Discussion
paper
on
Development
of
Self
Regulatory Organizations (SROs)
in
Indian
Securities Market
Comments to Mr. Manish Bansal at
manishb@sebi.gov.in may be forwarded on or before September 20, 2003
Title of
the paper
Discussion paper on development of Self Regulatory
Organizations (SROs) in Indian Securities Market.
Objective
of the paper
This discussion paper on development of “Self Regulatory Organizations” in Indian
Securities Market has been prepared by SEBI. Contents of this paper do not
necessarily reflect the views of SEBI. Paper is placed on the web site to
invite public comments, which would help SEBI in formulating a scheme to meet
the interest of all stakeholders in the market.
For
clarification/comments
Comments on this paper may please be forwarded to Mr.
Manish Bansal, Assistant General Manager at manishb@sebi.gov.in.
He may also be contacted for any clarification/information on the paper at the
numbers 2285 0451 – 56 (Ext. 121).
Time line
Comments may be forwarded on or before 20th September 2003
Executive
Summary
Globally, Regulators are debating on the development
of the Self Regulatory Organizations (SROs) in the Securities Market more than
ever before. Major thinking behind this concept is that some of the regulatory
responsibilities of the regulators may be shared with these SROs so that they
can focus on much bigger and macro level issues, concerning the Markets.
Another dimension of the concept is that it amounts to the self discipline
approach, which helps the industry itself in winning the confidence of the
market participants.
This paper is put up on SEBI web-site for the
comments from the market participants and public, which would be appreciated by
SEBI as this would amount to co-designing the policies with the stake holders
in the market. Further, this policy framework would have market orientation
with enormous practical relevance.
Introduction
Financial Markets, across the globe, are undergoing
profound, unprecedented and fast-paced changes. Technology has revolutionized
the processes and the information explosion has sparked off remarkable changes
in the way the world has been operating. Though organizations, their
competencies and product portfolios are expanding and going global, their
profit margins are shrinking, competition is intensifying and their lives are
becoming more and more complex and tougher day by day.
Unquestionably, Regulations need to keep pace with the dynamically changing business environment because Regulators cannot deal with the complexities of the new age business environment with archaic rules, regulations and a rudimentary perspective. Therefore, in this era of revolution across the globe, regulations need to be enterprising, forward looking and evolutionary in nature.
At the global level, Regulators’ focus is shifting
dramatically from regulations to the Development of the Markets. This change in
the regulators’ focus has brought in a paradigm shift in their approach, which
has become more market oriented. Today, Regulations focus on simply defining
the broad
framework / parameters for the game and within that framework; market
participants are allowed to operate without any intervention. This approach is
all about having confidence in the market and systems.
SEBI, accordingly, in view of the changing dimensions
of the market place has been trying to co-design the structure of the Indian
Securities Market with the help of the market participants. This is done to
ensure that most pragmatic and workable solutions are found for the issues in
the market. As a step beyond on the subject, the development of the SROs in the
system is thought as a crucial initiative within the organization. Accordingly,
this paper is prepared based on the deliberations/recommendations of the
various internal and external groups and committees.
Philosophy
of SROs
Self
Regulatory Organizations are typically the organizations created by the
industry players. But, they perform the functions much beyond that of an
industry association, which is merely an interface between the industry and the
regulators and other government bodies for propagating the industry benefits. Thought,
they do keep the industry developments in mind but run with the proposed ideas
only if they create values in the broader context of Market. SROs take
independent views on the proposals of the industry players, regulate their
activities, monitor them and also take disciplinary actions against the
members, in case they don’t adhere to the accepted norms (bye laws/ rules and
regulations) of SROs. Indeed, for all practical purposes, SROs become the first
level regulators and so the major tool for proliferation of the disciplinary
culture among the industry players.
These
organizations operate under the overall regulatory supervision of the main
regulator and help the main regulators in accomplishing their Regulatory
Objectives. This mechanism provides an effective
and efficient form of regulation in the constantly changing business
environment because SROs virtually strive to strike an intelligent balance
between the interest of its members and their regulatory responsibilities
delegated by the main regulators, while arriving at the solutions to the
various issues encountered by the market place.
Though different market across the globe have
developed the SROs in the different formats based on the prevailing practices
in those markets, there is a broad framework for the development of SROs suggested
by the International organization of Securities Commissions (IOSCO). IOSCO has
laid down certain principles (30 in numbers) for the efficient and effective
regulations in the Securities Markets, globally and among them principles 6 and
7 deal with the development of SROs. These principles are reproduced below (in
verbatim):
Principle 6 - Regulatory regime should make
appropriate use of Self Regulatory Organizations (SRO) that exercise some
direct oversight responsibility for their respective areas of competence and to
the extent appropriate to the size and complexity of the markets.
Principle 7 - SROs should be subject to the oversight
of the regulator and should observe standards of fairness and confidentiality
when exercising powers and delegated responsibilities.
These principles do communicate that the SROs can be
developed in the system with the help of market participants to help the main
regulator in creating a better manageable, efficient, effective and vibrant market
place.
Here,
it would not be out of context to mention that across the globe, self-regulations
existed before the statutory regulations came into being. Indeed, that
structure of the self regulations did wonderfully well for long. But, as markets
matured, competition intensified and activities became more and more global, it
became more and more difficult to ensure the compliance by the members and then
it was felt to have the statutory regulations in place to protect the integrity
of the overall markets. Accordingly, statutory regulations have prevailed in
almost all the markets including the Securities Markets.
Now,
with the proliferation and expansion of the securities markets, intermediaries
and investors, it is again felt to have some system of the self regulatory
organizations in place as a complement to the main regulator. This thinking has
originated from the point of view of facilitating the whole regulatory process
by putting in some self discipline at the industry level itself.
Delivery
from the SROs :
Self Regulatory Organizations (SROs) provide the
following benefits:
Industry
Specialized Knowledge – As
market participants are the members of the SROs, SROs posses good knowledge
base. Their interaction with the regulator on day to day basis improves the
overall quality of the regulations in the market.
Industry
Motivation- Industry participants want to reflect a clean image
to their associates and other operators in the market. Being the part of an SRO
helps them do the same.
Flexibility
in regulations – Continuous
dialogue of a market oriented body with the main regulator helps the
regulations being more dynamic and market oriented. The change becomes easy to
implement when both the main regulators and the markets interact on day to day
basis and co-design the regulations.
Lower cost
of regulation - Self-regulation is
less costlier than the statutory regulation.
Structure of
SRO’s in Indian Securities Market
SRO’s, as elaborated above, are created in the global
markets to share the responsibilities with the main regulator. Though the
common characteristic of SRO’s in most of the global jurisdictions has been
their separation from the government regulator, this regulator does exercise
the oversight over them. Further, as mentioned before, in global markets there
is no specific structure of these SROs and they have evolved differently in the
different markets.
With regard to the structure of the SROs in Indian
Securities Market, it would be relevant to raise certain questions while
formulating the policies. These questions along with the possible answers:
Issue 1.
What should be the broad constitution of an SRO – for profit or no profit
organization?
View 1 –
This is going to be a kind of regulatory body and regulatory body can not be
set up for profit. Therefore, it should essentially be a company under Sec. 25
of the Companies Act. i.e. a non profit making company. Further, only a company for no profit can
work independently for the best interest of the market.
View 2 –
It may be a company for profit and we may leave this issue to the market
forces.
Downside of the view 2 – In this case, there is a possibility of the
dilution of the standards by the SROs in pursuit of profit. Therefore, it is a
risky proposition to let for profit regulators develop in any market.
Issue 2.
What should be the structure of SROs – essentially industry wise SROs or this
piece be left to the market forces?
View 1 –
As every industry has a typical pattern, SROs should be developed industry wise.
Further, industry wise SROs only can best represent the industry interest.
Downside of the view – First - SROs are not developed just to represent
the industry interests and their role goes much beyond that. It may be
appreciated that the SROs operate as first level regulators in the market.
Second, industry dynamics are changing on day to day
basis. Intermediaries in the market are expanding their horizons and exploring
opportunities across the segments. In that kind of environment, it may be
difficult for an entity to deal with one main regulator (SEBI) through number
of SROs - so called first level regulators, if they are statutorily developed
independently for the each industry. Therefore, it would be prudent to leave
that piece to the market dynamics based on the certain eligibility criterion. This
would help the system develop as per the dynamics of the market at a point in
time.
Third, cost of developing the different SROs for the
different segments of the markets would be exorbitant and would leave the
concept on the papers only. Therefore, it should be left to the market forces,
where in two industries together can form an SRO or all industry segments
together can form an SRO (single SRO for the whole market). Therefore,
Regulators focus while developing an SRO should be on providing the broad
framework in the form of eligibility criterion and within that, market should
be left free to explore the options.
Fourth, leaving the structure of the SROs to the
market force may create a healthy trend from the point of view that there may
be a situation when there is the development of couple of SROs in a single
industry segment. For instance, in case of broking that is very much possible.
In that case, these SROs would be able to compete based on their inherent
strengths to serve the members and the market. This competition among the SROs
would create enormous efficiency in the overall system. Ultimately, which of
the competing ones would survive would also be a market driven phenomenon.
Last, it would be relevant to mention here that the
markets are evolutionary in nature. They are being redefined on continuous
basis and so it would be imperative to have the structures as flexible as
possible. If the evolution of the SROs is left to the market forces, then only
they can restructure themselves at the amazing speed by running with the changes
taking place in the market place.
View 2 – Another view on the subject is that
initially the development of the SROs can be on industry basis and then they
may be left to the market forces for consolidation.
Issue 3. What
would be the framework for SROs’ operations?
View 1 -
SROs would have their own memorandum of articles and association. They would
also have the Bye-laws, which will be approved by SEBI. At every point in time,
SROs would ensure that their rules/regulations and guidelines are consistent
with the policy framework created by SEBI. Accordingly, they would be required
to carry out changes in their regulatory framework in view of the changes taking
place in the main regulations.
Issue 4.
What should be the decision making authority in an SRO to ensure that the
conflict of interest does not jeopardize its credibility?
As SROs are created by industry participants and operate
as regulators under the auspices of the main regulator, striking balance
between the members’ interest and market’s interest (delegated by regulator) becomes
a major challenge for them. Any wrong action tilted in favor on the members may
endanger the SROs’ credibility. Further, conflict of interest may arise because
of the representation of the members on the board and disciplinary committee of
the SROs, which have the power to initiate the action against the members. Inequality
of the treatment among the members of the SRO may also be a potential conflict
situation.
Therefore, authority for the decision making is a
critical piece at the SROs level. It is believed that a properly structured
decision making authority can help crack this issues. Following is the view on
the decision making authority in the SROs.
View 1 – Composition
of board of SROs may be made more independent to ensure the prudent and
impartial decision making by SROs. For that, Board of SROs must have more than
50% independent members. Chairman of the SROs should essentially be an
independent board member. Further, for quorum in board meetings, the presence
of SROs’ members may not be counted. In addition to this, in all the board
meetings, it may be ensured by SROs that the representation of the independent
board members is more than 50%.
Similarly, to perform the credible function of the
various committees, their composition should be such so as to provide for majority
(more than 50%) of independent members. This may be applicable to all types of
committees viz Disciplinary Committee, Screening Committee etc.. Indeed, one view on the subject is that the
disciplinary committee should have all the independent members.
Further, SRO’s should follow similar professional
standards of behavior on matters such as confidentiality and procedural
fairness as would be expected from a regulator.
Issue 5.
Would SROs be authorized to take the disciplinary actions against it members?
That is an important issue as defined in the above
point. There are different views on the subject.
View 1 – SROs may be allowed to take even
disciplinary actions against the members. As mentioned above, the board and
disciplinary committee constitutions should take care of the potential conflict
of interest, if any.
View 2 – Second view on the subject is that the SROs
may prepare a status note and recommend actions to SEBI, which would ultimately
initiate the action against the erring entity/entities.
Issue 6.
How many board members should be there in an SRO?
View 1 –
This should be a fixed number of board members in SROs to ensure the
consistency among them.
Downside of the view – Being rigid may become an impediment in the
developmental process. SEBI may provide for a range for the board composition.
For instance, an SRO may have any number of members between 5 and 9. It
essentially means that board must have minimum 5 members and maximum 9 members.
This composition may follow the further structure as mentioned in the point 4
above. This would provide some flexibility to the SROs in situations like one
or two members resign from the board as board would still be able to carry out its
duties pending the fulfillment of the vacant board seats.
Issue 7.
How should these independent directors be chosen?
View 1 –
SEBI should nominate the independent directors on the boards of SROs.
Downside of the view – SROs’ Boards should be independent and SEBI should
not nominate any member on the boards of SROs. Indeed, these members should be
the professionals from the market with high integrity and proven track record.
It must be appreciated that the persons at the board would communicate to the
market in terms of the integrity of an SRO itself. Therefore, it would be in
the interest of the SRO itself to choose the best talents available in the market
and so the choice of the board members must be left to the respective SROs
without SEBI’s intervention.
Issue 8.
What kind of controls would SEBI exercise over these SROs?
This is an issue of the relationship between the SEBI
and the SROs. As described above, these SROs would essentially work on lines of
broad mandate given by SEBI. They would need to comply with the eligibility
criterion prescribed by SEBI at the initial stage and on continuation basis.
Further, they would need to report to SEBI on the periodical basis. The
frequency and the format of the report would be a dynamic phenomenon, depending
on the needs of time, and would be decided by the SEBI in consultation with the
respective SROs. In addition to this, at any point in time, SEBI would have the
right to take direct action against the office bearers of the SROs or their members.
Legally, as per the Securities Laws in
Issue 9.
What are the envisaged activities for an SRO?
At this point in time, it would not be possible to
mention that the following specific activities would be carried out by the SROs
as their development in the system would essentially be an evolutionary
process. Therefore, only a broad framework on the lines of the concept
elaborated above can be laid down and specifics would emerge only over a period
of time. Only important thing is that this evolution of the SROs culture in
Therefore, broadly, SROs are expected to work on the
delegation by SEBI in addition to carrying out the general activities for the
market development like investors’ education and professional up-gradation
among the members. They may also provide the certification facility among their
members for the purpose of creating professionalism among the market players.
Issue 10.
Whether it would be mandatory for the intermediaries in the market to be member
of recognized SROs before being registered with SEBI?
View on the subject is that for the intermediaries in
the market to register with SEBI, it would be mandatory for them to be the
member of any of the recognized SROs in the respective industry. These SROs
would be required to certify that the prospective intermediary satisfies the eligibility
criterion laid down by SEBI. Indeed, this is the practice for the brokers, who
have got to be the members of the exchanges before being registered with SEBI.
Further, exchange certifies that these intermediaries satisfy the eligibility
criterion laid down by SEBI.
Issue 11.
What is the eligibility criterion for being registered with SEBI as an SRO?
SROs as mentioned above perform the enormously
important function in any market. From that perspective, it is important to
think judiciously on their eligibility criterion. Following are the view on the
subject:
Financial capabilities
SROs must become self sustaining bodies based on
their economics over the period of time. Initially they may be financed by its members
with contribution in the form of equity holding.
One view is that there should be some minimum net-worth
criterion for the SROs. But the counter argument to this view is that which
regulator across the globe has the net-worth requirement. If these SROs are
envisaged as first hand regulators, not carrying out any commercial activity
and are non profit organizations, where is the need for the net-worth
requirement. Therefore, we may not have any requirement of the minimum net-worth
for the SROs and their financial capabilities should be sufficient enough to
let it carry out their responsibilities professionally.
Competency levels
SROs must possess the required competencies to carry
out their operations effectively and efficiently. At least two office bearers of
SROs must be professionally qualified with at least two years experience in the
relevant field. SROs must also have the required infrastructure and office set
up in place before applying for the registration with SEBI. Further, they must
also possess the ability to enforce standard of performance/compliance and code
of ethics among their members.
Minimum number of members at the time of application
These SROs must have some minimum number of members
at the time of making application to SEBI. This requirement of the minimum
number of members may also be a continuous requirement to avoid the situation
when these SROs proliferate without serving any significant purpose.
Issue 12. What
should be the terms of the registration of an SRO?
View 1 –
They may be granted the life time registration by SEBI.
View 2 –
Registration may be granted for a specific period say for 5 years or 3 years and
then based on the performance over that period, it may be renewed for the
similar time frame. This process of renewing the registration may continue this
way.
Downside of the view – Registration and its renewal again and again puts
the administrative burden on the system. If the concern of the main regulator
is the performance, it can anyway and anytime stop the SRO from functioning.
Therefore the registration may be granted only once without any requirement of
renewal. Indeed this may be considered for the other intermediaries in the
Securities Market.
Issue 13.
Would SEBI charge fee for the registration of the SROs?
View 1 –
SEBI may not charge the fee as SROs are the extended arms of the regulator
only. Further, these are not the commercial for profit organizations and so
SEBI should not put burden on their financial structures.
View 2 –
SEBI may charge only some nominal one time fee at the time of registration of
these SROs.
View 3 –
SEBI may charge the fee at the time of registration and then on annual basis
from these SROs.
Issue 14.
What is the way ahead for the existing organizations like Association of
Merchant Bankers (AMBI), Association of Mutual Funds (AMFI) and other similar
organizations?
These organizations, if desired to be recognized as
SROs, would be required to make an application to SEBI on the lines of the
regulations finally formulated by SEBI on the subject. SEBI would consider
their applications in view of the relevant regulations and either grant them
registration on merits or reject their applications.
Note - Necessary amendments in the various regulations would
be carried out based on the final policy formulated on the SROs in view of the
comments received from public.