asset -aluation and the pricin" and the redemption of units in a mutual fund. 1ith a -ie0 to make unitholders a0are of the securities in 0hich the funds ha-e een in-ested y the mutual fund/ it has een made mandatory for mutual funds to send to all unitholders a complete statement of the scheme portfolio on a half&yearly asis. #he mutual fund industry has played a si"nificant role in mo ili.ation of domestic sa-in"s. %u stantial pro"ress has een made in stren"thenin" re"ulation and impro-in" transparency in the mutual fund industry throu"h the *utual ,unds Re"ulations of 199E and su sequent amendments. <o0e-er/ a num er of challen"es still remain/ 0hich are outlined elo0. #he 9#I is the lar"est mutual fund in India/ 0hich 0as set up y an +ct of the (arliament Athe 9#I +ct/ 19E3B. +s such it is ound y the 9#I +ct and not y mutual funds re"ulations/ althou"h under a -oluntary arran"ement/ %E2I o-ersees all the in-estment schemes launched y 9#I since 199$. #he or"ani.ational structure of the 9#I differs from other mutual funds in t0o additional 0ays. ,irst/ there is no separate +*C 0ith an independent 2oard of Directors. %econd/ there has een no separation of mana"ement "roups mana"in" schemes launched prior to 199$G re"ulations apply only to schemes esta lished after 199$. Currently/ there are four 9#I schemes&&9%&E$/ 9)I(&=1/ CR#%& >1 and CCC,&93&&0hich do not comply 0ith %E2I re"ulations. #he 9%&E$/ the fla"ship scheme of the 9#I and the lar"est scheme in India/ does not ha-e a disclosed asis for asset -aluation or pricin" of units althou"h it has plans to mo-e to0ards this. 1' 2rin"in" the 9#I under %E2IFs pur-ie0 as 0ell as the introduction and implementation of international accountin" principles across the mutual fund industry 0ill help promote fairness and sta ility of the sector. Currently/ re"ulations appropriately require that the sale and redemption of funds should e ased on their N+Hs/ 0hich ha-e to e computed accordin" to specified rules. <o0e-er/ there is scope for further impro-ement in one si"nificant area: +*Cs still ha-e considera le room for discretion in adoptin" -aluation of thinly traded or non&traded securities/ as re"ulations specify only road "uidelines. #here is a need to reduce the +*CsF discretion in this re"ard. ,inally/ a couple of issues relatin" to prudential norms and corporate "o-ernance need to e e6amined. Re"ulations pro-ide that a fundFs o0nership in any sin"le company should not e6ceed 1! percent of a companyFs -otin" shares/ althou"h there is no upper limit on the total holdin"s of -otin" and non&-otin" shares of any sin"le company. ,urther/ there appears to e no restriction on corporate in-estment in a mutual fundFs units.

1'

#he 9%&E$ has a corpus of a out Rs.2!/ !!! crore/ a out a fifth of the total assets under mana"ement of all mutual funds. ,ollo0in" financial trou le in the scheme/ the 9#I constituted a committee Athe Deepak (arekh CommitteeB. #he recommendations of the committee are ein" implemented to restructure the 9%& E$. 1=

Anne"ure I Advisory Group on Securities Market Regulation 0ist of Me),ers %r. Name No. 1 *r. Deepak (arekh Desi"nation Chairman <ousin" De-elopment ,inance Corporation )imited Hice Chairman L *ana"in" Director D%( *erill )ynch )imited Chairman 8M*C ,inancial %er-ices )imited Chairman M.*. *or"an %tanley )imited (resident #he %tock E6chan"e/ *um ai Hice Chairman 8otak *ahindra ,inance )imited *ana"in" Director L CE3 National %tock E6chan"e of India )imited E6ecuti-e Director %ecurities and E6chan"e 2oard of India +d-iser/ DE+( Reser-e 2ank of India +ssistant +d-iser/ DE+( Reser-e 2ank of India Chairman

*r. %hitin Desai

*em er

*r. I. C. Main

*em er

*r. Nimesh 8ampani

*em er

'

*r. +nand Rathi

*em er

*r. 9day %. 8otak

*em er

*r. Ra-i Narain

*em er

>

*r. (ratip 8ar

(ermanent %pecial In-itee Con-enor Co&Con-enor

9 1!

Dr. R. 8annan %hri +.8. *itra

1>

Anne"ure II IOS#O Guiding Principles #his anne6ure sets out 3! principles of securities re"ulation/ 0hich are ased upon three o 7ecti-es of securities re"ulation. #hese are: #he protection of in-estorsG1E Ensurin" that markets are fair/ efficient and transparentG #he reduction of systemic risk. #he 3! principles need to e practically implemented under the rele-ant le"al frame0ork to achie-e the o 7ecti-es of re"ulation descri ed a o-e. #he principles are "rouped into ei"ht cate"ories. A% Principles Relating to the Regulator 1 #he responsi ilities of the re"ulator should e clear and o 7ecti-ely stated. 2 #he re"ulator should e operationally independent and accounta le in the e6ercise of its functions and po0ers 3 #he re"ulator should ha-e adequate po0ers/ proper resources and the capacity to perform its functions and e6ercise its po0ers. $ #he re"ulator should adopt clear and consistent re"ulatory processes. ' #he staff of the re"ulator should o ser-e the hi"hest professional standards includin" appropriate standards of confidentiality. B% Principles for SelfRegulation E #he re"ulatory re"ime should make appropriate use of %elfRe"ulatory 3r"ani.ations A%R3sB that e6ercise some direct o-ersi"ht responsi ility for their respecti-e areas of competence/ to the e6tent appropriate to the si.e and comple6ity of the markets. = %R3s should e su 7ect to the o-ersi"ht of the re"ulator and should o ser-e standards of fairness and confidentiality 0hen e6ercisin" po0ers and dele"ated responsi ilities. #% Principles for the 'nforce)ent of Securities Regulation > #he re"ulator should ha-e comprehensi-e inspection/ in-esti"ation and sur-eillance po0ers. 9 #he re"ulator should ha-e comprehensi-e enforcement po0ers. 1! #he re"ulatory system should ensure an effecti-e and credi le use of inspection/ in-esti"ation/ sur-eillance and enforcement po0ers and implementation of an effecti-e compliance pro"ram. +% Principles for #ooperation in Regulation 11 #he re"ulator should ha-e authority to share oth pu lic and nonpu lic information 0ith domestic and forei"n counterparts.

#he term Iin-estorI is intended to include customers or other consumers of financial ser-ices.
1E

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12 Re"ulators should esta lish information sharin" mechanisms that set out 0hen and ho0 they 0ill share oth pu lic and non&pu lic information 0ith their domestic and forei"n counterparts. 13 #he re"ulatory system should allo0 for assistance to e pro-ided to forei"n re"ulators 0ho need to make inquiries in the dischar"e of their functions and e6ercise of their po0ers. '% Principles for Issuers 1$ #here should e full/ timely and accurate disclosure of financial results and other information that is material to in-estorsF decisions. 1' <olders of securities in a company should e treated in a fair and equita le manner. 1E +ccountin" and auditin" standards should e of a hi"h and internationally accepta le quality. !% Principles for #ollective Invest)ent Sche)es 1= #he re"ulatory system should set standards for the licensin" and the re"ulation of those 0ho 0ish to market or operate a collecti-e in-estment scheme. 1> #he re"ulatory system should pro-ide for rules "o-ernin" the le"al form and structure of collecti-e in-estment schemes and the se"re"ation and protection of client assets. 19 Re"ulation should require disclosure/ as set forth under the principles for issuers/ 0hich is necessary to e-aluate the suita ility of a collecti-e in-estment scheme for a particular in-estor and the -alue of the in-estorFs interest in the scheme. 2! Re"ulation should ensure that there is a proper and disclosed asis for asset -aluation and the pricin" and the redemption of units in a collecti-e in-estment scheme. G% Principles for Market Inter)ediaries 21 Re"ulation should pro-ide for minimum entry standards for market intermediaries. 22 #here should e initial and on"oin" capital and other prudential requirements for market intermediaries. 23 *arket intermediaries should e required to comply 0ith standards for internal or"ani.ation and operational conduct that aim to protect the interests of clients and under 0hich mana"ement of the intermediary accepts primary responsi ility for these matters. 2$ #here should e procedures for dealin" 0ith the failure of a market intermediary in order to minimi.e dama"e and loss to in-estors and to contain systemic risk. 3% Principles for the Secondary Market 2' #he esta lishment of tradin" systems includin" securities e6chan"es should e su 7ect to re"ulatory authori.ation and o-ersi"ht. 2E #here should e on"oin" re"ulatory super-ision of e6chan"es and tradin" systems 0hich should aim to ensure that the inte"rity of tradin" is maintained throu"h fair and equita le rules that strike an appropriate alance et0een the demands of different market participants. 2= Re"ulation should promote transparency of tradin".
2!

2> Re"ulation should e desi"ned to detect and deter manipulation and other unfair tradin" practices. 29 Re"ulation should aim to ensure the proper mana"ement of lar"e e6posures/ default risk and market disruption. 3! #he system for clearin" and settlement of securities transactions should e su 7ect to re"ulatory o-ersi"ht/ and desi"ned to ensure that it is fair/ effecti-e and efficient and that it reduces systemic risk.

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