Indian regulators push self-policing to avert system crash

Reserve Bank of India (RBI) has been pushing fintechs towards self-regulation, and holding discussions both in private and in groups with heads of banks, non-banks and even asset turnaround companies on governance and other regulatory issues.

On the other hand, Securities and Exchange Board of India (Sebi) chairperson Madhabi Puri Buch recently urged the industry to proactively report on “mischief in the market" to maintain investors’ trust. “If the trust is belied, the edifice of the system will come down like a pack of cards," Buch said at a conference last week.

Experts said regulators are taking this approach because the rise in trained manpower to detect and tackle wrongdoings has not kept pace with rising regulatory challenges.

“The challenge for all financial regulators is that the market is growing wider and deeper, and the regulatory bench strength needs to expand further," said Srinath Sridharan, a policy researcher and corporate advisor.

At the same time, Sridharan pointed out that self-regulation might work to an extent, but it cannot fill in all the gaps that arise out of the “divergence between the growing number of regulatory challenges and the limitations of our regulatory ecosystem".

Emails sent to spokespersons of Sebi and RBI remained unanswered.

RBI's concerns

In its meetings with stakeholders, RBI officials have laid down what they broadly expect of these entities and also pointed out gaps in compliance in the hope that they will self-correct.

Das had said at the Mint BFSI Summit in January how in private conversations, bank chief executives have brought to his notice some areas they are concerned about. “...in the last six-eight months, two-three bank CEOs have shared in private that these are areas they are also getting worried (about)," Das had said, pointing to the consultative approach of the regulator.

To be sure, Das has in the past as well spoken of self-regulation among regulated institutions. In September, he said he would like to “urge and encourage fintechs to establish an SRO (self-regulatory organization) themselves".

In May, the regulator issued final guidelines on fintech SROs. Earlier, in March, the regulator had issued an omnibus framework for recognizing SROs across sectors.

In fact, this specific guideline highlights why RBI is pushing for self-regulation: “With the growth of the REs (regulated entities) in terms of number as well as scale of operations, increase in adoption of innovative technologies and enhanced customer outreach, a need is felt to develop better industry standards for self-regulation."

Sebi's concerns

Amid the recent market surge, the Sebi chief warned that erosion of trust following any industry mischief could lead to more stringent regulations and a potential collapse of the ecosystem.

Buch’s words followed regulatory circulars applicable to stock brokers and market infrastructure institutions (MIIs) to maintain effective surveillance.

In June, Sebi notified a framework on financial disincentives for MIIs, which include stock exchanges, clearing corporations and depositories, for their lapse in detecting abnormal or suspicious trading activity.

A month later, and on the day Buch spoke at the event, Sebi also directed stockbrokers to establish an institutional mechanism to detect and prevent fraud or market abuse.

The objective of both circulars was to ensure that market intermediaries detect manipulation or abusive trading and notify Sebi, supporting the regulator to enforce its regulations. These circulars indicated that the regulator is pushing for self-regulation by market intermediaries to add to its own surveillance.

Chirag M, Shah, a securities lawyer, said Sebi was appealing to the civic responsibility of a party to report any dubious practice. “If malpractices rise, then Sebi may come out with a regulation which would affect the ‘good guys’ of the industry who may have to suffer even if they have done nothing wrong," said Shah.

Limitations of self-regulation

However, Shah pointed out that for self-policing to work it was also important for industry participants to be proactive and aware about what constitutes malpractice. “It is important even for a layperson to know what is a malpractice or mischief. That is something that Sebi will have to inform and make market participants aware of," he said.

Other legal experts said that while self-policing might not be sufficient to address complex or systemic issues requiring in-depth investigation, it could give a good head start to the regulators.

“Advance analytics and random audits or surprise inspections by regulators can help the regulator uncover hidden potential violations," said Kshitij Asthana, capital markets practice leader at Singhania & Co, adding that a more robust legal framework was crucial for the protection of whistleblowers from retaliation.

The Sebi regulations mentioned earlier received mixed responses from market participants. Sanjay Israni, a partner at law firm Desai & Diwanji, said that although the direction seemed stringent, it did not cast an undue burden on intermediaries.

“Some think that self-policing can lead to quicker identification and resolution because insiders often spot irregularities first. Others worry about potential conflicts of interest and whether internal controls will be effective without strong external supervision," Israni said.

Others like Jitendra Motwani, a partner at law firm Economic Laws Practice, believe that intermediaries may face initial setback in the form of additional costs, but it might help prevent recent stock broking scams that had a huge impact on the market.