The regulators' conflict of interest

Fri, 26 Nov Pre-Open

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Most long time investors remember the days of Ketan Parekh and Harshad Mehta. Those were the days when the movements of the stock markets were controlled by a few. When the scams broke out, many investors lost their investments and some others their lifetime's worth of savings.

In a recent report, ex RBI Governor, Dr. Bimal Jalan has proposed guidelines on the governance and ownership of Market Infrastructure Institutions or MIIs. The guidelines particularly highlight the pros and cons of listing the stock exchanges. The report covers all institutions that are an important part of market's infrastructure. These include stock exchanges, depositories and the clearing corporations.

The report gives out guidelines on how to maximize the efficiency of the institutions. At a time when the western world is going through economic depression, these guidelines have come in at a good time. Especially because they are aimed at strengthening the financial structure in our economy. After all proper governance and stability of capital markets is essential for the sustainability of economic growth.

The guidelines discourage stock exchanges from earning supernormal profits. While prima facie, the term may appear to be vague, but the intention is very clear. The report wants to discourage all investors in the stock exchanges who are there just for speculation or trading gains. The report emphasizes this point by discouraging the listing of stock exchanges. If the exchanges were to be listed, they would be subject to enormous pressures in terms of quarterly performances, profits, etc. This would only lead to making the exchange a profit machine rather than it being a regulatory machine.

The conflict of interest arising out of private ownership of an entity like a stock exchange that is vested with regulatory responsibilities is bound to make its job difficult. A balance therefore needs to be maintained while selecting the management to ensure that there is no conflict of interest. This is to ensure that a handful few do not get together to run the stock exchange as had been seen in earlier days.

True, listing of exchanges would bring in transparency in their operations. But listing them would also mean running the exchanges just for profits. If this were to happen, we would have exchanges encouraging brokers to churn their client portfolios. And that could once again mean retail investors being at the mercy of greedy brokers.