SEBI vs.NSDL -- Part 2 : Regulation and supervision  

Aug 30, 2007

SEBI vs. NSDL- Part II

Target Practice: Supervising Depositories and others

By Sucheta Dalal

Mumbai, August 29:

Last week, the Securities and Exchange Board of India (Sebi) set stringent conditions for permitting the National Securities Depository Ltd (NSDL) to work as a Central Record-keeping Agency (CRA) for pension funds.

SEBI wants NSDL to carry out the activity through a strategic business unit (SBU) approved by its board and sponsors; that the CRA business must not erode the net worth required for the depository business, and that non-depository activities must be hived off in three years to a separate entity without legal and financial links to the parent. NSDL must also get additional insurance cover for risks associated with all non-depository activities.

These conditions are indeed important for proper regulation and supervision of the depository and all entities, which may be only partially under SEBI regulation. In fact, SEBI should have thought about the supervision issue right at the stage when NSDL was requested by the Finance Ministry to set up the massive Tax Information Network for the government. At that time a lax SEBI leadership was probably too busy trying to please the government to worry about core issues such as demarcation of activities and clarity over regulation and supervision of non-capital market activities. Ironically, part of the laxity was the fact that NSDL was always perceived as an efficient and well-run institution.

Over time, SEBI itself asked to create a database of biometric Unique Identification Numbers (UINs), it began to issue Permanent Account Numbers for the tax department, dematerialised Kisan Vikas Patras, Corporate bonds and National Savings Certificates (NSCs), and is now setting up a biometric based employee database for National Association of Software Companies (NASSCOM). It also bid to be CRA for the e-stamping business (bagged by the Stock Holding Corporation of India) and Pension Funds and explored the dematerialisation of warehousing receipts for the commodity markets.

All of these activities are under different regulators and obviously cannot be inspected or supervised by SEBI. NSDL was allowed to enter these businesses that are outside SEBI’s regulatory purview because depositories were set up under their own statute, even though the Depository Act was administered by SEBI.

Once NSDL has opened the door to other activities, the Central Depository of Securities Limited (CDSL) and the stock Holding Corporation of India Ltd. (SHCIL), followed NSDL’s lead without clarity over supervision, regulatory and security issues or separation of infrastructure. CDSL has bagged the mandate to set up the database for the Mutual Fund Identification (MIN) ad SHCIL bagged the e-stamping business in several states.

The regulatory and security concerns raised by SEBI apply to all of them, especially since they handle highly sensitive information. The concern ought to be greater because these companies are owned by a set of (mainly) public sector institutions that take little interest in day-to-day management. The monumental scandal at SHCIL is an extreme example of dereliction of fiduciary responsibility by the board. Since February this year, I have exposed how a somnolent board allowed SHCIL’s wholly owned subsidiary to slip out of their control, set up competing businesses and an overseas subsidiary (e-ventures at Singapore) to cream off half the profit from the e-stamping business.

In these circumstances, SEBI’s conditions are valid, but they would have been more credible and not perceived as vendetta if they were imposed on other entities as well. SEBI has made no known demands for such demarcation of responsibility at SHCIL, which does not even have the excuse of operating under the Depository act. In fact, its core activities as Custodian, Depository Participant are directly under SEBI’s supervision and it also has a spotty track record of governance.  Yet, the regulator has not even ordered a simple inspection of SHCIL or its subsidiary SHCIL Services Limited (SSL), even after skeletons have tumbled out of every cupboard.

In fact, in SHCIL’s case, SEBI is directly guilty of granting licenses to SSL for entering new businesses in direct competition with the parent without even verifying its shareholding structure. This benevolence towards SHCIL is a result of the close personal friendship between SEBI Chairman Mr. M. Damodaran and the Whole Time Members (S.C.Anantraman and TC Nair – SHCIL had even leased the latter’s flat as a guest house at Palghat, despite having no business in that town) with SHCIL’s rogue CEO R.Jayaraman Iyer and his co-conspirator S.Ramanathan.

Even today, SEBI has made no enquiry about the change in management or attempted to help in the clean up that was ordered by the Prime Minister’s Office in April 2007. The same goes for the CDSL, where SEBI seems a lot less inclined to haul it over the coals.

How does the regulator explain its extreme agitation over NSDL’s diversification when it is silent about the SHCIL scam, months after it has been exposed? And why is there no discussion paper on the inspection, regulation and supervision of all entities that are in a similar situation as NSDL, CDSL and SHCIL? The unfortunate conclusion is that SEBI’s activism seems to specifically target NSDL rather than push for much-needed changes in regulation, supervision and accountability to make the markets safer for investors. Unfortunately, targeting individuals and institutions out of vendetta can only undermine a regulator’s credibility.

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