Officially, it is an interim report on the demat scam, but the Securities and Exchange Board of India’s (Sebi) 252-page findings could be more accurately described as a report on systemic deficiencies and structural shortcomings. The report makes it clear that several niggling infrastructure issues need to be tackled on a war-footing, especially if the crackdown on Depository Participants (DPs) and Registrar and Transfer Agents (R&T agents) are to lead to improvement rather than shortages and hardship for investors.
For instance, while the primary market is booming, there are barely four R&T agents in India today. Sebi’s disciplinary action against the Karvy Group will virtually eliminate one of the biggest players from the R&T and DP business. How will Sebi ensure a smooth transfer of their business or that intermediaries who take on new customers are capable of coping with increased volumes?
Sebi chairman M Damodaran says, “If we were to rank weaknesses in the system, the absence of strong R&T agents would, in my book, be one of the biggest.” He says Sebi is informally talking to a few large players in the financial sector and asking them to consider the possibility of entering the R&T business. Ideally, Sebi would like to see the emergence of four or five pan-Indian service providers who can handle the increase in public offerings and increased investor population. However, while the business opportunity exists, Mr Damodaran is not sure if it is paying enough to be attractive. Clearly, Sebi’s disciplinary action against Karvy puts pressure on it to find a quick solution.
The same goes for DPs. After the scam of 2000, when several leading brokerages had their operations suspended by the regulator, other brokers worked overtime to grab their client lists and woo those on it to transfer their business. Nothing of that sort will happen in the DP business. The clients of the 12 DPs indicted by Sebi will have a tough job moving their accounts. The lopsided fee structure makes the DP business unattractive for large players such as nationalised banks. A few months before, the head of a private bank told me that the bank was in the DP business mainly to provide a full menu of services to its customer. As a business proposition it wasn’t paying enough to be attractive. After the demat scandal, the DP business has become downright unattractive. Banks now have to put in place better compliance systems and these have costs attached to them.
Again, Sebi recognises this difficulty. Sebi concedes that the DP business is not a paying proposition as a “stand alone operation,” but it is reluctant to dictate a fee structure to the depositories. It had hoped that depositories will themselves see the need for an equitable distribution of fees to make the business attractive enough for intermediaries.
• There’s a need to attract established providers into R&T and DP business
• The ambiguity on Sebi’s regulatory jurisdiction on NSDL needs resolving
• Insurance cover for depositories is another troublesome issue
Will the findings of iSec’s independent audit of the National Securities Depository Ltd (NSDL) make a difference? This is an issue for the finance ministry. Of all market intermediaries, only depositories operate under a separate statute. This had led to a great deal of ambiguity about Sebi’s regulatory jurisdiction, further exacerbated by NSDL’s recent claim that it is not a Self Regulatory Organisation. There are documented instances when NSDL ignored Sebi’s orders and went ahead with its plans.
Moreover, there is no clear statutory provision for supervising its major foray into the creation and maintenance of the Tax Information Network, the dematerialisation of National Savings Certificates or even the IT database that it is setting up for Nasscom through a subsidiary. Some of these businesses have been directly entrusted to NSDL by the finance ministry and it is presumed the ministry had mulled over the issue of inspection and supervision of these operations.
Finally, Sebi’s inspection points to the need for urgent thinking on protecting a base minimum shareholding per investor through something akin to a Deposit Insurance and Credit Guarantee Corporation for depositories. When large investments are entirely held in electronic form, Sebi must at least re-examine the comprehensiveness and adequacy of the insurance cover of depositories. All these are potentially explosive issues that need timely handling.