Sucheta Dalal :NSDL behind regulatory fog
Sucheta Dalal

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NSDL behind regulatory fog  

March 21, 2011

Who regulates the main businesses of the National Securities Depository Limited (NSDL) when it is no longer only a stock depository? The shocking answer is: nobody! Hopefully UK Sinha, the new SEBI chief, will realise that NSDL is far too big and sensitive to be operating under regulatory ambiguity right under his nose 
Sucheta Dalal

Six years ago, in May 2005, I wrote in a column in Indian Express which pointed out a serious regulatory gap: it was unclear who regulates the National Securities Depository Ltd (NSDL). NSDL was then nine years old and had already grown into a giant electronic database and custodial organisation whose ambit went far beyond its initial mandate of dematerialising equity shares.

A year later, an independent inspection found problems with NSDL’s functioning and soon thereafter, it was pulled up by the Securities and Exchange Board of India (SEBI) for failing to detect the rampant cornering of public issue allotment through multiple applications. This inspection exposed procedural lapses. Thus followed a bruising battle between NSDL and SEBI, which was dubiously covered up when CB Bhave became the capital market regulator. The stunning cover-up, which included discrediting its own board members to eliminate every speck of criticism against the organisation, is now before the Supreme Court of India. Yet, a core issue that I had raised in 2005 remains unaddressed even today: Who really regulates NSDL? And shouldn’t an organisation which forms the core of markets and public finance be subject to comprehensive supervision?

Technically, NSDL was set up by the National Stock Exchange of India (NSE) and is under the regulatory ambit of SEBI. However, for some curious reason, it is governed by its own independent statute—the Depositories Act of 1996. NSDL grew rapidly, because of its near monopoly status in the early days and SEBI’s support in mandating compulsory dematerialisation for secondary market transactions. Further, although it functioned as a public utility, SEBI allowed the organisation to charge high fees and become hugely profitable from the very beginning. Soon NSDL was dematerialising bonds, National Savings Certificates and Kisan Vikas Patras. However, very quickly under

Mr Bhave’s regime, NSDL had spread its tentacles in various directions, taking advantage of unclear regulation and weak leadership in SEBI. Here is how fast it has grown and in how many different directions:

• It set up the massive Tax Information Network (TIN) to convert paper records of over 16 million taxpayers into electronic form in 2003, with active support of the finance ministry, unconcerned about regulatory issues.

• The entity maintains a dynamic database for the Income-Tax Department by receiving and updating information on tax deducted at source (TDS) on behalf of taxpayers.

• NSDL dematerialises warehousing receipts of the multi-commodity exchanges (regulated by the Forward Markets Commission).

• It set up the National Skills Registry for NASSCOM (an Indian consortium for the Indian software industry and BPO units) to verify employee credentials in the IT industry.

• NSDL also maintains the electronic accounting system for excise and service tax.

• In 2007, it became the central recordkeeping agency for the New Pension System (NPS).

• The commerce ministry has also tied up with NSDL Database Management Ltd (a wholly-owned subsidiary of NSDL) to establish and manage a nationwide integrated solution for administration of special economic zones (SEZs) in India.

The Central Depository Services (India) Ltd, or CDSL, set up by the Bombay Stock Exchange, also competes for similar businesses.

More recently, in his Budget speech, finance minister Pranab Mukherjee said that the NSDL had been “selected as technology partner for incubating the National Information Utility that will establish and operate the IT backbone for GST (goods and services tax).” And that, by June 2011, it will set up a pilot portal in collaboration with 11 states in preparation for the GST rollout. In effect, the NSDL will be in charge of another giant IT facility that is completely unconnected with the capital market.

What is NSDL’s legal status and regulatory remit to do all this? Its website under the head ‘legal framework’ says that its byelaws and business rules are approved by SEBI; NSDL and its business partners follow the operating procedures laid out under these byelaws. This gives the impression that NSDL is comprehensively regulated by SEBI. But, as the list above shows, the non-capital market related businesses of NSDL are much larger than the depository services for the capital market. And none of these businesses is under SEBI regulation or supervision. Who then regulates the NSDL? The shocking answer is: nobody.

It is a private company with a clutch of Indian and foreign banks and the NSE as shareholders. The finance ministry likes to pretend that NSDL is regulated by SEBI. Former SEBI chairman M Damodaran raised the issue of regulatory oversight when he ordered an independent inspection of NSDL; but the finance ministry’s capital market division colluded with the depository to ensure that the issue was not addressed. With Mr Bhave as SEBI chairman, the issue was hushed up for three years. Interestingly, Mr Bhave as senior executive director at SEBI piloted the Depositories Act; he then quit the IAS and took over as the first managing director of NSDL. He remained with the organisation for over a decade, before moving to SEBI. In effect, he was best placed to understand the complex regulatory issues created by NSDL’s diversification, but was completely unwilling to address it. In this, he had the active support of the finance ministry’s capital market division, headed by  Dr KP Krishnan.

Can an organisation which is the repository of such sensitive information from across so many different sectors of the economy—virtually a giant electronic public utility—continue to function behind a deep regulatory fog?

NSDL has far outgrown its role as a capital market intermediary and it cannot remain under SEBI’s absent supervision. The same applies to the CDSL, although to a much lesser extent. In 2005, I had written that the finance ministry must take responsibility and create new legislation and regulatory structure for the various sensitive databases managed and maintained by the NSDL. And, the depository function should be spun off to a separate subsidiary that would be regulated by SEBI under the Depositories Act. An organisation which houses such sensitive information cannot be left to the mercies of a board of directors, representing a clutch of bank shareholders.

With Mr Bhave rigidly protective about NSDL, this did not happen for almost a decade. When he became SEBI chief, he played hardball with other regulated entities; but NSDL remained free from regulation. The exit of Mr Bhave should pave the way for an unbiased assessment. Hopefully, UK Sinha will realise that NSDL is far too big and sensitive, from the perspective of the national interest, to be operating under regulatory ambiguity, right under his nose. 

Sucheta Dalal is the managing editor of Moneylife. Subscribers get free help in resolving their problems with select providers of financial services. She can be reached at suchetadalal


-- Sucheta Dalal